Delaware Bankruptcy Court: Initial Transferee Need Not Be Defendant in Fraudulent Transfer Avoidance and Recovery Litigation
The Bankruptcy Code gives a bankruptcy trustee the power to avoid asset transfers that are either made with the intent to defraud creditors or that are "constructively" fraudulent because an insolvent debtor did not receive adequate value in exchange. The Bankruptcy Code also permits recovery of an avoided transfer from not only the initial recipient, but also from subsequent transferees. Courts, including two federal circuits courts of appeals, disagree over whether a transfer must actually be avoided before the trustee can seek recovery from a subsequent transferee and whether the initial transferee must also be a defendant in the recovery litigation against a subsequent transferee.
The U.S. Bankruptcy Court for the District of Delaware weighed in on this debate in Phillips v. SS Associates LLC (In re ONH AFC CS Investors, LLC), No. 23-10931 (CTG), 2026 WL 312892 (Bankr. D. Del. Feb. 4, 2026). The court adopted the majority view, ruling that the initial transferee need not be a defendant in avoidance and recovery litigation against a subsequent transferee, but that the trustee must establish the elements necessary to avoid the initial transfer as part of the recovery litigation.
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 (e.g., sections 544 (transfers avoidable under state law), 547 (preferences), 548 (fraudulent transfers), and 549 (unauthorized postpetition transfers)), 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 (emphasis added).
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. 2026) (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 these 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. Such factors include 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].
Courts disagree as to whether: (i) a transfer to an initial transferee must be actually avoided (as distinguished from being merely "avoidable") before a trustee can recover the property or its value from a subsequent transferee; and (ii) the trustee can recover from a subsequent transferee even if the initial transferee is not also a defendant in the recovery litigation.
In one camp on these issues (the minority view) lies the U.S. Court of Appeals for the Tenth Circuit. In In re Slack-Horner Foundries Co., 971 F.2d 577, 580 (10th Cir. 1992), the Tenth Circuit denied recovery from a subsequent transferee under section 550(a)(2) because the trustee failed to name the party deemed to be the initial transferee as a defendant in the recovery litigation. At least one bankruptcy court has also adopted this position. See In re Trans-End Technology, Inc., 230 B.R. 101, 104 (Bankr. N.D. Ohio 1998) (rejecting the argument that a trustee need only prove that a debtor's initial transfer was avoidable to recover from a subsequent transferee and stating that "a trustee must actually avoid an initial transfer as a prerequisite to obtaining recovery from subsequent transferees").
Arrayed (or at least partially arrayed) against the Slack-Horner camp, and representing the majority view lies the U.S. Court of Appeals for the Eleventh Circuit. In In re International Admin. Services, Inc., 408 B.R. F.3d 689, 704 (11th Cir. 2005), the Eleventh Circuit implicitly accepted the notion that an initial transferee need not be a defendant in litigation to avoid an initial transfer, and suggested that it is not necessary actually to avoid a transfer but, rather, to show that the initial transfer is "avoidable" because "strict interpretation of § 550(a) produces a harsh and inflexible result."
Many lower courts and commentators have agreed with this approach (in whole or in part). See, e.g., Securities Investor Prot. Corp. v. Bernard L. Madoff Inv. Sec. LLC, 501 B.R. 26, 31 (S.D.N.Y. 2013) (stating that "there is not basis in the language of either section 550(a) or the Bankruptcy Code's avoidance provisions to assume that avoidance actions must be brought—or fully adjudicated—against an initial transferee for recovery proceedings to go forward against a subsequent transferee"); Image Masters, Inc. v. Chase Home Fin., 489 B.R. 375, 398 n.18 (E.D. Pa. 2013) ("We find persuasive those cases that have held that § 550 does not render recovery from a subsequent transferee dependent on a prior action or recovery against the initial transferee. Indeed, the language of § 550 provides that a trustee may recover from either: the initial transferee or any immediate or mediate transferee of the initial transferee."); In re Advanced Telecomm. Network, Inc., 321 B.R. 308, 328 (M.D. Fla. 2005) ("Applicable case law and statutes do not require suit against the initial transferee before seeking to recover an avoidable transfer against subsequent transferees. Section 550 of the Bankruptcy Code provides that a plaintiff may recover a fraudulent transfer from the initial transferee or any immediate or mediate transferee."); In re Richmond Produce Co., Inc., 195 B.R. 455, 463 (N.D. Cal. 1996) ("BanCal incorrectly construes the 'to the extent that a transfer is avoided' language in section 550 to mean that in order to recover from a subsequent transferee, the trustee must first successfully avoid the transfer with respect to the initial transferee. Such an interpretation conflates Chapter 11's avoidance and recovery sections and contradicts existing Ninth Circuit law."); In re AVI, Inc., 389 B.R. 721, 734 (B.A.P. 9th Cir. 2008) (noting that "the concepts of avoidance and recovery [are] separate and distinct," and therefore the initial transferee need not be party to the recovery action against a subsequent transferee); see generally Collier at ¶ 550.02 ("Recovery 'to the extent that' a transfer is avoided has sometimes been interpreted to require a successful avoidance action against the initial transferee before recovery may be had from a subsequent transferee. The better view, adopted by the majority of courts, is that a transfer may be found avoidable and a recovery may be had from a subsequent transferee without suing the initial transferee.") (citations omitted).
