Attachment A

Duckworth v. Peoria Speakeasy, Inc. (In re Duckworth)
Only the Westlaw citation is currently available.

United States Bankruptcy Court,

C.D. Illinois.

In re David L. DUCKWORTH, Debtor.

Charles E. Covey, Trustee, Plaintiff,

v.

Peoria Speakeasy, Inc., d/b/a Big Al's Speakeasy,

Defendant.

Bankruptcy No. 10–83603.

Adversary No. 11–8092.

Nos. 10–83603, ADV 11–8092.

April 5, 2013.

Andrew W. Covey, Peoria, IL, for Plaintiff.

Samuel Benjamin Zabek, Graves Law Offices, P.C.,

Peoria, IL, for Defendant.

OPINION

THOMAS L. PERKINS, United States Bankruptcy

Judge.

*1 This matter is before the Court on cross motions for summary judgment filed by Charles E.

Covey, Trustee (TRUSTEE), as Plaintiff and Peoria

Speakeasy, Inc., d/b/a Big Al's Speakeasy

(SPEAKEASY), as Defendant, on the TRUSTEE'S

complaint to recover payments totaling $6,270.25,

as postpetition transfers under section 549 of the

Bankruptcy Code.

BACKGROUND

The facts are not controverted. The Debtor,

David L. Duckworth (DEBTOR), a self-employed

grain farmer, filed a Chapter 7 petition on November 23, 2010. According to the schedules of assets

and liabilities which were filed on November 29,

2010, the DEBTOR held no interest in any incorporated or unincorporated business, partnership or

joint venture. He reported cash on hand and in a

checking account in the total amount of $400. He

scheduled crops worth $363,158 and farm equipment valued at $323,000.

State Bank of Toulon (SBT) is scheduled as a

secured creditor on Schedule D filed by the DEBTOR, which lists debts owed to SBT totaling

$2,340,249 secured by collateral valued at

$686,158. The DEBTOR also scheduled several

farm ground landlords as secured creditors, holding

rights in crops. In its motion for relief from stay,

SBT alleges that as of the filing date it was owed

$2,329,226 and that the DEBTOR had no equity in

the collateral, which included farm equipment and

farm products (crops), and the proceeds therefrom.

Michlig AgriCenter, Inc. and/or Michlig AgriCenter Grain, L.L.C. (together “MICHLIG”), also asserted rights to the crops. The first meeting of creditors was held on December 29, 2010. At that meeting, the DEBTOR falsely denied that he was the

principal of Power Trading, LLC, and that he had a

bank account in that name.

On August 10, 2011, the DEBTOR pled guilty

to money laundering and bankruptcy fraud, admitting that, beginning in February 2009, he sold grain

out of trust, contracting to sell corn under the

names of Lighthouse Farms, Inc., and Midwest

Farms, LLC, having established those entities for

the purpose of selling the grain free of the lien of

secured creditors. The DEBTOR acknowledged that

he established bank accounts in the names of each

of those entities and deposited grain proceeds into

those accounts without SBT's knowledge or consent. On November 7, 2010, the DEBTOR formed

Power Trading, LLC as an Indiana limited liability

company. On November 12, 2010, the DEBTOR

withdrew funds totaling $97,000 from the Lighthouse Farms and Midwest Farms accounts. On

November 22, 2010, just one day prior to filing his

bankruptcy petition, the DEBTOR deposited

$95,000 into an account he had opened days earlier

in the name of Power Trading. On January 24,

2011, the DEBTOR established a second account in

the name of Power Trading, funding the account

with withdrawals totaling $24,000 from the existing

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account in the name of Power Trading.

