Bonded Financial Services, Inc., Debtor-Appellant v. European American BankBonded Financial Services, Inc., Debtor-Appellant v. European American Bank
Miсhael Ryan controlled a number of currency exchanges in Illinois. He also owned quite a few horses, doing business as Shamrock Hill Farm. Ryan had borrowed $655,000 from European American Bank to run this business. One of the currency exchanges, Bonded Financial Services, put $200,000 at Ryan’s disposal in January 1983. Bonded sent the Bank a check payable to the Bank’s order on January 21 with a note directing the Bank to “deposit this check into Mike[ Ryanj’s account.” The Bank did this. On January 31 Ryan instructed the Bank to debit the account $200,000 in order to reduce the outstanding balance of the Shamrock loan. The Bank did this. Ryan paid off the loan in two more installments, on February 11 and 14, 1983. The Bank released its security interest in the horses.
The currency exchanges and Ryan paid visits to the judicial system. Bonded filed a petition in bankruptcy on February 10, 1983, along with about 65 other entities that Ryan controlled. Creditors later filed involuntary proceedings against Ryan. Ryan was convicted of mail fraud on account of his irregular administration of the currency exchanges (Bonded was not, for starters) and is in prison. The transfer of $200,000 out of Bonded on January 21, 1983, was a fraudulent conveyance, see
The right of recovery depends on
(a) Except as otherwise provided in this section, to the extent that a transfer is avoided under section ... 548 ... of this title, the trustee may recover, for the benefit of the estate, the property transferred, or, if the court so orders, the value of such property, from—
(1) the initial transferee of such transfer or the entity for whose benefit such transfer was made; or
(2) any immediate or mediate transferee of such initial transferee.
(b) The trustee may not recover under section (a)(2) of this section from—
(1) a transferee that takes for value, including satisfaction or securing of a present or antecedent debt, in good faith, and without knowledge of the voidability of the transfer avoided; or
(2) any immediate or mediate good faith transferee of such transferee.
Bonded’s trustee contends in this adversary proceeding that the Bank is the “initial transferee” under
I
If the note accompanying Bonded’s check had said: “use-this check to reduce Ryan’s loan” instead of “deposit this check into [Ryan]’s account”,
Fraudulent conveyance law protects creditors from last-minute diminutions of the pool of assets in which they have interests. They accordingly need not monitor debtors so closely, and the savings in monitoring costs make businesses more productive. See Douglas G. Baird & Thomas H. Jackson, Fraudulent Conveyance Law and its Proper Domain, 38 Vand.L.Rev. 829 (1985); Robert Charles Clark, The Duties of the Corporate Debtor to its Creditors, 90 Harv.L.Rev. 505, 554-60 (1977). The original rule, in 13 Eliz. ch. 5 (1571), dealt with debtors who transferred property to their relatives, while the debtors themselves sought sanctuary from creditors. The family enjoyed the value of the assets, which the debtor might reclaim if the creditors stopped pursuing him. In the last 400 years the principle has been generalized to address transfers without either sufficient consideration or bad intent, for they, no less than gifts, reduce the value of the debtor’s estate and thus the net return to creditors as a group. 1 The trustee reverses, for the benefit of all creditors, un- or under-compensated conveyances within a specified period before the bankruptcy.
There have always been limits on the pursuit of transfers. If the recipient of a fraudulent conveyance uses the money to buy a Rolls Royce, the auto dealer need not return the money to the bankrupt even if the trustee can identify the serial numbers on the bills. The misfortune of the firm’s creditors is not a good reason to mulct the dealer, who gave value for the money and was in no position to monitor the debtor. Some monitoring is both inevitable and desirable, and the creditors are in a better position to carry out this task than are auto dealers and the many others with whom the firm’s transferees may deal. The considerations behind the holder in due course rule for commercial paper, Uniform Commercial Code § 3-302, and the bona fide purchaser rule for chattels, UCC § 2-403(1) — the waste that would be created if people either had to inquire how their transferors obtained their property or to accept a risk that a commercial deal would be reversed for no reason they could perceive at the time — also apply to subsequent holders of assets fraudulently conveyed out of bankrupts. Just as the holder in due course rule requires the transferor of commercial paper to bear the risk and burden of inquiry, increasing the liquidity of paper, so
The potential costs of monitoring and residual risk are evident when the transferees include banks and other financial intermediaries. The check-clearing system processes more than 100 million instruments every day; most pass through several banks as part of the collection process; each bank may be an owner of the instrument or agent for purposes of collecting at a given moment. Some of these instruments reрresent funds fraudulently conveyed out of bankrupts, yet the cost of checking back on the earlier transferors would be staggering. Bonded’s trustee dismisses financial intermediaries on the ground that they obviously are not initial transferees, but this is not so clear. Hundreds of thousands of wire transfers occur every day. The sender of money on a wire transfer tells its bank to send instructions to the Federal Reserve System (for a Fed-wire transfer) or to a correspondent bank to make money or credit available through still another bank. The Fed or the receiving bank could be called the “initiаl transferee” of the funds if we disregarded the function of fraudulent conveyance law. Similarly, an armored car company might be called the “initial transferee” if the bankrupt gave it valuables or specie to carry. Exposing financial intermediaries and couriers to the risk of disgorging a “fraudulent conveyance” in such circumstances would lead them to take precautions, the costs of which would fall on solvent customers without significantly increasing the protection of creditors.
