Wednesday, October 11, 2017

FYI: 9th Cir Limits Subsequent Good-Faith Transferee Exception in Bankruptcy Fraudulent Transfer Actions

The U.S. Court of Appeals for the Ninth Circuit recently held that a debtor corporation's sole shareholder ("Sole Shareholder") and third parties who sold real property and services to the Sole Shareholder could be liable for fraudulent transfers. 

 

In so ruling, the Ninth Circuit held that the third parties were initial transferees of the debtor corporation's funds because the Sole Shareholder paid the third parties with checks directly from a corporate account, even though the third parties did not have a pre-existing relationship or an ongoing relationship with the Sole Shareholder, his family, or any of his businesses.

 

A copy of this opinion is available at:  Link to Opinion

 

As you may recall, the Bankruptcy Code makes a distinction between initial and subsequent transferees when it comes to the recovery of fraudulent transfers. 

 

The trustee and the debtor's creditors may recover the property (or its value) from "(1) the initial transferee of such transfer or the entity for whose benefit such transfer was made; or (2) any [subsequent] transferee of such initial transferee."  11 U.S.C. § 550(a). 

 

The trustee and creditors, however, may not recover the property or its value from a subsequent transferee if that transferee accepted the property "for value …, in good faith, and without knowledge of the voidability of the transfer."  Id. at § 550(b)(1).

 

In 2002, the Sole Shareholder of the debtor corporation opened a separate corporate account and deposited certain vendor rebates into that account over a ten-year span.  The Sole Shareholder concealed the separate account from the debtor corporation's general ledgers and later attempted to conceal its existence from the bankruptcy court. 

 

The Sole Shareholder used the separate account for personal expenses.  The Sole Shareholder purchased real property from real property sellers ("Sellers") and design services from an interior designer ("Interior Designer").  The Sole Shareholder made these purchases using corporate checks drawn on the separate account.  Neither the Sellers nor the Interior Designer had a pre-existing relationship or an ongoing relationship with the Sole Shareholder, his family, or any of his businesses.

 

In 2012, the corporation filed for bankruptcy.  The unsecured creditor's committee ("Committee") sought to avoid certain transfers made from the separate account, including the payments to the Sellers and the Interior Designer.  The bankruptcy court found that the Sellers and Interior Designer were subsequent transferees entitled to the safe harbor under § 550(b)(1). 

 

The trial court reversed the bankruptcy court's decision and found that the Sellers and Interior Designer were strictly liable to the Committee because they qualified as "initial transferees" of the fraudulent payments.  The Bankruptcy Appellate Panel affirmed the trial court's decision.

 

The Ninth Circuit began its analysis by noting that it had adopted the dominion test for determining who is a transferee for purposes of Section 550.  Under the dominion test, a transferee is one who has dominion over the money or other asset.  The dominion test turns on whether the recipient of funds has legal title to them and whether the recipient has the ability to use the funds as he sees fit.  The Ninth Circuit explained that the test focuses on whether the recipient of funds has legal title to them because dominion strongly correlates with legal title and dominion is akin to legal control.

 

The Ninth Circuit then observed that courts have taken two approaches when applying Section 550 to fraudulent transfers involving the misappropriation of corporate funds by company directors, officers, or other insiders. 

 

Under the majority approach (which the Ninth Circuit follows), a principal of a debtor corporation who misappropriates company funds to satisfy personal obligations is not an initial transferee because the mere power of a principal to direct the allocation of corporate resources does not amount to legal dominion and control, which is required for initial-transferee status.

 

In contrast, under the minority approach, corporate principals may be strictly liable as initial transferees when they misuse company funds for personal gain.  Under this "two-step transaction" approach, the debtor company is deemed to have made the initial transfer to the corporate principal, thus making him or her strictly liable as the initial transferee.

 

The Ninth Circuit explained the merits of the majority approach.  The Ninth Circuit pointed out that the "flow of funds" matters and that receipt of the transferred property is a necessary element for that entity to be a transferee under section 550.  The Ninth Circuit found that simply directing a transfer, i.e., such as directing a debtor to transfer funds, is not enough. 

