Focus on Fraud 11th Circuit Supplants the Mere Conduit Fiction for Certain Subsequent Transferees

On May 3, 2005, the Eleventh Circuit Court
of Appeals released a 41-page opinion on <i>In re International
Administrative Services Inc.</i> (IAS) announcing a new legal theory for
suing certain subsequent transferees of property originating with a
debtor. The court also considered when and how a bankruptcy may extend
the limitations period set forth in §546(a) of the Bankruptcy Code,
what constitutes adequate tracing in a complex fraudulent transfer case,
and from what point in time an award of prejudgment interest is
appropriate.

</p><h4>A Man and His Schemes</h4>

<p>In 1986, Charles J. Givens Jr., a colorful entrepreneur and gifted
speaker, started the precursor to IAS, The Charles J. Givens Co., after
dabbling in such diverse businesses as music production and real estate
speculation. IAS was promoted through late-night infomercials as the
means by which ordinary people could accumulate "wealth without risk"
(also the titles of a series of best-selling books by Mr. Givens). This
insight was available to purchasers of a membership in the Givens
organization, followed by the purchase of various financial self-help
products and seminars. Although little of the information offered by IAS
to its members was proprietary or confidential, the charisma of Givens
and skill of his public relations handlers produced an organization
which, by the early 1990s, could boast more than 250,000 members and
annual sales of over $100 million. As the Eleventh Circuit noted, IAS
had become a "leviathan in the world of get-rich-quick schemes."

</p><p>Unfortunately for IAS, at the same time that its sales were
skyrocketing, storm clouds were gathering on its financial horizon. The
financial advice offered by IAS was often not custom-tailored to the
laws of the states in which its members resided. For example, advice
urging canceling of their uninsured motorist insurance proved disastrous
for citizens of various states who were involved in serious automobile
accidents with uninsured drivers. This bad advice spawned a series of
costly class-action law suits against the company and Mr. Givens. At the
same time, the company was targeted by the attorneys general of various
states for its failure to pay sales tax in those states, and both the
company and Givens were targeted by the Securities and Exchange
Commission (SEC) in connection with certain real estate investment
schemes. Finally, the Federal Trade Commission joined the fray by
launching investigations into the company's business practices.

</p><p>By this point, it became clear that the company would be facing some
very serious financial difficulties in the immediate future. In
response, Givens retained the services of asset protection attorney
David H. Tedder, his law firm and his company, The Institute for Asset
&amp; Lawsuit Protection, to devise a complex, multinational scheme to
protect IAS and Givens from their legitimate creditors. Tedder moved to
Florida, where IAS was based, to implement this exceedingly complex
program that included, among other things, sham employee leasing
arrangements, a bogus income stabilization program, the purchase of a
series of "private annuities" that had no value and the creation of
massive liens securing questionable loans. The end result was a
comprehensive asset-protection strategy that allowed Givens to remove
more than $50 million from IAS while simultaneously assuring IAS's
creditors that the company had no assets due to its massive "secured"
obligations to foreign lenders and financial institutions.

</p><p>By 1996, IAS had hemorrhaged so much capital through the
ministrations of Tedder and Givens that it could no longer fund its
ongoing operations. Accordingly, on June 20, 1996, IAS filed for
voluntary relief under chapter 11. A creditors' committee was appointed
and began an investigation into the finances of the debtor, which soon
revealed significant, potentially fraudulent activities. At the request
of the creditors' committee, the debtor transferred its avoidance powers
to that committee to avoid any conflict of interest with the debtor's
management, which was still controlled by members of the Givens family.
This transfer of certain recovery powers survived confirmation of the
debtor's reorganization plan creating the position of stock trustee to
continue the attempts to recover fraudulently transferred assets for the
benefit of IAS's creditors. Since confirmation, the stock trustee has
been North Carolina bankruptcy lawyer John A. Northen (trustee), who had
previously acted as the chairman of the creditors' committee.

</p><div class="para154">
<span class="text167"> The investigation into the potentially
fraudulent transfers made by the debtor, under the ultimate control of
Givens for the benefit of the Givens family, was routinely hampered by
Givens and his professionals. After a motion seeking sanctions for
failure to produce documents was filed by the trustee, Bankruptcy Judge
<b>Karen S. Jennemann</b> appointed a special master to investigate the
alleged discovery abuses on behalf of the Givens family. The special
master eventually concluded that documents crucial to the development of
the trustee's cases had been intentionally hidden or destroyed by Givens
and his professionals.

