At first, the challenge seemed formidable. Our clients, two Minnesota individuals, claimed that they had been fraudulently induced to lend millions of dollars to another individual, a resident of the State of Colorado. The borrower invested most of the money in real estate located in Montana, Idaho and Colorado, and was moving the rest of it through several banks in these and other states. There was great concern that these assets would disappear as the case progressed through discovery and trial. The question was: could one court obtain the necessary jurisdiction to not only grant final relief to our clients, but also to enter interlocutory orders securing these assets prior to judgment? Or would our clients be required to file duplicative lawsuits in each jurisdiction in which assets could be found?
The problem was two-fold. First, would a court in Minnesota have the power to reach assets which were not physically located in the State of Minnesota? Second, what was to stop the Defendant from transferring the assets to a bona fide purchaser before an interim order could be issued?
Initially, we thought that the answer to the first question would be found in the laws governing prejudgment attachment of assets; we thought that the filing of lis pendens notices on the real estate parcels at issue would protect against the possibility of a good faith purchaser taking title to the real estate.
We were surprised to find out that both courses of action were not as clear as we first believed.
Attachment or Constructive Trust? That was the Question
In reviewing the law governing prejudgment attachment of assets, we discovered a major barrier.
The Minnesota prejudgment attachment statute gives a court authority to attach assets as security for satisfaction of a final judgment. See Minn. Stat. Â§ 570.01, et. seq. There is no specific "territorial" limitation in the language of the statute. The Minnesota Court of Appeals, however, has ruled that attachment jurisdiction under Section 570 is limited to assets located within the boundaries of the State of Minnesota. See Allstate Sales & Leasing Co. v. Geis, 412 N.W.2d 30, 32-33 (Minn. Ct. App. 1987).
This territorial limit, as interpreted in AllState, erected a barrier not only for a Minnesota state court, but also posed a problem for a federal court located in the District of Minnesota, exercising diversity jurisdiction.
Federal Rule of Civil Procedure 64 governs "seizure of person or property" in federal court. This rule specifically provides that:
At the commencement of and during the course of an action, all remedies providing for seizure of person or property for the purpose of securing satisfaction of a judgment ultimately to be entered in the action are available under the circumstances and in the manner provided by the law of the state in which the district court is held, existing at the time the remedy is sought . . . .
Fed. R. Civ. P. 64. Some courts have held that a federal district court whose subject-matter jurisdiction derives from diversity of citizenship must comply with state limitations regarding prejudgment attachment. See e.g., Federal Deposit Ins. Corp. v. Rodenberg, 622 F. Supp. 286 (D. Md. 1985).
Combining Rule 64 with the Minnesota prejudgment attachment statute, as narrowly interpreted in Allstate, we were concerned that a federal court would find itself without power to enter a prejudgment attachment of real estate, money and other assets which were located outside the State of Minnesota.
Not satisfied with that outcome, we searched further and found salvation in the equitable doctrine of "constructive trust."
"Constructive trusts are designed to correct abuses of fiduciary relationships and force a conveyance to prevent unjust enrichment." D.J. Acquisition Corp. v. Skoglund, 453 N.W.2d 1, 20 (Minn. 1990). Or, as stated in Henderson v. Murray, 121 N.W. 214, 216 (Minn. 1909):
Where a party obtains the legal title to land by fraud or bad faith, or by taking advantage of confidential or fiduciary relations, or in any other unconscientious manner, so that he cannot justly retain the property, equity will impress a constructive trust upon it in favor of the party who is equitably entitled to it.
That was precisely what we sought to accomplish: to force the Defendant to convey assets which he acquired through abuse of a fiduciary relationship with our clients, in order to prevent the Defendant from being unjustly enriched by his conduct. We learned that federal courts have generally held that their power to issue interim injunctive relief to prevent a defendant from dissipating assets in order to preserve the possibility of a court's exercising the equitable remedy of constructive trust is not limited by Rule 64, or by state prejudgment attachment procedures.
