Recommended Principles:
• The trustee should be permitted to name an alleged subsequent transferee as a defendant in the original complaint to avoid any transfer under Bankruptcy Code section 544, 545, 547, 548, 549, or 553(b), and to recover such property under
them to assess sufficiently for Rule 9011 purposes the ordinary course and new value issues at little additional cost to them. On the other hand, the savings to factors and other creditors that would result from weeding out weak claims before they are even asserted would be substantial.”), available at Commission website, supra note 55.
section 550. If any alleged subsequent transferee is not named as a defendant in the original complaint, the trustee should be required to sue such transferee in a subsequent action under section 550, and such transferee should have the ability to raise any and all defenses, including those relating to the original avoidance action, in that litigation. Section 550 should be amended accordingly.
• The term “for the benefit of the estate” under section 550(a) should be interpreted broadly to permit recoveries for the benefit of “all creditors according to their statutory and contractual entitlements.” Mellon Bank, N.A. v. Dick Corp., 351 F.3d 290, 293 (7th Cir. 2003), cert. denied, 541 U.S. 1037 (2004). This interpretation of section 550(a) should include all creditors, including administrative claimants and prepetition equity security holders, but should not include lenders under a postpetition financing facility. See Section IV.B, Financing the Case. It also should not expand or otherwise affect the underlying causes of action that a trustee must establish prior to seeking recoveries under section 550.
• The trustee should be able to file an action under chapter 5 of the Bankruptcy Code to avoid and recover transfers occurring outside the United States to the same extent it could file such an action with respect to domestic transfers. In reviewing any avoidance action involving transfers occurring solely outside the United States, the court should consider whether allowing such action to proceed is consistent with general principles of comity and is reasonably necessary to protect the interests of the estate, considering the expectations of the defendants, the laws of the foreign jurisdiction, and the relief available to the trustee in the foreign jurisdiction.
Recoveries Under Section 550: Background
Section 550 of the Bankruptcy Code complements the trustee’s chapter 5 avoiding powers by allowing the trustee561 to recover the property involved in, or the value of, any avoided transfers.562 For example, a debtor in possession may avoid preferential transfers under section 547 or fraudulent transfers under section 548 or 544(b) and then seek to recover the security interest, lien, asset, or money transferred in those avoided transactions under section 550. Specifically, section 550(a) provides as follows:
(a) Except as otherwise provided in this section, to the extent that a transfer is avoided under section 544, 545, 547, 548, 549, 553(b), or 724(a) 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
561 As previously noted, references to the trustee are intended to include the debtor in possession as applicable under section 1107 of the Bankruptcy Code, and implications for debtors in possession also apply to any chapter 11 trustee appointed in the case.
See supra note 76 and accompanying text. See generally Section IV.A.1, The Debtor in Possession Model.
(2) any immediate or mediate transferee of such initial transferee.563
Section 550 establishes a two-step process: the debtor in possession first files a complaint to avoid the subject transfer or transaction; and then, after the court grants the relief requested by the complaint, the debtor in possession files a separate action to recover the property (or the value of the property) involved in the avoided transfer or transaction. Although the debtor in possession may assert the avoidance action and the recovery action against the transferee in the same complaint, the language
of the statute suggests that a separate action must be filed against any subsequent transferees.564
Some courts also are uncertain whether a debtor in possession is authorized to seek to recover property from foreign subsequent transferees under section 550.565
In addition, courts are divided concerning the interpretation of the phrase “for the benefit of the estate” as used in section 550.566 Some courts interpret the phrase broadly, permitting recovery as soon as there is some identifiable benefit to the estate.567 Other courts utilize a narrower interpretation, restricting recoveries to those circumstances in which a more direct benefit to creditors (at times, specifically unsecured creditors) can be shown.568
The Fifth, Seventh, and Tenth Circuits, as well as certain lower courts within those Circuits, interpret section 550 broadly.569 These courts hold that there is a benefit to the estate when any interested party in a bankruptcy case stands to benefit from avoidance action recoveries.570 The term “interested party” has been interpreted not only to include secured creditors, unsecured creditors, and administrative claimants,571 but also equity security holders.572 In addition, the benefit to the estate does not need to be direct, but may arise indirectly by, for example, increasing the likelihood of effectuating a successful reorganization or meeting payment obligations under a plan.573
563 Id. 564 Id.
565 See Sec. Investor Prot. Corp. v. Bernard L. Madoff Inv. Sec. LLC, 2014 U.S. Dist. LEXIS 91508 (S.D.N.Y. July 6, 2014). 566 See e.g., In re Acequia, Inc., 34 F.3d 800, 811–12 (9th Cir. 1994).
