Delaware Bankruptcy Court Allows Recovery from Subsequent Transferee Without Naming Initial Transferee

Summary

Ruling  on a question “where there is a square circuit split and no Third Circuit authority,” the united States Bankruptcy Court for the District of Delaware (the Court) recently held that in a fraudulent transfer action, it is not necessary to name the initial transferee in order to sue a subsequent transferee for recovery of fraudulently transferred funds.  However, avoidance of the initial transfer is an element which must be proved in order for a trustee to prevail against the subsequent transferee.  Phillips v SS Associates LLC (In re ONH AFC CS Investors, LLC), ___ B.R. ___, 2026 WL 312892, 2026 Bankr. LEXIS 293 (Bankr., D. Del. February 4, 2026).  To view the opinion, click here:

Read the full decision.

FACTS

Elchonon Schwartz formed debtor ONH AFC CS Investors LLC and other entities as part of a group of companies organized under Nightingale Properties LLC with the stated intention of raising equity from third parties to invest in real estate in Atlanta, Georgia.  The money raised from investors was to be held in the debtors’ bank accounts, controlled by Schwartz, until used for  investment in the Atlanta Financial Center.  Schwartz instead used the investor funds for his own personal use. He eventually pled guilty to wire fraud in February 2025.

The investment entities filed chapter 11 bankruptcy petitions in July 2023.  The plan confirmed by the Court in December 2023 created a trust which succeeded to the debtors’ claims.  The trustee filed a fraudulent transfer action against SS Associates LLC (“SS”) as the subsequent transferee of $250,000 in funds which originated with the debtor, were transferred to Schwart’s bank account,  and then were transferred to SS.  The debtors had no business dealings with SS.

SS filed a motion to dismiss the complaint under Federal Rule of Civil Procedure 12(b)(6), asserting that the complaint failed to state a claim because the initial transferee, Schwartz, was not a named party.  The Court overruled the motion, holding that it was not necessary to name the initial transferee in an action against a subsequent transferee as a matter of law.

REASONING

The Court recognized that the question presented on the motion was one which had split circuits, without controlling precedent in the Third Circuit.  However, the Court made analogy to a slip and fall case, where the victim routinely may sue the grocery store without suing the employee who spilled the liquid which caused the accident.  Although the plaintiff must prove the spilled liquid caused the fall, there is no reason to sue the employee.  In the same way, although the trustee must prove that the initial transfer is avoided, there is no reason why the initial transferee need to be a party to the action against the subsequent transferee.

Looking at the complaint, the Court first noted that it adequately alleged that the debtors made an actual fraudulent transfer to Schwartz under § 548 when he took the investor money and put it into his own bank account.  When Schwartz then transferred $250,000 of the investor money to SS, SS became the subsequent transferee from whom the transfer or its value may be recovered under § 550(a).  Where the Court differed from other decisions on the issue, in particular In re Slack-Horner Foundries Co.,  971 F. 2d 577 (10th Cir. 1992), was whether the initial transferee (Schwartz) was a necessary party.  The Tenth Circuit said yes, he must be named, and the Court (and others described below) said no.

The Court saw as the major flaw in the Slack-Horner reasoning that it failed to recognize that the avoidance of the initial transfer is just an element of the claim that needs to be proved in the action against the subsequent transferee before recovery may be had against that subsequent transferee.  The fraudulent transfer statute, § 548, requires that the initial transfer be avoided.  However, that element can be proved without naming the initial transferee as a party.  Here, presumably part of the criminal plea agreement with Schwartz was a waiver of civil claims against him, so he could not be named.

In ruling that the initial transfer must be avoided but the initial transferee need not be named, the Court aligned itself with the Ninth Circuit BAP in In re AVI, Inc.  389 B.R. 721, 734 (9th Cir. BAP 2008) and  the Southern District of New York in Securities Investor Prot. Corp v. Bernard L Madoff Inv. Sec. LLC, 501 B.R. 26, 31 (S.D. N. Y. 2005).

AUTHOR’S COMMENT:     

The Court’s reasoning is simple and straight-forward.  The statute does not require the presence of the initial transferee in the lawsuit.  But the plaintiff must prove the avoidance in order to prevail. 

[The Commercial Finance Newsletter is written by an ad hoc group of lawyers in the Business Law Section of the California Lawyers Association.  This review was written by the Hon. Meredith Jury, U.S. Bankruptcy Judge, Central District of California (Ret.), a member of the ad hoc group.   The opinions contained herein are solely those of the author.]