Tenth Circuit: Bankruptcy Trustee May Recover Only the Actual Property (Not Proceeds) Fraudulently Transferred to Subsequent Transferees

The ability of a bankruptcy trustee to avoid certain transfers of a debtor's property and to recover the property or its value from the transferees is an essential tool in maximizing the value of a bankruptcy estate for the benefit of all stakeholders. However, a ruling recently handed down by the U.S. Court of Appeals for the Tenth Circuit could, if followed by other courts, curtail a trustee's avoidance and recovery powers. In Rajala v. Spencer Fane LLP (In re Generation Resources Holding Co.), 964 F.3d 958 (10th Cir. 2020), reh'g denied, No. 19-3226 (10th Cir. Aug. 24, 2020), the Tenth Circuit held that, according to the plain language of section 550(a) of the Bankruptcy Code, a recipient of proceeds traceable to fraudulently transferred property does not qualify as a "transferee" because the recipient does not possess the fraudulently transferred property itself.

Post-Avoidance Recovery of Property or Its Value in Bankruptcy

If a bankruptcy trustee, a chapter 11 debtor-in-possession ("DIP"), or, in some cases, an individual debtor (see 11 U.S.C. § 522(i)) avoids a transfer of the debtor's property under any of the avoidance provisions of the Bankruptcy Code, section 550 provides that, with certain restrictions, the trustee, DIP, or debtor may recover the transferred property or its value from the initial transferee, and from any subsequent transferee that does not take the transfer for value, in good faith and without knowledge of the transfer's voidability. It states in part as follows:

(a) Except as otherwise provided in this section, to the extent that a transfer is avoided under section 544, 545, 547, 548, 549, 553(b), or 724(a) of this title, the trustee may recover, for the benefit of the estate, the property transferred, or, if the court so orders, the value of such property, from—

(1) the initial transferee of such transfer or the entity for whose benefit such transfer was made; or

(2) any immediate or mediate transferee of such initial transferee.

(b) The trustee may not recover under section (a)(2) … from—

(1) a transferee that takes for value, including satisfaction or securing of a present or antecedent debt, in good faith, and without knowledge of the voidability of the transfer avoided; or

(2) any immediate or mediate good faith transferee of such transferee.

11 U.S.C. § 550.

The Bankruptcy Code does not define the terms "initial transferee," "immediate transferee," and "mediate transferee." Any entity that receives a transfer of property directly from the debtor is generally deemed to be the initial transferee. However, many courts have concluded that a party acting as a mere conduit in connection with a transfer from the debtor to a third party is not a "transferee" and, therefore, not the initial transferee. See, e.g., Lamonica v. Harrah's Atlantic City Operating Co., LLC (In re JVJ Pharmacy Inc.), 2020 WL 4251666, at *9 (Bankr. S.D.N.Y. July 24, 2020) (citing and discussing cases); see generally Collier on Bankruptcy ("Collier") ¶ 550.02[4][a] (16th ed. 2020) (same). Section 550(a)'s distinction between initial transferees and immediate and mediate transferees of the initial transferee is important. The protections of section 550(b) are given only to those subsequent transferees. Id.

Finally, the court may authorize recovery of the value of property transferred rather than the property itself. The Bankruptcy Code is silent as to the circumstances under which this may be warranted. In keeping with the intent of section 550 to restore the estate to the financial condition it would have enjoyed if the transfer had not occurred, courts exercising their broad discretion in this context consider several factors, including whether the property can be recovered, whether it has diminished in value due to depreciation or conversion, whether the value of the property is disputed, and whether a monetary award would result in a savings to the estate. See Collier at ¶ 550.02[3].

Generation Resources

Generation Resources Holding Company, LLC ("GR") developed three wind power projects in Pennsylvania. The projects were to be sold to Edison Capital ("Edison"), which agreed to construct the projects pursuant to a memorandum of understanding. After it became clear that GR was on the brink of insolvency, GR insiders created two other companies—Lookout Windpower Holding Company, LLC ("Lookout") and Forward Windpower Holding Company, LLC ("Forward")—to assume GR's development rights for the wind projects. Edison later agreed to pay $13 million for the projects to Lookout and Forward instead of GR.

