Protecting Property: A Matter of “Trust”


The Illinois Student Assistance Commission (“ISAC”) used the former firm of Friedman & Wexler, LLC (“F&W”) in Chicago for many years as its attorneys to assist with collecting defaulted student loans. In 2006, ISAC terminated F&W and instructed them to stop work on ISAC’s files. In response, F&W asserted they were owed over $13mm in fees and asserted an attorneys’ lien on files they continued to work on. ISAC subsequently sued F&W in state court, which after many years of litigation, resulted in judgments in favor of ISAC and against its former attorneys in an amount exceeding $17mm.

While the state court litigation was ongoing, several different bank accounts were established. The proper ownership of accounts were at issue in bankruptcy cases filed by F&W and two of the former principal attorneys with F&W individually. ISAC filed a complaint against each of the bankruptcy trustees in those cases seeking a declaratory judgment that the funds held in these accounts did not constitute property of the bankruptcy estates, but belonged to ISAC. ISAC moved for summary judgment on its complaint.

Judge Barnes noted in his opinion that the facts and drafted state court orders with regard to the funds in these bank accounts were far from clear. [1] Given this, the court reviewed principles of what constitutes “property of the estate” under the Bankruptcy Code and Illinois law before it was able to reach its conclusion as to the proper ownership of three separate bank accounts at issue in the case.

Section 541(a)(1) of the Bankruptcy Code defines property of the estate to include “all legal or equitable interests of the debtor in property as of the commencement of the case.” [2] Property of the estate does not include property to which the debtor holds only bare legal title. Congress also clearly excluded from a bankruptcy estate any property held in trust by a debtor for another person. [3]

The nature of the status of the accounts and nature of the funds in those accounts turned on elements of Illinois law. If the beneficial interest in a trust is created under Illinois law, then an entity’s ownership and right in its interest is subject to state law. [4]

With regard to the first bank account, the parties conceded that the funds were trust funds, and that the bankruptcy estate of F&W had no interest in those funds. This account had been established by order of the state court clearly designating the funds as trust funds held for the benefit of ISAC.

The second bank account was created after the attorneys were ordered to repay monies that had been taken from the first account. The parties disagreed as to the nature of the money in this account. The trustees argued that the circumstances under which the payment was made (to secure the release of the Wexlers from prison for contempt), and the nature of the bank account, gave the defendant bankrupts a better right to the money. The trustees also argued that the state court orders regarding “restoration” of the monies were not final. The court ultimately rejected each of these arguments, in favor of ISAC, finding that the essential trust nature of the funds had not changed. [5]

The third bank account was created by orders of the state court in the context of accounting fees being generated in the litigation. The order only specified that a “special escrow account” with the sum of $40,000 was to be established. Notably, the order did not specify any other terms or conditions regarding the “special escrow,” other than conditioning the release of any funds from that account on court order. Although the court found it evident that the funds in this account were intended to be a source of assurance for the accounting fees, none of the orders clearly stated this fact.

None of the orders contained the essential elements for the establishment of an escrow account in Illinois – i.e., the legal obligation for which the escrow was being established, the condition under which the escrow would be released, or the identity of the grantee, promisee or obligee to whom the escrow would be released upon fulfillment of the obligation and condition. [6] The court found that as the orders failed to meet the express requirements of state escrow law, something more definitive was required to defeat the interest of the defendant trustees. It considered a few possibilities such as whether the order could be construed as a prejudgment attachment, or taking into account the eventual judgment in the underlying case. But it concluded that none of these were sufficient to defeat the trustees’ interest, and found the escrowed funds to be estate funds belonging to the bankruptcy estates. [7]

[1] Illinois Student Assistance Commission v. David Herzog, solely in his capacity as Trustee of the Estate of Friedman & Wexler, LLC and as Trustee of the Estate of Norman Paul Wexler, and John Gierum in his capacity as Trustee of the Estate of Mitchell H. Wexler, 494 B.R. 724, No. 11-27030, Adv. No. 12-1057 (Bankr. N.D. Ill. June 19, 2013) (“Opinion“).

[2] 11 U.S.C. § 541; Opinion p. 7.

[3] Opinion p. 7, citing In re Marrs-Winn Co., Inc., 103 F.3d 584, 589 (7th Cir. 1996) and United States v. Whiting Pools, Inc., 462 U.S. 198, 205 n.8 (1983) (citing 124 Cong. Rec. 32399, 32417 (1978) (remarks of Rep. Edwards).

[4] Opinion, p. 8, citing DeKorwin v. First Nat. Bank of Chicago, 318 F.2d 176, 178 (7th Cir. 1963) and Am. Invs-Co Countryside, Inc. v. Riverside Bank, 596 F.2d 211, 215 (7th Cir. 1979).

[5] Opinion, pp. 9-10.

[6] Opinion, pp. 11, citing Midwest Decks, Inc. v. Butler & Baretz Acquisitions, Inc., 649 N.E. 2d 511, 517 (Ill. App. Ct. 1995).

[7] Opinion, pp. 11-12.


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