After those facts came to light, the TRUSTEE

filed an adversary proceeding to deny the DEBTOR'S discharge and for a money judgment for the

value of the assets not disclosed. The TRUSTEE

and the DEBTOR entered into a stipulated judgment for denial of the DEBTOR'S discharge and

awarding judgment in the TRUSTEE'S favor for

$99,816.25, plus costs of $250.FN1 In that judgment, the DEBTOR admitted the underlying elements of sections 727(a)(2), (a)(3), (a)(4), (a)(5)

and (a)(6), and agreed that, on the date of bankruptcy, he “owned” $94,900 in an account in the

name of Power Trading, LLC.FN2

FN1. The complaint in Adv. No. 11–8058

was filed on July 11, 2011. The stipulated

order was entered on September 19, 2011.

The DEBTOR was represented by an attorney.

FN2. The DEBTOR also admitted to being

the owner of an account in the name of

Midwest Farms, LLC, which had a balance

as of the filing of $1,416.25 and a 2008

Kawasaki Vulcan Classic 900 motorcycle,

which he sold after the filing of the petition for $3,500.

*2 SBT brought an adversary proceeding, Adv.

No. 11–8002, against the TRUSTEE and various

creditors, claiming liens against the DEBTOR'S

property, seeking a determination of the validity,

priority and extent of its claimed liens. The

TRUSTEE asserted counterclaims and crossclaims,

seeking, inter alia, a determination that SBT's security interest was not valid, or alternatively, was

avoidable, and in addition, to avoid each of the

landlord's liens on crops. In that adversary, this

Court has determined that SBT had a valid, unavoidable lien on crops that secured a promissory

note dated December 15, 2008, in the principal

amount of $1,100,000. In re Duckworth, 2012 WL

986766 (Bankr.C.D.Ill.2012). The appeals from that

decision were dismissed, based on the district

court's determination that this Court's order was not

an appealable final order and that an interlocutory

appeal was not appropriate, given the related and

overlapping claims which this Court had not yet addressed.FN3

FN3. Appeals were taken by the TRUSTEE, SBT, Michlig AgriCenter Grain, LLC

and Michlig AgriCenter, Inc.

Among the pending matters referred to by the

district court, apart from the unresolved issues in

SBT's first adversary proceeding, was a second adversary proceeding, Adv. No. 11–8037, brought by

SBT against the TRUSTEE to determine the validity of its lien in excess equipment proceeds remaining after satisfaction of its loans securing purchase

money security interests in the equipment. This

Court recently issued its decision in that proceeding, again interpreting SBT's documents and reaffirming its earlier ruling that SBT's security agreement dated December 13, 2008, secured the $1.1M

Note dated December 15, 2008, despite the misidentification of the date of the note in the security

agreement. In re Duckworth, 2013 WL 211231

(Bank.C.D.Ill.2013). The TRUSTEE has appealed

that decision.

The TRUSTEE brought this adversary against

SPEAKEASY, an establishment featuring live adult

entertainment, seeking to avoid a series of transfers

it received during the period from December 30,

2010 to February 7, 2011, from the accounts in the

name of Power Trading as unauthorized postpetition transfers pursuant to section 549 and to recover

the value of those transfers under section 550(a)(1).

Attached to the complaint is a copy of the checking

account statements for the two accounts of Power

Trading reflecting the $95,000 deposit made on

November 22, 2010. Those statements reflect that

between November 23, 2010, and March 18, 2011,

four hundred and sixty transactions were debited to

the accounts, expending virtually the entire initial

deposit of $95,000. Funds totaling $6,270.25 were

paid to SPEAKEASY.FN4 SPEAKEASY answered

the complaint, denying that any of the funds it rePage 2

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ceived were transfers of property of the bankruptcy

estate. Both the TRUSTEE and SPEAKEASY filed

motions for summary judgment, which are

presently before the Court.

FN4. Purchases were made as follows:

December 29, 2010–$89.75; January 13,

2011–$517.50; January 16,

2011–$1,708.75; January 20,

2011–$1,837.00; January 29,

2011–$541.50; January 29, 2011–$106.25;

February 4, 2011–$196.00; and February

20, 2011–$1,273.50.

