Commentary: A gold dealer and investor meet the bankruptcy judge

A quick review of the reported bankruptcy cases reveals a pleasant surprise: There are few reported bankruptcy cases involving insolvent gold dealers. Nevertheless, every dog has its day, and considering the volatility of the gold market of late, it may be worthwhile to examine one of the few reported bankruptcy cases involving a gold dealer. It is not a pretty sight.

In Matter of International Gold Bullion Exchange, Inc., [53 B.R. 57 (Bankr.S.D.Fla. 1985)], an investor delivered to a gold dealer thirty 100 oz. silver bars and 65 gold Krugerrands worth US$49,425 in total, together with US$2,834 in cash.

The purpose was to have the precious metals stored by the gold dealer for the investor’s benefit, and the dealer issued to the investor a Precious Metals Certificate of Ownership on Sept. 7, 1982.

On March 14, 1983, after repeated demand by the investor, the dealer delivered to the investor three thousand 1 oz. silver bars and seventy 1 oz. gold Krugerrands, together with two cheques in the amount of US$3,325 and US$4,995, which were intended to fully settle the dealer’s obligations to the investor.

If the investor breathed a sigh of relief, he soon found that it was premature. The gold dealer filed a petition in bankruptcy shortly thereafter, and the bankruptcy trustee sued the investor to recover the precious metals for the benefit of the bankruptcy estate on the legal theory that the debtor’s transfer to the investor was a preference.

The bankruptcy court in Miami ruled that because the transfer was made within 90 days prior to the bankruptcy for the purpose of settling the pre-existing obligations of the gold dealer to investor, it was indeed a preference, and ordered the investor to return the metals to the debtor’s estate (so that all creditors could share equally), or face entry of a money judgment against him in the amount of US$70,975, which was the value of the metals on the date that the investor received them from the dealer.

The court rejected the investor’s argument that the transaction was a “bailment.” A bailment is a transaction where one person delivers possession of personal property to another for a special purpose, but without transferring ownership.  A good example is when you drop off your car at a repair shop for service. The repairman is a bailee. He does not take ownership of the vehicle — merely possession. The investor was arguing, in effect, that by delivering the precious metals to the dealer for storage, he was creating only a bailment, not transferring ownership of the metals to the dealer.

The court said that in order for there to be a bailment, there would need to be an agreement for a bailment. Apparently, the court did not consider the certificate of ownership to qualify in that regard. More to the point, however, the court noted that when the dealer received the gold and silver from the investor, the dealer immediately applied it for the dealer’s own use, and did not store it. The gold and silver that the dealer returned to the investor was different gold and silver, which the dealer acquired immediately before sending it to the investor.

The court also cited the Uniform Commercial Code, which specifically states that any “entrusting” of possession of goods to a merchant who deals in goods of that kind gives him power to transfer all rights of the entruster to a buyer in the ordinary course of business. By entrusting the gold and silver to the gold dealer, the investor gave to the dealer power to sell the precious metals to a bona fide purchaser.

However, whether the gold dealer was acting properly or improperly when it failed to store the metals, the fact remains that the metals were not stored. The gold and silver that the investor received was different gold and silver, and so the investor had no property interest in that gold and silver until he actually received it from the gold dealer. That being the case, it seems as a legal matter that the bankruptcy court was correct in its conclusion.

It was a hard lesson for the investor, and it underscores both the importance of doing business only with a reputable dealer, and of securing physical possession of the gold through some trustworthy means other than simply allowing a dealer to hold possession for the investor’s benefit.

— David E. Peterson is of counsel with Lowndes, Drosdick, Doster, Kantor & Reed, P.A., and has a broad background in bankruptcy and creditors’ rights, as well as commercial litigation. He represents lenders, creditors and lessors in sophisticated Chapter 11 reorganizations and Chapter 7 liquidations.

Based in Orlando, Fla., and founded in 1969, Lowndes, Drosdick, Doster, Kantor & Reed, P.A., is a multi-practice law firm with approximately 100 attorneys. Visit www.lowndes-law.com for more information.