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"Single-Satisfaction Rule" Does Not Preclude Bankruptcy Trustee's Recovery of Mortgage Loan Proceeds After Avoidance of Mortgage Lien

Under the "single-satisfaction rule," although a bankruptcy trustee or a chapter 11 debtor-in-possession ("DIP") may seek to avoid and recover avoidable transfers of a debtor's property from more than one transferee, the aggregate recovery is limited to the value of the property transferred. The U.S. Court of Appeals for the Second Circuit examined this rule in Jones v. Brand Law Firm PA (In re Belmonte), 931 F.3d 147 (2d Cir. 2019). The court affirmed lower court decisions that a chapter 7 trustee's avoidance of an unauthorized postpetition mortgage lien did not amount to a "double recovery" precluding the trustee from avoiding and recovering a transfer of the loan proceeds.

The Single-Satisfaction Rule

Section 550(a) of the Bankruptcy Code provides a mechanism for the recovery from initial, subsequent, "immediate," and "mediate" transferees of transferred assets (or their value) that have been avoided by a bankruptcy trustee or DIP as preferences, fraudulent transfers, unauthorized postpetition transactions, or otherwise voidable transfers. A limitation on the ability to recover avoided transfers is set forth in section 550(d) of the Bankruptcy Code, which provides that "[t]he trustee is entitled to only a single satisfaction under [section 550(a)]."

The "single-satisfaction rule" is designed to "prevent a single plaintiff from recovering its damages several times over from multiple defendants." Laborers Local 17 Health & Benefit Fund v. Philip Morris, Inc., 191 F.3d 229, 241 (2d Cir. 1999); accord Freeland v. Enodis Corp., 540 F.3d 721, 740 (7th Cir. 2008) (stating that "the trustee can recover from any combination of the entities mentioned [in section 550(a)] subject to the limitation of a single satisfaction"); Aalfs v. Wirum (In re Straightline Invs., Inc.), 525 F.3d 870, 883 n.3 (9th Cir. 2008); Attestor Capital LLP v. Lehman Brothers Holdings Inc. (In re Lehman Brothers Holdings Inc.), 2019 WL 3852445, at *12–13 (S.D.N.Y. Aug. 16, 2019); Collier on Bankruptcy ¶ 550.01 (16th ed. 2019) (the trustee is generally prevented by section 550(d) from "obtaining a windfall for the estate by recovering from multiple transferees so that the total recovery is in excess of the value of the property transferred").

Belmonte

In October 2012, creditors of Alice Belmonte ("debtor") filed an involuntary chapter 7 petition against her in the Eastern District of New York on the basis of claims arising from the debtor's activities as an investment advisor. The debtor hired the Brand Law Firm ("Brand"), a criminal defense and commercial litigation firm, to represent her in connection with the bankruptcy case.

The bankruptcy court entered an order for relief in the case in April 2013. During the gap period between the involuntary bankruptcy filing and the date of the entry of an order for relief, the debtor paid Brand $170,000 for services rendered as her bankruptcy counsel.

In October 2013, the debtor was arrested for allegedly having engaged in a scheme to defraud her creditors. The debtor retained Brand and two other criminal defense lawyers to defend her in the state criminal proceedings.

At the time of the bankruptcy filing, the debtor owned a house ("property") with her husband as tenants by the entirety. The two jointly had approximately $260,000 of equity in the property. In January 2014, the debtor and her husband executed a second mortgage on the property to secure a $250,000 loan from a friend to fund the debtor's criminal defense costs. The proceeds were wired to Brand, which retained approximately $118,864 and wired the remainder to the other two criminal defense lawyers.

In November 2014, the chapter 7 trustee commenced an adversary proceeding against the debtor, her husband, and the lender seeking to avoid the second mortgage under section 549 of the Bankruptcy Code as an unauthorized postpetition transaction. The complaint also sought to recover the second mortgage or its value under section 550(a) and to preserve the mortgage lien for the benefit of the estate under section 551. In March 2015, the bankruptcy court approved a settlement with the lender whereby the second mortgage was avoided and the lien was preserved for the benefit of the estate.

Arguing that the second mortgage loan proceeds were property of the debtor's estate, the trustee also commenced an adversary proceeding seeking to avoid the transfer of the proceeds to Brand under section 549 and to recover the $250,000 under section 550(a). In an interlocutory order, the bankruptcy court rejected Brand's argument that, because the trustee had successfully avoided the second mortgage, he was prohibited from recovering any of the loan proceeds as a double recovery. The court reasoned that, "until finally paid, litigants may look to multiple parties to recover the same loss." Because the trustee had not recovered the $250,000 allegedly borrowed by the debtor and transferred to Brand, the court wrote, "no double recovery has occurred."

The trustee separately sought a court order under section 329(b) of the Bankruptcy Code directing Brand to disgorge the $170,000 in fees it received as bankruptcy counsel during the gap period because the amount of the fees exceeded the reasonable value of the services provided.

In a March 2017 oral ruling, the court found that a reasonable fee for the services provided by Brand to the debtor as bankruptcy counsel was $50,000. The court accordingly ordered Brand to disgorge $120,000 of the fees it had received as bankruptcy counsel pursuant to section 329(b).

The bankruptcy court also found that half of the second mortgage loan amount was property of the debtor's estate because the property was jointly held by the debtor and her husband as tenants by the entirety. The court accordingly ruled that "because [Brand] retained $118,864 and because that was procured by a transaction which involved one-half of the marital residence which belonged to the estate, [Brand] will be entitled to retain one-half of the amount [it] received but must surrender to the estate the other half." According to the court, Brand was not liable for the amounts paid to the other criminal defense attorneys because it acted as mere conduit or escrow agent for funds that it did not retain.

