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Secure Leverage Group, Inc. v. Bodenstein

United States District Court, N.D. Illinois, Eastern Division

August 15, 2016

SECURE LEVERAGE GROUP, INC., TREASURE ISLAND COINS, INC., DAVID G. BEYERLEING, RICHARD W. MEDLEY, MICHAEL KRALL, JAMES LANDRUM, JR Plaintiffs-Appellants
v.
IRA BODENSTEIN, Defendant-Appellee;
v.
U.S. COMMODITY FUTURES TRADING COMMISSION, Intervenor. ROBERT MILLER, FARGO 500 LLC, GAINESVILLE COINS, INC., Plaintiffs-Appellants,
v.
IRA BODENSTEIN, Defendant-Appellee. ROBERT MILLER, FARGO 500 LLC, GAINESVILLE COINS, INC., Plaintiffs-Appellants,
v.
IRA BODENSTEIN, Defendant-Appellee.

          MEMORANDUM OPINION AND ORDER

          John J. Tharp, Jr. United States District Judge

         Pending before the Court are the bankruptcy appeals brought by two groups of former customers of the now defunct Peregrine Financial Group (“Peregrine”) against its trustee, and appellee here, Ira Bodenstein. The first appeal, 14 C 05024, raises two primary issues. First, the appellants in that case challenge the bankruptcy court’s ruling that their retail foreign exchange (“forex”) and OTC metal contracts were not commodity contracts within the meaning of 11 U.S.C. § 761(4), and therefore did not receive Chapter 7 protection as “customer funds.”[1] In re Peregrine Fin. Group, Inc., 510 B.R. 190, 205 (Bankr. N.D.Ill. 2014). Second, they appeal the bankruptcy court’s finding, after the conclusion of a bench trial, that their funds were not held in a resulting trust by Peregrine and, thus, were properly included in the bankruptcy estate. See In re Peregrine Fin. Group, Inc., 12 B 27488, 2014 WL 2197945, at *23 (Bankr. N.D.Ill. May 27, 2014).

         After the bankruptcy court entered its judgment, a second group of customers, represented by the same attorney, filed a class action complaint (“the FOREX Class Action”) against Bodenstein, which the bankruptcy court dismissed as untimely. See In re Peregrine Fin. Group, Inc., No. 12 B 27488, 2015 WL 2237201, at *3 (Bankr. N.D.Ill. May 13, 2015). That dismissal forms the basis of the second appeal, 15 C 04260, in which the customers argue that the court should have construed their class action claims as amended proofs of claim that relate back, under Rule 15(c), to their timely filed initial proofs of claim.

         Not content merely to defend on appeal these victories in the bankruptcy court, Bodenstein has, for his part, moved for sanctions against the customers and their counsel. That motion is pending in case 15 C 344, which was opened when the customers moved to withdraw the reference in the Forex Class Action. For the reasons that follow, the bankruptcy court’s judgments are affirmed and Bodenstein’s motion for sanctions is denied.

         BACKROUND

         Peregrine was a registered “Future Commission Merchant” (“FCM”) and a registered “Forex Dealer Member” of the National Futures Association. FCMs are similar to stock brokerages but instead of dealing in stocks they deal primarily in financial instruments known as futures contracts.[2] FCMs also may deal in instruments other than futures. Peregrine, in addition to futures, dealt in retail foreign currency transactions (“retail forex”) and spot metal transactions.[3] These instruments are often referred to as “over the counter” transactions because, among other things, unlike futures they are not traded on an exchange or cleared by a clearing organization.

         The appellants are investors who executed a number of retail forex and spot metals contracts with Peregrine.[4] In executing these contracts, Peregrine required all of the appellants to sign a Customer Agreement (or “Agreement”) before they could open a trading account. Brief of Appellee 4, 14-CV-05024, ECF No. 13. The Agreement required customers to wire the funds they wished to trade to an account at JPMorgan Chase Bank in the name of “PFG, Inc., ” before Peregrine would execute the trade for them. Id. Per the Agreement, Peregrine was not required to hold the appellants’ forex and spot metals funds separate from its operating funds. Indeed, when the forex bank accounts’ assets exceeded Peregrine’s obligations to its retail forex customers, Peregrine would use the excess balance to pay off its own liabilities. Id. This stands in contrast to Peregrine’s customers’ futures funds, which by law were required to be held in separate accounts. The Agreement also contained a risk disclosure, which informed the plaintiffs that their forex deposits lacked the regulatory protections given to futures funds and warned that if Peregrine filed for bankruptcy, the plaintiffs might be treated as unsecured creditors. Id.

