Routine Withdrawals from a Bank Account Aren’t ‘Transfers,’ Eleventh Circuit Says

Routine deposits and withdrawals from a bank account are not “transfers” and thus cannot form the basis for a fraudulent transfer suit against the bank, according to the Eleventh Circuit.

And even if the bank was aware of fraud, the appeals court ruled that a receiver cannot successfully mount aiding and abetting claims against the bank if the company was completely dominated by fraudsters.

The Ponzi Scheme

A corporation was a thoroughgoing Ponzi scheme. The state court appointed a receiver. Alleging that the corporation’s primary bank was aware of fraud, the receiver sued the bank in state court for receipt of fraudulent transfers under Florida’s version of the Uniform Fraudulent Transfer Act, or FUFTA.

The receiver also mounted tort claims against the bank for aiding and abetting breach of fiduciary duty, conversion and fraud.

The district court granted the bank’s motion to dismiss, and the receiver appealed.

The Eleventh Circuit upheld dismissal in a June 1 opinion by Circuit Judge Gerald B. Tjoflat, a federal judge for almost 50 years.

The Fraudulent Transfer Claims

To construct a claim under FUFTA, there must be a “transfer.” Although the word is defined broadly, Judge Tjoflat explained that the plaintiff must “show that the debtor either disposed of his asset or relinquished some interest in that asset . . . . As long as the debtor relinquishes some interest in or control over the asset a FUFTA transfer has occurred, even if he remains the technical owner of the asset.” [Citations omitted.]

As transfers, the complaint identified deposits into the bank account, withdrawals from the account, and intercompany transfers for one account to another. The trustee argued that the activities amounted to transfers under FUFTA because the bank took title to the money and owed a debt to the company in return.

Not so, Judge Tjoflat said. “We disagree that a routine bank deposit constitutes a transfer to the bank within the meaning of the FUFTA.” For a transfer, he said, “the relevant inquiry is not one of ownership or title but of control.”

Although the bank replaced money with a debt, Judge Tjoflat said that the company never relinquished its interest or control by maintaining full control over the funds. Thus, he held that the company “did not transfer that money to [the bank] within the meaning of the FUFTA.”

Judge Tjoflat upheld dismissal of the FUFTA claims without reaching the question of whether the bank had a defense as a “mere conduit.” He did not reach the issue because “mere conduit” only comes into play if there was a transfer in the first place.

The Tort Claims

The appeals court had the parties submit supplemental briefs on the question of whether the misdeeds of the fraudsters were imputed to the receiver. We bet you’re guessing that Judge Tjoflat would uphold dismissal of the tort claims under the doctrine of in pari delicto, which means in equal fault. Under English common law, courts invoked the doctrine to prevent the court from aiding one fraudster to sue another.

Nope, in pari delicto was not the basis for dismissal. There were other fatal defects, relating to claims that a receiver may or may not bring.

A receiver may not assert claims belonging to creditors. “Rather, he is limited to bringing only those actions previously owned by the party in receivership,” Judge Tjoflat said.

The question then becomes whether the company could have brought aiding and abetting claims and whether the Ponzi schemers’ fraud was therefore imputed to the receiver.

Judge Tjoflat turned to an intermediate Florida appellate court for guidance. The state court said that a receiver does not always inherit the sins of the company. For complicated reasons that amount to a convenient legal faction, courts hold that a receiver in a Ponzi scheme has standing to sue under FUFTA.

“On the other hand,” Judge Tjoflat said, there “are common law tort claims against third parties to recover damages for the fraud perpetrated by the corporation’s own insiders.” In those cases, he said, the receiver has no standing unless the company had “at least one honest member of the board of directors or an innocent stockholder.” If someone was honest, then there was injury to the corporation that a receiver could seek to remedy.

In his complaint, the receiver alleged that the fraudsters had complete control and wholly dominated the company. Consequently, Judge Tjoflat said, the “Receivership Entities cannot be said to have suffered any injury from the Ponzi scheme that the Entities themselves perpetrated.”

In a case like the one on appeal, Judge Tjoflat said that the aiding and abetting claims “belong to the investors who suffered losses from this Ponzi scheme, not the Receivership Entities.”

Making a distinction that did not alter the outcome, Judge Tjoflat said that the receiver’s “ability to pursue these claims is barred not by the doctrine of in pari delicto, but by the fact that the Receivership Entities were controlled exclusively by persons engaging in and benefitting from the Ponzi scheme, and so the Receivership Entities were not injured by that scheme.”

In short, the Eleventh Circuit upheld dismissal of the aiding and abetting tort claims based on convenient legal fictions that bar a receiver from mounting claims for the benefit of all creditors.

Observations

If we live long enough, Congress and the states will adopt laws permitting receivers and bankruptcy trustees to sue wrongdoers without facing defenses like in pari delicto. Or, perhaps a brave appellate court will free courts in the 21st century from the shackles of English common law, which, in the view of this writer, has been misapplied to receivers and bankruptcy trustees.

Imposing doctrines like in pari delicto on bankruptcy trustees overlooks an important reform in the Bankruptcy Code. Under the prior Bankruptcy Act, trustees took title to estate property. It was also said that trustees stepped into the shoes of the debtors. As a result, there was some theoretical basis for making trustees subject to in pari delicto.

Instead, the Bankruptcy Code creates an estate (Section 541(a)), and the trustee administers the estate. The trustee neither takes title to estate assets nor steps into the shoes of the debtor. As a result, there is a basis in the statute to recognize that in pari delicto does not apply to bankruptcy trustees.