567 In re C.W. Mining Co., 477 B.R. 176, 189 (B.A.P. 10th Cir. 2012), aff’d, 749 F.3d 895 (10th Cir. 2014) (explaining that the phrase “for the benefit of the estate,” as used in section 550, should be construed broadly, rather than narrowly, to include indirect benefits). See also Weaver v. Aquila Energy Marketing Corp., 196 B.R. 945, 956 (S.D. Tex. 1996) (noting that section 550’s “benefit” requirement is satisfied as soon as there is some identifiable benefit to the estate).
568 See In re Burlington Motor Holdings, Inc., 231 B.R. 874, 877 (Bankr. D. Del. 1999) (holding that “any recovery of preferences in this case will benefit only the Successor Corporation” and that “unsecured creditors must be benefitted by recovery”) (citing
In re Resorts Int’l, Inc., 145 B.R. 412, 474–75 (Bankr. D.N.J. 1990)); Harstad v. First Am. Bank, 39 F.3d 898, 905 (8th Cir. 1994)
(holding that “ increas[ing] the likelihood that [debtors] will be able to pay their creditors as the Plan requires, even though it will not increase the amount paid to the creditors” is insufficient benefit to the estate to permit recovery under section 550(a)). 569 Mellon Bank, N.A. v. Dick Corp., 351 F.3d 290, 293 (7th Cir. 2003), cert. denied, 541 U.S. 1037 (2004) (holding that the term
“estate,” as used in section 550(a), means the set of all potentially interested parties, and not any one particular class of creditors);
In re NETtel Corp., Inc., 364 B.R. 433, 442 (Bankr. D.C. 2006); In re Furrs, 294 B.R. 763, 783 (Bankr. D. N.M. 2003).
570 See MC Asset Recovery LLC v. Commerzbank A.G. (In re Mirant Corp.), 675 F.3d 530, 532–34 (5th Cir. 2012); Mellon Bank, N.A. v. Dick Corp., 351 F.3d 290, 293 (7th Cir. 2003), cert. denied, 541 U.S. 1037 (2004); In re NETtel Corp., Inc., 364 B.R. 433, 442 (Bankr. D. D.C. 2006).
571 Silverman Consulting, Inc. v. Hitachi Power Tools, U.S.A., Ltd. (In re Payless Cashways, Inc.), 290 B.R. 689, 696–97 (Bankr. W.D. Mo. 2003) (holding that a chapter 11 trustee had standing to pursue preference claims even though recoveries would go solely to satisfy administrative claims).
572 See Kipperman v. Onex Corp., 411 B.R. 805, 876–88 (N.D. Ga. 2009) (holding that all interests, including those of all creditors and equity security holders, are comprised in the estate); In re Bayou Grp., LLC, 372 B.R. 661, 664 n. 2 (Bankr. S.D.N.Y. 2007) (refusing to adopt a bright-line rule that avoidance actions can never be brought in whole or in part for the benefit of equity security holders).
573 In re P.A. Bergner & Co., 140 F.3d 1111, 1118 (7th Cir. 1998), cert. denied, 525 U.S. 964 (1998) (explaining that though preference action recovery will benefit reorganized debtor and thus owners of reorganized debtor, recovery under section 550(a) is permissible because owners of reorganized debtor were the largest creditor group of old debtor, so benefit to these creditors provides a sufficient benefit to the estate to satisfy the requirements of section 550); In re Furrs, 294 B.R. 763, 780 (Bankr. D.N.M. 2003) (holding that “an action which will generate funds for the payment of administrative claims is a proper use of [t]rustee’s avoiding and recovery powers”). See also Weaver v. Aquila Energy Marketing Corp., 196 B.R. 945, 956 (S.D. Tex. 1996) (holding that section 550’s “benefit” requirement is satisfied as soon as there is some identifiable benefit to the estate).