After defaulting on its debts, GR filed a chapter 7 petition in the District of Kansas on April 28, 2008.

In December 2008, Lookout hired the law firm Husch Blackwell LLP ("Husch") to sue Edison for the balance due on the wind power projects. In April 2009, GR's chapter 7 trustee informed Husch that the claims against Edison involved funds that belonged to GR's estate. Shortly afterward, Husch sued Edison on Lookout's behalf in federal district court.

After denying the trustee's motion to enjoin the litigation, the district court entered a $9 million judgment in May 2011 against Edison in Lookout's favor. The district court then transferred enforcement of the judgment to the bankruptcy court to determine whether the judgment was property of GR's bankruptcy estate. Edison deposited funds to cover the judgment in the bankruptcy court's registry.

Another law firm—Spencer Fane LLP ("Spencer")—appeared on behalf of Lookout and Forward in GR's bankruptcy case and successfully petitioned the court for an order determining that the $9 million judgment was not property of GR's bankruptcy estate because the trustee had not yet commenced litigation on his fraudulent transfer claims. The court distributed the proceeds of the judgment to Lookout in May 2012. After the trustee unsuccessfully attempted to enjoin dissipation of the funds, Lookout ultimately distributed the proceeds during the next four years to several different recipients, including Spencer, which received approximately $723,000 in legal fees, and Husch, which received approximately $1.3 million in fees.

The trustee subsequently brought fraudulent transfer claims against the GR insiders, Lookout, and Forward. The bankruptcy court entered summary judgment in favor of the defendants, but the Tenth Circuit reversed on appeal (in a separate case). In May 2017, the chapter 7 trustee settled the fraudulent transfer litigation against the GR insiders, Lookout, and Forward. The bankruptcy court entered a consent judgment avoiding the transfers of GR's development rights and empowering the trustee to recover approximately $11.5 million from Lookout and Forward.

Unable to collect from Lookout and Forward, the trustee commenced an adversary proceeding in March 2018 against Spencer and Husch, seeking to recover under section 550 the more than $2 million in fees paid to the two law firms. The bankruptcy court denied the firms' motion to dismiss the complaint, holding that the defendants were transferees of proceeds derived from the fraudulent transfer claims. The bankruptcy court certified a direct appeal of its ruling to the Tenth Circuit.

The Tenth Circuit's Ruling

The Tenth Circuit reversed, ruling that the trustee could not recover the fees paid to Spencer and Husch because they were not "transferees" within the meaning of section 550(a). Examining the plain language of section 550(a), the Tenth Circuit concluded that the law firms were not transferees of the fraudulently transferred property—GR's contractual right to receive the sale proceeds from Edison—and consequently did not fall within the ambit of section 550(a). The Tenth Circuit explained that there was no evidence that GR transferred the right to receive sale proceeds to Spencer and Husch. Therefore, the court wrote, "neither firm is a transferee of the property that was set aside as fraudulently transferred."

The Tenth Circuit rejected the chapter 7 trustee's argument that, because section 550(a) permits recovery of "the property transferred, or, if the court so orders, the value of such property," he had the right to recover proceeds from the fraudulent transfer as the "value" of the fraudulently transferred property. Even if the bankruptcy court had ordered recovery of the value of the transferred property, the Tenth Circuit reasoned, the chapter 7 trustee could not recover under section 550(a) because "the firms [were] not transferees" of the property that was fraudulently transferred.

According to the chapter 7 trustee, because section 541(a)(6) of the Bankruptcy Code provides that property of the estate includes the "proceeds" of estate property, the "property transferred" under section 550(a) should similarly include the proceeds of that property. The Tenth Circuit rejected this argument as being contrary to the plain language of section 550(a), "which permits the trustee to recover certain property from a limited group of persons." Because Spencer and Husch were not transferees of the fraudulently transferred property (i.e., the right to proceeds from the wind projects sale), "nothing about § 541's definition of property expands the trustee's powers under § 550 to recover from persons who are not transferees." 

