Categories & Search

Bankruptcy Court Addresses Standard For Recovery Of An Alleged Fraudulent Transfer From A Subsequent Transferee

The Bankruptcy Code gives a trustee powers to avoid certain pre-bankruptcy transfers of the debtor’s property to other entities. For example, a trustee can avoid transfers made with the intent to impair the ability of creditors to collect on their debts. 11 U.S.C. § 548(a)(1)(A). The Code gives the trustee the power to recover the transferred property from the initial recipient, and also from subsequent recipients, “to the extent the transfer is avoided.” 11 U.S.C. § 550(a). Courts have split on whether this language requires a trustee to get a judgment avoiding a transfer prior to recovering from a subsequent transferee, or whether a trustee can simply show that the transfer is avoidable as part of the action against the subsequent transferee. A related question, however, concerns what happens when a trustee has gotten a judgment avoiding a transfer, and then seeks to recover from subsequent transferees. Can those transferees challenge whether the original transfer was avoidable? This question is the central issue in a recent decision from the United States Bankruptcy Court for the Southern District of Florida. Yip v. Google LLC (In re Student Aid Ctr., Inc.), Adv. Proc. No. 18-1493, 2019 Bankr. LEXIS 3310 (Bankr. S.D. Fla. Oct. 22, 2019).

Student Aid Center, Inc. (the “Debtor”) filed for bankruptcy in February 2016, and Maria M. Yip (the “Trustee”) was appointed as trustee. In July 2017, the Trustee filed an adversary proceeding against Alan Alvarez, the father of the Debtor’s president, and two companies he allegedly controlled, seeking to avoid $6.3 million in transfers from the Debtor to the defendants. The two companies defaulted and the transfers to them were avoided. Alvarez answered pro se but ultimately lost and the transfers to him were also avoided.

In December 2018, the Trustee sued Google, seeking the recovery of $4.7 million that the Trustee alleged originated from the transfers avoided in the prior adversary proceeding. Google sought discovery into whether the transfers had been appropriately avoided. The Trustee sought a protective order, arguing that the issue was irrelevant—the transfers had already been avoided in the separate proceeding, so the only remaining question was whether Google was liable as a subsequent transferee. Google responded that since it was not a party in the prior action, it would violate Google’s due process rights to rely on the judgment of avoidance in that action. It further argued that two default judgments and a judgment obtained against a pro se defendant were not judgments that could be appropriately relied on. Thus, Google argued, it was the Trustee’s burden to show (again) that the transfers were avoidable.

The bankruptcy court took a position somewhat in between that of the two parties. First, the bankruptcy court noted that avoidance (of a transfer) and recovery (of the proceeds of a transfer, from a transferee) are separate causes of action. Avoidance is a condition precedent of recovery. While the Eleventh Circuit has ruled that a trustee may demonstrate the avoidability of an underlying transfer as part of a suit against a subsequent transferee, IBT International Inc. v. Northern (In re International Administrative Services), 408 F. 3d 689 (11th Cir. 2005), the bankruptcy court concluded that it would not rule that a trustee must do this. The court noted that nothing in the text of the Bankruptcy Code limited recovery to cases where the avoidance claim and the recovery claim were brought in the same action. The court added that requiring trustees to repeatedly re-prove the avoidability of the underlying transfer would be a waste of judicial resources.

Second, the bankruptcy court rejected the argument that this approach violated Google’s due process rights. Relying on Tibble v. Farmers Grain Express Inc. (In re Michigan Biodiesel, LLC), 510 B.R. 792 (Bankr. W.D. Mich. 2014), the bankruptcy court held that Google could still contest the avoidability of the underlying transfers—it just had to do so as an affirmative defense, with Google having the burden of proof rather than the Trustee. The bankruptcy court pointed to the defense available under section 550(b)(1) for “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.” Since the transferee of a transfer that is not avoidable cannot have “knowledge of the voidability of the transfer avoided,” the court reasoned that this provision effectively establishes a defense that the initial transfer was not avoidable. Since Google could still take advantage of this defense, it was not being deprived of its ability to contest the voidability of the transfers and its due process rights were not violated. The court additionally held that the avoidance judgment against Alvarez could be relied upon for purposes of section 550, though it held off on deciding whether the default judgments against the companies could be.

Because the bankruptcy court held that Google could contest the avoidability of the transfers as a defense, it ruled that the discovery Google sought was appropriate.