 

In addition, the Court reasoned, section 550(a)(1)'s structure indicates that a principal does not become an initial transferee simply by using his or her control over corporate assets to effect a fraudulent transfer because section 550 imposes strict liability on both initial transferees and any beneficiaries of the fraudulent transfers.  Thus, the Ninth Circuit held that section 550 indicates that initial transferees and beneficiaries are separate persons. 

 

Finally, the Ninth Circuit found that the alternative approach (under which every agent or principal of a corporation is deemed the initial transferee when he or she effected a transfer of property in his or her representative capacity) both misallocates the monitoring costs that section 550 seeks to impose and deprives the trustee of a potential source of recovery for creditors.  The Ninth Circuit observed that recovery from an embezzling principal would be difficult, thus Congress also made the first recipient of those funds liable to returning them.

 

The Ninth Circuit then held that the Sellers and the Interior Designer were initial transferees because legal control over the funds had never passed from the Corporation to the Sole Shareholder.  Recall that the Sole Shareholder had paid the Sellers and the Interior Designer using checks drawn on the Corporation's account, albeit a concealed, separate account.

 

Thus, the Ninth Circuit found that section 550 allowed the trustee to recover funds from the Sellers and the Interior Designer as initial transferees and from the Sole Shareholder as the beneficiary.

 

Judge Nguyen dissented from the majority's opinion.  Judge Nguyen suggested that the Ninth Circuit should abandon its dominion test, in favor of the control test used by other circuits.  Under the control test, courts "view the entire transaction as a whole to determine who truly had control of the money." In addition, Judge Nguyen argued that the debtor corporation did not have legal title to the funds prior to the transfer as a matter of state law.  Judge Nguyen argued that under state law, the Sole Shareholder converted corporate funds by transferring them into his personal account, making him the initial transferee.

 

 

 

 

Ralph T. Wutscher
Maurice Wutscher LLP
The Loop Center Building
105 W. Madison Street, 18th Floor
Chicago, Illinois 60602
Direct:  (312) 551-9320
Fax: (312) 284-4751

Mobile:  (312) 493-0874
Email: rwutscher@MauriceWutscher.com

 

Admitted to practice law in Illinois

 

 

 

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Tuesday, October 10, 2017

FYI: 1st Cir Holds MA Pred Home Loan Practices Act Claim Barred by 5-yr SOL

The U.S. Court of Appeals for the First Circuit recently held that a borrower's claim under the Massachusetts Predatory Home Loan Practices Act ("MPHLPA") was barred by the applicable five year statute of limitations where the loan was extended more than five years before the complaint was filed and the borrower did not allege facts to demonstrate that tolling should apply.

 

Accordingly, the First Circuit affirmed the ruling of the trial court dismissing the borrower's complaint with prejudice, and denying his motion for leave to file an amended complaint as futile. 

 

A copy of the opinion is available at:  Link to Opinion

 

The borrower ("Borrower") filed an eight count complaint against the servicers, holders, and assignees of his mortgage loan ("Loan") that had been executed in 2006.  The trial court dismissed the complaint in its entirety with prejudice, and denied the Borrower's request for leave to file an amended pleading.

 

In reaching its ruling on the MPHLPA claim, the trial court determined that "because the facts underlying [the borrower's] claim that the loan was predatory were contained in the mortgage documents themselves," he could not avail himself of any tolling mechanism.

 

The Borrower appealed the ruling with respect to one count only, the alleged violation of the MPHLPA.  Specifically, the Borrower argued that: (1) the trial court erred in dismissing the MPHLPA claim as untimely, and (2) the trial court abused its discretion in dismissing the complaint without leave to amend.

 

On appeal, the First Circuit noted that it was undisputed that the Loan was extended on May 26, 2006, and that the complaint was not filed until April 28, 2015, outside the five year statute of limitations.  Thus, the only way the complaint could survive a motion to dismiss was if it was subject to tolling.

 

However, in the Borrower's opening brief in the Fifth Circuit, he merely laid out the law on tolling, but "completely fail[ed] to articulate how the facts in this case support its application."  In his reply brief, the Borrower argued that the statute of limitations should have been tolled until January 11, 2013, when he purportedly first discovered that an assignment of mortgage securing his Loan had not been properly signed. 

 

In rejecting the Borrower's argument, the First Circuit first noted that it was waived because it was raised for the first time in the reply brief.  The First Circuit further held that the argument lacked merit. 

