Focus on Fraud 11th Circuit Supplants the Mere Conduit Fiction for Certain Subsequent Transferees

Focus on Fraud 11th Circuit Supplants the Mere Conduit Fiction for Certain Subsequent Transferees

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On May 3, 2005, the Eleventh Circuit Court of Appeals released a 41-page opinion on In re International Administrative Services Inc. (IAS) announcing a new legal theory for suing certain subsequent transferees of property originating with a debtor. The court also considered when and how a bankruptcy may extend the limitations period set forth in §546(a) of the Bankruptcy Code, what constitutes adequate tracing in a complex fraudulent transfer case, and from what point in time an award of prejudgment interest is appropriate.

A Man and His Schemes

In 1986, Charles J. Givens Jr., a colorful entrepreneur and gifted speaker, started the precursor to IAS, The Charles J. Givens Co., after dabbling in such diverse businesses as music production and real estate speculation. IAS was promoted through late-night infomercials as the means by which ordinary people could accumulate "wealth without risk" (also the titles of a series of best-selling books by Mr. Givens). This insight was available to purchasers of a membership in the Givens organization, followed by the purchase of various financial self-help products and seminars. Although little of the information offered by IAS to its members was proprietary or confidential, the charisma of Givens and skill of his public relations handlers produced an organization which, by the early 1990s, could boast more than 250,000 members and annual sales of over $100 million. As the Eleventh Circuit noted, IAS had become a "leviathan in the world of get-rich-quick schemes."

Unfortunately for IAS, at the same time that its sales were skyrocketing, storm clouds were gathering on its financial horizon. The financial advice offered by IAS was often not custom-tailored to the laws of the states in which its members resided. For example, advice urging canceling of their uninsured motorist insurance proved disastrous for citizens of various states who were involved in serious automobile accidents with uninsured drivers. This bad advice spawned a series of costly class-action law suits against the company and Mr. Givens. At the same time, the company was targeted by the attorneys general of various states for its failure to pay sales tax in those states, and both the company and Givens were targeted by the Securities and Exchange Commission (SEC) in connection with certain real estate investment schemes. Finally, the Federal Trade Commission joined the fray by launching investigations into the company's business practices.

By this point, it became clear that the company would be facing some very serious financial difficulties in the immediate future. In response, Givens retained the services of asset protection attorney David H. Tedder, his law firm and his company, The Institute for Asset & Lawsuit Protection, to devise a complex, multinational scheme to protect IAS and Givens from their legitimate creditors. Tedder moved to Florida, where IAS was based, to implement this exceedingly complex program that included, among other things, sham employee leasing arrangements, a bogus income stabilization program, the purchase of a series of "private annuities" that had no value and the creation of massive liens securing questionable loans. The end result was a comprehensive asset-protection strategy that allowed Givens to remove more than $50 million from IAS while simultaneously assuring IAS's creditors that the company had no assets due to its massive "secured" obligations to foreign lenders and financial institutions.

By 1996, IAS had hemorrhaged so much capital through the ministrations of Tedder and Givens that it could no longer fund its ongoing operations. Accordingly, on June 20, 1996, IAS filed for voluntary relief under chapter 11. A creditors' committee was appointed and began an investigation into the finances of the debtor, which soon revealed significant, potentially fraudulent activities. At the request of the creditors' committee, the debtor transferred its avoidance powers to that committee to avoid any conflict of interest with the debtor's management, which was still controlled by members of the Givens family. This transfer of certain recovery powers survived confirmation of the debtor's reorganization plan creating the position of stock trustee to continue the attempts to recover fraudulently transferred assets for the benefit of IAS's creditors. Since confirmation, the stock trustee has been North Carolina bankruptcy lawyer John A. Northen (trustee), who had previously acted as the chairman of the creditors' committee.

The investigation into the potentially fraudulent transfers made by the debtor, under the ultimate control of Givens for the benefit of the Givens family, was routinely hampered by Givens and his professionals. After a motion seeking sanctions for failure to produce documents was filed by the trustee, Bankruptcy Judge Karen S. Jennemann appointed a special master to investigate the alleged discovery abuses on behalf of the Givens family. The special master eventually concluded that documents crucial to the development of the trustee's cases had been intentionally hidden or destroyed by Givens and his professionals.

