Generation Resources: Tenth Circuit Holds that a Subsequent Transferee of Proceeds of an Initial Fraudulent Transfer is not a Transferee, for Purposes of Section 550

In a factually complex and quickly criticized opinion,[1] a panel of the Tenth Circuit recently held that a chapter 7 trustee cannot maintain a fraudulent transfer action against subsequent transferees of a fraudulent transfer if the subsequent transferee receives only proceeds of the “property that was set aside as fraudulently transferred.”[2] Almost immediately, experts lamented that “the Tenth Circuit gutted fraudulent transfer law and blessed a process allowing a fraudster to immunize proceeds from recovery[,]” opining that the Generation Resources opinion “is so wrong that [they] don’t know exactly where to begin.”[3]

Summary of Factual and Procedural Background

The Generation Resources debtor was a company with rights to develop a wind-power project, whose builder agreed to pay the debtor a fee and the developer’s costs when the project was completed and sold. While insolvent but before filing for bankruptcy, the debtor transferred its rights to a transferee who thereby acquired the debtor’s rights to be paid all costs and fees incurred in connection with the development of the project from the builder upon completion and sale of the project.

When the project was completed and sold, the builder paid the transferee, but the transferee deemed that amount inadequate to satisfy the costs and expenses to which it was entitled via the transfer from the debtor. Accordingly, the transferee obtained counsel and sued the builder to obtain such costs and expenses. Ultimately, the transferee obtained a $9 million judgment against the builder, $2 million of which the transferee used to pay its counsel.

While the transferee’s action against the builder was pending, the debtor filed a chapter 7 petition. Eventually, the chapter 7 trustee commenced an adversary proceeding against the transferee to avoid the transfer of the debtor’s rights to be paid fees and costs upon the completion and sale of the project as a fraudulent transfer. The trustee obtained a judgment against the transferee but was unable to collect on the judgment. In an effort to obtain a recovery for the debtor’s estate, the trustee sued the two law firms who had represented the transferee in its action against the builder for the $2 million in fees the law firms were paid by the transferee from the proceeds of its judgment against the builder, which, in turn, constituted proceeds of the fraudulently transferred right to be paid developer’s costs and fees originally held by the debtor.

The bankruptcy court denied the law firms’ motions to dismiss, and the Tenth Circuit reversed.

The Generation Resources Holding: A Trustee Cannot Recover From a Subsequent Transferee Who Receives Only Liquidated Proceeds of an Initial Fraudulent Transfer

The Tenth Circuit based its opinion on a plain-meaning interpretation of Section 550 of the Bankruptcy Code. The court enumerated the three essential elements for a claim under Section 550:[4]

First, a trustee must invoke a transfer that was avoided under one of the enumerated sections of the Bankruptcy Code. Second, a trustee must plausibly allege that he seeks to recover “the property transferred” or “the value of such property.” Third, a trustee must plausibly allege that the defendants are either “the initial transferee,” “the entity for whose benefit such transfer was made,” or “any immediate or mediate transferee of such initial transferee.”

“The first step in ascertaining the identity of the transferees is to pinpoint ‘the property transferred.’”[5] Ultimately, the court held that the trustee’s claims failed because the “firms [were] not subsequent transferees because they never received the property transferred, i.e., the contractual right to the … sales proceeds.”[6]

The Tenth Circuit’s holding may prove problematic and will certainly generate many a defense for subsequent transferees in fraudulent transfer litigation. Bill Rochelle distilled the Generation Resources holding as follows:[7]

The Tenth Circuit appears to have held: If a debtor fraudulently transfers a contract claim, and if the initial transferee converts the contract claim to cash, a subsequent transferee of the cash did not receive a transfer of the fraudulently transferred property (the contract claim) and therefore cannot be held liable under Section 550(a).

Criticism of the Tenth Circuit’s Opinion

If Generation Resources truly stands for the proposition that a subsequent transferee of liquidated proceeds of an initial fraudulent transfer can never be a “transferee” for purposes of Section 550, then such a “subsequent transferee has a complete defense,” in the Tenth Circuit, “even if the subsequent transferee was aware of the initial fraud.”[8] Such an absolute defense could lead to absurd results:[9]

How would this holding apply to a run-of-the mill case? If the result is silly, try again. A transfers Greenacre to A’s brother as a gift while A is insolvent. A’s brother sells Greenacre to Joe, who takes it in good faith and for fair value. A’s brother then transfers the cash proceeds of the sale to A’s daughter. How would the Tenth Circuit resolve this issue if A then files a bankruptcy petition and his trustee commences a section 548/550 action against A’s brother, Joe and A’s daughter? Assume A’s brother is hopelessly insolvent. The trustee avoids the transfer to A’s brother; insolvents can’t make gifts. But A’s brother no longer has the property or the proceeds and is insolvent — so no luck. Worse, the property is in the hands of a protected BFP, so no recovery of the property here, either. That leaves A’s daughter. But she does not have the ‘property transferred,’ so she is not subject to Section 550, according to the Tenth Circuit. And she gets to keep the cash. That is a silly result. Silly amplifies the fallacy in the Tenth Circuit’s opinion. This is, and should be, a ‘good faith’ case.

Had the Tenth Circuit panel been presented with Professor Williams’ above scenario, it is easy to imagine that its Generation Resources holding might have been different.

Conclusion

Only time will tell if Generation Resources will provide a definitive defense to subsequent transferees of proceeds of an initial fraudulent transfer in the Tenth Circuit, or if the court’s sister circuits will adopt this approach. Perhaps, however, commentators should be more sanguine about the effects of the opinion — for example, nothing in Generation Resources would prevent a bankruptcy court from exercising its equitable power to collapse a series of fraudulent transfers that ultimately results in a subsequent transferee’s receipt of proceeds of an initial fraudulent transfer.[10] Whatever ultimately results from the Tenth Circuit’s recent opinion, one thing is certain in the short-term: subsequent transferees of proceeds of an allegedly fraudulent transfer will attempt to rely on it.