James Paulett Charlton

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UNITED STATES BANKRUPTCY COURT
FOR THE NORTHERN DISTRICT OF CALIFORNIA
In re
JAMES PAULETT CHARLTON,
Debtor.
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Case No. 04-32400 TEC
Chapter 7
MEMORANDUM RE TRUSTEE’S MOTION FOR SUMMARY JUDGMENT FOLLOWING
REMAND FROM BANKRUPTCY APPELLATE PANEL
For the reasons stated below, I determine that the trustee’s
rights under her strong-arm powers are superior to the rights of
Debtor’s former spouse under the retroactive constructive trust and
the retroactive property division imposed by a Utah state court.
FACTS
This court allowed the bankruptcy estate to retain the
proceeds from the post-petition sale of a Marc Chagall painting
(the Painting). 	Debtor (hereinafter James) and his former wife
(hereinafter Consuelo) stipulated that, prior to their divorce, the
Painting had been held by James as his separate property. 	Consuelo
Signed and Filed: May 30, 2008
________________________________________
THOMAS E. CARLSON
U.S. Bankruptcy Judge
________________________________________
Entered on Docket
June 02, 2008
GLORIA L. FRANKLIN, CLERK
U.S BANKRUPTCY COURT
NORTHERN DISTRICT OF CALIFORNIA
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filed a petition for divorce in Utah before James filed his
bankruptcy petition, but the Utah state court made no division of
property before the bankruptcy filing. 	Consuelo argued that under
Utah law she became vested in an undivided interest in the Painting
upon the filing of the divorce petition, citing In re White, 212
B.R. 979 (10th Cir. BAP 1997).
This court held that, under Utah law, Consuelo had only an
inchoate interest in the Painting unless and until the state court
entered an order awarding her that property. 	See Hamilton v.
Hamilton, 562 P.2d 235, 237 (Utah 1977). 	The White case does not
govern, because it involved a Wyoming statute providing that, upon
the filing of a divorce petition, the spouse is vested with an
undivided interest in all property acquired during the marriage.
Because Utah had no such statute, and because the Utah state court
had not entered an order dividing marital property before James’
bankruptcy petition, the bankruptcy estate prevailed against
Consuelo’s inchoate claim under the trustee’s strong-arm powers.
See 11 U.S.C. § 544.
This court later approved a stipulation lifting the automatic
stay to permit the Utah court to decide the issues that remained
unresolved under the bifurcated decree of divorce: child custody,
support, and division of property. 	The Utah court commenced a
trial regarding these issues on November 29, 2005, issued written
findings and conclusions on February 27, 2006, and entered an order
on August 14, 2006.
The state court awarded the Painting to Consuelo, and imposed
a constructive trust on the Painting for her benefit. 	The state
court also made this award retroactive to the date of the
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bifurcated decree, which had dissolved the marriage but had
reserved for later decision all issues re property division. 	The
date of the bifurcated decree (December 18, 2003) was before the
date of James’ bankruptcy petition (August 24, 2004).
The state court found that none of the property held by either
spouse was separate property. 	Although James had inherited
property from his grandmother and two great aunts, he had invested
that property in various business ventures, where it became co-
mingled with property acquired during the marriage. 	See Request to
Take Judicial Notice in Support of Trustee’s Motion for Summary
Judgment (“RJN”), Exh. 1 at pp. 12-14. 	Artwork acquired from the
proceeds of sale of these business interests could not be traced to
property James inherited, and was thus marital property,
irrespective of how title was held. 	Id.
The state court found that James was responsible for a decline
in the value of marital assets, but that his conduct did not amount
to fraud. 	James was a software engineer at the time he married
Consuelo in 1993. 	Id. at p. 11. 	During the marriage, he founded
various businesses, some of which were very successful and were
sold for millions of dollars. 	Id. at pp. 15, 26. 	Virtually all of
this value had been lost By the time of the bifurcated decree in
December 2003. 	Regarding this loss, the court noted:
[T]he ineluctable finding is that respondent possessed,
then lost, a fortune. 	The court finds; however, that the
steps that led inexorably to the losses were not the
result of malice, and certainly not actions tailored
exclusively, or even primarily, to deprive petitioner of
any benefit from the assets. . . . In very brief summary,
the losses result from mistakes of a newly-rich but
unsophisticated business man, who invested badly, trusted
others unwisely, and then found his mistakes compounded
by the plunging stock market and technology collapse of
2000 and thereafter. 	As regrettable as these
circumstances are, petitioner has not carried her burden
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of showing that most of the cumulative and devastating
errors amounted to dissipation.
RJN, Exh. 1 at p. 17: ¶¶ 53, 55.
