Fourth Circuit Clarifies Narrow Scope of Earmarking, Trust and §541(b)(1) Exclusions in Bankruptcy Estates

Introduction

In In re: Star Development Group, LLC, the Fourth Circuit addressed whether $1 million held in a bank account in the debtor’s name—funds originally deposited by a related entity and its managing member—must be included in the Chapter 7 bankruptcy estate. The appeal stemmed from an adversary proceeding brought by Hopkins Hospitality Investors, LLC (“HHI”) and Mukesh Majmudar (collectively, “Plaintiffs”) against the Chapter 7 trustee, Zvi Guttman. Plaintiffs sought a declaratory judgment that the money deposited in a debtor‐owned account was not estate property. They advanced three independent theories: (1) earmarking, (2) implied trust, and (3) exclusion under 11 U.S.C. § 541(b)(1). The bankruptcy court and the district court rejected each theory. On April 17, 2025, a unanimous Fourth Circuit panel affirmed, establishing important guardrails for these defensive doctrines.

Summary of the Judgment

The Fourth Circuit held, as a matter of law, that none of Plaintiffs’ three proposed exclusions removed the $1 million from the debtor’s bankruptcy estate. The court concluded:

Earmarking applies only when a debtor borrows from one creditor to pay a specific, existing debt to another and actually does so; here, no such agreement or payment existed.
No express or implied trust was created in favor of the bank (or HHI); under Maryland law, trusts require clear and convincing evidence, absent here.
Section 541(b)(1) excludes only a debtor’s power held solely for another’s benefit (e.g., a trust power); it does not apply to raw funds in the debtor’s account intended for another entity.

Accordingly, the deposited funds remained “property of the estate” under 11 U.S.C. § 541(a)(1).

Analysis

1. Precedents Cited

In re ESA Environmental Specialists, Inc., 709 F.3d 388 (4th Cir. 2013): Defined and narrowly construed the earmarking defense under § 547.
Begier v. IRS, 496 U.S. 53 (1990): Held that property held in constructive trust is excluded from the estate under § 541(d).
In re FirstPay, Inc., 773 F.3d 583 (4th Cir. 2014): Applied Maryland law to define trust creation and the “clear and convincing” standard.
Sheehan v. Ash, 889 F.3d 171 (4th Cir. 2018): Recognized that bank accounts in the debtor’s name presumptively belong to the estate.
In re LandAmerica Financial Group, 412 B.R. 800 (Bankr. E.D. Va. 2009): Presumed that funds in a debtor’s bank account are estate property.
T & B Scottdale Contractors, Inc. v. United States, 866 F.2d 1372 (11th Cir. 1989): Took a broader view of § 541, but was distinguished as factually inapposite.
Other § 541(b)(1) cases (e.g., In re Cybermech, Inc., Shurley, Unicom): Excluded only a debtor’s limited powers or rights held for another.

2. Legal Reasoning

The court applied a de novo standard to issues of statutory interpretation and summary judgment rulings. It began by acknowledging that § 541(a)(1) broadly defines “property of the estate” to include “all legal or equitable interests of the debtor in property as of the commencement of the case.” Because the account was in the debtor’s name and no statutory exception plainly applied, the starting presumption favored inclusion.

For each exclusion theory, the Fourth Circuit analyzed both the governing law and the evidentiary record:

Earmarking: Under ESA Environmental Specialists, earmarking is a defense to preference actions (§ 547) that requires (a) a new loan, (b) a requirement to pay a specific, existing creditor, and (c) actual payment. Here, no agreement compelled the debtor to use the money only to pay the bank, and no payment ever occurred.
Trust: Section 541(d) excludes only equitable interests the debtor holds in trust for another. Maryland law requires express or implied trusts created by clear, deliberate language or operation of law. Neither the account agreement nor any other contemporaneous document created such a trust, and debtor’s own prior sworn statements denied holding any trust property.
§ 541(b)(1) Exclusion: That provision excludes “any power that the debtor may exercise solely for the benefit of an entity other than the debtor.” The court held it applies to discrete fiduciary powers (e.g., trust powers, powers of appointment), not to sums of money in a debtor’s account that might benefit a third party.

3. Potential Impact

This decision reinforces strict boundaries around non-statutory and statutory exceptions to property of the estate:

Lawyers and debtors cannot rely on subjective intent or side agreements to carve out estate assets without contemporaneous, written, binding instruments.
Earmarking remains confined to the preference-action context and will not serve as an independent cause of action.
Trusts under § 541(d) must be documented or clearly implied; mere holding of funds under a letter of credit arrangement will not suffice.
Section 541(b)(1) defenses will be limited to narrowly defined powers, preserving the broad sweep of § 541(a).

Complex Concepts Simplified

Earmarking: A judicially created defense to preference claims. It applies when a debtor receives a loan from one lender to pay a specified existing creditor and actually makes the payment.
Bankruptcy Estate (§ 541(a)): All legal and equitable interests of the debtor as of filing, wherever located and whoever holds them, unless an exception applies.
Trust Exclusion (§ 541(d)): Money a debtor holds in a trust for another is excluded to the extent the debtor has no equitable interest. Requires clear evidence of trust creation.
Power Exclusion (§ 541(b)(1)): A “power” (e.g., to appoint trust property or to sue on behalf of another) held solely for a third party is excluded; raw funds in a debtor’s bank account are not a “power.”

Conclusion

In In re Star Development Group, LLC, the Fourth Circuit reaffirmed that bankruptcy’s broad definition of estate property is not easily circumvented. Earmarking remains a narrow preference defense, trusts require clear formation evidence, and § 541(b)(1) protects only discrete fiduciary powers. Absent precise written agreements or statutory carve-outs, funds in a debtor’s account will be swept into the estate. This decision brings welcome clarity and predictability to practitioners navigating the boundaries of estate inclusions and exclusions.