ONH
ONH AFC CS Investors, LLC and its affiliates (collectively, the "debtors") were part of a group of real estate investment companies formed and directed by Elchonon Schwartz ("Schwartz"). The debtors raised funds for offerings to invest in commercial real estate projects in Georgia and Florida. Accredited investors signed subscription agreements providing that the capital raised would be held in the debtors' bank accounts, which Schwartz controlled. However, Schwartz removed the funds from the debtors' accounts and used them for personal expenses. Schwartz pled guilty to wire fraud for these indiscretions in 2025, admitting that he misappropriated the funds and made false representations to investors as the debtors' representative.
Prior to 2023, after moving investor funds to his personal bank account, Schwartz transferred $250,000 to SS Associates LLC ("SSA"), an entity unrelated to the debtors. The debtors did not receive any consideration in exchange.
In July 2023, the debtors filed for bankruptcy protection under subchapter V of chapter 11 in the District of Delaware. In December 2023, the bankruptcy court confirmed a chapter 11 plan for the debtors. The plan established a liquidating trust for the estate assets, including claims and causes of action. The plan also incorporated a settlement between the liquidating trustee and Schwartz. The settlement did not contemplate "avoiding" the debtors' transfers to Schwartz, and released him from all liabilities, including those arising from the transfers.
In July 2025, the trustee sued SSA to recover the $250,000 transfer as a transfer made with the intent to defraud creditors under state law (via section 544 of the Bankruptcy Code) and sections 548 and 550 of the Bankruptcy Code. The complaint, however, was unclear as to whether the trustee was suing SSA as an initial or a subsequent transferee (an issue subsequently resolved by the court in favor of the latter).
SSA moved to dismiss the complaint, arguing that: (i) the trustee could not recover from a subsequent transferee (Schwartz being the initial transferee) without first avoiding the transfer to the initial transferee; and (ii) the initial transferee must be a party to any action to avoid the initial transfer.
The Bankruptcy Court's Ruling
The bankruptcy court granted SSA's motion to dismiss the complaint, but without prejudice to the trustee's right to amend the complaint to request avoidance of the initial transfer.
At the outset of his decision, U.S. Bankruptcy Judge Craig T. Goldblatt noted that "[t]his is a question on which there is a square circuit split and no Third Circuit authority." ONH, 2026 WL 312892, at *2.
After examining relevant case law on both sides of the issue, Judge Goldblatt agreed that the trustee had to avoid the initial transfer to recover from either an initial or a subsequent transfer, but determined that the initial transferee (Schwartz) need not be a defendant in the avoidance and recovery litigation.
In so ruling, the bankruptcy court rejected in part the Slack-Horner (10th Circuit) approach espousing the contrary view and instead embraced the Int'l Administrative Services (11th Circuit) approach. The court agreed with Slack-Horner's conclusion that the transfer from the debtor to the initial transfer must be actually avoided, rather than merely avoidable, before a subsequent transferee can be held liable. However, Judge Goldblatt saw no reason that avoidance could not take place in the recovery litigation against the subsequent transferee, even if the initial transferee was not party to the litigation and therefore could not be bound by the court's ruling.
On that score, the bankruptcy court explained that the reasoning of Slack-Horner and its progeny was fundamentally flawed:
The central flaw of the Slack-Horner line of reasoning, which is implicitly accepted even in cases like International Administrative Services that reject its holding, is that it fails to recognize that the "avoidance" of a transfer is simply an element of claim that needs to be proven against the defendant against whom recovery is sought. It is insufficient to show that the initial transfer is "avoidable." The language of the statute is clear that the initial transfer must be avoided. There is no reason, however, why the initial transferee needs to be a party to the lawsuit in which that transfer is avoided.
The central analytic flaw in these cases is that they do not treat the avoidance of the "transfer" like an element of a lawsuit that must be established for the trustee to establish the liability of a particular defendant. Rather, they treat the "transfer" almost as if it were a physical object existing somewhere in the universe, and a bright orange sticker with the word "avoided" either has or has not been affixed to it. If it has, then the transfer has been avoided with respect to everyone and anyone, and the trustee is welcome to pursue subsequent transferees. But if the transfer has not been avoided in a case involving the initial transferee, then it cannot be "avoided" at all. At most, in the reasoning of International Administrative Services, it can be shown to be "avoidable."
Id. at *7.
The bankruptcy court accordingly rejected SSA's argument that the complaint failed to state a claim because Schwartz was not a named defendant. Given the trustee's settlement with and inability to sue Schwartz, the court remarked, to rule otherwise would mean "that all subsequent transferees have effectively won get-out-of-jail free cards." Id. at *1.
However, because the trustee's complaint did not expressly seek avoidance of the initial transfer to Schwartz, the court dismissed the complaint with leave to amend to remedy the defect.
Outlook
The bankruptcy court's ruling in ONH does not represent a sea change in bankruptcy jurisprudence regarding the ability of a bankruptcy trustee to recover fraudulent transfers from subsequent transferees. Moreover, with only $250,000 at stake and no immediate prospect of an appeal of the bankruptcy court's interlocutory ruling, the likelihood of the issue reaching the Third Circuit for additional guidance is remote.
Even so, the decision is significant. In accordance with the majority view, the ruling indicates that, although an initial transferee need not be a defendant in fraudulent transfer avoidance and recovery litigation, recovery litigation under section 550 against a subsequent transferee must seek avoidance of the initial transfer as well as recovery of the transferred property (or its value). As the court emphasized, [a]voidance is just an element of liability that must be shown to permit a trustee, as plaintiff, to recover against a [subsequent transferee] under § 550." Id. at *2.
This approach is a practical one. It conserves judicial resources by obviating the necessity of separately suing both the initial transferee and subsequent transferees. It also promotes maximization of the value of the bankruptcy estate by permitting recovery against subsequent transferees even when—as in ONH—the trustee cannot sue the initial trustee to avoid the transfer.
