The Chapter 11 Trustee sought to avoid and recover as preference, premium payments that Railworks transferred made to CPG within 90 days of filing bankruptcy, which later transferred them to TIG, which provided various insurance coverage to Railworks. While CPG had physical control over the transfers it received, it held the funds in trust for TIG.
Pursuant to 11 U.S.C. § 550(a)(1), a preferential transfer can be recovered from an “initial transferee.” The Court of Appeals applied the ‘dominion and control’ test to determine whether an entity qualifies as such holding that under this test, an initial transferee must
(1) have legal dominion and control over the property—e.g., the right to use the property for its own purpose; and
(2) exercise this legal dominion and control.”
“[A] party cannot be an initial transferee if he is a ‘mere conduit’ for the party who had a direct business relationship with the debtor.” In re Se. Hotel Props. Ltd. P’ship, 99 F.3d 151, 155–56 (4th Cir. 1996) and In re Columbia Data Prods., 892 F.2d 26, 29 (4th Cir. 1989).
The Court of Appeals rejected the Trustee’s argument CPG was not a “mere conduit”, since it benefitted from the transfer, in that the transfer extinguished the contingent liability for CPG for making such payment. To hold otherwise would erase the “mere conduit” exclusion, since “a conduit, by definition, has an obligation to pass the funds on to a third party, and, if he fails to pass the funds to the third party, he is liable for those funds.”
This will add, or at least accentuate, another level in preference litigation, as defendants would be likely to argue that they are “mere conduits” or structure payments in this manner to insulate the actual beneficiary of the payment. A brief review of the docket in this bankruptcy, which extends back to 2001, so it was a very brief review, does not clarify why the Trustee did not seek recovery from TIG, but that may be because TIG provided insurance and thereby a contemporaneous exchange of new value to Railworks.
The factors used to define the “dominion and control” test (which, by using the phrase “dominion and control” twice to define the phrase “dominon and control”, is rather a double tautology) were easily applied here to what is characterized as basically a trust account. This opinion but sheds little light on harder issues- For example can payments by a debtor be recovered from a mortgage servicer, which then passes those funds along to the beneficiary of the Deed of Trust? Does the servicer’s ability to grant mortgage modifications, initiate foreclosures or decline to take any action constitute “dominion and control” or are such actions so strictly dictated by HAMP regulations, the National Mortgage Settlement, or the PSA, that the servicer has insufficient actual authority?
For a copy of the opinion, please see: