The defendant “was merely a ‘mere conduit’ of [a] fraudulent transfer and cannot be held liable to the bankruptcy estate for funds never known to it,” the United States Court of Appeals for the Second Circuit said on May 5, 2022. In re BICOM NY, LLC, 2022 WL 1419997 (2d Cir. May 5, 2022). Upholding the lower courts’ grant of summary judgment to the assignee defendant, the court declined to “equate … mere receipt [of corporate debtor funds] with liability”, holding that “mere conduits” of fraudulent transfers are not “original assignees” under Bankruptcy Code 550(a)(1) (“the trustee may recover” the fraudulently transferred assets from the “ original transferee of this transfer”).
The Code does not define the “original assignee”, which has led to a series of factual appeal decisions on the subject. Generally, a financial intermediary or financial intermediary would not be an “assignee” of the debtor’s assets because they do not have control of those assets. See, for example, In re Pony Express Delivery Servs.
Inc., 440 F.3d 1296, 1304 (11th Cir. 2006) (insurance broker received premium payments from debtor more than three weeks after paying insurance companies on behalf of debtor; held, the insurance broker was not the original assignee under 550); Christy v. Alexander & Alexander Inc., 130 F.3d 52, 59 (2d Cir. 1997) (simple intermediary insurance broker), certificate refused, 524 US 912 (1998); In re Red Dot Scenic, Inc., 351 F.3d 57, 58 (2d Cir. 2003) (debtor’s buying shareholder paid personal debt with checks drawn on debtor’s business accounts; held, the recipient of the checks was the original assignee “and was therefore required to return the funds regardless of any potential good faith defence”; the buying shareholder was not the original assignee because “he exercised no control over the funds involved once they had been transferred from [debtor’s] account”); Bonded Fin Servs., Inc. v. European AM Bank, 838 F.2d 890, 893 (7th Cir. 1988) (“the minimum requirement of ‘assignee’ status is dominance over money or another asset, the right to use the money for its own purposes”).
The defendant in BICOM was a friend of the principal of the debtor company and “opened a joint bank account with [the principal] which aimed to keep only his money and facilitate his permanent residence in the United States. “Bicom, 2022 WL 1419997, at *1. According to the lower courts, the “defendant believed (correctly or not) that she could not open a U.S. bank account on her own because she did not have US social security number. “In re BICOM NY, LLC, 619 BR 795, 796 (Bankr. SDNY 2020). When the debtor’s principal “ran into financial trouble and had to move funds between his businesses while keeping his lending banks in the dark he “routed $1 million from [the corporate debtor] through the joint account, where he stayed two days before [the principal] transferred it to his other company via a fake check [the defendant’s] name to hide the source.” BICOM, 2022 WL 1419997, at *1.
The debtor company subsequently requested receivership. In her lawsuit “to recover the million dollars in transferred funds” from the individual defendant, the bankruptcy trustee claimed that she was the “original assignee” of the debtor company’s funds. Identifier. Although the defendant could, in theory, withdraw and spend the transferred funds, it was completely unaware of the funds and never kept or used the money, “on the basis of [her agreement with the debtor’s principal] that the joint account should only contain his money.” Id.
The intentional fraudulent transfer from the debtor company to its affiliate, using the defendant’s bank account as a screen to conceal the transfer, was also uncontested. According to the trustee, however, as the “original assignee” of the funds, the defendant was “strictly liable” even though it had received the funds “in good faith, and without knowledge of the cancellation and avoided transfer”, if relying on Code 550(a)(b) and In re Red Dot Scenic, Inc., 351 F.3d 57, 58 (2d Cir. 2003).
Strict liability of the initial assignee
The Second Circuit upheld the general rule: where “the recipient of the debtor’s funds was the original assignee, the bankruptcy code imposes strict liability and the trustee in bankruptcy may recover the funds. Id. at *1, citing In re Red Dot Scenic Inc., 351 F.3d 57, 58 (2d Cir. 2003). The “trustee’s right to recover from the original assignee is absolute”. Schaffer v. Las Vegas Hilton Corp. (In re Video Depot, Ltd.) 127 F.3d 1195, 1197-99 (9th Cir. 1997) (An “initial assignee is exposed to stricter liability than a subsequent assignee because an initial assignee is best placed to assess whether conveyance is fraudulent.”). Accord In re Harwell, 628 F.3d 131213,1324, (11th Cir. 2010) (Reverse Bankruptcy Court; detainee, attorney who allegedly “conspired with” the debtor “for the funds of the debtor to be placed in [the attorney’s] trust account and then distribute it to the “debtor” personally, to his family members and to selected creditors” was liable as the original assignee of the fraudulent conveyance); Paloian v. LaSalle Bank, MA, 619 F.3d 688, 691 (7th Cir. 2010) (Easterbrook, J.) (a trustee of a securitized investment pool may be an initial assignee because it is “the legal owner of the assets of the trust”; despite the “duties of the fiduciary to the beneficiaries of the trust (the investors) regarding the application of funds, the owner of the assets remains the appropriate subject of [a] n … action for annulment”; any liability imposed on the defendant bank would arise from the “corpus of the trust, not from the assets of the bank …. [T]The money actually comes from the investors in the trust – the people “for whose benefit [the] transfer has been made. Instead of requiring the trustee in bankruptcy to sue thousands of investors who may have received interest payments…one action is enough…”)
Simple Conduit Defense
The Second Circuit has previously “described who may be termed the ‘original assignee'” in Christy v. Alexander & Alexander of New York, Inc. (In re Finley, Kumble, Wagner, Heine, Underberg, Manley, Myerson & Casey), 130 F.3d 52 (2nd Cir. 1997). She explained that “the term ‘original assignee’ refers to something more specific than the original recipient”. Identifier. at 57. The court therefore refused to “equate … mere receipt with liability”, holding that “mere conduits” of fraudulent transfers are not “original assignees”. Identifier. She felt that the insurance broker in Christy’s case was only a middleman because he had no[TRADUCTION]”no discretion or power to do anything other than pass the money” from the debtor to the insurer, and that there was “no doubt” that he was “acting solely to channel the funds” to the insurer. Identifier. at 59 years old.
The Sixth Circuit emphasized the factual nature of the inquiry In re Hurtado, 342 F.3d 528, 535 (6th Cir. 2003). He followed the Second Circuit analysis, finding that once legal title to the funds passes, the transferee generally cannot be considered a mere intermediary. In the case before it, the defendant was liable as the original assignee because it “had control over the [funds] for a number of years, exercising control to issue checks…” and the assigning debtor would have no “legal recourse…if [the defendant transferee] had elected to use the funds for its own benefit.” See also, In re Internat’l. Mgmt Assoc., 399 F.3d 1288, 1292 (11th Cir. 2005) (no initial liability of assignee under 550( a) if no benefit received from the transfer; “the non-quantifiable benefit is not the type of ‘benefit’ contemplated by [Code] 550(a).”).
The sensible opinion of the court in the BICOM case is based on the defendant’s extensive development of the facts in the bankruptcy court. Because the plaintiff trustee could not refute these undeniable facts, the bankruptcy court duly granted the defendant’s motion for summary judgment. As Mr. Gradgrind of Dickens pointed out, “[f]only deeds are willed in life.” Charles Dickens, Hard Times (1854). And the facts here have overcome the general rule of strict liability.