On an issue where the circuits are split, Chief Bankruptcy Judge Kathleen H. Sandberg of Minneapolis came down on the side of the majority of courts by holding that a trustee is not required to obtain a judgment against the initial recipient of a fraudulent transfer before suing to recover from a subsequent transferee under Section 550(a)(2).
The dispute arose in the wake of the Ponzi scheme perpetrated by Thomas Petters. The defendant was an investor in a special purpose entity, or SPE, that invested with Petters. The SPE had received payments from Petters that the trustee claimed to be fraudulent transfers with “actual intent” under Section 548(a)(1)(A).
The trustee sued the investor as a mediate, immediate or subsequent transferee under Section 550(a)(2). The investor countered with a motion to dismiss, contending that the suit was premature because the trustee had not yet won a judgment against the SPE as the initial transferee.
The investor relied on Section 550, which says that a trustee may recover from a subsequent transferee “to the extent that a transfer is avoided under section . . . 548.” The investor interpreted the statute to mean that a transfer must be avoided before the trustee can sue a subsequent recipient of the transfer.
The circuits are split. The Tenth Circuit has held that there must first be a judgment against the initial transferee. The Eleventh Circuit, like the majority of courts, ruled to the contrary and held that suit is permissible against the initial and subsequent transferees simultaneously.
Holding in her Jan. 17 opinion that a judgment voiding the transfer is not a prerequisite, Judge Sandberg agreed with the Eleventh Circuit and the bankruptcy court in the Bernard Madoff Ponzi scheme. Securities Investor Protection Corp. v. Bernard L. Madoff Investment Securities LLC (In re Bernard L. Madoff Investment Securities LLC), 480 B.R. 501 (Bankr. S.D.N.Y. 2012).
Judge Sandberg explained that the “to the extent that” language was inserted to ensure that a subsequent transferee’s liability would not exceed the initial transferee’s liability, and that the subsequent transferee could raise any defenses that are available to the initial transferee.
Reading the statute literally and forcing the trustee to obtain a judgment first against the initial transferee “could lead to absurd results,” Judge Sandberg said. If the initial transferee has disappeared or is judgment-proof, she said there would be no justification for requiring the trustee “to engage in costly and protracted litigation . . . with little chance of meaningful recovery.”