 

In so ruling, the Court noted that "the heart of [the MPHLPA claim] are the terms contained in the mortgage loan."  Further, under Massachusetts law, "equitable tolling only applies if a plaintiff exercising reasonable diligence could not have discovered information essential to the suit." 

 

Because the terms of the Loan were in the Borrower's possession since 2006, and because with reasonable diligence he could have discovered and initiated his claim within the five year statute of limitations, tolling did not apply.

 

The Fifth Circuit further held that to the extent the Borrower alleged unlawful practices outside the terms of the Loan itself, he made "no argument as to why these actions fall within the purview of the [MPHLPA] – a statute primarily concerned with loan origination and lending terms." 

 

Thus, the Fifth Circuit held the Borrower's claim under the MPHLPA was time barred, and correctly dismissed by the trial court.

 

The Court next turned to the Borrower's argument that the district court erred in denying his motion for leave to amend the complaint.

 

The Borrower argued that he should have been permitted to file an amended pleading because "the proposed amendment has a valid [MPHLPA] claim against defendants." 

 

The Fifth Circuit disagreed, ruling that the "proposed second-amended complaint raises new allegations which go solely to the merits of his predatory loan claim," but did not "include any factual allegations that would either plausibly place [the MPHLPA claim] inside the 5-year window or support a tolling argument." 

 

Thus, the proposed amended complaint would also be time-barred.  Accordingly, the Fifth Circuit affirmed the ruling of the trial court denying the Borrower leave to amend, because "the complaint, as amended, would fail to state a claim upon which relief could be granted." 

 

 

 

 

Ralph T. Wutscher
Maurice Wutscher LLP
The Loop Center Building
105 W. Madison Street, 18th Floor
Chicago, Illinois 60602
Direct:  (312) 551-9320
Fax: (312) 284-4751

Mobile:  (312) 493-0874
Email: rwutscher@MauriceWutscher.com

 

Admitted to practice law in Illinois

 

 

 

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Monday, October 9, 2017

FYI: Missouri Sup Ct Holds Statutory Post-Judgment Interest Allowed for All Non-Tort Actions

The Supreme Court of Missouri recently affirmed, in part, a trial court order dismissing two debtors' petitions attempting to assert violations of the federal Fair Debt Collection Practices Act and the Missouri Merchandising Practices Act against a hospital for failure to state a claim, holding that judgments in non-tort actions include post-judgment interest as a matter of law pursuant to § 408.040.1 even if the judgment does not expressly include post-judgment interest.

 

A copy of the opinion is available at:  Link to Opinion

 

A hospital provided medical services to the debtors.  After the debtors failed to pay their debt, the hospital sued the debtors in separate breach of contract actions. 

 

The court in each action entered judgments against the debtors. Neither judgment expressly provided for the recovery of post-judgment interest pursuant to § 408.040. Nevertheless, the hospital attempted to collect on the judgments, including seeking post-judgment interest.

 

The debtors, in separate petitions, sued the hospital and its debt collection counsel alleging they violated the federal Fair Debt Collection Practices Act and the Missouri Merchandising Practices Act because the judgments did not award post-judgment interest.

 

The hospital and its counsel moved to dismiss arguing that the petitions failed to state a claim on which relief can be granted. The trial court consolidated the cases and granted the motions to dismiss finding that the petitions failed to state a claim on which the court could grant relief.

 

The debtors appealed and, after the Court of Appeals opinion, the Supreme Court of Missouri accepted the case pursuant to article V, § 10 of the Missouri Constitution.

 

On appeal, the debtors argued that they properly stated a claim because § 408.040 does not provide for automatic accrual of post-judgment interest, and the judgments at issue did not expressly include post-judgment interest.

 

As you may recall, Section 408.040 provides, in relevant part, that:

 

          1. In all nontort actions, interest shall be allowed on all money due upon any judgment or order of any court from the date judgment is entered by the trial court until satisfaction be made by payment, accord or sale of property; all such judgments and orders for money upon contracts bearing more than nine percent interest shall bear the same interest borne by such contracts, and all other judgments and orders for money shall bear nine percent per annum until satisfaction made as aforesaid.