Notwithstanding these efforts by Givens and his professionals to hamper the investigation, the trustee eventually filed suit against various transferees who had improperly received property of the debtor through the workings of the asset-protection plan. Two of these were IBT Inc. (IBT) and South California Sunbelt Developers Inc. (SCSD and, collectively with IBT, the "defendants"); both companies were owned by a business partner of Tedder. After a three-day trial, the bankruptcy court entered judgment against IBT and SCSD for the full amount of the funds transferred from the debtor, together with prejudgment interest from the date of the initial transfer to SCSD. The defendants appealed, but the U.S. District Court for the Middle District of Florida affirmed. The defendants then appealed to the Eleventh Circuit.

Issues on Appeal

The defendants raised four general issues on appeal. First, they maintained that both the bankruptcy court and the district court had erred as a matter of law when they permitted the trustee to recover a fraudulent transfer from subsequent transferees without first suing the initial transferees. Second, the defendants raised a number of issues relating to the ability of a bankruptcy court to extend the limitations period set forth in §546(a). Next, the defendants maintained that the bankruptcy court erred by finding that the trustee had satisfied his burden of tracing the relevant funds from the debtor to the defendants. Finally, they questioned the bankruptcy court's ability to award prejudgment interest from the date of the initial transfer of the debtor's property to the defendants. The Eleventh Circuit affirmed Judge Jennemann's original ruling on each of these points.

Recovering Directly from Subsequent Transferees

On appeal, the defendants argued that the clear language of §550(a) required the trustee to sue the initial transferees of the debtor's property as a condition precedent to bringing suit against the defendants as subsequent transferees. The trustee sued the defendants under the fraudulent-transfer provisions of Florida law as made applicable to the IAS bankruptcy case through §544, the so-called strong-arm provision. The trustee never sued the initial transferees (in this case judgment-proof companies), some of which had undergone liquidation proceedings in Panama. Section 544(b) requires a transaction to be avoided by a plaintiff before it can be recovered under §550. The support for the defendants' argument that an initial transferee must actually be sued before suit can be brought against a subsequent transferee is found in §550(a) dealing with the scope of permitted recovery.

In relevant part, §550(a) provides that "to the extent that a transfer is avoided under §544...the trustee may recover for the benefit of the estate property transferred, or if the court so orders, the value of such property from (1) the initial transferee...or (2) any immediate or mediate transferee of such initial transferee." The defendants' argument is based on the phrase "to the extent that the transfer is avoided," which they interpret to mean that a recovery of property can only been made "to the extent that the transfer has previously been avoided." In other words, according to the defendants, §550 of the Code required the trustee to avoid the initial transfer of the property at issue before bringing suit against the defendants as subsequent transferees.

In support of their position, the defendants relied on In re Trans-End Technology Inc., 230 B.R. 101 (Bankr. N.D. Ohio 1998), in which a bankruptcy court interpreted §550(a) as requiring the actual avoidance of the initial transfer before seeking recovery from subsequent transferees. In reaching this interpretation, the Trans-End court characterized the relevant language of §550(a) as "unarguably ...unambiguous and plain." 230 B.R. at 104. The Eleventh Circuit, however, disagreed with the Trans-End court both with respect to this characterization and that court's ultimate ruling.

The Eleventh Circuit instead found that the strict interpretation of the language found in §550(a) imposed by the Trans-End court and embraced by the defendants "produces a harsh and inflexible result that runs counterintuitive to the nature of avoidance actions." Specifically, the court found, following the majority position on this point outside of the Eleventh Circuit, that the phrase "to the extent that transfer is avoided under §544" found in §550(a) refers to the extent of the property that may be recovered rather than to the timing of the avoidance action. In other words, the language simply means that a plaintiff can only recover a transfer of a debtor's property to the extent that such a transfer is avoidable under §544. This interpretation is consistent with the legislative history of §550. See, 24 Cong. Rec. H. 11,097 (Sept. 28, 1978), S 17,414 (Oct. 6, 1978).

While the position adopted by the Eleventh Circuit in the IAS case is consistent with that of the majority of the courts considering this issue and with the legislative history of §550, it is not entirely consistent with the Eleventh Circuit's previous treatment of subsequent transferees in fraudulent-transfer actions. In prior cases in which the Eleventh Circuit permitted fraudulent-transfer actions to proceed against subsequent transferees, the court avoided the strict interpretation of §550(a), which requires avoidance of the transfer to the initial transferee before proceeding against subsequent transferees by modifying the definition of "initial transferee." See, i.e., In re Chase & Sanborn Corp., 904 F.2d 588 (11th Cir 1990). Those cases involved an initial transferee, such as a bank, which did not have an ownership interest in or control over the property transferred and which did not act in bad faith. Accordingly, such an entity could be deemed a "mere conduit" in the transaction and thus disregarded as an initial transferee.

