When a company files bankruptcy, you can generally assume that funds in its bank accounts will be property of the bankruptcy estate. Exceptions are rare.
In Chapter 7, more money in the estate means more money for creditors. In a decision this year by the Fourth Circuit Court of Appeals, In re Star Development Group, LLC, a debtor tangled with a Chapter 7 Trustee over a $1 million deposit and failed to convince the courts that it should not be estate property.
In 2013, Hopkins Hospitality Investors, LLC ("HHI") and a related entity began developing a hotel in Maryland, with Star Development Group serving as the development manager. Mukesh Majmudar was the owner of both companies. To finance construction, they obtained loans from PeoplesBank, including a Small Business Administration–backed bridge loan. As the project neared completion, payment disputes with the general contractor led to a mechanic’s lien of over $1.7 million. Because the lien blocked refinancing of the bridge loan, the parties struck a deal: Hanover Insurance would issue a bond to lift the lien—but only if backed by a $1 million irrevocable letter of credit.
The bank agreed to provide the letter of credit if it received $1 million in cash collateral. Majmudar and HHI supplied the cash. But rather than deposit the funds into HHI’s name, Majmudar opened a new account in Star Development Group’s name, supposedly to avoid complications with the SBA. He and HHI deposited $1 million into the account. Star Development Group then executed a promissory note, business loan agreement, and assignment pledging the account to the bank as collateral for the letter of credit. The bond was issued and the project continued.
In 2017, an arbitrator awarded $1.7 million to the contractor against Star Development Group. Two years later, Star Development Group filed Chapter 7. In its bankruptcy filings, the Debtor—through Majmudar—represented multiple times under penalty of perjury that it held no property belonging to others. The account was listed as the Debtor’s property, the interest earned on the account was reported as the Debtor’s income, and some of that interest was even used to pay the Debtor’s legal fees.
But in 2020, Majmudar amended the schedules to claim that the $1 million was really owned by HHI and himself. HHI and Majmudar advanced three arguments for why the bankruptcy court should exclude the account from the bankruptcy estate. First, they claimed the $1 million was “earmarked” for the bank and therefore never part of the estate. The courts rejected this argument, noting earmarking is a narrow, judicially created defense to preference actions under Section 547—not an independent claim. More importantly, there was no contemporaneous written agreement limiting the Debtor’s discretion as to the funds, which stayed in the account and never paid down a specific, existing debt.
Second, they argued the funds were held in trust for the Bank. But a trust requires clear evidence and none existed here. Indeed, the Debtor’s filings in 2019 contradicted this argument by expressly denying holding property in trust.
Finally, they argued the Debtor merely held the funds for HHI’s benefit. The courts rejected this argument because the evidence showed the Debtor owned the account, pledged it to the Bank, and represented itself as the lawful owner. There were no written agreements or other evidence to corroborate this argument.
This case provides several takeaways for investors, insiders, and creditors navigating projects involving multiple affiliated entities. Opening an account in the debtor’s name almost inevitably makes those funds property of the estate. Courts give great weight to legal title and documentary evidence over subjective intent. Bankruptcy schedules, sworn statements, tax returns, and accounting records are all scrutinized. Inconsistencies—such as later amending schedules to claim funds were “really” someone else’s—are unlikely to persuade the court.
The earmarking doctrine does not apply outside preference actions under § 547, and certainly not where funds never actually extinguished a specific, designated debt. Courts demand clear, contemporaneous evidence of a trust. Unsubstantiated after-the-fact assertions will not suffice. When insiders move funds among related entities, documenting the arrangement in real time is essential. Without written agreements, courts will presume the debtor owns what is in its own name.
The Fourth Circuit’s decision underscores a familiar truth: in bankruptcy, courts give great weight to documents, records, and sworn statements. When insiders blur the lines between entities and offer post-hoc rationales for actions that will harm the estate's creditors, the estate will usually win.
