Transferee may be Responsible to Return Fraudulent Transfers Made by Agents on Their Behalf

Alyssa DiBenedetto                                                                                                            

St. John’s University School of Law

American Bankruptcy Institute Law Review Staff

Section 550 of title 11 of the United States Code (the “Bankruptcy Code”) allows a trustee to “recover, for the benefit of the estate, the property transferred” or “the value of the property” from “any immediate or mediate transferee of such initial transferee.”[1] In Schmidt v. Rechnitz (In re Black Elk Energy Offshore Operations, LLC), the United States Court of Appeals for the Fifth Circuit held that when a shareholder’s agent fraudulently acquires funds, the shareholder is not afforded the protection of a good-faith transferee when that shareholder has constructive knowledge of the agent’s fraudulent transfers.[2]

Mark Nordlicht founded New York based hedge fund, Platinum Partners (“Platinum”), and served as its chief investment officer.[3] Platinum was the controlling shareholder of Black Elk, an oil and gas company based in Texas.[4]Around 2012, Black Elk needed cash, so it issued “Series E preferred equity shares.”[5] Platinum then created special-purpose entity Platinum Partners Black Elk Opportunities Fund LLC (“PPBEO”) to purchase these shares and solicit investors.[6] Platinum offered the Rechnitzes, investors in Platinum, a return on their investment in PPBEO.[7] The Rechnitzes agreed and invested $10 million.[8] In their agreement with PPBEO, the Rechnitzes designated “PPBE Holdings” (a Platinum entity) as their agent, where Nordlicht sat as the managing member.[9] As Black Elk lost money, Nordlicht worked to pay back the PPBEO investors ahead of any debt that Black Elk owed.[10] Platinum sold Black Elk’s “best assets to Renaissance Offshore for $125 million.”[11] With these proceeds, Platinum devised a plan to “redeem the Series E equity shares instead of paying Black Elk's senior secured bondholders or substantially overdue trade creditors.”[12] This gave Platinum a “priority position” in Black Elk’s impending bankruptcy.[13] To prioritize PPBEO investors, Platinum needed the consent of a “majority of Black Elk’s disinterested bondholders” to subordinate the bonds into Series E equity shares, so Nordlicht planned to rig the vote.[14] Nordlicht moved Platinum-controlled entities into bondholder positions and “then shifted the PPBEO investment from Series E equity to bonds” so that the entities that were “secretly controlled by Platinum” could pose as “disinterested bondholders.”[15] The amendment passed.[16] Black Elk sent over $70 million in proceeds from the Renaissance sale to Platinum to buy the Series E shares back.[17] Nordlicht then started paying the PPBEO investors back, including the Rechnitzes.[18] In 2019, Nordlicht was found guilty of securities fraud and Black Elk commenced a bankruptcy proceeding.[19]

In Black Elk’s 2016 bankruptcy plan, two trusts (the “Trusts”) were established.[20] The Trustee for Black Elk’s bankruptcy proceeding moved to extend the dissolution deadline for the Trusts to recover Renaissance funds from the Rechnitzes.[21] The Rechnitzes opposed the motion because the Trusts dissolved “by their own terms . . . three years after the bankruptcy plan took effect.”[22] The bankruptcy court rejected this argument and found the three-year timeline required “[a]n act of dissolution.”[23] The court approved an amendment to the Trusts to extend the dissolution date.[24]An adversary proceeding against the Rechnitzes ensued and in 2023 the court granted the Trustee partial summary judgment to recover fraudulently transferred funds.[25] The Rechnitzes argued that they did not need to return their funds because, under section 550(b)(1) of the Bankruptcy Code, they were deemed “‘good faith’ transferees.”[26] The court rejected this argument, finding that Nordlicht’s fraudulent actions were imputed on the Rechnitzes because they were not good-faith transferees.[27] The bankruptcy court created a tracing method to determine if the Rechnitzes’ funds were “traceable to the fraud.”[28] The bankruptcy court entered final judgment for the Rechnitzes to return funds to the Trustee, which the Rechnitzes appealed.[29]

The Fifth Circuit reviewed the bankruptcy court’s decision de novo to determine whether: (1) the case was moot because the Trusts dissolved after a three-year period; (2) the Rechnitzes were good faith transferees under section 550(b)(1); and (3) the bankruptcy court abused its discretion when it established a tracing method.[30] First, the Fifth Circuit court (the “Court”) agreed with the bankruptcy court that the Rechnitzes “lacked standing” on their mootness argument because under the “‘person aggrieved’ test, only persons ‘directly, adversely, and financially impacted by a bankruptcy order may appeal it.’”[31] The Fifth Circuit also concluded that standing “must be connected to the exact order being appealed.”[32] The Rechnitzes argued they met this standard because “they were directly harmed by the bankruptcy court’s subsequent judgment in the adversary proceeding.”[33] The Fifth Circuit dismissed this argument because the Rechnitzes failed to cite any supporting decisions and because their argument did not comport with the “person aggrieved standing.”[34] The Court then affirmed the amendments to the Trusts that were approved by the bankruptcy court.[35]

Second, the Court analyzed the Rechnitzes’ assertion of good faith.[36] In doing so, the Court addressed the Rechnitzes’ two-pronged argument: (1) “the Trustee had to prove they personally knew about Nordlicht’s wrongdoing”; and (2) “Nordlicht’s fraudulent knowledge cannot be imputed to them because his actions fell outside the scope of his authority as their agent.”[37] The Rechnitzes argued section 550(b)(1)’s use of the term “knowledge” implies actual knowledge because the Bankruptcy Code fails to “mention imputed or constructive knowledge.”[38] Under section 550(b)(1), a trustee cannot recover fraudulent funds transferred to “a transferee that takes for value . . . in good faith, and without knowledge of the voidability of the transfer.”[39] The Court rejected the Rechnitzes’ argument under the rationale that the Bankruptcy Code does not redefine the “traditional linkage between principal and agent.”[40] The Court also found Nordlicht’s fraudulent knowledge could be imputed on the Rechnitzes as their agent.[41] Further, the Court rejected cases cited by the Rechnitzes because they “involved radical detours from the agent’s duties.”[42] Here there were no such radical detours.

Third, the Court analyzed the method that the bankruptcy court used to trace the Rechnitzes’ fraudulent funds to determine if it was an abuse of discretion.[43] The bankruptcy court “focus[ed] on Nordlicht’s objective in defrauding Black Elk’s creditors” to trace the funds, which they described as an application of the “Lowest Intermediate Balance Rule” (“LIBR”).[44]  However, the Fifth Circuit found that this is most similar to the “proceeds-in, first-out” rule, which assumed tainted funds are used first when commingled with untainted funds.[45] Using this approach, the bankruptcy court traced most of the Renaissance proceeds into one specific account.[46] Since Nordlicht made principal and interest payments to the Rechnitzes from this account and the account had “enough tainted funds to cover those transfers,” the bankruptcy court reasoned that the payments made to the Rechnitzes were traceable to Nordlicht’s fraud.[47] The Fifth Circuit concluded that this exercise was not an abuse of discretion because courts may exercise the method “best suited to achieve a fair and equitable result.”[48]

The Fifth Circuit’s ruling in this case narrows the definition of “good faith” as established in section 550(b)(1) and holds transferees to a higher level of accountability and liability for the actions of their agents.  It also broadens how a court can trace fraudulent transfers.  As a result, trustees may have greater opportunities  to recover funds that were fraudulently transferred for the benefit of estates and creditors.