In this case, however, the initial transferees were not third-party financial institutions with no material interest in the overall transaction but rather special-purpose entities created by Tedder at the behest of Givens; these were entities with guilty knowledge that do not fit into the mold of a "mere conduit." Therefore, the Eleventh Circuit altered its position on initial transferees to find that although the defendants were subsequent transferees, rather than initial transferees, they could still be sued in the first instance by the trustee because the distinction between initial transferees and subsequent transferees for avoidance purposes is entirely irrelevant provided that the entities being sued either exercised dominion and control over the property transferred or "held some beneficial right in it." In reaching this decision, the Eleventh Circuit was careful to note that its ruling should not be viewed as eroding its existing conduit theory, but rather providing an alternative theory of liability for cases involving multiple fraudulent transfers and no initial transferees that could credibly be characterized as mere conduits.

Statute-of-limitations Issues

The defendants also raised a number of statute-of-limitations issues in their appeal involving whether and how a bankruptcy court may enlarge the limitations period set forth in §546(a) of the Code. Section 546(a) required the trustee to commence his avoidance action against the defendants within two years after the entry of relief in the IAS bankruptcy case. Since the IAS case was filed on June 20, 1996, the §546(a) period for bringing suit would normally have expired on June 20, 1998. While the trustee did not file his complaint until Feb. 10, 1999, he did file a motion seeking to extend the §546(a) period prior to its expiration; the bankruptcy court granted this motion and extended the §546(a) period.

The defendants argued that the trustee's complaint was not timely because the bankruptcy court does not have the authority to enlarge the §546(a) period, i.e., that §546(a) creates a jurisdictional bar (that cannot be extended) rather than a statute of limitations (which is subject to waiver, equitable tolling and equitable estoppel). This argument was rejected by the Eleventh Circuit on several grounds. First, the court noted that reading "a jurisdictional bar into §546(a) would lead to absurd results," and therefore §546(a) should be viewed as a statute of limitations that may be extended by a bankruptcy court under appropriate circumstances. Second, the Eleventh Circuit found that the trustee had demonstrated an equitable basis to toll the §546(a) limitations period. Specifically, the court found that where, as in the instant case, a trustee acts diligently but does not learn the details of a fraudulent transaction due to "fraud or extraordinary circumstances beyond the trustee's control," then the doctrine of equitable tolling will act to prevent the expiration of §546(a)'s limitations period. Citing In re Levy, 185 B.R. 378 (Bankr. S.D. Fla. 1995), and Lampf, Pleva Lipkind, Prupis & Petigrow v. Gilberson, 501 U.S. 350, 363; 111 S.Ct. 2773, 2782; 115 L.Ed.2d 321 (1991).

Tracing and Prejudgment Interest

The final issues raised by the defendants on appeal dealt with the sufficiency of the trustee's proof of tracing offered at trial and the propriety of the bankruptcy court's imposition of prejudgment interest against the defendants commencing from the original date that they received property of the debtor. With respect to tracing, the defendants argued that the trustee had failed to trace every dollar from the debtor to the defendants. The Eleventh Circuit held that while a plaintiff seeking recovery of a fraudulent transfer clearly has the burden of tracing the funds it claims originated with a debtor, "it is also true that proper tracing does not require dollar-for-dollar accounting." In a complex fraud case, the Eleventh Circuit found that a plaintiff needs to show by a preponderance of the evidence that the funds for which recovery is sought originated with the debtor, flowed through certain pathways and were eventually transferred to the defendant.

Finally, the defendants argued that the bankruptcy court's award of prejudgment interest against the defendants from the date upon which they originally received property of the debtor was improper. The Eleventh Circuit disagreed, holding that while the Code does not specifically authorize awards of prejudgment interest, the instant case with its findings of "massive fraud...calls for the award of such interest" as compensation to IAS's creditors for the improper use of funds that rightfully belonged to those creditors as represented by the trustee.


1 Attorney Hans Christian Beyer initially represented the creditors' committee in the IAS bankruptcy case and related litigation and, post-confirmation, has represented the trustee. Return to article

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Friday, July 1, 2005