ANALYSIS

Under Federal Rule of Civil Procedure 56(c),

made applicable to adversary proceedings in bankruptcy by Federal Rule of Bankruptcy Procedure

7056, summary judgment is proper if the pleadings,

depositions, answers to interrogatories, and admissions on file, together with any affidavits, show that

there is no genuine issue of material fact and that

the moving party is entitled to judgment as a matter

of law. Celotex Corp. v. Catrett, 477 U.S. 317, 322,

106 S.Ct. 2548, 91 L.Ed.2d 265 (1986). Where the

material facts are not in dispute, the sole issue is

whether the moving party is entitled to a judgment

as a matter of law. ANR Advance Transp. Co. v.

Int'l Broth. of Teamsters, Local 710, 153 F.3d 774,

777 (7th Cir.1998).

*3 The TRUSTEE argues that the alter ego

doctrine requires that the separate existence of the

three nondebtor entities be disregarded. Although

the TRUSTEE does not expressly rely upon section

105(a)'s grant of general equitable powers to bankruptcy courts, his reliance upon the equitable alter

ego doctrine triggers the same concerns. It is well

established that a bankruptcy court's equity powers

are cabined by the Bankruptcy Code's explicit provisions. Norwest Bank Worthington v. Ahlers, 485

U.S. 197, 198, 108 S.Ct. 963, 99 L.Ed.2d 169

(1988). A bankruptcy court may not use its equitable powers to circumvent the law. Matter of

Greenig, 152 F.3d 631, 635 (7th Cir.1998). The

power conferred by section 105(a) is one to implement rather than to override. In re Kmart Corp.,

359 F.3d 866, 871 (7th Cir.2004). When a specific

Code section addresses an issue, a court may not

employ its equitable powers to achieve a result not

contemplated by the Code or to expand or contract

a right explicitly granted. Matter of Fesco Plastics

Corp., 996 F.2d 152, 154–55 (7th Cir.1993); In re

Ludlow Hosp. Soc'y, Inc., 124 F.3d 22, 28 (1st

Cir.1997). This Court sees no reason why these

principles should not apply here.

Sections 549 and 550

Section 549 authorizes a trustee to avoid an unauthorized, postpetition transfer of property of the

estate. 11 U.S.C. § 549(a). An action to avoid a

transfer has four elements: (1) property was transferred; (2) the property was property of the bankruptcy estate; (3) the transfer occurred after the

commencement of the case; and (4) the transfer was

not authorized by the bankruptcy court or the Bankruptcy Code. In re Blair, 330 B.R. 206

(Bankr.N.D.Ill.2005). The Bankruptcy Code does

not set forth rules for determining whether a debtor

has an ownership interest in property, so ownership

is determined by applicable nonbankruptcy law,

typically state property law. Grede v. FCStone,

LLC, 485 B.R. 854, 868 (N.D.Ill.2013). Once the

trustee establishes that a postpetition transfer of estate property occurred, the burden shifts to the defendant to prove the validity of the transfer. Fed. R.

Bankr.P. 6001; In re Rood, 459 B.R. 581, 606

(Bankr.D.Md.2011). Since the funds paid to

SPEAKEASY came from Power Trading's account,

whether the transferred funds were property of the

estate is a disputed issue.

Section 550 of the Bankruptcy Code governs

the liability of transferees and beneficiaries of

avoided transfers. Under section 550(a)(1), an

avoided transfer can be recovered from the “initial

transferee.” Under section 550(a)(2), the transfer is

also recoverable from an “immediate or mediate”

transferee of the initial transferee. Under that provision, however, a subsequent transferee who takes a

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ledge of its voidability, is shielded from liability.

Neither the initial transferee nor the entity for

whose benefit the transfer was made is protected by

the good faith defense to liability. In re Baker &

Getty Fin. Serv., Inc., 974 F.2d 712, 722 (6th

Cir.1992). So a trustee has greater rights against an

initial transferee than he does against a subsequent

transferee. In an effort to take advantage of this distinction, the TRUSTEE attempts to characterize

SPEAKEASY as an initial transferee even though

the chain of transfers indicates SPEAKEASY is a

subsequent transferee.