More specifically, the state court found that James was
responsible for the loss of marital assets after the parties’
separation in March 1999. 	The court found that James had expended
marital assets on a lavish lifestyle and that in doing so he
breached his fiduciary duty to preserve marital assets for the use
of the marital estate, but that this breach of duty did not amount
to fraud.
Respondent breached the promise, not for the most part by
dissipation as that term is usually defined, and not by
fraud, but respondent allowed himself to get into a
position where he could not keep his promises and meet
his obligations in the marital relationship.
Id. at p. 31: ¶ 33.
Although the state-court order awards Consuelo the Painting,
its findings and conclusions do not support the award of that
particular property. 	Rather, they indicate that the court intended
to award Consuelo an interest only in those artworks in her
possession on the date of trial, and that the constructive trust
was intended to protect art in Consuelo’s possession but to which
James held title.
This court specifically focused on art work in the
possession of petitioner at the date of trial. . . .
Regarding the foregoing property, the court concludes
that respondent held the entire equity of the Woodside
house, any art titled in his name, and half of the Parc
Royal judgment in constructive trust for the benefit of
petitioner. . . . The art work and personal property that
is not at this time controlled by the Bankruptcy Trustee,
but is in the possession of petitioner, represents her
equitable share of the marital estate. 	In fact, it
represents a value that is likely much lower than her
equitable share, but for respondent’s mismanagement, but
it is essentially the only property remaining outside the
Bankruptcy estate that may be awarded to her pursuant to
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this court’s equitable powers. 	If any of the art work is
titled in respondent’s name, a constructive trust is
imposed on that art for petitioner’s benefit.
Id., Exh. 1 at pp. 30-31: ¶¶ 31, 32, 35 (emphasis added). 	The
state court was aware that the trustee had sold the Painting in
November 2004 and had possession of the proceeds on the date the
state-court trial commenced (November 26, 2005). 	Id. at p. 3.
While the state-court action was proceeding, Consuelo appealed
from this court’s order upholding the bankruptcy estate’s claim to
the Painting. 	That appeal went to the Ninth Circuit Bankruptcy
Appellate Panel (BAP). 	The Utah state court issued its decision
before the BAP heard Consuelo’s appeal. 	Because the respective
rights of Consuelo and the bankruptcy estate might be affected by
the state-court order, and because this court had not had an
opportunity to consider the effect of that order, the BAP remanded
the matter to allow this court to consider the effect of the state-
court order.
QUESTION PRESENTED
Does the post-petition imposition of a constructive trust on
the Painting, or the post-petition division of property awarding
the Painting to Consuelo, made via an order purporting to be
retroactive to a date before the filing of the bankruptcy petition,
remove the Painting from the bankruptcy estate or otherwise defeat
the trustee’s interest in the Painting under her strong-arm powers?
DISCUSSION
I.
We must first examine Consuelo’s property rights under Utah
law. 	Utah is not a community property state. 	Under Utah law,
property traceable to assets owned by one spouse before the
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marriage or to assets inherited by a spouse during the marriage,
are separate property. 	Bradford v. Bradford, 993 P.2d 887, 892-93
(Utah App. 1999) (citing Utah Code Ann. § 30-2-3). 	Property
acquired during marriage that is not traceable to separate property
is marital property. 	Id. 	Upon divorce, the state court is
authorized to divide the marital property equitably between the
spouses. 	Utah Code Ann. § 30-3-5. 	In appropriate circumstances,
the court may award the separate property of one spouse to the
other spouse. 	E.g., Elman v. Elman, 45 P.3d 176, 180-82 (Utah App.
2002); Thomas v. Thomas, 987 P.2d 603, 610-11 (Utah. App. 1999).
Although which spouse holds title does not determine whether
property is marital property, how title to marital property is held
is important in dealings with third parties. 	A spouse who is not
on title does not have a present, vested interest in marital
property until the court awards such property to that spouse.
Hamilton, supra, 562 P.2d at 236-37. 	Thus, after the filing of a
petition for divorce but before the state court enters an order
dividing marital property, the title-holding spouse may convey
marital property to a third party free of the inchoate marital
property interest of the non-title-holding spouse. 	Id.
Utah courts are permitted to enter, upon notice and a finding
of good cause, nunc pro tunc orders in matters “relating to
marriage, divorce, legal separation or annulment of marriage”.
Utah Code Ann. § 30-4a-1. 	But this court has found no published
Utah decision suggesting that a nunc pro tunc division of marital
property overrides Hamilton and is effective against a bona fide
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1 No published case has applied Utah’s nunc pro tunc statute
to modify third party rights retroactively. 	One of the four cases
applying Utah’s statute determined that it did not apply because
the action did not involve dissolution of a marriage. Whyte v.