<p>Notwithstanding these efforts by Givens and his professionals to
hamper the investigation, the trustee eventually filed suit against
various transferees who had improperly received property of the debtor
through the workings of the asset-protection plan. Two of these were IBT
Inc. (IBT) and South California Sunbelt Developers Inc. (SCSD and,
collectively with IBT, the "defendants"); both companies were owned by a
business partner of Tedder. After a three-day trial, the bankruptcy
court entered judgment against IBT and SCSD for the full amount of the
funds transferred from the debtor, together with prejudgment interest
from the date of the initial transfer to SCSD. The defendants appealed,
but the U.S. District Court for the Middle District of Florida affirmed.
The defendants then appealed to the Eleventh Circuit.

</p><h4>Issues on Appeal</h4>

<p>The defendants raised four general issues on appeal. First, they
maintained that both the bankruptcy court and the district court had
erred as a matter of law when they permitted the trustee to recover a
fraudulent transfer from subsequent transferees without first suing the
initial transferees. Second, the defendants raised a number of issues
relating to the ability of a bankruptcy court to extend the limitations
period set forth in §546(a). Next, the defendants maintained that
the bankruptcy court erred by finding that the trustee had satisfied his
burden of tracing the relevant funds from the debtor to the defendants.
Finally, they questioned the bankruptcy court's ability to award
prejudgment interest from the date of the initial transfer of the
debtor's property to the defendants. The Eleventh Circuit affirmed Judge
Jennemann's original ruling on each of these points.

</p><h4>Recovering Directly from Subsequent Transferees</h4>

<p>On appeal, the defendants argued that the clear language of
§550(a) required the trustee to sue the initial transferees of the
debtor's property as a condition precedent to bringing suit against the
defendants as subsequent transferees. The trustee sued the defendants
under the fraudulent-transfer provisions of Florida law as made
applicable to the IAS bankruptcy case through §544, the so-called
strong-arm provision. The trustee never sued the initial transferees (in
this case judgment-proof companies), some of which had undergone
liquidation proceedings in Panama. Section 544(b) requires a transaction
to be avoided by a plaintiff before it can be recovered under §550.
The support for the defendants' argument that an initial transferee must
actually be sued before suit can be brought against a subsequent
transferee is found in §550(a) dealing with the scope of permitted
recovery.

</p><p>In relevant part, §550(a) provides that "to the extent that a
transfer is avoided under §544...the trustee may recover for the
benefit of the estate property transferred, or if the court so orders,
the value of such property from (1) the initial transferee...or (2) any
immediate or mediate transferee of such initial transferee." The
defendants' argument is based on the phrase "to the extent that the
transfer is avoided," which they interpret to mean that a recovery of
property can only been made "to the extent that the transfer has
previously been avoided." In other words, according to the defendants,
§550 of the Code required the trustee to avoid the initial transfer
of the property at issue before bringing suit against the defendants as
subsequent transferees.

</p><p>In support of their position, the defendants relied on <i>In re
Trans-End Technology Inc.,</i> 230 B.R. 101 (Bankr. N.D. Ohio 1998), in
which a bankruptcy court interpreted §550(a) as requiring the
actual avoidance of the initial transfer before seeking recovery from
subsequent transferees. In reaching this interpretation, the
<i>Trans-End</i> court characterized the relevant language of
§550(a) as "unarguably ...unambiguous and plain." 230 B.R. at 104.
The Eleventh Circuit, however, disagreed with the <i>Trans-End</i> court
both with respect to this characterization and that court's ultimate
ruling.

</p><p>The Eleventh Circuit instead found that the strict interpretation of
the language found in §550(a) imposed by the <i>Trans-End</i> court
and embraced by the defendants "produces a harsh and inflexible result
that runs counterintuitive to the nature of avoidance actions."
Specifically, the court found, following the majority position on this
point outside of the Eleventh Circuit, that the phrase "to the extent
that transfer is avoided under §544" found in §550(a) refers
to the extent of the property that may be recovered rather than to the
timing of the avoidance action. In other words, the language simply
means that a plaintiff can only recover a transfer of a debtor's
property to the extent that such a transfer is avoidable under
§544. This interpretation is consistent with the legislative
history of §550. <i>See,</i> 24 Cong. Rec. H. 11,097 (Sept. 28,
1978), S 17,414 (Oct. 6, 1978).

</p><p>While the position adopted by the Eleventh Circuit in the IAS case is
consistent with that of the majority of the courts considering this
issue and with the legislative history of §550, it is not entirely
consistent with the Eleventh Circuit's previous treatment of subsequent
transferees in fraudulent-transfer actions. In prior cases in which the
Eleventh Circuit permitted fraudulent-transfer actions to proceed
against subsequent transferees, the court avoided the strict
interpretation of §550(a), which requires avoidance of the transfer
to the initial transferee before proceeding against subsequent
transferees by modifying the definition of "initial transferee." <i>See,
i.e., In re Chase &amp; Sanborn Corp.,</i> 904 F.2d 588 (11th Cir 1990).
Those cases involved an initial transferee, such as a bank, which did
not have an ownership interest in or control over the property
transferred and which did not act in bad faith. Accordingly, such an
entity could be deemed a "mere conduit" in the transaction and thus
disregarded as an initial transferee.