*4 The TRUSTEE concedes that Lighthouse

Farms, Midwest Farms and Power Trading were

properly created and validly existing entities under

state law. He concedes that before bankruptcy, each

entity had one or more bank accounts opened in its

name. He concedes that before bankruptcy the

DEBTOR sold grain and deposited the proceeds

first in the Lighthouse Farms and Midwest Farms

accounts and later transferred the funds to the

Power Trading accounts. He concedes that the challenged transfers to SPEAKEASY were all made out

of the Power Trading accounts. Finally, he concedes that SPEAKEASY gave adequate value for

each transfer, in good faith, and without knowledge

of voidability.

On the face of those conceded facts, the

TRUSTEE'S cause of action should fail because the

transferred funds, on deposit in Power Trading's account before bankruptcy, were not property of the

estate and because SPEAKEASY was a subsequent

(not initial) transferee protected by the good faith

defense. Recognizing these inconvenient facts, the

TRUSTEE reprises the alter ego theory that he previously put forth in a similar avoidance action

against Casey's General Stores (Casey's) in Adversary No. 11–8104, which this Court rejected. In

re Duckworth, 2012 WL 4434681

(Bankr.C.D.Ill.2012)(decided Sept. 24, 2012).

The Prior Decision in Casey's

In his motion for summary judgment in that

case, the TRUSTEE asserted that Lighthouse

Farms, Inc., Midwest Farms, LLC, and Power Trading, LLC, were alter ego entities of the DEBTOR

whose separate status should be disregarded as a

matter of Illinois law. Disregarding those separate

entities and treating their assets as if owned by the

DEBTOR, the TRUSTEE maintained that the funds

in Power Trading's account were property of the

DEBTOR'S bankruptcy estate at the time he filed

his petition and remained so thereafter. In support

of his motion, the TRUSTEE presented a portion of

the DEBTOR'S deposition, a copy of his plea

agreement and a transcript of his criminal guilty

plea hearing in federal district court. In his deposition, the DEBTOR admitted that he had full

dominion and control over the funds transferred to

the Power Trading accounts and that the funds were

spent on his personal living expenses. Also submitted by the TRUSTEE was a letter written by Michael Clark, as Trustee of TDA Concepts, a member of Power Trading, LLC, stating that Power

Trading was not a business entity and that it was

created for the “purpose of providing asset privacy

and protection” of the personal property owned by

the DEBTOR, along with various documents papering the trail of the grain proceeds from the elevator

through the bank accounts held by the nondebtor

entities to Casey's. The TRUSTEE did not dispute

that each Casey's transaction represented an ordinary retail sale of consumer goods. Nor did he dispute Casey's assertions that neither it nor any of its

employees were aware of the DEBTOR'S bankruptcy filing and that it provided equivalent value

in exchange for the transfers.

*5 Like SPEAKEASY here, Casey's also filed

a motion for summary judgment which disputed the

TRUSTEE'S alter ego theory. Casey's asserted that

Power Trading was the initial transferee of the

funds from the DEBTOR, and that as a subsequent

transferee, it took the funds in good faith and

without knowledge of the avoidability of the transfers, and was protected under section 550(b)(1).

This Court issued its decision in favor of Casey's on September 24, 2012, rejecting the TRUSTPage 4

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EE'S application of the alter ego theory. Finding

that ownership of the funds was validly transferred

prepetition to the non-debtor entities created for

that purpose, the Court determined that the funds

held in Power Trading's account on the date of

bankruptcy were the property of Power Trading, not

the DEBTOR, so that they did not become property

of the estate. Notwithstanding the fraudulent nature

of the DEBTOR'S transfers of funds to those entities, a determination not seriously contested in any

of these proceedings, each entity was properly created, validity existing, and capable of owning property, including bank accounts. The Court turned to

Indiana law, which governed the issue of the application of the doctrine of alter ego, recognizing

that Indiana courts, like those of most states, were

reluctant to disregard a corporate entity, applying

the doctrine only to avoid an injustice. Rather than

prevent an injustice, this Court concluded that holding Casey's liable for the fraud perpetrated by the

DEBTOR would in fact result in an injustice to Casey's, an innocent party.

