Tenth Circuit: Proceeds from Fraudulently Transferred Property Not Recoverable

The US Court of Appeals for the Tenth Circuit has ruled that proceeds from property that was fraudulently transferred cannot be recovered under Section 550 of the Bankruptcy Code.[1] This decision limits a subsequent recipient’s exposure where the initial transferee of the property had altered the form of the property that was initially received prior to transferring it to that subsequent recipient.

Prior to filing for chapter 7 bankruptcy protection, the debtor, a power project developer, had transferred its rights to development fees to its subsidiaries. During the course of the bankruptcy proceeding, one of the subsidiaries sued the payor for outstanding development fees and recovered a $9 million judgment against the payor. A portion of these proceeds was used to pay attorney fees to two separate law firms which had represented the subsidiary during the litigation, and in the bankruptcy proceeding.

The chapter 7 trustee appointed to administer the bankruptcy estate brought a fraudulent transfer claim against the law firms, claiming that the fees they received were proceeds of property (the right to receive development fees) that had been fraudulently transferred by the debtor. The bankruptcy court denied the law firms’ motions to dismiss the trustee’s complaint and certified its order to the Tenth Circuit.

The Tenth Circuit accepted an interlocutory appeal and reversed the bankruptcy court’s decision, effectively dismissing the trustee’s complaint against the law firms. The court held that, under Section 550 of the Bankruptcy Code, only the “property transferred,” which here was the right to receive development fees, could be recovered, and not the proceeds of the property. The court also held that, since the proceeds were not the property transferred by the debtor, the law firms were not “subsequent transferees” under Section 550, from whom the trustee could seek a recovery.

This decision has a narrow application to instances where a third party received the proceeds of an initial transfer, and offers such parties a defense when faced with a demand to return property under Section 550.

Contacts

If you have any questions or would like more information on the issues discussed in this LawFlash, please contact any of the following Morgan Lewis lawyers:

Philadelphia
John C. Goodchild

Boston
Andrew Gallo