The Tenth Circuit further noted that the chapter 7 trustee's argument was inconsistent with the "structure" of section 541. Although section 541(a)(6) provides that proceeds of estate property are property of the estate, section 541(a)(3) provides that "[a]ny interest in property that the trustee recovers under section … 550" is estate property. The Tenth Circuit noted that "if proceeds were available under § 550, there would be no reason to list them separately in § 541." And, "[t]he fact that the Code treats '[p]roceeds' as distinct from 'property that the trustee recovers' under § 550 is strong evidence that the two species of property are different, at least in some respects."

Finally, the Tenth Circuit observed that lawmakers evidently knew how to include proceeds in the scope of section 550(a), yet declined to do so:

§ 541 demonstrates that when Congress intended to include proceeds, it knew how to do so. Section 550 allows the trustee to follow the property fraudulently transferred and recover it, or its value. And it permits the trustee to recover only from transferees of the property. If its intent was to provide the trustee the power to trace proceeds derived from the property against any person who received those proceeds as payment for goods or services, Congress could have said so.

Possible Implications

According to the Tenth Circuit's interpretation of section 550(a), if a debtor fraudulently transfers a contract claim to an entity that converts the contract claim to cash and thereafter transfers the cash to a subsequent transferee, the trustee cannot recover the payments to the subsequent transferee because it did not receive the fraudulently transferred property (i.e., the contract claim). This could be the case even if the subsequent transferee knew that the initial transfer was fraudulent.

Whether or not this is an accurate construction of section 550(a) is an open question. Although the Tenth Circuit did not cite any authority in support of its decision, such cases exist, including one discussed by the bankruptcy court in Generation Resources. In Lassman v. Santosuosso (In re Ruthaford), 2015 WL 1510566, at *12 (Bankr. D. Mass. Mar. 30, 2015), a chapter 7 trustee argued that transfers of real property from debtor to a person who subsequently sold the property to a good faith buyer were avoidable under section 544 and state fraudulent transfer law. The trustee sought to recover some of the proceeds of the real property under section 550(a)(2) from two defendants—an attorney and a law firm—to whom the real property itself had never been transferred. The court held that the defendants were entitled to summary judgment, reasoning:

Section 550(a) does not extend the right of recovery to the proceeds of the property transferred. Where the drafters of the Bankruptcy Code meant to include proceeds, they were clear about it. See 11 U.S.C. §§ 541(a)(6) (property of the estate includes proceeds of property of the estate) and 552(b)(1) (extending certain prepetition security interests to postpetition proceeds). I conclude … that § 550(a) permits a trustee to recover that property, or its value, only from transferees of that property.

2015 WL 1510566, at *12; see also In re Air Conditioning, Inc. of Stuart, 845 F.2d 293, 299 (11th Cir. 1988) ("The district court, in fact, did not allow the trustee to recover the proceeds of the letter of credit (as LSC characterizes the district court's judgment). Instead, the district court correctly allowed the trustee to recover from LSC the property transferred: the certificate of deposit."). 

However, this view is at odds with the approach applied by courts in a number of other cases. See, e.g., In re Wolf, 595 B.R. 735, 788 (Bankr. N.D. Ill. 2018) ("Scott Wolf, SHBM, Hound Ventures, and Michael Wolf, as alleged, are subsequent (mediate or immediate) transferees of the proceeds, products, or profits of the allegedly fraudulently transferred property (the MMQB business). The value of the MMQB business may be recovered from ZZC as an initial transferee and from Scott Wolf and MMQB, Inc. as subsequent transferees."); In re Fehrs, 391 B.R. 53, 76 (Bankr. D. Idaho 2008) ("The initial transferee, Jae, sold the Terrill Loop Property to the Johansens, converting that real property interest to cash. He then allowed all the cash proceeds (with the exception of $200.00) to be retained by Debtor, who became an 'immediate or mediate' transferee. … Trustee adequately traced the proceeds of sale into her hands, and established that the same represented 'the value of such property' under § 550(a)."); see also In re Richmond Produce Co., Inc., 118 B.R. 753, 756–57 (Bankr. N.D. Cal. 1990) ("To be an ultimate transferee [for purposes of section 550(a)], one must receive the fraudulently transferred property or, at a minimum, its proceeds."); In re Morris Commc'ns NC Inc., 75 B.R. 619, 629 (Bankr. W.D.N.C. 1987) ("The clear legislative intent of [sections 548 and 550] is that the fraudulently transferred property and all proceeds and profits derived therefrom should be returned to the trustee subject only to certain specific liens in favor of a good faith transferee."), rev'd on other grounds, 914 F.2d 458 (4th Cir. 1990).