         In 2012, it was discovered that over a twenty-year period Peregrine’s CEO, Russel L. Wasendorf, had embezzled nearly $200 million from Peregrine’s segregated customer future accounts. Brief of Appellants 2, 14-CV-05024, ECF No. 8. In July 2012, as a result of this defalcation, Peregrine filed for bankruptcy. Ira Bodenstein was appointed as Peregrine’s trustee. In September 2012, Bodenstein filed a motion seeking authority under section 766(h) of the Bankruptcy Code to make interim distributions of “customer property” to Peregrine customers who had traded in “commodity contracts, ” as that term is defined in section 761(4) of the Bankruptcy Code. See In re Peregrine Fin. Group, Inc., 510 B.R. at 192. Bodenstein excluded Peregrine’s retail forex and OTC metal customers from the partial distribution, however, on the ground that forex and OTC metal accounts did not qualify as “commodity contracts.” Id.

         The customers objected and filed an adversary complaint against Bodenstein arguing that their forex and OTC metal transactions with Peregrine qualified as commodity contracts under section 761 and that the funds in those accounts should have been included in the interim distribution. Id. They argued that although their transactions were not futures contracts-which are expressly included within the definition of commodity contracts-they were close enough to futures contracts to fall within section 761(4)(F)(i), which includes as commodity contracts transactions that are “similar to” the other types of transactions specifically defined section 761(4). 11 U.S.C. § 761(4)(F)(i). In the alternative, the customers also argued that their funds had been held in a resulting trust by Peregrine and, thus, should be distributed apart from the bankruptcy estate. Because title to their funds was never transferred to Peregrine, the customers argued, they should have their funds paid in full immediately.

         On summary judgment, the court rejected the customers’ contention that their forex and OTC metal transactions shared enough features with futures contracts to fall within the “similar to” provision of Section 761 and therefore dismissed the related counts of the customers’ complaint. In re Peregrine Fin. Group, Inc., 510 B.R. at 205. After a bench trial on the remaining counts, [5] the court went on to find that the customers had failed to meet their burden of proof with respect to their argument that the funds had been held in a resulting trust and concluded that once the customers transferred their funds to Peregrine they no longer retained title to those funds. See In re Peregrine Fin. Group, Inc., WL 2197945 at *23.

         After the first adversary proceeding was terminated, the second group of customers filed the FOREX Class Action adversary proceeding against Bodenstein, alleging breach of fiduciary duty, fraud, unjust enrichment, and conversion; they also sought the imposition of a constructive trust. After filing their class action complaint, the customers filed a motion to withdraw the proceeding from the bankruptcy court to the district court, arguing that they had a right to a jury trial on their claims and that their claims against the trustee were non-core under 28 U.S.C. § 157(b). That motion was mooted, however, on May 13, 2015, when the Bankruptcy Court dismissed the class action complaint as untimely. See In re Peregrine Fin. Group, Inc., 2015 WL 2237201, at *3. Bodenstein’s motion for sanctions in that case, however, survives the dismissal of the motion to withdraw the reference and is addressed herein.

         DISCUSSION

         District courts have jurisdiction to hear appeals from final judgments, orders, and decrees of bankruptcy judges entered in Chapter VII bankruptcy proceedings. 28 U.S.C. § 158(a). Because “[d]istrict courts sit as appellate courts when hearing appeals from bankruptcy courts, ” Hijjawi v. Five North Wabash Condo. Ass’n, 491 B.R. 876, 880 (N.D. Ill. 2013) (citing In re Neis, 723 F.2d 584, 588 (7th Cir. 1983)), the district court applies a dual standard of review that “examine[s] the bankruptcy court’s determinations of law de novo and its findings of facts for clear error.” In re Smith, 582 F.3d 767, 777 (7th Cir. 2009).

         In their consolidated appeals, appellants present the following issues for review:

a. Did the bankruptcy court err in finding that Peregrine’s forex and spot metal customers were not placed in a resulting trust?
b. Did the bankruptcy court err in finding that 11 U.S.C. § 761(4)(F)(i) (the “similar contracts clause”) does not extend to forex and metals contracts because such contracts are not “similar to” futures contracts?
c. Did the bankruptcy court err in dismissing the customers’ class action complaint as untimely because they brought it after the bar date for filing a proof of claim?
d. Did the Bankruptcy Court err in refusing to consider the class action complaint as an amendment of customers’ proofs of claim which related back to the date those claims were filed?

         These issues are addressed in turn below.