The Court further determined that the good

faith defense provided to a subsequent transferee,

not available to an initial transferee, must necessarily be applied based on the chain of transfers as

they occurred as a matter of fact among the validly

created and existing entities. This plainly follows

from the fact that Congress tied the good faith

transferee defense to a party's status as a mediate

transferee, i.e., one who received a transfer from

someone other than the debtor. Using a so-called

equitable doctrine to disregard a chain of transfers

and thereby deprive a good faith transferee of a

statutorily mandated defense contradicts the plain

meaning of section 550. Equitable remedies are not

permitted to overrule statutory rights. Douglas v.

Indep. Living Ctr. of S. Cal., Inc., ––– U.S. ––––,

132 S.Ct. 1204, 1213, 182 L.Ed.2d 101 (2012);

Hedges v. Dixon County, 150 U.S. 182, 192, 14

S.Ct. 71, 37 L.Ed. 1044 (1893); In re United Airlines, Inc., 438 F.3d 720, 737 (7th Cir.2006). In the

very context of Bankruptcy Code section 550, the

Seventh Circuit has expressed serious doubts about

the propriety of a bankruptcy court declining to enforce the statute's liability scheme for reasons of

equity. Bonded Financial Services, Inc. v.

European American Bank, 838 F.2d 890, 894–95

(7th Cir.1988)(Easterbrook, J.). Summary judgment

was entered in favor of Casey's and against the

TRUSTEE. The TRUSTEE did not appeal the

Court's decision. FN5

FN5. Before deciding the case on that

basis, the Court noted an oversight by the

TRUSTEE. The Court observed that the

TRUSTEE'S theory ignored the fact that

the funds transferred by the DEBTOR

were fully encumbered by landlord liens

and the security interests of SBT and

MICHLIG. But this issue played no role in

the Court's decision in Casey's and plays

no role in its decision today.

The Court's Reasoning in Casey's Applies Here

*6 Turning to the motions presently before the

Court, the TRUSTEE, conceding that the facts do

not differ in any material way from those before the

Court in the previous proceeding involving Casey's,

asks this Court to reconsider its analysis in the prior

ruling. The TRUSTEE's theory is the same. The

controlling law remains unchanged. With one exception, the only difference is in the outcome

sought by the TRUSTEE.

Apart from the new argument relating to the lien releases, which is discussed below, the TRUSTEE'S motion for summary judgment largely repeats

the arguments he made in Casey's, that Lighthouse

Farms, Midwest Farms and Power Trading were the

alter egos of the DEBTOR, so that the payments

made to SPEAKEASY by Power Trading may be

treated as if they were made directly by the DEBTOR and are recoverable from SPEAKEASY as if it

was an initial transferee. The TRUSTEE'S reliance

on the alter ego doctrine in this context is unprecedented. The TRUSTEE is not asserting what has become recognized by some bankruptcy courts as a

permissible use of the alter ego doctrine, akin to

substantive consolidation, in order to combine the

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assets in the possession of Power Trading and its liabilities, along with those of the DEBTOR, to be

administered as part of the DEBTOR'S bankruptcy

estate. See In re Cyberco Holdings, Inc., 431 B.R.

404 (Bankr.W.D.Mich.2010). Rather, the TRUSTEE is seeking to apply the alter ego doctrine to disregard the transfers from the DEBTOR to Lighthouse Farms and to Midwest Farms, and from those

entities to Power Trading, in order to deny SPEAKEASY the statutory good faith transferee defense

specifically provided by section 550(b)(1) of the

Bankruptcy Code. According to the TRUSTEE, the

only issue to be decided is whether, on the date the

DEBTOR'S petition was filed, the separate corporate existence of Power Trading should be disregarded, based on an application of the general

factors commonly regarded in determining whether

to pierce the corporate veil, such as intermingling

of assets and business activity, failure to observe

corporate formalities, pervasive control, and the use

of the corporation to promote fraud. Should he prevail on that issue, the TRUSTEE maintains that the

funds in the Power Trading account on the date of

bankruptcy are property of the DEBTOR'S bankruptcy estate and pursuant to section 549, he is authorized to avoid any and all postpetition transfers.