The basis for this principle is that where an action seeks to impose a constructive trust, rather than to act directly on the title to property, jurisdiction is in personam. See Massie v. Watts, 6 Cranch 148, 3 L.Ed. 181, 10 U.S. 148, 159 (1810); Keller v. Millice, 838 F. Supp. 1163, 1174 (S.D. Tex. 1993) (citing Massie). So long as the court has personal jurisdiction over the defendant, that party's equitable rights in the property may be tried in a court outside the state where the property is sited: "[I]n a case of fraud, of trust, or of contract, the jurisdiction of a court of chancery is sustainable wherever the person be found, although lands not within the jurisdiction of that court may be affected by the decree." Massie, 10 U.S. at 159; Keller v. Millice, 838 F. Supp. 1163, 1174 (S.D. Tex. 1993) (citing Massie); Reebok Int'l Ltd. v. Marnatech Enterprise, Inc., 970 F.2d 552, 559, n. 10 (9th Cir. 1992).
These decisions reason that the imposition of a constructive trust is a "transitory" action, not a "local" action. As such, they hold that any court with personal jurisdiction over the parties may adjudicate the matter. See Keller, 838 F. Supp. at 1174. In Keller, plaintiff sought imposition of a constructive trust on out-of-state property under a theory of breach of fiduciary duty arising from a contract. The defendant argued that the Texas court could not impose a constructive trust on property outside the jurisdiction because property matters are "local" actions. The Court found that the action was transitory, stating:
When an action relates to real property located outside of the jurisdiction of the forum, if the action requires the court to determine a party's title interest in the real property, the action is local and must be brought in the jurisdiction where the real property is located. Suits to try title or to remove a cloud from title are local actions under this reasoning. If the action requires the court to enforce a right in real property arising from a preexisting ownership interest, the action is transitory and may be brought in any court where personal jurisdiction over the defendant may be properly asserted. Suits to enforce contractual rights or equitable duties that are related to real property are transitory actions, even though the action may appear to be local, since a party's title interest to the property may be affected by the court's decision.
Id. at 1173 (emphasis supplied). See also Mandley v. Backer, 121 F.2d 875, 876 (D.C. Cir. 1941) (holding that court could make equitable decree affecting real property outside jurisdiction because personal jurisdiction was present); Miller & Lux, Inc. v. Nickel, 149 F. Supp. 463 (N.D. Cal. 1957) (holding district court could exercise equitable jurisdiction over property located in Southern District of California for purposes of imposing constructive trust).
We decided to file the case in the U.S. District Court for the District of Minnesota, based on the diversity of citizenship between the Minnesota Plaintiffs and the Colorado resident Defendant. After early discovery, which produced substantial evidence validating our fears about the Defendant's dissipation of the assets at issue, we sought a preliminary injunction. We supplied the Court with evidence supporting our constructive trust theory, as well as the existence of the factors otherwise necessary to support preliminary injunctive relief, the so-called "Dataphase" factors: (1) the nature of the relationship between the parties; (2) balance of harms; (3) likelihood of success on the merits; (4) public interest; and (5) administrative burden. See Dataphase Systems, Inc. v. CL Systems, Inc., 640 F.2d 109 (8th Cir. 1981) (en banc).
The Court granted the motion, restraining the Defendant from taking any action to alienate any of the real estate at issue in the case. After additional discovery, the Court sequestered almost $500,000 which the Defendant had been circulating through various out-of-state banks. The Defendant took interlocutory appeals of these orders; both were affirmed by the U.S. Court of Appeals for the 8th Circuit. See Hoehne v. Kerns, 2002 WL 3126000 (per curiam) (8th Cir. 2002)
A Court is a Court is a Court
As soon as we filed the suit, we filed notices of lis pendens in the county recorder offices for each of the real estate parcels at issue in the case. The lis pendens notices were designed to put any potential purchaser of the property on notice of the "pendency" of our clients' lawsuit, which asserted their claim to "constructive ownership" of the property.
Unfortunately, the fight to protect these assets was not over yet. After we filed the lis pendens notices, but before the Minnesota court issued its injunction, the Defendant deeded a portion of the Colorado property to a third party. The Defendant then challenged the validity of the lis pendens notices. First, he sought an order from the Minnesota federal court that the notices were invalid because the Minnesota court lacked jurisdiction over the real estate, or in rem jurisdiction.
