Escrow Funds: Who Gets to Keep the Cash?

In Re Cypress Health Systems Florida, Inc., 536 B.R. 334 (Bankr. N.D. Fla. 2015) –

A Chapter 11 debtor filed a motion to require a title company to turn over a $50,000 escrow deposit that had been made by a buyer in connection with a proposed acquisition of the debtor’s assets. The buyer objected, contending that the funds were not part of the bankruptcy estate.

The debtor had entered into a letter of intent (LOI) to sell its primary asset, a hospital. The LOI required a deposit by the buyer into escrow as follows:

Within Thirty (30) Days of the last Party to execute this Offer [August 13, 2009], Buyer [Partner’s Healthcare] shall deposit or see deposited into the Escrow or Trust Account of the Seller’s [Debtor’s] choice, the sum of fifty thousand (50,000.00) dollars, as the sum which would revert permanently to the possession and control of the Seller should the purchase by Buyer not be consummated subsequent to loan approval within the ninety (90) Day Exclusivity Period. This sum ($50,000.00) shall be refunded subsequent to the successful close of the acquisition of the assets of Nature Coast Regional Hospital by PHD International, LLC.

The exclusivity period expired in November 2009, and the sale never closed.

The debtor filed bankruptcy in October 2012. It listed the buyer as a creditor so that it received notice of both the bankruptcy and the claims bar date of February 1, 2013. The buyer never filed a claim seeking return of the escrow deposit. The debtor confirmed a liquidating plan in June 2013, and then sought to require the title company to turn over the $50,000 deposit as required by the plan.

Under Section 541 of the Bankruptcy Code, “‘property of the estate’ is defined as all of a debtor’s legal or equitable interest in property, wherever located, as of the commencement of the case.” For the turnover motion to succeed, the debtor had to establish that the escrow deposit was part of the bankruptcy estate.

The buyer first argued that the debtor had no interest in the deposit because it did not include the deposit in its bankruptcy schedules. However, the court noted that there is nothing in the Bankruptcy Code that limits property of the estate to property actually scheduled by a debtor.

The buyer next argued that it had a claim based on the debtor’s failure to negotiate in good faith so that the debtor did not have a right to the escrow deposit at the time of the bankruptcy filing. The court noted that state law determines the nature of the debtor’s interest in property at the commencement of the case, and the bankruptcy estate does not acquire a greater interest in property than the debtor held prior to bankruptcy.

Under applicable state law escrow funds do not become the property of a grantee “until they are irretrievably placed beyond the grantor’s reach.” In this case the deposit was to revert “permanently” to the debtor/seller if a purchase was not closed within the applicable period. In the court’s view the analysis was simple: no sale occurred; the buyer lost any interest in the funds; the debtor was entitled to the funds.

As for the buyer’s argument that the debtor was not entitled to the escrow deposit because it did not negotiate the sale in good faith, the court noted that the buyer raised this issue by sending a letter to the title company in 2010, but took no action for 4 years. It had actual knowledge of the bankruptcy case and the bar date, yet never filed a proof of claim. If the buyer did have a claim against the debtor it “necessarily needed to assert it in this bankruptcy case.” Since it did not, it could not now assert any claim against the debtor or the deposit.

The buyer also argued that the court should abstain and allow a state court to determine the issues. However, the bankruptcy court had “related to” jurisdiction, the test for abstention was not met, and the debtor’s confirmed plan specifically provided that the court would retain jurisdiction, including disputes regarding title to assets of the debtor.

At one point the buyer argued that discretionary abstention was appropriate because “if the Debtor recovers the Escrow Deposit, it would only provide the bankruptcy estate funds to transfer to the creditors.” However, the court commented that that is exactly what is supposed to happen under a liquidating plan of reorganization.

Thus the court held that the $50,000 escrow deposit was property of the bankruptcy estate, and the title company was directed to turn over the funds.

It is not clear why the buyer waited so long to try to recover its deposit. There is a continuing theme in bankruptcy that “you snooze, you lose.” The buyer may not have been successful even if it filed a timely claim, but its failure to do so left it with no options.

Vicki R Harding Esq.