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Tcherepnin v. Franz

decided: July 27, 1973.


Fairchild, Cummings and Stevens, Circuit Judges.

Author: Fairchild

FAIRCHILD, Circuit Judge.

These appeals represent still another aspect of the long and complex litigation occasioned by the insolvency of City Savings Association (hereinafter City Savings).*fn1

They follow from the district court's imposition of a constructive trust upon a number of tracts of land in the Chicago area for the benefit of City Savings. Appellants Braewood Building Corporation and Peerless Closure Company each claim title to particular parcels as bona fide purchasers and seek to overturn the district court's imposition of a constructive trust. Appellant McGurren, in whom title to a number of these properties was vested as trustee, contends the court erred in entering certain findings which reflect upon him individually.

I. Background.

The proceeding from which these appeals arise is ancillary to an action initiated by a group of shareholder-depositors of City Savings in 1964. The original plaintiffs alleged fraudulent solicitation of deposits by City Savings, a state chartered savings and loan association, and sought rescission of their purchases of withdrawable capital shares under the Securities and Exchange Act of 1934. After the Supreme Court confirmed the applicability of the 1934 Act and hence jurisdiction of the district court over their claim*fn2 the district court removed state appointed liquidators then having custody of City Savings' assets, appointed federal receivers,*fn3 and instructed the receivers to litigate all claims of City Savings as ancillary to the principal action.

On April 4, 1969, the receivers, in the name of defendant City Savings, filed a four count second cross-complaint against officers and employees of City Savings, as well as other persons. The cross-complaint alleged, among other things, a conspiracy and land fraud scheme, pursuant to which excessive loans were made in violation of fiduciary duty and with intent to defraud, and cross-defendants acquired parcels of real estate for personal benefit in violation of duty to City Savings. Count II listed tracts which allegedly were so acquired, including the properties claimed by appellants Braewood and Peerless, and requested the imposition of a constructive trust.

On July 24, 1969, the district court granted the receivers' motion to amend the cross-complaint. This amendment added a fifth count and additional property to Count II of the cross-complaint.

On August 7, 1969, the district court ordered appellant Henry McGurren as trustee to show cause why title to the property claimed by Braewood should not be conveyed to City Savings. McGurren defended by alleging that Braewood acquired this property from Suburban Life Builders Corporation in good faith in return for services rendered. From September 29 to October 1, 1969, hearings were held on the issue of ownership of this property. By stipulation of the parties, these proceedings were consolidated for briefing and final order with the proceedings held in May, 1970 concerning title to the remaining parcels described in Count II.

On March 13, 1970, the court granted receivers' motion to file a second amendment to the cross-complaint. Inter alia, this amendment added appellant Henry McGurren, both individually and as trustee, as a cross-defendant in Counts II and III.

From May 4 through May 8, and on May 21, 1970, hearings on the issue of title were conducted. Appellant Peerless participated, contending it was a bona fide purchaser from Washington Capital Corporation of a parcel with respect to which the receivers sought to impose a constructive trust. Appellant McGurren was present, but the attorney who represented McGurren was not. Both had notice.

On August 6, 1970, the district court entered its "Findings of Fact, Conclusions of Law, Memorandum, Order and Judgment,"*fn4 wherein a constructive trust was imposed upon all the properties listed in Count II, including those claimed by Peerless and Braewood. No judgment was entered against McGurren other than to require him to convey certain property. The court, however, in stating the basis upon which its relief was grounded, found that McGurren acted as a "conspirator" and "nominee" in the fraudulent scheme. McGurren, Braewood, and Peerless appealed.

II. Nature and Pattern of the Fraudulent Scheme.

City Savings fell into hopeless insolvency as a consequence of the fraudulent activity of its principal officers in concert with others. C. Oran Mensik, the president, chairman of the board, chairman of the executive committee and chief executive officer, apparently masterminded the scheme. Mensik was principally assisted by Robert M. Kramer, a vice-president of City Savings, a member of the executive committee, and a member of the board. Kramer's role was generally directed by Mensik and he often appeared as an officer in corporations controlled by Mensik.

While other persons had varying roles in the scheme, Mensik apparently preferred to manage a complex network of nominee corporations and their fraudulent transactions by himself. He was in custody after 1968 as a result of a conviction arising out of dealings in Maryland. His deposition was taken early in these proceedings. His present whereabouts are unknown. Consequently it has not been possible to obtain a wholly coherent picture of the scheme. Nevertheless, from the testimony, depositions and exhibits, one gains a fair understanding of both the pattern and the extent of the fraud.

With the assistance of the late attorney Alexander Pikiel, Mensik directed the creation of a large number of corporations. The ostensible officers and directors of these corporations would be elected or otherwise placed in their respective positions by Mensik and they, in turn, would respond to his direction and control. The controlling officers of City Savings, in accordance with Mensik's instructions, would then approve loans to these corporations secured by overvalued real estate. Indeed, the controlling officers along with other employees of City Savings often served as the nominal officers and directors of the corporations to which the loans were made.

While some of the money loaned might then be used to pay the purchase price of the land, the rest would be channelled to other Mensik-controlled corporations or partnerships, ostensibly for services rendered.

Frequently other Mensik-controlled corporations would acquire property from these nominees, the land being used as security for further inflated loans. And, because the amount of the loans usually far exceeded the fair market value of the property acquired, these corporations were sometimes able to acquire property without any encumbrances in favor of City Savings.

Beginning in 1959 and 1962 two land development projects in particular were used as a cover for depleting the assets of City Savings in this fashion: the Apple Orchard development in Bartlett, Illinois and the Howie-In-The-Hills project in Palatine, Illinois.