Defendant relied on cases such as Flader v. Campbell, 120 Colo. 66, 207 P.2d 1188 (1949), Humble Oil & Refining Co., 398 F.2d 364 (4th Cir. 1968), and Ellenwood v. Marietta, 158 U.S. 105, 15 S.Ct. 771 (1895), which stand for the proposition that only a court located where the property is situated can try title because it is a "local" action. Based on this principle, the court in Hayes v. Gulf Oil Corp., 821 F.2d 285 (5th Cir. 1987), and a few others, have refused to issue orders which have "extraterritorial" effect, due to the lack of in rem jurisdiction. According to such cases, any attempt by a federal court or court of a foreign state to enter orders affecting title to real estate infringes the sovereignty of the state where the land is located.
These decisions have been criticized. See e.g., Hallaba v. Worldcom Network Servs., Inc., 196 F.R.D. 630, 650 (N.D. Okla. 2000) (criticizing the reasoning of Hayes v. Gulf Oil as "flawed and inapplicable" and stating "This Court can clearly render decisions that 'affect' the real estate title records in [Missouri] state court, such as, for example, deciding to set aside a fraudulent conveyance."). See also Gail M. Hashimoto, Note: The Protection of Land Decrees: The Use of Lis Pendens in Interstate Litigation Affecting California Real Property, 36 Hastings L.J. 255, 258-59 (1984).
The Minnesota federal court denied the motion. The Court held that because it had personal jurisdiction over the Defendant, who had legal title to the property, it could order the Defendant to convey title to the Plaintiffs as a final equitable remedy in the case; therefore, in rem jurisdiction, or jurisdiction over the "res," or "thing in question" was not necessary. The court based its ruling on the language of the lis pendens statute, which it found to be devoid of any language excluding cases pending in courts of foreign jurisdictions, and on the case of Andre v. Morrow, 680 P.2d 1355 (Idaho 1984), in which the Court gave full faith and credit to a California judgment which imposed a constructive trust on Idaho property.
Disappointed with the ruling of the Minnesota court, the Defendant then filed a "quiet title action" in his home county in Colorado, seeking a ruling that, under Colorado law, the Colorado lis pendens notices were not valid because the lawsuit to which they referred was pending in a non-Colorado court. Defendant again argued that the Minnesota court's lack of in rem jurisdiction rendered the lis pendens notices ineffective and that his transfer of the Colorado real estate to the third party, before the Minnesota court issued its injunction, was therefore valid. No such territorial restriction was contained in the plain language of the Colorado lis pendens statute. Nevertheless, the local district judge, accepting the argument that the Minnesota court lacked in rem jurisdiction, ordered our clients to remove the lis pendens notice so that the sale to the third party could proceed.
We then immediately sought, and obtained, an emergency stay from the Colorado Supreme Court, which ultimately reversed the district court.
In a published decision, the Court agreed that only a Colorado court could act directly upon the title to real estate located within the state. The Court affirmed that "principles of state sovereignty dictate the rule that the courts of one state have no power to directly affect title to land located wholly within the borders of another." Kerns v. Kerns, 53 P.3d 1157, 1163 (Colo. 2002). See Fall v. Eastin, 215 U.S. 1, 11-12, 30 S. Ct. 3, 54 L. Ed. 65 (1909); see also Flader v. Campbell, 120 Colo. 66, 76, 207 P.2d 1188, 1193 (1949); Hashimoto, supra, at 264 ("The limitation on a court's ability to affect land outside its territorial jurisdiction 'is an ancient one and represents the view when the common law of England quite naturally looked with distrust upon any effort of a foreign power to dictate with respect to English land.'" (quoting Byron R. Bentley, Equity Decrees in Sister States, 8 S. Cal. L. Rev. 1, 9 (1934)).