The Tenth Circuit's ruling has also been criticized by leading commentators. See, e.g., Bruce A. Markell, Where Does the Flame Go When the Candle Is Blown Out, or Why Can't Courts Grasp the Concept of Intangibles?, 40 Bankr. L. Letter 1 (2020) (contending that the Tenth Circuit "got it wrong" in Generation Resources).

Moreover, the Tenth Circuit's approach is arguably inconsistent with the purpose of section 550. See In re Fabric Buys of Jericho, Inc., 33 B.R. 334, 336–37 (Bankr. S.D.N.Y. 1983) ("Section 550 provides the Trustee with greater flexibility to recover preferences when the actual transferee of its assets may have disappeared at the direction of another entity. … By passing section 550, Congress hoped to preclude multiple transfers or convoluted business transactions from frustrating the recovery of avoidable transfers."). Indeed, it is logical that section 550 brings all of the debtor's property—including the proceeds thereof—into the estate because, "'property of the debtor' is best understood to mean property that would have been part of the estate had it not been transferred." Begier v. IRS, 496 U.S. 53, 59 (1990).

While superficially appealing—and textually precise—the holding in Generation Resources may severely impair the ability of bankruptcy trustees in avoidance litigation to recover property or its value from subsequent transferees. Indeed, nefarious parties could immunize a transferee from liability by orchestrating a conversion of the fraudulently transferred property to cash that is then transferred to the intended recipient. To the extent this is the case, the Tenth Circuit's ruling is a startling development in fraudulent transfer law, which generally recognizes that property of the debtor subject to avoidance is property that would have been property of the estate had it not been transferred, which includes the proceeds of such property. This approach is in keeping with the court's power to authorize recovery of the "value" of the property. Further, the defenses available under section 550(b) to subsequent transferees—i.e., good faith recipients—should be adequate to maintain the balance between the estate's recovery of fraudulently transferred property and a good faith subsequent transferee's right to retain such property.


One bankruptcy court in another circuit already also parted ways with the Tenth Circuit's approach in Generation Resources, writing that the decision creates "perverse incentives" for the initial transferee to liquidate the property to make the proceeds "unrecoverable." In In re Giant Gray, Inc., 2020 WL 6226298 (Bankr. S.D. Tex. Oct. 22, 2020), the CEO of a financially distressed software company secretly arranged for the company to issue to him convertible preferred stock, which he sold for $15 million that otherwise would have been paid to the company. He claimed that he gave adequate consideration for the stock by agreeing to take on the additional role of chairman. The CEO transferred approximately $5 million of the proceeds to subsequent transferees.

After creditors filed an involuntary chapter 7 case against the company, the chapter 7 trustee sued the subsequent transferees to avoid and recover the $5 million as a fraudulent transfer under the Texas Uniform Fraudulent Transfer Act and sections 544 and 550(a)(2) of the Bankruptcy Code. The defendants moved to dismiss. They argued that, in accordance with Generation Resources, they were not subsequent transferees subject to avoidance liability because they received proceeds from the preferred stock, not the stock itself.

The bankruptcy court acknowledged that Generation Resources "is the only circuit-level case directly on point." Even so, after examining the language of section 550, the court concluded that, although the initial transferee must have received a transfer of the property, "that same restriction is not placed on immediate and mediate transferees." If Generation Resources were correct, the court explained, a subsequent transferee could take proceeds with knowledge of the fraud and still escape liability. "That result," it wrote, "fails to consider Section 550(a) in context … [and] [t]he complete defense set forth in Section 550(b) adequately protects those who were not privy to the initial transferee's wrongdoing." The court ultimately denied the motion to dismiss, observing that the approach taken in Generation Resources does not "square with the Bankruptcy Code's policy of maximizing the estate for all creditors."

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