Consumer Bankruptcy Journal Winter 2018 - Page 40

Up Against the Wall (design) By Wayne Silver, Wayne Silver Law Mountain View, California (First appeared: Bankruptcy’s avoiding powers often turn otherwise unexceptional transfers on their heads. Henry to recover all of the money she was paid for her work as fraudulent transfers. outcomes in quite some time. But who expected that an unsuspecting business would have to disgorge nine years of honestly earned payments because the customer paid with a check on his LLC? And the third court to hear the case held that the payments were fraudulent as to the debtor, since Bello got the benefits, and Ms. Henry didn’t get the good faith defense of Bankruptcy Code 550(b)(1). At first, the Ninth Circuit correctly focused on the critical distinction between an initial and subsequent transferee, because trustees have an absolute right of recovery against the “initial transferee” and any “entity for whose benefit such transfer was made.” Welcome to the 9th Circuit’s decision in Walldesign. Paid with someone else’s money. For nearly a decade, Ms. Henry provided design and construction- related services for a building owned by Mr. Bello at her standard rates, in arms’ length transactions. Aside from their commercial dealings, she had no ongoing relationship with Bello, his family, or any of his businesses. He spent over $230,000 on Ms. Henry’s design services and paid for them using checks from businesses he operated, one of which was called Walldesign. What Ms. Henry didn’t know was that the payments from Walldesign came from a secret Walldesign bank account Bello used to siphon money from Walldesign to support his lavish lifestyle. When Walldesign filed for bankruptcy, the creditors’ committee sued Ms. 40 CONSUMER BANKRUPTCY JOURNAL Can she get to the safe harbor? At trial in the bankruptcy court, the court held that the Committee could only recover the fraudulently transferred funds solely from the corporate cheat (Bello), and not from Ms. Henry, because Ms. Henry was a subsequent transferee who accepted these payments for value, in good faith, and without any knowledge of their voidability. (See 11 U.S.C. §550(b)(1) (the “safe-harbor” provision)). Seems like a logical and equitable result for a court of equity like the bankruptcy court. But wait. The Committee appealed and the District Court reversed, finding the Committee could recover the funds from both the corporate cheat and those parties to whom Bello first made payments from the secret Walldesign corporate account. The Ninth Circuit affirmed, giving us one of the most inequitable bankruptcy Winter 2018 Who was the initial transferee? And while trustees theoretically can also recover from subsequent transferees, those subsequent transferees who accepted the property “for value, in good faith, and without knowledge” of the voidability of the transfer are safe. § 550(b). But then the Ninth Circuit found that although “transfer” is defined broadly in §101(54)(D), the definition was “misplaced in connection with the inquiry at hand: determining whether Ms. Henry qualified as an initial transferees under §550(a)(1)”. Instead, the Ninth Circuit decided to use the Seventh Circuit’s approach in Bonded Fin. Servs., Inc. v. European Am. Bank, 838 F.2d 890, 894 (7th Cir. 1988), which found that treating anyone who touches the money as a transferee could lead to absurd results and require useless analytical steps. National Association of Consumer Bankruptcy Attorneys