The functions of fraudulent conveyance law lead us to conclude that thе Bank was not the “initial transferee” of Bonded’s check even though it was the payee. The Bank acted as a financial intermediary. It received no benefit. Ryan’s loan was fully secured and not in arrears, so the Bank did not even acquire a valuable right to offset its loan against the funds in Ryan’s account. Under the law of contracts, the Bank had to follow the instructions that came with the check. The Uniform Commercial Code treats such instructions as binding to the extent any contract binds (see UCC § 3-119). 2 The Bank therefore was no different from a courier or an intermediary on a wirе transfer; it held the check only for the purpose of fulfilling an instruction to make the funds available to someone else.
Although the Bankruptcy Code does not define “transferee”, and there is no legislative history on the point, we think the minimum requirement of status as a “transferee” is dominion over the money or other asset, the right to put the money to one’s own purposes. When A gives a check to B as agent for C, then C is the “initial transferee”; the agent may be disregarded. This perspective had impressive support under the 1898 Code, e.g.,
Mayo v. Pioneer Bank & Trust Co.,
As the Bank saw the transaction on January 21, it was Ryan’s agent for the purpose of collecting a check from Bonded’s bank. Cf. UCC § 4-201(1) (giving a collecting bank a presumption of agency status unless “a contrary intent clearly appears”). It received nothing from Bonded that it could call its own; the Bank was not Bonded’s creditor, and Ryan owed the Bank as
We are aware that some courts say that an agent (or a bank in a case like ours) is an “initial transferee” but that courts may excuse the transferee from repaying using equitable powers. See, e.g.,
Colombian Coffee Co.,
There is a related, and more nettlesome, question about the use of equitable powers under
II
If the Bank is not the “initial transfereе”, the trustee insists, it is at least the “entity for whose benefit such transfer was made”. The Bank ultimately was paid and therefore, one might think, it got the “benefit” of the transfer — though the Bank cancelled the note and gave up a security interest in horses that, the trustee concedes, was sufficient to cover the balance. Kenneth Kortas, Bonded’s day-to-day manager, filed an affidavit stating that he prepared the check in question at Ryan’s request as part of Ryan’s program “to put the horse business in a position where it could function and sustain itself for at least several months even if his other business ventures ran into financial difficulty.... At the request of Ryan, I routinely prepared checks payable to banks where Ryan had personal accounts and loan accounts to finance his horse business.” This may show that Ryan intended all along to wash the $200,000 through his personal account and pay the Bank; at a minimum, the argument would run, questions of intent prevent summary judgment.
The Bank responds that
it
did not “intend” to be the beneficiary of the transfer; it was not in cahoots with Ryan or Bonded and did not know of their plans. Moreover, the Bank insists that it did not receive a “benefit” because it gave value for the $200,000. Thе only beneficiary on this view was Ryan, who increased his equity position in Shamrock Hill Farm and obtained clear title to the horses. As both initial transferee and ultimate beneficiary, Ryan is the only person covered by
This exchange seems to raise difficult questions. To what extent does “intent” matter under
These questions need not be answered, because a subsequent transferee cannot be the “entity for whose benefit” the initial transfer was made. The structure of the statute separates initial transferees and beneficiaries, on the onе hand, from “immediate or mediate transferee[s]”, on the other. The implication is that the “entity for whose benefit” is different from a transferee, “immediate” or otherwise. The paradigm “entity for whose benefit such transfer was made” is a guarantor or debtor— someone who receives the benefit but not the money. In the Firm-Guarantor-Lender example at the end of Part I, when Firm pays the loan, Lender is the initial transferee and Guarantor, which no longer is exposed to liability, is the “entity for whose benefit”. If Bonded had sent a check to the Bank with instructions to reduce Ryan’s loan, thе Bank would have been the initial transferee and Ryan the “entity for whose benefit”. See
In re Universal Clearing House Co.,
The legislative history of
Section 550(a)(1) of the House amendment has been modified in order to permit recovery from an entity for whose benefit an avoided transfer is made in addition to a recovery from the initial transferee of the transfer.Section 550(c) would still apply, and the trustee is entitled only to a single satisfaction. The liability of a transferee undersection 550(a) applies only “to the extent that a transfer is avoided”. This means that, liability is not impоsed on a transferee to the extent that a transferee is protected under a provision such assection 548(c) which grants a good faith transferee for value of a transfer that is avoided only as a fraudulent transfer, a lien on the property transferred to the extent of value given.