The court again rejected Brand's claim of a double recovery. According to the court, "[t]he estate simply succeeded to any lien rights claimed by [the lender] against the Debtor's home. But recovering the fruits of that unauthorized transfer does not result in a double recovery."

In its April 2017 judgment with respect to these rulings, the bankruptcy court: (i) directed Brand to disgorge $120,000 under section 329; and (ii) awarded the trustee an additional $59,432 to be paid by Brand, pursuant to sections 549 and 550.

Brand appealed the judgment. The trustee also appealed, arguing that he should have been able to recover the full amount of the $250,000 loan proceeds from Brand.

The District Court's Ruling

The district court consolidated the appeals and affirmed the bankruptcy court's ruling. According to the district court, the bankruptcy court's analysis under section 329 was sound. In addition, the district court explained, Brand could be liable for no more than the amount of criminal defense fees it retained because the remaining funds, which were held in its trust account, were clearly earmarked for the other criminal defense lawyers. It therefore found no error in the bankruptcy court's determination to award the trustee half of the fees retained by Brand under sections 549 and 550.

The district court rejected the trustee's argument that he should be able to recover the full amount of the $250,000 loan proceeds under section 329 because the payment was for legal fees paid to Brand for its services "in connection with" the debtor's bankruptcy case, which was closely related to the criminal case, and because such fees "were inherently excessive, and provided no benefit whatsoever" to the estate. According to the district court, the bankruptcy court did not conduct a reasonableness analysis of the criminal defense fees under section 329 but instead ordered that the funds be returned under section 550.

The trustee's argument was flawed, the district court wrote, "in that he seeks to recover the same funds under § 329 that the Bankruptcy Court already ordered must be returned pursuant to § 550." The court explained that, under section 329, the bankruptcy court can order only the return of property paid to an attorney that "would have been property of the estate." Although Brand initially received $250,000, the court noted, Brand was paid only $118,864 "and only half that amount was property of the estate." The court accordingly held that there were no remaining funds for Brand to disgorge pursuant to section 329.

Brand appealed to the Second Circuit.

The Second Circuit's Ruling

A three-judge panel of the Second Circuit affirmed.

Like the lower courts, the Second Circuit concluded that the trustee's recovery of a portion of the loan proceeds did not constitute a double recovery in violation of section 550. Because the transfer of the loan proceeds was avoided pursuant to section 549, the court reasoned that the trustee was permitted to seek recovery of either the transferred property or its value pursuant to section 550.

In so ruling, the court rejected the trustee's argument that the trustee had already recovered the debtor's interest in the proceeds of the loan when it approved the settlement avoiding and preserving the second mortgage. Rather, the Second Circuit panel found that the settlement gave the trustee only the rights of a lien creditor with respect to the property, and the second mortgage lien carried with it only the right to foreclose on the property in the event of default.

Moreover, the court noted that the bankruptcy court had denied a motion by the trustee to sell the property notwithstanding the husband's joint interest as a tenant by the entirety. The Second Circuit panel reasoned that, because the trustee was unable to liquidate the estate's equity in the property, preservation of the lien did not create any value for the estate's creditors. Thus, the court explained, the trustee's only route to recovery for the estate was by seeking to recover the loan proceeds unlawfully transferred to Brand. According to the court, "where (as here) avoidance does not result in the avoided lien becoming available for liquidation and distribution to creditors, § 550(d)'s single satisfaction rule is no obstacle to recovery by the Estate from other sources."

Concluding that recovery of a portion of the loan proceeds from Brand was not barred by section 550(d), the Second Circuit affirmed the lower court decisions. The court noted that, if the trustee were to realize any recovery on the debtor's interest in the property, this amount would be reduced by the amount already recovered under section 550 from Brand.

Outlook

The Second Circuit's ruling in Belmonte does not break new ground in applying the single-satisfaction rule under section 550(d), although the narrative is clouded somewhat by challenged transfers received by the debtor's attorneys in two different capacities. Section 550 is an important tool among the avoidance and recovery powers in bankruptcy. It casts a wide net by permitting the recovery of transferred assets or their value from multiple defendants—i.e., initial and subsequent transferees—subject only to the caveat that the total amount recovered from all defendants cannot exceed the value of the property transferred.

The courts' conclusion that only one-half of the amount received by Brand was recoverable as "estate property" is interesting. The debtor's one-half interest in the loan proceeds secured by the second mortgage amounted to $125,000. Because Brand retained $118,864 of the loan proceeds as a payment of fees for representing the debtor in her criminal case, it is difficult to understand why only half of those fees were recoverable.

In addition, there is no indication in the court's rulings that the trustee pursued the other criminal defense attorneys to recover the approximately $130,000 in transfers that they received.

The Second Circuit was not the only court of appeals to weigh in on the scope of the single-satisfaction rule in 2019. In Whitlock v. Lowe (In re Deberry), 2019 WL 7046904 (5th Cir. Dec. 23, 2019), the U.S. Court of Appeals for the Fifth Circuit ruled that a bankruptcy trustee may not recover transfers under section 550(a) if the payments were returned by the transferee to the debtor prior to the bankruptcy petition date. Noting that every other court to consider the question has reached this conclusion, the Fifth Circuit vacated the bankruptcy court's determination that "the single-satisfaction rule does not apply to funds that were returned prior to the petition date." According to the Fifth Circuit, other courts have come to this conclusion on the basis of either section 550(d) or the bankruptcy courts' equitable powers to prevent the estate from realizing a windfall.

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