Second Circuit Holds Trustee’s Recovery of Fraudulent Transfer Is Not Double Recovery

The Bottom Line

In Jones v. Brand Law Firm, P.A. (In re Belmonte), Case No. 18-2098-bk (2d Cir. July 25, 2019), the Second Circuit affirmed both the bankruptcy court and district court decisions that found the Trustee was not barred by 11 U.S.C. § 550(d) from recovering loan proceeds that were illegally transferred. The Trustee had avoided a mortgage as a fraudulent transfer and then sought to recover the loan proceeds related to that mortgage, which were given to the debtor’s attorney. The Second Circuit found no double recovery in permitting the Trustee to recover the loan proceeds, because Section 550(a) authorizes him to pursue recovery from all available sources until the full amount of the unlawfully transferred property is realized for distribution to creditors.

What Happened?

Alice Belmonte (the “Debtor”) and her husband, as tenants by the entirety, owned a home and property (the “Property”) in which there was approximately $260,000 in equity cushion as of the petition date. Accordingly, roughly $130,000 belonged to the Debtor and thus constituted property of the estate. The Debtor’s attorney in connection with her bankruptcy case was Craig Brand of the Brand Law Firm (“Brand” or the “Transferee”).

Post-petition, the Debtor was arrested and hired Brand and two other attorneys to represent her in the criminal case. To assist with her defense, one of the Debtor’s friends agreed to lend $250,000 to the Debtor and her husband, a loan secured by a lien on the Property (the “Second Mortgage”). The $250,000 loan was wired to Brand, who paid the other two attorneys and retained $118,864 of the loan.

The Trustee filed an adversary proceeding against the Debtor, her husband, and the friend to avoid the Second Mortgage as a transfer that violated the automatic stay. The bankruptcy court subsequently approved a settlement between the Trustee and the Debtor’s friend whereby the adversary proceeding was dismissed, the Second Mortgage was avoided under 11 U.S.C. § 549 and the lien created by the Second Mortgage was preserved for the benefit of the estate. The Trustee sought to force a sale of the Property under 11 U.S.C. § 363(h) but the bankruptcy court denied the request because the husband and his daughter lived in the home.  

The Trustee filed an adversary proceeding against Brand to avoid the loan under Section 549 of the Bankruptcy Code as an improper post-petition transfer. By way of background, when a transfer is avoided pursuant to Section 549, Section 550(a) permits the trustee to recover the property transferred or its value. However, Section 550(d) states that the “trustee is entitled to only a single satisfaction under [Section 550(a)].”

In an interlocutory order, the bankruptcy court rejected Brand’s argument that because the Trustee avoided the Second Mortgage, allowing him to recover any of the loan proceeds would constitute a double recovery. The bankruptcy court found that until litigants are finally paid, they can look to multiple parties to recover the same loss and here the Trustee had not recovered any of the loan proceeds. After a bench trial, the bankruptcy court ruled that the loan was avoidable and that the Trustee could recover the property transferred or the value of such property under Section 550(a); thus, the Trustee was entitled to a judgment for one-half of the loan — specifically, $59,432 (representing half of what Brand retained after paying the other attorneys).

The district court affirmed and explained that avoiding the Second Mortgage simply allowed the estate to obtain the lien rights to the Property that had been improperly transferred, and did not bar the Trustee from looking to recover the loan proceeds.

The Second Circuit found that the plain language of Section 550(a) granted the Trustee the right to pursue recovery of the loan proceeds from the Transferee. The court found that recovery of a portion of the loan from the Transferee did not violate Section 550(d)’s “single satisfaction rule” and rejected the Transferee’s argument that because the Second Mortgage was avoided and the lien preserved for the estate, the Trustee already had recovered the Debtor’s equity interest in the Property. The court observed that Section 550(d) typically applies where a trustee seeks to recover the value of transferred property from more than one transferee — potentially allowing him or her to recover more than the value of what was transferred. Here though, when the Trustee sought to recover the loan from the Transferee, he had not realized any of the value of the Debtor’s interest in the Property. Preservation of the lien only granted the Trustee the right to foreclose on the Property, but the bankruptcy court prohibited the Trustee from doing so. Since the Trustee could not liquidate the interest in the Property, preserving the lien did not create any value for the estate’s creditors, and the Trustee’s only option to realize a recovery was to pursue the loan proceeds. Thus, this case is distinguishable from others where the trustee recovers the equity value of the property or obtains title to the real property.

The Second Circuit concluded that where the avoided lien cannot be liquidated and distributed to creditors, Section 550(d) is not a bar to recover from other sources. However, in this case, if the Trustee were able to liquidate the Debtor’s equity interest in the Property, the Trustee’s recovery would be net of the $59,432 recovered from Brand.

Why This Case Is Interesting

This decision explains what constitutes an impermissible double recovery in the fraudulent transfer context. Where the trustee has not recovered the equity value of property from a debtor, it is authorized to seek recovery from multiple sources until it actually obtains the value of the avoided transfer. It did not address, however, whether the Transferee had a right to seek contributions from the other lawyers who received payment from the loan proceeds. Further, the Second Circuit noted that on appeal, the Transferee did not challenge the bankruptcy court’s holding that the loan — secured by the Property — was a proceed of the estate pursuant to Section 541(a)(6), and therefore, the court assumed that it was. Presumably, the result would be different if this argument were made successfully on appeal, because the loan would not be property of the estate and thus could not be recovered by the Trustee.