This is the only discussion of the enacted version of
To say that the categories “transferee” and “entity for whose benefit such transfer was made” are mutually exclusive does not necessarily make it easy to determine in which category a given entity falls. The method we employed in Part I of this opinion to decide that the Bank was not an “initial” transferee governs the question whether entities are subsequent transferees, too. The answer is not difficult in this case, however. The Bank did not obtain a benefit from the transfer to Ryan on January 21; it obtained dominion over the funds on January 31. The Bank is a transferee.
Ill
A trustee may not recover from a subsequent transferee who “takes for value, including satisfaction ... of a present or antecedent debt, in good faith, and without knowledge of the voidability of the transfer avoided”,
The statute does not say “value to the debtor”; it says “vаlue”. A natural reading looks to what the transferee gave up rather than what the debtor received. Other portions of the Code require value to the debtor.
Transferees and other purchasers generally deal only with the previous person in line; they give value, if at all, to their transferors (or the transferors’ designees). The statute emulates the pattern of other rules protecting good faith purchasers. All of the courts that, have considered this question have held or implied that value to the transferor is sufficient. E.g.,
Smith v. Mixon,
IV
The final question is whether the Bank received the $200,000 “in good faith, and without knowledge of the voidability of the transfer avoided”. The trustee does not contend that the Bank knew of Bonded’s precarious condition or Ryan’s plan to use Bonded’s money to pay his personal debts. He does not say that the Bank acted in bad faith—or even that there is a difference between “good faith” and “without knowledge of the voidability of the transfer”. See 4
Collier on Bankruptcy
¶ 550.03[1] p. 550-10 (treating the two as redundant); Countryman, 3 Bankruptcy Developments J. at 475-80. (We need not decide whether there is a difference.) And the trustee does not try to show that this transaction satisfies the test suggested by the legislative history of
The phrase “good faith” in [§ 550(b) ] is intended to prevent a transferee from whom the trustee could recover from transferring the recoverable property to an innocent transferee, and receiving a transfer from him, that is, “washing” the transaction through an innocent third party. In order for the transferee to be excepted from liability ... he himself must be a good faith transferee.
H.R.Rep. No. 95-595, 95th Cong., 2d Sess. 376 (1978); S.Rep. No. 95-989, 95th Cong., 2d Sess. 90 (1978), U.S.Code Cong. & Admin.News 1978, pp. 5787, 5876, 6332. The trustee contends, instead, that the Bank should have known about Bonded’s distress and Ryan’s chicanery; had it investigated the deposit on January 21, it would have found out; and because it should have known, this is as good as knowledge.
Imputed knowledge is an old idea, employed even in the criminal law. See
United States v. Ramsey,
Nothing in the record of this case suggests that the Bank knew of Bonded’s financial peril or Ryan’s plan. Bonded was not the Bank’s customer. The transfer from Ryan to the Bank on January 31 was innocuous. The Bank thought it got Ryan’s money; its loan was fully secured; it perceived Ryan as a well-heeled horse breeder, with a balance sheet in the millions, current on his loan payments.
The transfer from Bonded to Ryan on January 21 was only slightly more problematic from the Bank’s perspective. A corporation was transferring $200,000 to one of its executives. This does not hint at a fraudulent conveyance by a firm on the brink of insolvency; for all the Bank knew, Bonded had plenty more where the $200,-000 came from. Banks frequently receive large checks from corporations to their officers; think of the annual bonus checks General Motors issues, or the check to repurchase a bloc of shares. A $200,000 check is not a plausible bonus for a currency exchange, however. It сould hint at embezzlement. Several Illinois cases say that a bank should inquire when a firm’s employee signs a large check with himself as payee. See
People ex rel. Nelson v. Peoples Loan & Trust Co.,
Since those cases were decided, Illinois adopted the Uniform Fiduciaries Act, which relieves banks of such a duty to inquire into the authority of the fiduciary signing the cheek on the maker’s behalf. Ill.Rev. Stat. ch. 17 ¶ 2009;
Johnson v. Citizens National Bank of Decatur,
The Bank is a subsequent transferee covered by
Affirmed.
Notes
. The fraudulent conveyance must be distinguished from a preferential transfer to a creditor, which does not diminish the total payoff for the group, but which may be undone to reduce the incentive individual creditors have to rush to dismember the debtor before rival creditors can do so. The collective bankruptcy proceeding solves the common pool problem, which otherwise may produce a reduction in the value of the productive assets takеn jointly.
. The instructions do not “affect the negotiability of an instrument”, § 3-119(2), so that a subsequent purchaser could be a holder in due course even if the Bank had disregarded the instructions, but this qualification is unimportant here.
. One who conspires with the debtor to make a fraudulent transfer, but has the transfer washed through an innocent party before reaching him, does not thereby escape. The conspirator will be a subsequent transferee under