Nevertheless, the Court recognized that in personam actions may also "affect" title to real estate within the meaning of a lis pendens statute. Kerns, 53 P.3d at 1164. The Court noted that in Fall v. Eastin, 215 U.S. 1, 30 S. Ct. 3, 54 L. Ed. 65 (1909), the United States Supreme Court clarified that:
The territorial limitation of the jurisdiction of courts of a State over property in another State has a limited exception in the jurisdiction of a court of equity, but it is an exception well defined. A court of equity having authority to act upon the person may . . . decree a conveyance of land situated in another jurisdiction, and even in a foreign country, and enforce the execution of the decree by process against the defendant . . . . [I]ts decree is made effectual through the coercion of the defendant.
Fall, 215 U.S. at 8, 9-10, 30 S. Ct. 3; see also Hallaba v. Worldcom Network Servs. Inc., 196 F.R.D. 630, 650 (N.D. Okla. 2000) ("This Court can clearly render decisions that 'affect' the real estate title records in state court, such as, for example, deciding to set aside a fraudulent conveyance."); Andre v. Morrow, 106 Idaho 455, 680 P.2d 1355, 1361 n. 2 (1984) (holding that "a foreign court has the power to indirectly affect out-of-state property by means of a decree based on personal jurisdiction over the parties, which determines the parties' personal rights or equities in that property" and citing cases in support of that proposition). The Court noted that the jurisdictional grant of federal bankruptcy courts provides another exception to the in rem rule. See Kaiser Steel Corp. v. Frates, 80 B.R. 216, 219-21 (Bankr. D. Colo. 1987) (California's lis pendens statute permitted party to action before United States Bankruptcy Court for the District of Colorado to file notice of lis pendens against California property.).
The Court recognized that an equitable action to impose a constructive trust on real property does not operate directly upon title, but is a type of in personam action that may "ultimately change legal title." Ross v. Specialty Risk Consultants, Inc., 621 N.W.2d 669, 676; see also Mandley v. Backer, 121 F.2d 875, 876 (D.C. Cir. 1941) (holding that a court has the power to fashion an equitable decree enforcing a constructive trust on property located outside the jurisdiction (relying on Massie v. Watts, 10 U.S. (6 Cranch) 148, 3 L. Ed. 181 (1810))); cf. Keller v. Millice, 838 F. Supp. 1163, 1174 (S.D. Tex. 1993) (holding that an action seeking to impose a constructive trust is transitory). See Polk v. Schwartz, 399 A.2d at 1004 ("There is no doubt that an action to impress a constructive trust on realty affects title to that property, so that a notice of lis pendens may be filed under a statute such as ours."); Ross, 621 N.W.2d at 676 (holding that a party to an out-of-state action to impose a constructive trust on Wisconsin real estate is entitled to file a notice of lis pendens under Wisconsin's lis pendens statute); see also 14 Richard R. Powell, Powell on Real Property, at 82A-16; Hashimoto, supra at 256; cf. Hawthorne Trust v. Maine Sav. Bank, 136 N.H. 533, 618 A.2d 828, 830-31 (1992) (holding that an equitable interest in real estate is within the purview of a recording statute which only applies to instruments affecting title to real estate).
The Court relied on In re Marriage of Allen, 724 P.2d 651 (Colo. 1986), in which the Court discussed the concept of a constructive trust:
The constructive trust is an equitable device used to compel one who unfairly holds a property interest to convey that interest to another to whom it belongs. When property has been acquired in such circumstances that the holder of legal title may not in good conscience retain the beneficial interest, equity converts him into a trustee. The successful plaintiff in a constructive trust action wins an in personam order that requires the defendant, the constructive trustee, to transfer specific property in some form to the plaintiff, the beneficiary, of the trust.
724 P.2d at 656-57 (internal quotation marks and citations omitted). Thus, the Court concluded, an action to impose a constructive trust has the potential to "affect" title to real property, albeit indirectly.