City Savings was seized by the state June 26, 1964 and turned over to liquidators September 20, 1964. The land development projects continued, some of the operations being carried out by nominee corporations among a rash of corporations first organized in 1964. Mensik remained active until imprisoned in late 1968. He aided in negotiation for loans made in 1966 by a Teamsters' pension fund.

The property claimed by Braewood, now known as Palatine Estates, is a portion of a tract acquired by Mensik-controlled Howie-In-The-Hills Building Corporation in 1962 and subdivided as Howie-In-The-Hills Unit 2. Braewood's claim is based on a deed dated March 1, 1966 from a later owner, Mensik-controlled Suburban Life Builders Corporation.

The property claimed by Peerless, usually referred to as the Mensik homesite, is a portion of a tract acquired by the Mensik group January 10, 1959. Title was taken in the name of Henry McGurren, trustee under a trust agreement dated January 10, 1959, as were other 1959 acquisitions. Although most of the tract was conveyed out by McGurren to a nominee corporation and subdivided, as were other tracts from time to time, the homesite continued until 1968 to be occupied by Mensik and was not subdivided. McGurren apparently continued to hold its title as trustee until he conveyed to Peerless in January, 1969. An interest which seems to have amounted to the beneficial interest in the homesite was transferred among Mensik nominees and to Washington Capital. Peerless' claim to the beneficial interest is based on a transaction with Washington Capital in May, 1967.

III. Jurisdiction.

Appellants have challenged the district court's subject matter jurisdiction over the proceedings. The district court considered its jurisdiction as ancillary to the principal action which occasioned the receivers' appointment. Appellants contend this was error and that facts constituting a basis for federal jurisdiction had to be pleaded in these actions before the court could take jurisdiction. We disagree.

The ancillary jurisdiction of federal courts over actions incident to a receivership established by a federal court has long been recognized.*fn5 So long as an action commenced by a court appointed receiver seeks "to accomplish the ends sought and directed by the suit in which the appointment was made, such action or suit is regarded as ancillary so far as the jurisdiction of the . . . court of the United States is concerned."*fn6

Here, receivers were appointed by the court to marshal and preserve assets belonging to City Savings in order to create a fund from which the original plaintiffs and the intervening shareholders in the principal action might be reimbursed.*fn7 The instant actions were consonant with these goals. Accordingly, the district court could properly rely upon its ancillary jurisdiction and need not have an independent jurisdictional base. Accord, Esbitt v. Dutch-American, 335 F.2d 141, 142 (2d Cir., 1964).*fn8

IV. Imposition of constructive trust on property held by Mensik nominees.

Appellants Braewood and Peerless do not seriously challenge the findings that those through whom they claim ownership were instruments employed by Mensik and his associates in their scheme to convert to their own use the wealth contributed by the depositors of City Savings. They do argue that City Savings money was not traced directly into the properties they claim. Braewood relies on the fact that the public records indicate that any loan by City Savings secured by Howie Unit 2 had been repaid. Peerless relies on the fact, essentially, that although the funds used in the 1959 purchase of the tract which included the property claimed by Peerless were supplied by one or another Mensik nominee, they were not shown to have come directly from City Savings.

Such identification and tracing was not, however, the burden of the receivers in these circumstances. Mensik and his associates, through self dealing, violated their fiduciary duty to City Savings and made its assets the source of property virtually in their own hands, although held among the assets of other corporations organized for their own benefit. In a similar situation the Supreme Court of Illinois concluded that the bilked corporation did not have the burden of identifying and tracing its assets.

In Winger v. Chicago City Bank & Trust Co., 394 Ill. 94, 67 N.E.2d 265, 277 (1946), it was said:

"It is contended in this case, however, that there can be no recovery because there is no identification of the property obtained by the individual defendants, since it comes through the corporation defendant, the insurance company. In making this contention one very important principle is overlooked, viz., -- there is a duty resting upon trustees not to commingle their own property with that of the beneficiaries (White v. Sherman, 168 Ill. 589, 48 N.E. 128, 61 Am. St. Rep. 132), and when they do so commingle, in cases where the fiduciary relation exists and they have obtained the property by reason and because of the fiduciary relationship, the burden then rests upon the trustees to show by strong and convincing evidence, the property, or the part thereof that belonged to them before the commingling took place.

"It is also a principle applying to the obtaining of property by a fiduciary that if it appears the property taken has been converted into a new form the beneficiaries have the right to elect whether to take such property as a substitute for the original property, improperly and illegally acquired by the trustees."

We have no difficulty in concluding that the properties claimed by appellants Braewood and Peerless were subject to a constructive trust in favor of City Savings when in the hands of appellants' predecessors. The real question on appeal is whether the district court's findings that appellants were also nominees or at least were not purchasers in good faith for value are clearly erroneous.

V. Claim of Braewood Building Corporation.

Braewood is a virtually one-man corporation, and for present purposes can be equated with its principal stockholder, Clark B. Frothingham. At the time of the hearings, at least, Henry McGurren was a director, the secretary, and owned ten per cent of the stock.

Braewood claims ownership of an eight acre parcel which was formerly Lot 12 of Block 32 of Howie Unit 2, but which Braewood resubdivided in 1966 into 22 lots known as Palatine Estates. Braewood received title by deed dated March 1, recorded April 7, 1966, from Suburban Life. The consideration for the deed was allegedly services rendered by Frothingham since April 1, 1965 and agreed to be rendered until the close of 1966. The documentary evidence and Frothingham's testimony leave considerable confusion as to the relevant agreements, the value and performance of the services, and the extent to which Frothingham received other payment.

Three payments were made to Frothingham in 1965 by Chicago Title and Trust out of a trust account in connection with a loan by a Teamsters pension fund. Each of these was for "project engineering and inspections" at Howie Unit 2, owned by Suburban Life. In each case an officer of Suburban Life signed a certificate that Frothingham was ...

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