Recovering Stolen Business Assets: Constructive Trusts and Tracing

Why a judgment is not enough

A business that proves embezzlement or fraud and obtains a judgment for the amount taken has an unsecured claim against a person who, by then, usually has little in their own name. The money has become a house, a down payment, a boat, a brokerage account, a loan to a brother, or the capital of a new LLC. Equity developed a set of remedies for exactly this problem, and Texas courts apply them. They share one feature: they attach to specific property rather than to the person, so they reach assets titled to others and take priority over the thief's ordinary creditors.

Constructive trust: what it is and what it requires

A constructive trust is not a trust anyone created. It is a remedy the court imposes: a declaration that the person holding the property holds it for the plaintiff and must convey it. The Texas Supreme Court described the remedy in KCM Financial LLC v. Bradshaw (Tex. 2015) and Texas courts state three requirements:

1. the property was acquired through breach of a fiduciary or confidential relationship, or through actual fraud;
2. the holder would be unjustly enriched by keeping it; and
3. the plaintiff can trace the wrongfully obtained funds or property to an identifiable asset, the res.

The first element limits the remedy. Ordinary breach of contract or negligence does not support a constructive trust, however unfair the result; there must be a fiduciary breach or actual fraud. In business theft cases that is rarely a problem: an officer, partner or trusted employee who diverted funds breached a fiduciary duty, and a vendor who invoiced for goods never shipped committed fraud. Who qualifies as a fiduciary is covered in who owes a fiduciary duty in a Texas business.

The third element, tracing, is where the work is. Without an identifiable asset there is no constructive trust, only a money judgment.

Tracing: following the money through accounts

Tracing is the factual exercise of connecting the stolen funds to the asset now held. When the money went directly from the company's account to a title company for a house, tracing is a single wire. When it passed through the thief's personal checking account, mixed with salary, and then paid for several things, courts apply presumptions developed for exactly this situation.

• The lowest intermediate balance rule. Where trust funds are mixed with the wrongdoer's own money, the trust funds are treated as remaining in the account as long as the balance never fell below the trust amount; if it did, only the lowest balance is traceable, and later deposits of the wrongdoer's own money do not replenish it unless intended to.
• Presumptions against the wrongdoer. Where it cannot be determined whose money paid for an asset, the wrongdoer is presumed to have spent their own money first and preserved the victim's, and the victim may elect to claim the asset or a lien on it.
• Proportional tracing. Where an asset was bought partly with stolen funds, the victim may claim a proportionate share of it, including its appreciation.

This is forensic accounting work: bank statements for every account the funds touched, in date order, with each deposit and withdrawal classified. What that work looks like is described in how forensic accountants are used in fraud litigation. The records come by subpoena to the banks once suit is filed, which is one reason suit often has to be filed before the full picture is known.

Example

Suppose a bookkeeper at a Richardson engineering firm diverted $410,000 over five years into a joint checking account she held with her husband. From that account the couple paid $120,000 toward their mortgage, bought a truck titled to the husband for $65,000, and wired $150,000 to a brokerage account in her name, which has since grown to $190,000. The firm's bank records show each transfer into the joint account; the couple's records, subpoenaed, show each payment out. The firm seeks a constructive trust over the brokerage account, including its growth, because every dollar in it traces to the diverted funds; a constructive trust or equitable lien on the truck; and an equitable lien on the house for the $120,000 in equity the mortgage payments created, since the house itself was bought earlier with other money. The husband's lack of knowledge does not protect the truck or the house equity from the lien, because he paid nothing for the benefit he received.

Equitable lien

Where the stolen funds improved or paid down an asset that was not itself acquired with them, or where the plaintiff prefers security to ownership, the court can impose an equitable lien: a charge on the property for the traced amount, enforceable by foreclosure. The lien reaches the house whose mortgage was paid with company money without requiring the plaintiff to take the house. It requires the same tracing as a constructive trust.

Fraudulent transfer claims under TUFTA

The Texas Uniform Fraudulent Transfer Act, chapter 24 of the Business and Commerce Code, addresses a different move: the thief, knowing a claim is coming, gives property away or sells it cheaply to someone else. Section 24.005(a) makes a transfer fraudulent as to a creditor if the debtor made it with actual intent to hinder, delay or defraud any creditor, or made it without receiving reasonably equivalent value while insolvent or about to incur debts beyond their ability to pay. Section 24.005(b) lists the badges of fraud courts use to infer intent: transfer to an insider, retained possession or control, concealment, a pending or threatened suit, transfer of substantially all assets, absconding, removal of assets, lack of equivalent value, insolvency, and timing around a large debt.

Under section 24.008 the creditor may obtain avoidance of the transfer, an attachment against the transferred asset, an injunction against further disposition, appointment of a receiver, or any other relief the circumstances require, and after judgment may levy on the asset. Section 24.009 protects a transferee who took in good faith and for reasonably equivalent value, so a bona fide purchaser keeps the asset and the creditor pursues the proceeds. A relative who received the property for nothing has no such defense.

Section 24.010 sets the reach-back: an actual-intent claim must be brought within four years after the transfer or, if later, within one year after the transfer was or reasonably could have been discovered; constructive-fraud claims have four years with no discovery extension. Unlike a constructive trust, TUFTA needs no fiduciary breach or fraud in the original taking; it requires only that the plaintiff be a creditor and the transfer meet the statute. The two remedies overlap and are usually pleaded together.

Reaching third parties who hold the money

The spouse, relative or new company that holds the asset is a necessary party. The claims against them depend on what they knew and paid.

• A recipient who paid nothing holds the asset subject to the constructive trust or lien whether or not they knew of the theft; unjust enrichment does not require guilt.
• A recipient who knew of the theft and helped is also personally liable, under knowing participation or conspiracy, for the full loss. Those theories are in civil conspiracy and knowing participation in Texas.
• A recipient who paid fair value in good faith generally keeps the asset, and the plaintiff follows the proceeds.

Money had and received, an equitable claim that asks only whether the defendant holds money that in fairness belongs to the plaintiff, is the usual vehicle against an innocent recipient of cash.

Timing: freezing the asset before it moves again

Constructive trust and TUFTA claims are decided at the end of a case, and assets move during cases. Texas courts can issue a temporary injunction preserving specific property that is the subject of an equitable claim, and TUFTA itself authorizes injunctions and attachment against the transferred asset. Where the asset is real property, a notice of lis pendens filed in the county records warns buyers and lenders of the claim. The prejudgment tools and their requirements are compared in freezing assets before judgment in Texas.

Why these remedies beat a judgment

Three reasons. Priority: property held in constructive trust is not the thief's property, so it is not available to their other creditors and, in a bankruptcy, is generally excluded from the estate to the extent it can be traced. Appreciation: the plaintiff who traces into a brokerage account or real estate takes the growth, not just the principal. Reach: the remedies attach to the asset wherever it sits and whoever holds title, so a transfer to a spouse or an LLC does not end the case. The cost is proof: every dollar must be traced, which is why the bank records and the forensic work come first.

Deadlines

A constructive trust is a remedy, not a cause of action, so its deadline is that of the underlying claim: four years for fraud and breach of fiduciary duty under section 16.004 of the Civil Practice and Remedies Code, with the discovery rule often applying to concealed thefts. TUFTA's own periods in section 24.010 govern transfer claims. Tina Wysk represents businesses recovering diverted assets in fraud and fiduciary litigation in Dallas state and federal courts.