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Suppose Mr. Investor gives $50,000 to Mr. X to invest in his business. And suppose instead of investing in the business, Mr. X gives the $50,000 to his brother, a day or so later. That would be conversion, I believe. And let's assume that this money was easily traceable.

Suppose Mr. X later files for personal bankruptcy. The bankruptcy trustee will want to pull the $50,000 of "fraudulent conveyance" to the brother into the bankruptcy estate. But the investor files a conversion claim for the same amount?

Who (the bankruptcy estate or the investor) gets priority on the $50,000 in such a situation? Is there a legal means of determining this?

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I'm assuming you're talking about U.S. federal bankruptcy law (Title 11).

Once bankruptcy is declared, any claims against the debtor are subject to the bankruptcy laws, and any claims against the debtor in any other court are automatically stayed under 11 USC 362.

That means if you bring an action against the debtor for conversion, a court will not hear it, because the debtor's bankruptcy stays any such action.

It gets more complicated if you want to sue the brother. In general, except in limited circumstances, the brother is not protected by the bankruptcy stay. [source]. So you can likely sue the brother.

Your question about "priority," however, may be based on a misunderstanding of how the law works. If you sue the brother and win, you will get a judgment against the brother, which you can then attempt to collect from the brother's assets.

If the trustee convinces a court that the property in question is, in fact, the property of the estate, the trustee can recover it from the brother, or from anyone the brother subsequently gave it to, until it is transferred to a bona fide purchaser for value--who must be unaware of the fraudulent nature of the conveyance. See 11 USC 550. Because you were aware of the fraud, you are not a bona fide purchaser for value, and the statute seems to give the trustee the ability to recover the money from you, just as it would from the brother.

In practical terms, this will rarely happen--but if it did, the bankruptcy estate would win, because the avoidance of a transfer means the property was never the brother's in the first place.

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This sort of thing can get muddy and turns on specifics like the form of the investment, and whether it was in a business entity controlled by Mr. X, and then embezzled by Mr. X in transferring the money to his brother (thus potentially recoverable by the investor in an action against the company through tracing despite the personal bankruptcy); or invested in Mr. X's sole proprietorship, making it a part of his personal bankruptcy estate before it was embezzled (and thus properly recoverable by the trustee, with the investor a creditor of the bankruptcy estate).

If you really wanted to look at it through a lens of priority, I suppose you could say that in the first case of Mr. X embezzling the invested funds from a separate company, the constructive trust over the embezzled funds trumps the bankruptcy stay, but I think the better way to look at it is as above.

See, e.g., IN RE: George D. NEWPOWER for discussion of tracing embezzled funds in bankruptcy, the implications of title to property under the law of theft vs. false pretenses, and some trust theory.

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