          2. Notwithstanding the provisions of subsection 1 of this section, in tort actions, interest shall be allowed on all money due upon any judgment or order of any court from the date of judgment is entered by the trial court until full satisfaction. All such judgments and orders for money shall bear a per annum interest rate equal to the intended Federal Funds Rate, as established by the Federal Reserve Board, plus five percent, until full satisfaction is made. The judgment shall state the applicable interest rate, which shall not vary once entered.

 

The debtors cited McGuire v. Kenoma, LLC, 447 S.W.3d 659 (Mo. 2014), to support their argument that a nontort judgment does not accrue post-judgment interest if the judgment does not expressly state that it includes post-judgment interest.

 

The Missouri Supreme Court distinguished McGuire, because, unlike these breach of contract actions, it was a tort case that concerned subsection 2 of section 408.040.  Subsection 2 of § 408.040 provides that post-judgment "shall be stated" in the judgment or it is not collectible. The Court observed that subsection 1 (nontort actions) and subsection 2 (tort actions) are distinct because only subsection 2 requires that the "judgment shall state the applicable interest rate." § 408.040.

 

In contrast, section 408.040.1 states that "judgments and orders for money upon contracts bearing more than nine percent interest shall bear the same interest borne by such contracts, and all other judgments and orders for money shall bear nine percent per annum until satisfaction made as aforesaid." § 408.040.

 

Thus, the Missouri Supreme Court held, post-judgment interest under subsection 1 of § 408.040 accrues automatically because the plain language does not require any findings by a trial court "for a nontort judgment to bear 9-percent interest."  If the judgment does not specify the amount of interest the contract allows, then the judgment "shall bear nine percent interest," and the judgment holder may collect post-judgment interest "even if the judgment does not specifically award the statutorily approved post-judgment interest."

 

The Court observed that post-judgment interest is designed to ensure that "a money judgment will be worth the same when it is actually received as it was when it was awarded."  Also, post-judgment interest compensates "the successful plaintiff for being deprived of compensation for the loss from" when damages are ascertained and the defendant pays.  Kaiser Aluminum & Chem. Corp. v. Bonjorno, 494 U.S. 827, 835–36 (1990).  Moreover, courts have often recognized that "a judgment need not explicitly state it bears interest.  Laughlin v. Boatmen's Nat. Bank of St. Louis, 189 S.W.2d 974, 980 (Mo. 1945)

 

Thus, the Missouri Supreme Court explained, the prevailing party does not lose the "right to collect the statutorily authorized interest by the lack of a specific award as to post-judgment interest in nontort actions." Instead, a "judgment must only recite the 'money due' or principal, and then the statute makes that amount bear interest, at the statutorily defined rate, to the time of payment." Judgments in nontort actions include post-judgment interest as a matter of law pursuant to section 408.040.1 "regardless of whether the judgment expressly includes it."

 

Finally, the Court found that debtors petitions contained additional allegations — such as the law firm's failure to credit all payments — that may state a claim upon which relief can be granted. The Missouri Supreme Court noted that the trial court should consider these issues in the first instance.

 

Accordingly, the Court reversed the trial court's dismissal of the petitions, and remanded the case to consider the remaining issues.

 

 

 

 

Ralph T. Wutscher
Maurice Wutscher LLP
The Loop Center Building
105 W. Madison Street, 18th Floor
Chicago, Illinois 60602
Direct:  (312) 551-9320
Fax: (312) 284-4751

Mobile:  (312) 493-0874
Email: rwutscher@MauriceWutscher.com

 

Admitted to practice law in Illinois

 

 

 

Alabama   |   California   |   Florida   |   Georgia  |   Illinois   |   Indiana   |   Maryland   |   Massachusetts   |   Michigan   |   New Jersey   |   New York   |   Ohio   |   Pennsylvania   |   Texas   |   Washington, DC   |   Wisconsin

 

 

NOTICE: We do not send unsolicited emails. If you received this email in error, or if you wish to be removed from our update distribution list, please simply reply to this email and state your intention. Thank you.


Our updates and webinar presentations are available on the internet, in searchable format, at:

 

Financial Services Law Updates

 

and

 

The Consumer Financial Services Blog

 

and

 

Webinars

 

and

 

California Finance Law Developments