Blair, 885 P.2d 791 (Utah 1994). 	The three other cases each held
that entry of an order nunc pro tunc was not appropriate. 	Behrman
v. Behrman, 139 P.2d 307 (Utah App. 2006); Bagshaw v. Bagshaw, 788
P.2d 1057 (Utah App. 1990); Horne v. Horne, 737 P.2d 244 (Utah App.
1987).
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purchaser or against a judgment lien creditor of the title-holding
spouse. 1
II.
We must next examine the effect of constructive trust claims
on the bankruptcy estate. 	Ninth Circuit law regarding the effect
of a claim for constructive trust upon property of the bankruptcy
estate and upon the trustee’s “strong-arm” powers can be summarized
as follows.
(1) 	If a constructive trust has been imposed by court order
pre-petition, the constructive trust is fully effective and removes
the property in question from the bankruptcy estate. 	Torres v.
Eastlick (In re North Am. Coin & Currency), 767 F.2d 1573, 1575
(9th Cir. 1985); Airwork Corp. v. Markair Express (In re Markair
Express), 172 B.R. 638, 642 (9th Cir. BAP 1994).
If the claim for constructive trust has not been granted pre-
petition, the effect of the claim depends upon the validity of the
claim and the grounds upon which the constructive trust is sought.
Markair, supra, 172 B.R. at 641-42.
(2) 	If imposition of a constructive trust is warranted under
state law, and if the basis for the constructive trust is that
debtor did not have a beneficial interest in the property in
question as of the petition date (because the debtor obtained the
property by theft, fraud, mistake, or upon the implied or express
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understanding that the debtor held the property for another), then
a constructive trust may be imposed post-petition, removing the
property from the bankruptcy estate. 	Misui Manufacturers Bank v.
Unicom Computer Corp. (In re Unicom Computer Corp.), 13 F.3d 321,
325 (9th Cir. 1994); Torres, supra, 767 F.2d at 1576; Golden
Mortgage Fund #14 v. Kennedy (In re Golden Triangle Capital, Inc.),
171 B.R. 79, 82-83 (9th Cir. BAP 1994).
Bankruptcy trustees have been held to have no interest in
property acquired by fraud of bankrupts, as against the
rightful owners of the property. 	The principle
underlying this rule is that the creditors should not
benefit from fraud at the expense of those who have been
defrauded.
Torres, supra, 767 F.2d at 1576 (citations omitted).
(3) If the debtor was the beneficial owner of the property in
question as of the petition date, and a constructive trust is
sought as a remedy for debtor’s failure to fulfill some obligation,
then the claim for constructive trust pending on the petition date
is subject to the trustee’s strong-arm powers under section 544.
Chbat v. Tleel (In re Tleel), 876 F.2d 769, 771-74, n. 7 (9th Cir.
1989); Torres, supra, 767 F.2d at 1577-78; Markair, supra, 172 B.R.
at 642-43. 	This is so, because courts must
act very cautiously in exercising such a relatively
undefined equitable power in favor of one group of
potential creditors at the expense of the other
creditors, for ratable distribution among creditors is
one of the strongest policies behind the bankruptcy laws.
Torres, supra, 767 F.2d at 1575.
Consuelo’s claim does not come within the first category,
because it is undisputed that the state court did not enter an
order imposing a constructive trust pre-petition.
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Consuelo’s claim does not come within the second category,
because the parties stipulated that prior to the filing of the
divorce petition James held the Chagall painting as his separate
property, and Consuelo does not contend, nor did the state court
find, that James acquired that interest by theft, fraud, mistake,
or upon the understanding that he actually held the painting for
Consuelo.
Consuelo’s claim comes within the third category, because the
reasoning of the state court shows clearly that it imposed a
constructive trust as a remedy unrelated to any claim of previous
beneficial ownership. 	The state court did not find that Consuelo
had been the beneficial owner of the painting. 	Rather, the state
court imposed a constructive trust to help her recover an
appropriate share of the couple’s total property. 	RJN at pp. 30-
31, ¶¶ 31, 32, 35.
III.
Next, we must examine the trustee’s strong-arm powers. 	The
strong-arm powers of section 544(a)(1) give the trustee the status
and power of a creditor who obtains a judgment lien against
property of the debtor at the time the petition is filed. 	The
effect of this status is governed by state law. 	In re Hilde, 120
F.3d 950, 952 (9th Cir. 1997).
