Business Law

Matter of DeBerry (5th Cir.)

The following is a case update written by Uzzi O. Raanan, a partner at Danning, Gill, Israel & Krasnoff, LLP, analyzing a recent decision of interest:

The Fifth Circuit Court of Appeals rejects lower court ruling that a bankruptcy trustee could avoid prepetition transfers and recover their values under 11 U.S.C. section 550(a), when the immediate transferee had returned the funds in question to the debtor prepetition, as such recovery would violate the prohibition against double recovery in Section 550(d).  Matter of DeBerry, ___ F.3d ___, 2019 WL 7046904 (5th Cir. 2019).

To view the full opinion, click here.

Facts:

A few months before debtor Curtis DeBerry filed for bankruptcy under chapter 7, his wife Kathy DeBerry (maiden name Whitlock) opened a joint Wells Fargo bank account with her sister-in-law Cheri Whitlock.  Mrs. DeBerry allegedly wanted to use the account to transfer funds to her adult children who were away at school.  As the appellate court noted, it is not clear why the joint account was needed to accomplish this goal.

Mrs. DeBerry was briefly on the joint account with Ms. Whitlock but removed herself after about three days.  However, she instructed Ms. Whitlock about how the money in the account, which was funded with a $275,000 check written on a DeBerry joint account, should be disbursed.  At Mrs. DeBerry’s request, Ms. Whitlock authorized transfers of $33,500 to a culinary school attended by the DeBerry’ daughter, $9,200 to Marla Bainbridge, whom Ms. Whitlock did not know, $32,000 to Mrs. DeBerry’s personal bank account, which was held in her name alone, and $200,000 to an account owned by the debtor’s LLC, “MBC”.  All transfers were made within two months of when the account was opened.

Ms. Whitlock testified that she never questioned requests that she make the above transfers, as the funds belonged to Mrs. DeBerry.  She was merely helping her sister-in-law.

About four months after the last two transfers, Mr. DeBerry filed his chapter 7 case.  His trustee sued Ms. Whitlock for fraudulent transfer and sought to recover from her $241,500 under Section 550(a).  The trustee settled with the DeBerry daughter regarding the $33,500 transfer.

Ms. Whitlock raised two defenses: (1)  she was never a “transferee” of the funds in question, as she was merely a “conduit” for the DeBerrys, and (2)  the funds she transferred to her sister-in-law and to MBC represented a return of funds to the debtor, so the trustee could not recover the funds from her a second time.

The bankruptcy court held that Ms. Whitlock was the “initial transferee” of the funds under Section 550(a)(1), as they became her sole property and she had dominion and control over the money.  The more difficult question was whether allowing the trustee to recover from Ms. Whitlock would result in an impermissible double recovery to the debtor’s estate.  Section 550(d) states, “The trustee is entitled to only a single satisfaction under subsection (a) of this section.”

The bankruptcy court ruled that the single satisfaction rule does not apply when the funds in question were returned prior to the petition date.  It therefore entered a judgment for the trustee, holding Ms. Whitlock liable for the entire $241,500.

The district court affirmed the trial court’s ruling and Ms. Whitlock appealed to the Fifth Circuit Court of Appeals.

Reasoning:

The court of appeals reversed the trial court’s ruling, holding that a transferee who received but returned a fraudulent transfer prepetition cannot be required to return the assets a second time when the transferor subsequently files for bankruptcy.

The court rejected the Trustee’s argument that a plain reading of Section 550(d) establishes that the single-satisfaction rule does not apply when funds are returned to the debtor prepetition, rather than post-petition.  The Trustee had asserted that if funds were returned to the debtor without a need to sue under Section 550(a), it could not be argued later that the trustee had utilized his rights under that section and thus there was no double-recovery under Section 550(d).  The Trustee had relied on the language in Section 550(d), which states that, “[t]he trustee is entitled to only a single satisfaction under subsection (a) of this section.”  (Emphasis added.)  Thus, if Ms. Whitlock returned the funds to the debtor prepetition, the trustee had not received a prior recovery under Section 550(a) to trigger the single-recovery rule.

The appellate court concluded that the word “satisfaction” used in Section 550(d) “presupposes an obligation.”  If Ms. Whitlock returned the funds in question, she satisfied her obligation leaving no right of action for the trustee to pursue in an avoidance action.

Similarly, the appellate court rejected an argument that all prior cases reviewing this issue were distinguishable as they found that the recovery by a trustee would have resulted in a windfall for the bankruptcy estates.  Here, the estate never received the funds in question as they were spent by the debtor prepetition.  The DeBerry court responded that the debtor’s decision to fritter his funds away prepetition was not relevant to the trustee’s subsequent fraudulent transfer claims against Ms. Whitlock.  After all, the debtor could have dissipated the funds in question whether or not they had ever been transferred to Ms. Whitlock.

The Court of Appeals acknowledged in a footnote that the bankruptcy court never decided whether the transfers to Mrs. DeBerry and MBC amounted to a return of funds to the debtor and left the issue for the bankruptcy court to resolve on remand.

Author’s Comments:

The appellate court’s opinion appears to reach the correct result, as the lower courts’ rulings in favor of the trustee appear counter-intuitive on their face.  As the appellate court notes, the trial court’s ruling contradicted all other decisions in cases where the issue arose, raising questions as to what motivated the lower court to rule in the trustee’s favor and the district court to affirm that decision.

It is entirely possible that the lower court’s ruling relied on facts and legal arguments that were not fully discussed in the appellate court’s decision.  However, barring such explanation, it is hard to imagine a state of the law where a transferee of a fraudulent transfer who returned the funds prepetition could be required to repay the funds a second time pursuant to an avoidance action brought in the transferor’s subsequent bankruptcy case.  After all, what were the bankruptcy estate’s damages if Ms. Whitlock indeed returned the funds in question to the debtor prepetition?

These materials were written by Uzzi O. Raanan, a partner at Danning, Gill, Israel & Krasnoff, LLP, located in Los Angeles, California, who is a member of the ad hoc group and the representative from the Business Law Section (BLS) to the CLA’s Board of Representatives.  Editorial contributions were made by the Honorable Meredith Jury (United States Bankruptcy Judge, C.D. Cal, Ret.), also a member of the ad hoc group.  Thomas Reuters holds the copyright to these materials and has permitted the Insolvency Law Committee to reprint them. This material may not be further transmitted without the consent of Thomas Reuters.

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