         A. Resulting Trust

         The customers contend that the funds they placed in their forex and spot metals accounts were held by Peregrine in a resulting trust and thus should not be distributed as part of the bankruptcy estate distributions. Brief for Appellants 4-10, 14-CV-05024, ECF No. 8. Because their funds were not part of the bankruptcy estate, the customers argue, they should be paid in full immediately. After a bench trial, the bankruptcy court, in an exhaustive 46-page written opinion, provided a clear and convincing explanation for its holding that the customers’ funds were not held by Peregrine in trust. In sum, the bankruptcy court concluded that the customers had failed to establish by clear and convincing evidence that in transferring funds to Peregrine they intended to create a trust. To the contrary, the bankruptcy court found that the customers knew and understood that in funding their forex and metals accounts at Peregrine, they were surrendering legal and equitable ownership of those funds to Peregrine, that the funds could be comingled with other Peregrine accounts and funds, that Peregrine could use the funds for its own purposes, and that in the event of Peregrine’s insolvency, the customers would not have a secured or priority claim on the funds credited to their Peregrine accounts.

         Both parties agree that Illinois state law controls the question as to whether the customer Agreement between Peregrine and the customers formed a resulting trust. Generally, a resulting trust arises when one person purchases property in the name of a third party that has no actual interest in that property. In re Estate of Koch, 697 N.E.2d 931, 933 (Ill.App.Ct. 1998). Because resulting trusts seek to further the intent of the parties who entered the transaction, they are characterized as “intent enforcing” devices that are created by operation of law with their “roots in the presumed intention of the parties.” In re Wilson’s Est., 410 N.E.2d 23, 26 (Ill. 1980). Thus, in assessing whether the Agreement created a resulting trust, the Court’s inquiry turns on the intent of the parties when they consummated the transaction. Id. Under Illinois law, the burden is on the plaintiff to show by clear and convincing evidence that the parties intended to create a resulting trust. In this vein, a presumption of a resulting trust will not be found if “the transaction can be construed in any other reasonable fashion.” Gary-Wheaton Bank v. Myer, 473 N.E.2d 548, 552 (Ill.App.Ct. 1984). Once a party has met this burden, there is a rebuttable presumption that a resulting trust was created. Id. Here, however, it is apparent that the customers have failed to raise any such presumption.

         The customers’ principal argument is that they have provided sufficient evidence to warrant the presumption that a resulting trust existed because they offered evidence indicating that they paid consideration for the right to trade on their accounts. Under Illinois law, a presumption of “[a] resulting trust arises wherever the circumstances surrounding the disposition of property raise an inference . . . that the transferor does not intend that the person taking or holding the property . . . should have the beneficial interest therein.” Hong Kong ElectroChemical Works, Ltd. v. Less, 539 F.3d 795, 798 (7th Cir. 2008) (internal quotation and citation omitted). As the customers note, Illinois courts have found that a resulting trust was created when one person furnishes consideration for the purchase of property and conveys title to that property to another. See, e.g., Meyer, 473 N.E.2d at 551. This is often referred to as a “purchase money trust.” Am. Nat. Bank and Trust Co. of Rockford, Ill. v. United States, 832 F.2d 1032, 1035 (7th Cir. 1987). In the typical purchase money trust scenario, “one person supplies the money to buy something but title is placed in another person’s name.” Id. Because title to the property was taken in the name of a third party, the payment of consideration serves an evidentiary function, supporting a claim that although the payer purchased the property in the name of another, he actually intended to retain equitable title to that property. Id. at 1036.

         As the bankruptcy court observed, however, “the situation in this case bears no resemblance to the purchase money resulting trust cases cited by the plaintiffs.” In re Peregrine Fin. Group, Inc., 2014 WL 2197945, at *3. In support of their argument, appellants cite In re Estate of Wilson and In re Estate of Koch, both of which involved a purchase money trust. In Wilson, a husband used his own funds to purchase several hundred shares of securities in his wife’s name. 410 N.E.2d at 26. Wilson, the husband, put the securities in his wife’s name to make it easier for her to receive the shares if he died, but he did not intend for her to have a present interest in the shares while he was living. Things did not go according to plan, however, as his wife died before he did. In finding that the shares were held in a resulting trust in favor of Wilson, and that his wife never had a present possessory interest in the stocks, the court noted that Wilson had retained the management, use, and control of those stocks. Aside from being the strawman owner of the stocks, his wife had no role in overseeing the management of the shares. Thus, the payment of consideration was just one of many factors the court looked to in determining that Wilson retained equitable title to the property. Similarly, in In re Estate of Koch the court found that a resulting trust existed in favor of Koch when he purchased a vacation home in his wife’s name but had furnished all the consideration for that property, selected its location, and consummated the real estate transaction. 697 N.E.2d at 933.

