Third Circuit Pronounces a Damages Formula for Fraudulent Entireties Transfers

Bankruptcy Judge Thomas P. Agresti of Erie, Pa., was given the supreme compliment by the Third Circuit: The appeals court saluted his “prescient thinking” in devising a formula for calculating damages in a complex fraudulent transfer suit.

A man had been a partner in a law firm that went out of business. He was saddled with millions of dollars of liability for his guarantee of his “old” firm’s lease. While working at a “new” firm, he was hit with a multimillion-dollar judgment in favor of the landlord.

To avoid having income from his “new” firm garnished, he directed the firm to deposit his income directly into an entireties account in his name and his wife’s. Because the wife was not liable on the judgment, the landlord could not attach the joint bank account.

The man was forced into bankruptcy by the judgment. The trustee sued the debtor and his wife to recover fraudulent transfers under the Pennsylvania Uniform Fraudulent Transfer Act.

Eventually, the bankruptcy judge entered judgment against the debtor and his wife, calculating damages of about $275,000 under a formula suggested by the Third Circuit. The district court affirmed. Both the couple and the trustee appealed.

In an opinion on February 20, Circuit Judge Thomas L. Ambro upheld the judgment. In the process, he lauded Judge Agresti for recommending a formula for calculating damages resulting from fraudulent transfers into entireties accounts.

Liability

Judge Ambro had no difficulty finding fraudulent transfer liability. “When the wages of an insolvent spouse are deposited into a couple’s entireties account, both spouses are fraudulent transferees,” he said.

The direct deposit of the debtor’s wages into the joint account was a “transfer” of an “asset” because: (1) Wages were the debtor’s asset; (2) the wages were no longer his asset after deposit into the entireties account; and (3) the change in status was a “transfer.”

The Third Circuit, Judge Ambro said, presumes that transfers into an entireties account are not made for reasonably equivalent value. Because the debtor was insolvent, the transfers of the debtor’s income were therefore fraudulent transfers.

Next, Judge Ambro said that the wife was liable as a transferee. He cited the Third Circuit and numerous courts that have held a spouse liable for a fraudulent transfer into entireties property.

Judge Ambro went on to hold that the debtor was liable as both the transferor and a transferee.

Damages

The tricky question was damages, because some of the funds in the account came from the wife or sources that were not fraudulent transfers. Moreover, courts have held there is no liability when money is spent for reasonable and necessary household expenses. In that regard, the trustee must “prove by a preponderance of the evidence that [the debtor’s] wage deposits were not spent on necessities,” Judge Ambro said.

At that juncture, Judge Ambro said that the trustee faces “what appears to be an impossible task in a commingled account.” Because money is fungible, he said it may be impossible to determine what deposit was used for a particular expenditure.

For his “prescient thinking,” Judge Ambro praised Judge Agresti for advocating a damages formula that the Third Circuit went on to adopt in the February 20 opinion.

For “future courts facing commingled funds,” Judge Ambro laid down what he called the “pro rata” formula for damage calculation. He said it “accounts for the fungibility of wage and nonwage funds that are commingled.”

It goes like this: First calculate the deposits that were fraudulent transfers and those that were not. In the case at bar, the debtor’s wages represented fraudulent transfers equaling about 60% of the deposits into the joint account.

Payments from the account totaled about $2.1 million, of which about $1 million were for non-necessities.

Applying the percentage of fraudulent deposits to the expenses for non-necessities, Judge Ambro said that the judgment should have been about $600,000.

Applying a prior formula that the Third Circuit seemingly had endorsed, the bankruptcy judge found the couple liable for only $275,000.

In substance, Judge Ambro said that the damages formula from the prior Third Circuit opinion was not holding and thus was not binding on a subsequent panel. In that respect too, he praised Judge Agresti for “sounding the alarm” about shortcomings in the prior damages formula.

The debtor got off lucky, however. Judge Ambro upheld that $275,000 judgment because the trustee had waived the issue regarding the formula.

N.B.: Circuit Judge Patty Shwartz did not join in the discussion of the pro rata formula, believing it was unnecessary given the trustee’s waiver of the issue. She also believes that the amount of liability should be left to the discretion of the trial court.