Although a check payable to a university represented stolen money, Bankruptcy Judge Carol A. Doyle of Chicago ruled that the university was not the recipient of a fraudulent transfer.
Judge Doyle’s July 11 opinion is important for a second holding: A bankruptcy judge has constitutional power to enter final judgment in a fraudulent transfer suit when there is no request for a jury trial.
The case involved the infamous Peregrine Financial Group Ponzi scheme.
Peregrine was a commodities futures merchant. Over the course of 20 years, Peregrine’s founder, Russell Wasendorf Sr., stole $200 million that should have been held in a segregated account for customers. The fraud was discovered after Wasendorf tried unsuccessfully to commit suicide in a parking lot outside company headquarters. A receivership morphed into a chapter 7 liquidation. Wasendorf pleaded guilty and is serving a 50-year prison sentence.
In a written agreement years before bankruptcy, Wasendorf had made a $2 million pledge to the University of Northern Iowa Foundation for the benefit of a specified athletics fund. Less than a year before bankruptcy, he fulfilled $500,000 of the pledge as follows: Wasendorf caused Peregrine’s bank to issue a $500,000 cashier’s check, payable to “University of Northern Iowa,” with funds from a Peregrine account. When Wasendorf delivered the check, the university immediately endorsed the check to the foundation. The funds were then deposited into a foundation account.
Judge Doyle described the foundation as a “separately organized entity that has tax-exempt status under § 501(c)(3) of the Internal Revenue Code.”
The Peregrine trustee sued the university to recover the $500,000 as a constructively and intentionally fraudulent transfer under Section 548(a)(1)(A) and (B). The university did not contest the transfer as being an actual and constructively fraudulent transfer. Instead, the university contended that it was not liable under Section 550.
The Stern Issue
Because the university did not consent to the entry of final judgment in bankruptcy court, the university and the trustee agreed that Judge Doyle should only make proposed findings of fact and conclusions of law.
Judge Doyle thought otherwise. She said that “many courts” read Stern narrowly and conclude that a bankruptcy court may not enter a final judgment in a fraudulent transfer suit. But, she said, some district courts in Illinois have “adopted a broad reading of Stern as well as [Granfinanciera, S.A. v. Nordberg, 492 U.S. 33 (1989)]” and hold that neither decision strips the bankruptcy court of power to enter final judgment.
Granfinanciera, according to Judge Doyle, held that a fraudulent transfer defendant who had not filed a claim was entitled to a jury trial. She said the Supreme Court in Granfinanciera “did not address the constitutional authority of a bankruptcy court to enter a final judgment on a fraudulent transfer claim after holding a bench trial.”
Judge Doyle therefore adopted “a more narrow interpretation consistent with the Stern observation that its holding is limited to one isolated issue and will not have a significant impact on bankruptcy proceedings.”
Judge Doyle next said that “Executive Benefits Insurance Agency v. Arkison (In re Bellingham Insurance Agency Inc.), __ U.S. __, 134 S. Ct. 2165 (2014), does not require a different result.” In Executive Benefits, she said, the Supreme Court “expressly stated that it assumed without deciding that the fraudulent transfer claims were Stern claims.” [Emphasis in original.]
If an appellate court takes a different view, Judge Doyle said that her 37-page opinion should “be considered as proposed findings of fact and conclusions of law.”
The University Wasn’t the Initial Transferee
Conceding that the transfers were recoverable fraudulent transfers, the university argued that it could not be held liable under Section 550(a) as the initial transferee. If it were a subsequent transferee, the university would have a solid “good faith” defense under Section 550(b), since the university was not aware that Wasendorf was operating a Ponzi scheme.
Judge Doyle, however, rejected the university’s contention that Wasendorf was the initial transferee, because he never had “dominion and control” over the funds as required in the Seventh Circuit by Bonded Financial Services Inc. v. European American Bank, 838 F.2d 890, 893 (7th Cir. 1988). Wasendorf, she said, never held the funds in an account of his own and could not have negotiated the bank check payable to the university.
Judge Doyle said that the “dominion and control” test has been “widely adopted,” citing the Fifth, Eighth and Eleventh Circuits.
The trustee argued that the university had to be the initial transferee because it was the payee of the bank check. The university nevertheless got traction with Judge Doyle on a second argument, that the university was a “mere conduit” and was not the initial transferee.
Looking at all the “facts and circumstances,” Judge Doyle assigned herself the task of deciding whether the university “had sufficient right to use the money for its own purposes to be considered an initial transferee instead of a conduit.”
Judge Doyle said that Wasendorf made a pledge to the foundation, not to the university. Without dispute, she found that the university and the foundation had agreed that all donations for the benefit of the university would be made to the foundation.
Because Wasendorf was contractually obligated for a contribution to the foundation, Judge Doyle said that the university immediately endorsed the check and caused the funds to be deposited into a foundation account. She said the “university was not free to use the money for any purpose” and therefore “was a mere conduit for the foundation.”
Because the foundation was obliged to use the contribution for the benefit of the university, the trustee argued that the university was liable under Section 550(a)(1) not only as the initial transferee but also as “the entity for whose benefit such transfer was made.”
Since the university “will get the benefit of the funds sometime later,” Judge Doyle cited Bonded for the proposition that someone cannot be both a subsequent transferee and the “entity for whose benefit” the transfer was made. Under the trustee’s theory, she said, the university would be a “subsequent transferee under Section 550(b)(2), and a subsequent transferee cannot be considered a transfer beneficiary under Section 550(a)(1).”
Wasendorf, according to Judge Doyle, was the transfer beneficiary because the gift satisfied his pledge.
Because the trustee had not attempted to prove that the university was a subsequent transferee, Judge Doyle entered judgment in favor of the university.
Standard of Review on Appeal
On appeal, Judge Doyle’s Stern ruling could be pivotal.
This year in U.S. Bank NA v. The Village at Lakeridge LLC, 200 L. Ed. 2d 218, 86 U.S.L.W. 4121 (Sup. Ct. March 5, 2018), the Supreme Court prescribed the standard of appellate review for mixed questions of law and fact. Assuming an appellate court believes that Judge Doyle was primarily parsing the facts, her opinion would be subject to the “clear error” rule if she had power to enter final judgment.
On the other hand, if her ruling was a Stern decision, Judge Doyle’s findings of fact would be subject to de novo review, where the district court need give no deference to the bankruptcy court’s fact findings. Conceivably, a district judge could review the trial record but conclude that the university, as a matter of fact finding, was the initial transferee and therefore liable.
Thus, the standard of review in district court might determine the outcome. An appeal will require a district judge to apply Lakeridge to an important case where the issue is pivotal, not merely theoretical. Of course, a district or circuit court could pass the issue by affirming Judge Doyle under both standards.