Courts narrowly interpreting section 550(a) do not require an absolute direct benefit to unsecured creditors, but they generally require a more direct benefit to those creditors than do courts that employ the broader interpretation.574 For example, the Eighth Circuit575 and the Bankruptcy Court
for the District of Delaware576 have interpreted section 550(a) as effectively requiring that the
contemplated recovery be somehow targeted, or legally tied, to the benefit of creditors (e.g., pursuant to a plan in which avoidance action proceeds are distributed or in a settlement under Bankruptcy Rule 9019). In both cases, the courts found that the demonstrated benefit was insufficient to permit recovery under section 550(a).577
Recoveries Under Section 550: Recommendations and Findings
The Commission reviewed several issues relating to avoidance action recoveries under section 550. This section of the Bankruptcy Code is an integral component of the trustee’s avoiding powers under chapter 5 of the Bankruptcy Code. It essentially represents the mechanism by which the trustee can recover any value resulting from avoidance actions for the estate. Recognizing the section’s importance in the avoidance process and the need to provide a clear, efficient, and fair path to recoveries, the Commissioners discussed the actual mechanics of section 550.
Several Commissioners commented on the sometimes cumbersome process of suing on the underlying avoidance action and then bringing the recovery action under section 550 after the fact. Many of the Commissioners believed that providing subsequent transferees with at least notice of the underlying avoidance action and an opportunity to intervene would improve this system. This kind of notice would prevent duplicative litigation when no notice is provided, and a subsequent transferee disputes the existence of a valid cause of action. Others suggested requiring the trustee to name any potential subsequent transferees as defendants in the underlying avoidance action. Some of the Commissioners questioned whether such a requirement was feasible, because often the identity of any subsequent transferees is discovered in the litigation on the underlying avoidance claim and is not necessarily known to the trustee at the time of filing the complaint. Notice would not be possible in those cases.
574 See, e.g., In re Acequia, Inc., 34 F.3d 800, 811 (9th Cir. 1994) (allowing recovery of fraudulent transfers even though creditors have been paid in full when recovery would aid continuing performance under plan and pay administrative creditors because “[c]ourts construe the ‘benefit to the estate’ requirement broadly, permitting recovery under section 550(a) even in cases where distribution to unsecured creditors is fixed by a plan of reorganization and in no way varies with recovery of avoidable transfers”); Harstad v. First Am. Bank, 39 F.3d 898, (8th Cir. 1994) (“We do not hold that a bankruptcy trustee or a debtor in possession (or a debtor or an appointed representative under powers reserved via § 1123(b)(3)) must demonstrate a direct benefit to the creditors in the form of a distribution to the creditors of the preference recovery (although that would certainly make this a much easier issue to decide). Nevertheless, we do hold that those wishing to bring preference actions must show a more definite benefit to creditors than the [debtors] have shown here.”); Wellman v. Wellman, 933 F.2d 215, 218 (4th Cir. 1991), cert. denied, 502 U.S. 925 (1991) (holding that there is no benefit to the estate “when the result is to benefit only the debtor rather than the estate”); Adelphia Recovery Trust v. Bank of Am., N.A., 390 B.R. 80, 94 (S.D.N.Y. 2008), aff’d, 379 Fed. App’x 10 (2d Cir. 2010), cert.
dismissed, 131 S. Ct. 896 (2011) (“[I]t is well settled in the Second Circuit, that avoiding powers may be exercised by a debtor in
possession only for the benefit of creditors, and not for the benefit of the debtor itself.”) (citations omitted) (internal quotation marks omitted); Trans World Airlines, Inc. v. Travellers Int’l AG (In re Trans World Airlines, Inc.), 163 B.R. 964, 972 (Bankr. D. Del. 1994) (“[T]he Code clearly contemplates the use of avoidance action recoveries in the operation of the business in a manner which only indirectly benefits creditors.”).
575 Harstad v. First Am. Bank, 39 F.3d 898, 904–05 (8th Cir. 1994).
576 In re Burlington Motor Holdings, Inc., 231 B.R. 874, 877 (Bankr. D. Del. 1999) (“[The] Plan does not delegate preference recoveries to the estate or list them as a source of funds designated to pay down the Note. Rather, any recovery of preferences in this case will benefit only the Successor Corporation.”).
577 See Harstad v. First Am. Bank, 39 F.3d 898, 904–05 (8th Cir. 1994); In re Burlington Motor Holdings, Inc., 231 B.R. 874, 877 (Bankr. D. Del. 1999).
