Recovery of Avoided Transfers: Section 550 Run Amok (Again)?

Rajala v. Husch Blackwell LLP (In re Generation Resources Holding Co., LLC), 604 B.R. 896 (Bankr. Kan. 2019) –

After a consent decree avoiding the transfer of property from the debtor to a second entity, a chapter 7 trustee sought to recover from law firms paid by the second entity from proceeds of sale of the transferred property. Recovery turned on the meaning of “immediate transferee” under section 550(a)(2) of the Bankruptcy Code.

As background, the debtor developed wind-power projects, including one referred to as Lookout. Insiders of the debtor formed a new company called Lookout Windpower Holding Company (LWHC). The debtor’s interests in Lookout were transferred to LWHC, leaving the debtor insolvent. LWHC sold the interests in Lookout for ~$6.7 million. It used a portion of the proceeds to pay ~$1.3 million and ~$700K to two law firms.

The debtor filed for bankruptcy. Eventually a consent decree was entered ordering:

(1) [the debtor] transferred an interest in the Lookout wind project to defendant [LWHC] and that transfer is avoided, and (2) [the Trustee] shall recover the value of the transfer from defendant [LWHC] in the amount of $9,941,448 with each party to bear their own costs and fees.

The court noted that the law firms were not parties to the settlement and were not bound by it.

Relying on section 550, the trustee sought to recover the money paid to the law firms by LWHC. Section 550(a) provides:

Except as otherwise provided in this section, to the extent that a transfer is avoided …, 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.

In connection with motions to dismiss, all parties agreed that (a) LWHC was the “initial transferee,” (b) the Lookout interest was the “property transferred,” and (c) the transfer was “avoided” for purposes of section 550.

The only question was whether either law firm was an “immediate transferee” of LWHC under section 550(a)(2). The firms argued this section was limited to transferees of the fraudulently transferred property itself (i.e. the Lookout interest), while the trustee argued that it also includes entities who receive proceeds of the fraudulent transferred property (as opposed to the property itself).

The firms cited a bankruptcy case holding that section 550(a) does not extend the right of recovery to proceeds:

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 interest to postpetition proceeds). I conclude … that § 550(a) permits a trustee to recover that property, or its value, only from transferees of that property.

Unfortunately for the firms, this bankruptcy court disagreed. It found that omission of the word “proceeds” was not dispositive since the trustee was authorized to recover either the property or the value of that property.

The court reasoned that if LWHC had retained the proceeds, the trustee could have recovered them because they represented the value of the Lookout interest. It then concluded that the plain language of section 550 allows the trustee to recover the value from any immediate or mediate transferee “without any reference to, or limitation on, what property LWHC transferred away.”

In addition to the plain language, the court noted that the purpose of section 550 is “to restore the estate to the financial condition that would have existed had the transfer never occurred.” It rejected the firms’ interpretation because the court asserted this would mean that the proceeds were immune from recovery so long as LWHC transferred them to anyone “whether for value or not, and whether in good faith or bad faith.”

Accordingly, the law firms’ motions to dismiss were denied.

This seems to be a surprisingly broad interpretation of the scope of recovery for avoided transfers. Under section 550((b) a trustee cannot recover from an immediate transferee that takes for value without knowledge of the voidability of the transfer. This defense is not addressed in the opinion, so perhaps the facts suggest that the law firms were complicit in the fraudulent transfer transaction, causing the court to be less than sympathetic?

Note that this will not be the first time that section 550 has been broadly construed to the consternation of those affected. For a while third-party lenders with debt guaranteed by insiders found themselves exposed to potential preference recovery for payments made during the extended insider one year look back period (as opposed to the normal 90 day look back period).

Vicki R Harding, Esq.

About BankruptcyRealEstateInsights

Vicki R. Harding was a partner in the Detroit office of Pepper Hamilton LLP who moved to Arizona seeking warmer weather. Ms. Harding continues to handle commercial transactions with an emphasis on real estate and bankruptcy issues (but no longer owns a snow shovel).
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