The Court held that because in personam actions pending out-of-state may result in orders which indirectly "affect" Colorado real estate, it would be improper to narrowly construe the lis pendens statute as limited to actions pending in Colorado courts. Kerns, 53 P.3d at 1165. See e.g., Crown Life Ins. Co. v. April Corp., 855 P.2d 12, 14-15 (Colo. App. 1992) (holding that a creditor seeking to set aside a conveyance of real property as fraudulent may file a notice of lis pendens against such property under section 38-35-110); Cooper v. Flagstaff Realty, 634 P.2d 1013, 1015 (Colo. App. 1981) (litigation concerning promise to grant deed of trust to specific parcel of real property "affects title" within meaning of lis pendens statute, even though it does not seek to change ownership in any way, because it does involve a determination of rights and liabilities incident to ownership); see also TWE Retirement Fund Trust, 8 P.3d at 1186; Hashimoto, supra, at 256. Thus, the Court held that "even litigation that does not seek to change ownership in any way but does 'involve a determination of certain rights [and liabilities] incident to ownership' falls within the purview of the statute."
The Court reasoned that because a notice of lis pendens recorded in relation to an extraterritorial action that indirectly affects real property does not "create, transfer, or vest title or interests in realty," it "does not affect title in a manner that violates the territorial sovereignty of the situs state." Kerns, 53 P.3d at 1163.
The Court expressly declined to follow a precedent from the Wyoming Supreme Court, Ludvik v. James S. Jackson Co., 635 P.2d 1135 (Wyo. 1981). In Ludvik, the Wyoming Supreme Court held that its lis pendens statute codified the common law. 635 P.2d at 1141. Following the common law, the Court reasoned that a notice of lis pendens could only be filed when the action to which it pertained is brought before a court having jurisdiction over the res. Id. Because an extraterritorial court cannot proceed in rem against Wyoming real estate, the Wyoming Supreme Court held the Wyoming lis pendens statute did not permit the filing of such notice where the underlying action was pending outside the state. Id. In contrast to Ludvik, the Colorado Supreme Court held that its lis pendens statute "modifies or restricts" the common-law doctrine of lis pendens on this point and is therefore not so restrictive in its application.
The Court observed that, unlike at common law, a lis pendens statutory system allows prospective purchasers to readily determine whether a judicial proceeding -- local or otherwise -- potentially affects title to a piece of property simply by visiting the county clerk's and recorder's office in the county where the property is located. Kerns, 53 P.3d at 1162. See also Bankers Trust Co. v. El Paso Pre-Cast Co., 192 Colo. 468, 475, 560 P.2d 457, 462 (1977); Belleville State Bank, 345 N.W.2d at 411. The Court observed that a prospective purchaser need only conduct a standard title search -- as any prudent buyer would do -- to discern whether the property is the subject of litigation anywhere in the world. Kerns, 53 P.3d at 1162. The Court expressed concern that without a rule permitting out-of-state litigants to avail themselves of the lis pendens procedures, those interested in purchasing Colorado real estate would be unaware of an extraterritorial proceeding potentially affecting the property's title. Id. See Belleville State Bank, 345 N.W.2d at 411 (holding that the lis pendens statute has "the additional objective of giving prospective purchasers and encumbrancers notice of pending actions so that they may avoid buying a lawsuit" (internal quotation marks omitted)); Alden, supra, at 593 ("Would-be purchasers would not be responsible for searching all the courts of the nation to verify the full alienability of the land.").
Thus, the Court concluded that a broad interpretation of the Colorado lis pendens statutes furthered important public policies:
Just as it prevents the title-holder from colluding with a third party to thwart a judicial proceeding, a duly recorded notice of lis pendens also prevents him from unscrupulously foisting the property upon an innocent purchaser.
Kerns, 53 P.3d at 1162.
We are pleased to report that on the eve of trial this case settled on extremely favorable terms for our clients, including transfer to them of virtually all of the assets covered by the preliminary injunction and lis pendens notices. These two courses of action, obtaining a preliminary injunction asserting the Minnesota Court's equitable power, together with the prompt filing and vigorous defense of the lis pendens notices, were critical to our ultimate success in securing millions of dollars worth of valuable assets in this case.
For further information contact Jonathan S. Parritz at (612) 672-8334 or [email protected].
The author would like to acknowledge the contributions of Dawn Van Tassel, whose astute legal research was critical to our success in this case. Ms. Van Tassel can be reached at 612-672-8377 or [email protected].
Mr. Parritz' and Ms. Van Tassel's website biographies can be found www.maslon.com.