Martinez v. Hutton (In re Harwell), 628 F.3d 1312 (11^th Cir. 2010)

In Martinez v. Hutton (In re Harwell), the chapter 7 trustee commenced a fraudulent conveyance action against the debtor’s attorney under Sections 548(a)(1)(A) and 550(a)(1) of the Bankruptcy Code.  The trustee sought personal liability against the attorney as an “initial transferee,” alleging that the attorney conspired with the debtor prior to the debtor’s bankruptcy filing to fraudulently convey the debtor’s funds in his attorney trust account to the debtor, the debtor’s family, and select creditors. 

The Bankruptcy Court held that the attorney was not an “initial transferee” of the funds in his attorney trust account because he did not have control over such funds, and therefore, there could be no personal liability to the attorney as an initial transferee under 548(a)(1)(A) and 550(a)(1), even if he was the mastermind of fraudulent conveyances.  The District Court affirmed the Bankruptcy Court’s ruling, and the trustee appealed to the United States Court of Appeals for the Eleventh Circuit. 

Pursuant to Bankruptcy Code Section 548, the trustee “may avoid any transfer…of an interest of the debtor in property,” made within two years before the filing of the bankruptcy petition, if the transfer was made “with actual intent to hinder, delay or defraud…” any then-existing or future creditors.  11 U.S.C. § 548(a)(1)(A). 

Section 550(a) of the Bankruptcy Code in turn provides:

(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.

The Court of Appeals held that the attorney was the first to receive the funds in his attorney trust account, and therefore, technically, he was the “initial transferee.”  However, the Court of Appeals confirmed that an equitable exception to the literal statutory term “initial transferee” existed for the first recipients of transfers who (i) were “mere conduits” with no control over the transferred funds, and (ii) acted in good faith.  The Court of Appeals held that the Bankruptcy Court erred in allowing the equitable exception to “initial transferee liability” in the absence of a finding that the attorney acted in good faith.  Accordingly, the Court of Appeals reversed and remanded for further findings with respect to the attorney’s exercise of control over the funds and his good faith (or lack thereof).

Commentary

This case illustrates that a first recipient of a transfer seeking the equitable exception to initial transferee liability, also known as the “mere conduit defense,” must show more than a lack of control over the property.  He or she must also show good faith in relation to the transaction.