         The purchase money transactions in Koch and Wilson, where the owner of title never actually physically possessed the property, stand in contrast with cases where property- including money-was physically transferred to a third party. In this situation, under Illinois law, there is presumption that the possessor owns the property. See, e.g., In re Stand. Foundry Products, Inc., 208 B.R. 164, 167 (Bankr. N.D.Ill. 1997). This is because the evidentiary function that consideration serves in determining who held equitable title to the property is overborne by the third party’s actual possession of the property. For example, when a customer deposits money into a bank, under Illinois law, the customer has transferred ownership of those funds to the bank. Durkee v. Franklin Savings Assoc., 309 N.E.2d 118, 120 (Ill.App.Ct. 1974) (“[T]he moment the money is deposited it actually becomes the property of the bank. The bank and the depositor thereby assume the legal relation of debtor and creditor.”). Although the customer may intend to retain access to those funds, they have in fact relinquished title to the bank, which then owes a contractual obligation to pay out those funds when the customer wishes to make a withdrawal. United States v. Davis, 989 F.2d 244, 246 (7th Cir. 1993) (noting that once a check is deposited, the bank becomes the owner of the money and the depositors are mere creditors to the bank rather than owners of the funds); Menicocci v. Archer National Bank of Chicago, 385 N.E.2d 63, 66 (Ill.App.Ct. 1978) (indicating that “[a] debtor/creditor relationship exists between the depositor and the bank” once funds are deposited). Thus, even though the depositor has in some sense furnished consideration to the bank with the deposit, no presumption of a trust arises because, unlike the purchase money situation, the bank has physical control over the funds and has authority to deal in them as it sees fit. Instead, the bank simply owes the depositor a contractual obligation to pay out those funds upon the depositor’s request.

         As the bankruptcy court aptly noted, notwithstanding the customers’ payment of consideration, their forex and metals accounts had none of the features of the purchase money trust scenarios present in Wilson and Koch. Instead, the customers’ relationship with Peregrine was more akin to a debtor/creditor relationship that a depositor forms with a bank. Unlike the transactions in Wilson, or any other purchase money transaction, the customers did not furnish consideration to purchase property in the name of someone else with the intent that they would retain ownership of that property. Indeed, as the bankruptcy court’s opinion details, at trial the customers were unable to articulate what they purchased with the funds they deposited in their accounts. The trading accounts were opened before any funds were deposited and so far as the evidence shows, there was no required minimum to keep an account open; the deposit of funds into the account was, as the bankruptcy court explained, “a contractual precondition to placing trades, ” 2014 WL 2197945, at *23, not consideration for opening the accounts. The customers themselves disavowed the notion that the funds on deposit were consideration for foreign currencies purchased by testifying that they believed Peregrine could use the funds in their accounts only to pay commissions and to cover trading losses, and in any event they presented no evidence of how the deposited funds were used, what the margin requirements were, or how Peregrine conducted forex trades, so there was no evidentiary basis to conclude that the customers’ funds, in whole or part, had in fact been used to purchase foreign currencies generally, much less what specific transactions had occurred. There was, in short, no basis to conclude what, if anything, the funds deposited by the customers had purchased. Instead, much like a depositor at a bank, appellants placed their funds in their Peregrine accounts with the expectation that they would be able to trade in retail forex and OTC metals when they requested to do so; the bankruptcy court therefore reasonably concluded that the customers’ claims to those funds sounded in contract and not in equity.[6]

         When asked what the foundation was for their belief that they retained an equitable ownership of their funds, the appellants pointed-as they do here-to paragraph eight of the Peregrine Customer Agreement. But that provision in fact belies their assertion that they retained ownership of the deposited funds. Paragraph eight of the Agreement, which pertains to collateral, states in part:

All funds, securities, commodities, commodity futures contracts, commodity option contracts, and other property of Customer which PFGBEST or its affiliates may at any time be carrying for Customer . . . are to be held by PFGBEST as security and subject to a general lien and right of setoff against liabilities of Customer to PFGBEST . . .At any time, PFGBEST may in its discretion, with or without notice to Customer, apply and/or transfer any or all funds or other property of Customer between any of Customer’s Accounts. Additionally, Customer hereby grants to PFGBEST the right to pledge, repledge, hypothecate, sell or purchase, invest or loan . . . property of Customer held by PFGBEST as margin or security. The value of any such collateral shall be determined by PFGBEST in its sole discretion and based upon what PFGBEST would receive if PFGBEST sold the relevant collateral for immediate delivery. PFGBEST shall at no time be required to deliver to Customer the identical property delivered to or purchased by PFGBEST for any account of Customer.

Appellants’ Ex. 1: Customer Agreement, ¶ 8, 14-CV-05024, ECF No. 9. This provision of the Agreement, which applies to both futures and non-futures accounts, gives Peregrine complete control over collateral funds deposited into customer accounts. Just as banks may loan and borrow against customer deposits at their discretion, paragraph 8 gave Peregrine absolute discretion to dispose of collateral funds and to determine the value of those funds. Nothing in that provision-or any ...


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