</p><p>In this case, however, the initial transferees were not third-party
financial institutions with no material interest in the overall
transaction but rather special-purpose entities created by Tedder at the
behest of Givens; these were entities with guilty knowledge that do not
fit into the mold of a "mere conduit." Therefore, the Eleventh Circuit
altered its position on initial transferees to find that although the
defendants were subsequent transferees, rather than initial transferees,
they could still be sued in the first instance by the trustee because
the distinction between initial transferees and subsequent transferees
for avoidance purposes is entirely irrelevant provided that the entities
being sued either exercised dominion and control over the property
transferred or "held some beneficial right in it." In reaching this
decision, the Eleventh Circuit was careful to note that its ruling
should not be viewed as eroding its existing conduit theory, but rather
providing an alternative theory of liability for cases involving
multiple fraudulent transfers and no initial transferees that could
credibly be characterized as mere conduits.

</p><h4>Statute-of-limitations Issues</h4>

<p>The defendants also raised a number of statute-of-limitations issues
in their appeal involving whether and how a bankruptcy court may enlarge
the limitations period set forth in §546(a) of the Code. Section
546(a) required the trustee to commence his avoidance action against the
defendants within two years after the entry of relief in the IAS
bankruptcy case. Since the IAS case was filed on June 20, 1996, the
§546(a) period for bringing suit would normally have expired on
June 20, 1998. While the trustee did not file his complaint until Feb.
10, 1999, he did file a motion seeking to extend the §546(a) period
prior to its expiration; the bankruptcy court granted this motion and
extended the §546(a) period.

</p><p>The defendants argued that the trustee's complaint was not timely
because the bankruptcy court does not have the authority to enlarge the
§546(a) period, <i>i.e.,</i> that §546(a) creates a
jurisdictional bar (that cannot be extended) rather than a statute of
limitations (which is subject to waiver, equitable tolling and equitable
estoppel). This argument was rejected by the Eleventh Circuit on several
grounds. First, the court noted that reading "a jurisdictional bar into
§546(a) would lead to absurd results," and therefore §546(a)
should be viewed as a statute of limitations that may be extended by a
bankruptcy court under appropriate circumstances. Second, the Eleventh
Circuit found that the trustee had demonstrated an equitable basis to
toll the §546(a) limitations period. Specifically, the court found
that where, as in the instant case, a trustee acts diligently but does
not learn the details of a fraudulent transaction due to "fraud or
extraordinary circumstances beyond the trustee's control," then the
doctrine of equitable tolling will act to prevent the expiration of
§546(a)'s limitations period. <i>Citing In re Levy,</i> 185 B.R.
378 (Bankr. S.D. Fla. 1995), and <i>Lampf, Pleva Lipkind, Prupis &amp;
Petigrow v. Gilberson,</i> 501 U.S. 350, 363; 111 S.Ct. 2773, 2782; 115
L.Ed.2d 321 (1991).

</p><h4>Tracing and Prejudgment Interest</h4>

<p>The final issues raised by the defendants on appeal dealt with the
sufficiency of the trustee's proof of tracing offered at trial and the
propriety of the bankruptcy court's imposition of prejudgment interest
against the defendants commencing from the original date that they
received property of the debtor. With respect to tracing, the defendants
argued that the trustee had failed to trace every dollar from the debtor
to the defendants. The Eleventh Circuit held that while a plaintiff
seeking recovery of a fraudulent transfer clearly has the burden of
tracing the funds it claims originated with a debtor, "it is also true
that proper tracing does not require dollar-for-dollar accounting." In a
complex fraud case, the Eleventh Circuit found that a plaintiff needs to
show by a preponderance of the evidence that the funds for which
recovery is sought originated with the debtor, flowed through certain
pathways and were eventually transferred to the defendant.

</p><p>Finally, the defendants argued that the bankruptcy court's award of
prejudgment interest against the defendants from the date upon which
they originally received property of the debtor was improper. The
Eleventh Circuit disagreed, holding that while the Code does not
specifically authorize awards of prejudgment interest, the instant case
with its findings of "massive fraud...calls for the award of such
interest" as compensation to IAS's creditors for the improper use of
funds that rightfully belonged to those creditors as represented by the
trustee.

</p><hr>
<h3>Footnotes</h3>

<p>^{<small><a name="1">1</a></small>} Attorney Hans Christian
Beyer initially represented the creditors' committee in the IAS
bankruptcy case and related litigation and, post-confirmation, has
represented the trustee. <a href="#1a">Return to article</a>