I determine that California law governs the rights of the
trustee as a judgment lien creditor in the present case. 	The
bankruptcy petition was filed in California, and James lived in
California on the petition date. 	The evidence suggests that the
Painting was also in California and under James’ control on the
petition date. 	I note that schedule B did not specify the location
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of personal property, except to indicate that certain items were in
Consuelo’s custody and located outside of California. 	The Painting
was not identified as one of the items outside of California. 	The
fact that James resided in California on the petition date, and did
not list the Painting among the items of property outside of
California, suggest that the Painting was within California and
under James’ control on the petition date. 	Consuelo has not
suggested otherwise. 	The strong-arm powers of a trustee in a
bankruptcy case pending in California with respect to property
located in California should be determined under California law.
See Restatement (Second) Conflicts § 222 (1971); Hilde, supra, 120
F.3d at 952.
Under California law, the rights of a judgment lien creditor
are superior to those of a party that later obtains an order
retroactively imposing a constructive trust. 	ChoPP Computer Corp.
v. United States, 5 F.3d 1344 (9th Cir. 1993).
In ChoPP, the United States enforced a judgment against
Laurins by levying upon funds in Laurins’ brokerage account. 	The
United States did so with knowledge that ChoPP had filed a state-
court action against Laurins, and had obtained a preliminary
injunction prohibiting Laurins from transferring funds from the
brokerage account. 	Id. at 1345-46. 	ChoPP later obtained judgment
against Laurins. 	As part of that judgment, the court retroactively
imposed a constructive trust in favor of ChoPP on the funds in
Laurin’s brokerage account. 	Id. at 1346. 	ChoPP then brought an
action against the United States, asserting that its rights to the
funds in Laurin’s brokerage account were superior to the rights of
the United States. 	Id.
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The Ninth Circuit held that the United States had the superior
claim to the funds. 	First, neither the pending action nor the
preliminary action gave ChoPP a present interest in the brokerage
account at the time of the levy. 	Id. at 1347. 	Second, under
California law, the retroactive imposition of a constructive trust
was ineffective against a prior levy by a judgment creditor. 	Id.
at 1348-50.
ChoPP’s view to the contrary, if adopted, would
cause disruption that we conclude would not be
countenanced by California law. 	If a retroactive
creation of a constructive trust may defeat a prior
and otherwise legal levy, one creditor may deter
competitors from satisfying their judgments against
a common debtor merely by initiating an action that
seeks recognition of a constructive trust over the
debtor’s assets.
Id. at 1348. 	It is also worthy of note that California law
expressly provides that a judgment creditor may execute upon
property whose ownership is the subject of a pending action, if the
property at issue, like the Painting involved here, is tangible
personal property in the possession or control of the judgment
debtor. 	Cal. Code Civ. Proc. § 700.180(a)(3).
IV.
The state-court order retroactively dividing marital property
fares no better against the trustee’s strong-arm powers than the
retroactive constructive trust. 	Consuelo cites no reason why the
retroactive division of property should not be subject to the test
used to determine whether the retroactive imposition of a
constructive trust should be effective against the trustee’s
strong-arm powers. 	The state court’s retroactive award of the
Painting to Consuelo was not based upon the determination that she
had been the equitable owner, or that James had obtained ownership
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from her by theft, fraud, mistake, or upon the understanding that
he would hold the Painting for her benefit. 	Rather, the state
court awarded Consuelo the Painting for a remedial purpose--to
leave her with an appropriate amount of wealth. 	Enforcing the
retroactive property division against the estate is therefore not
necessary to prevent James’ creditors from gaining a windfall from
stolen property, but would favor one creditor over others, thereby
undermining the policy of ratable distribution. 	See Torres, supra
at 1575-76.
It is also doubtful whether the property division can be given
retroactive effect against creditors under Utah law. 	As noted
previously, this court has found no published decisions applying
section 30-4a-1 to the detriment of third parties. 	See n.1, supra.
Furthermore, the Utah statute authorizing the state court to
allocate property and debts among the spouses upon divorce
expressly provides that the assignment of joint debts incurred
during the marriage does not alter the rights of creditors. 	Utah
Code Ann. § 30-3-5(1)(c) (incorporating Utah Code Ann. § 15-4-6.5).
CONCLUSION
For the reasons stated above, I determine that the trustee’s
rights in the Painting (and proceeds from its sale) are superior to
Consuelo’s rights under the retroactive constructive trust and
retroactive division of marital assets imposed by the Utah state
court.
**END OF MEMORANDUM**
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Court Service List
Thomas F. Koegel, Esq.
Folger, Levin and Kahn
275 Battery St. 23rd Fl.
San Francisco, CA 94111
Louis J. Cisz, III, Esq.
Thelen, Reid and Priest
101 2nd Street, Suite1800
San Francisco, CA 94105-3601
James P. Charlton
2995 Woodside Rd. #432
Woodside, CA 94062
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