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New Appeals Court Ruling on the Scope of Subsequent Transferee Liability Under Section 550

Section 550 of the Bankruptcy Code provides that, when a transfer is avoided under one of several other sections of the Code, a trustee may recover “the property transferred, or, if the court so orders, the value of such property” from “the initial transferee of such transfer,” “the entity for whose benefit such transfer was made,” or “any immediate or mediate transferee of such initial transferee.”  11 U.S.C. § 550(a).  (Transferees in the last category are known as subsequent transferees.)  For example, if an entity receives a fraudulent transfer of cash, and then passes on the cash to a third party, the third party can be liable under section 550.[1]  But what if the transfer is of a non-cash asset?  To qualify as an “immediate or mediate transferee” under section 550, is it necessary to receive the actual asset, or does it suffice to receive funds derived from the asset?  The Tenth Circuit addressed this question in its recent decision in Rajala v. Spencer Fane LLP (Generation Resources Holding Company, LLC), 2020 WL 3887850 (10th Cir. July 10, 2020).  The Tenth Circuit held that, to qualify as a “transferee” under section 550, a party must have received the actual “property transferred.”

The case arose out of a complex history of transactions and litigation involving certain wind power projects in Pennsylvania.  The basic facts are these.  Generation Resources Holding Company, LLC (“Generation Resources”) agreed in July 2005 to sell the right to construct three wind power projects to Edison Capital in exchange for certain payments.  Generation Resources then became unable to pay its debts, and in December 2005 the rights to payment under the contract were transferred to two affiliates, Lookout Windpower Holding Company, LLC (“LWHC”) and Forward Windpower Holding Company, LLC (“FWHC”).  In April 2008, Generation Resources filed for bankruptcy, and Eric C. Rajala (the “Trustee”) was appointed as trustee. 

Meanwhile, in November 2008, LWHC and Edison Capital became embroiled in a payment dispute, and in December 2008 LWHC hired Husch Blackwell on a contingency fee arrangement to sue Edison Capital.  LWHC ultimately obtained a $9 million judgment, which Edison Capital paid; the funds were deposited with the bankruptcy court overseeing Generation Resource’s bankruptcy case.  LWHC then hired another law firm, Spencer Fane, to seek release of the funds on the ground that the judgment was not part of the bankruptcy estate.  The bankruptcy court ultimately granted the request and released the funds.  The funds were then dispersed, with much of the money paid to the two law firms.  The Trustee obtained a consent judgment avoiding the original transfers from Generation Resources to LWHC and FWHC, but was unable to recover against LWHC.  He then sued the law firms, seeking to hold them liable as subsequent transferees under section 550.  The law firms moved to dismiss and the bankruptcy court denied the motion, reasoning that the law firms had received proceeds of the fraudulent transfer and therefore were subsequent transferees.  Upon the law firms’ motion, the bankruptcy court certified its denial order for interlocutory appeal.

The Tenth Circuit reversed.  The court’s analysis began with the text of section 550.  To be liable under section 550, a defendant must be “the initial transferee,” “the entity for whose benefit such transfer was made,” or “any immediate or mediate transferee of such initial transferee.”  Because section 550 entitles a trustee to recover “the property transferred” from the transferees, the court reasoned that it must identify “the property transferred,” which the court interpreted as the property fraudulently transferred in the first instance.  Here, that property was the right to payment under the contract with Edison Capital, which was transferred from Generation Resources to LWHC.   The “initial transferee” of that property was therefore LWHC.  But the law firms, the court held, were not subsequent transferees, because they never received the property transferred—the contractual rights that made up the fraudulent transfer never passed to the law firms.

The Tenth Circuit rejected the reasoning of the bankruptcy court that section 550’s provision for recovery of “the value of such property” enabled the Trustee to reach the law firms.  The court held that this conflated what could be recovered under section 550 with whom a trustee could recover from.  Since the law firms were not transferees of the property, they were not liable under section 550.

The Trustee argued that “the property transferred” under section 550 includes the proceeds of such property.  The Trustee pointed to section 541 of the Code, which includes “[p]roceeds, product, offspring, rents, or profits of or from property of the estate” as part of the property of a bankruptcy estate.  11 U.S.C. § 541(a)(6).  The Tenth Circuit rejected this argument for several reasons.  First, the Tenth Circuit reasoned that the argument was inconsistent with the plain language, since nothing about section 541’s definition of property affects the scope of liability under section 550.  Second, the Tenth Circuit noted that section 541 separately lists “[a]ny interest in property that the trustee recovers” under certain Code sections including section 550, thus treating the “property that the trustee recovers” as distinct from its “proceeds.”  Id. § 541(a)(3).  Third, the Tenth Circuit reasoned that this language actually indicates that proceeds are not included within property under section 550, since when Congress wants to include proceeds, it knows how to do so.

The Tenth Circuit thus reversed the bankruptcy court and ruled that the claims against the law firms should be dismissed.


[1] Section 550 includes a safe harbor for a subsequent transferee that “takes for value . . . in good faith, and without knowledge of the voidability of the transfer avoided.”