Given those obstacles, the Commissioners discussed whether the federal notice standards as articulated by the U.S. Supreme Court in Mullane v. Central Hanover Bank & Trust Co. would suffice.578 The Mullane standard basically requires notice by means “reasonably calculated, under all the circumstances, to apprise the interested parties of the pendency of the action, and afford them an opportunity to present their objections.”579 The Commission determined, however, that to the extent the trustee would be seeking to recover value from the subsequent transferees, actual notice should be required. Based on these considerations, the Commission recommended clarifying section 550 to permit the trustee to name a subsequent transferee as a defendant in the original, underlying cause of action and, if not named, to require the trustee to sue the subsequent transferee in a subsequent action, at which time the subsequent transferee should be permitted to assert defenses to the original avoidance cause of action.
The Commissioners then analyzed the extra-territorial application of the trustee’s avoiding powers and recovery rights under section 550 to subsequent transferees. The Commissioners acknowledged the primary competing interests at stake: the perceived unfairness in permitting avoidance of transfers made to parties within the United States, but then precluding that remedy as to any subsequent transferees overseas; and the reasonable expectations of foreign transferees, particularly those who may not know that the transfer originated from the debtor, including the expectation that any payments they received were governed by the laws of their respective jurisdictions. The Commissioners methodically walked through examples when this issue may present itself. They considered situations were a feeder fund is the initial transferee and noted the relevance of the solvency of the feeder fund. They examined the facts of the Madoff and Maxwell cases and discussed the factual nuances of these cases.580 The Commissioners acknowledged and appreciated the delicate balance required in these instances.
The Commissioners discussed how best to balance the competing interests with well-established principles of comity. The Commissioners generally agreed with the notion that foreign transfers should be subject to the chapter 5 avoiding powers, but only if such application was consistent with principles of comity. Accordingly, the Commission approved the recommendation that section 550 cover domestic or foreign subsequent transferees extra-territorially to the same extent as domestic subsequent transferees, but agreed that the court should consider whether allowing such action to proceed is consistent with general principles of comity and is reasonably necessary to protect the interests of the estate considering the expectations of the defendants, the laws of the foreign jurisdiction, and the relief available to the trustee in the foreign jurisdiction.
Once a trustee identifies potential avoidance and recovery actions under chapter 5 of the Bankruptcy Code, courts have differed on whether the trustee may pursue those actions if recoveries will go to stakeholders other than general unsecured creditors. The Commissioners discussed the origins of the concept that avoidance action recoveries should inure only to the benefit of general unsecured
creditors and whether such a limited purpose aligned with the concept of the estate.581 The
Commissioners discussed witness testimony that supported limiting the beneficiaries of preference
578 Mullane v. Central Hanover Bank & Trust Co., 339 U.S. 306, 314 (1950). 579 Id.
580 See, e.g., In re Maxwell Commc’n Corp., 93 F.3d 1036, 1047–48 (2d Cir. 1996); Sec. Investor Prot. Corp. v. Bernard L. Madoff Inv. Sec. LLC, 2014 U.S. Dist. LEXIS 91508 (S.D.N.Y. July 6, 2014).
581 See, e.g., Mellon Bank NA v. Dick Corp., 351 F.3d 290, 293 (7th Cir. 2003), cert. denied, 541 U.S. 1037 (2004) (explaining that section 550 “speaks of benefit to the estate — which in bankruptcy parlance denotes the set of all potentially interested parties”).
actions to unsecured creditors. They also considered whether administrative claimants or old equity should be permitted to benefit from recoveries under section 550. The Commissioners drew on the facts and holding in Mirant Corp., in which the Fifth Circuit interpreted section 550(a) and found that “[a] bankruptcy trustee may still have standing to avoid a fraudulent transfer after the unsecured creditors are satisfied in full.”582
The Commissioners found the reasoning of courts following a broader interpretation of section 550(a) to be sound and consistent with the general concept of the bankruptcy estate. The estate does not represent only general unsecured creditors in a case, but often represents a variety of stakeholders whose interests also may have been harmed by improper transfers and transactions subject to avoidance under chapter 5 of the Bankruptcy Code. The Commission voted to endorse a broad interpretation of the term “for benefit of the estate” in section 550(a) to mean all parties with claims against, or interests in, the estate, including administrative claimants and old equity but not including claims of postpetition secured creditors. In reaching this conclusion, however, the Commission agreed that this principle only affected a trustee’s action for recoveries against transferees under section 550; it did not expand or otherwise affect a trustee’s underlying cause of action under section 544, 545, 547, 548, 549, or 553(b).