Upon reconsideration of the TRUSTEE'S arguments and its earlier opinion in Casey's, the Court

reaffirms its reasoning and adopts and incorporates

it here. FN6 Without repeating the entire opinion,

several points are worth expanding upon and emphasizing.

FN6. This Court's opinion in Casey's will

be docketed in this Adv. No. 11–8092, in

conjunction with the issuance of the instant

Opinion.

DEBTOR Held Neither Legal nor Equitable

Title to the Funds

As discussed above, section 549 applies only to

transfers of property of the estate. All legal and

equitable interests of the debtor in property at the

time the bankruptcy petition is filed become property of the estate. 11 U.S.C. § 541(a)(1). As the

grain proceeds were transferred to and among the

non-debtor entities prepetition and were on deposit

in Power Trading's account on the petition date, the

DEBTOR did not hold legal title to the funds and

they did not become property of the estate by operation of section 541. The theory that a debtor holds

an “equitable” interest in fraudulently transferred

property for purposes of section 541 has been thoroughly debunked. The clear majority rule, with

which this Court agrees, is that fraudulently transferred property is not property of the estate until

and unless the transfer is avoided and the property

itself is recovered. Rajala v. Gardner, 709 F.3d

1031, 2013 WL 924455 (10th Cir.2013); Federal

Deposit Ins. Corp. v. Hirsch ( In re Colonial Realty

Co.), 980 F.2d 125 (2nd Cir.1992); In re Minh Vu

Hoang, 469 B.R. 606, 618–22 (D.Md.2012); In re

Murray, 214 B.R. 271, 278–79

(Bankr.D.Mass.1997); In re Saunders, 101 B.R.

303 (Bankr.N.D.Fla.1989). Contra, Am. Nat'l Bank

v. MortgageAmerica Corp. (In re MortgageAmerica

Corp.), 714 F.2d 1266 (5th Cir.1983); In re Swallen's, Inc., 205 B.R. 879, 882 (Bankr.S.D.Ohio

1997).

*7 That the grain proceeds did not enter the estate upon filing and were subsequently dissipated is

of no consequence to a trustee's power to avoid a

fraudulent transfer and obtain a recovery for the benefit of the estate and creditors. A trustee is not

limited to merely recovering the property in kind

that was fraudulently transferred. He is broadly empowered to recover the monetary value of the property transferred. 11 U.S.C. § 550(a). So even

though the grain proceeds in question did not become property of the estate when the DEBTOR

filed his chapter 7 petition, the TRUSTEE became

vested with the power to avoid the prepetition

fraudulent transfers and, within the confines of section 550, to recover the value of the funds fraudulently transferred to Lighthouse Farms, Midwest

Farms and Power Trading from those entities, none

of whom could utilize the good faith transferee defense provided in section 550(b)(1). The fact that

the TRUSTEE deemed his remedies against these

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entities to be worthless since the funds were subsequently spent and entirely dissipated should not

alter the analysis or conclusion that the funds paid

to SPEAKEASY were paid by Power Trading, a

non-debtor entity, and were not property of the

DEBTOR'S estate.

The proper remedy in this situation is the one

provided by the Bankruptcy Code for avoidance of

fraudulent transfers. Because section 550 limits the

effectiveness of that remedy as against good faith

subsequent transferees, the TRUSTEE tries to pull

an end-run around those limits by reframing the issue as a property of the estate question rather than a

fraudulent transfer avoidance question. This Court

didn't buy that argument in Casey's and isn't buying

it here. The TRUSTEE is unable to prove one of the

fundamental elements of a cause of action under

section 549, that property of the estate was transferred to SPEAKEASY.

Power Trading had Dominion and Control

The TRUSTEE relies heavily on the fact that

the DEBTOR testified that he retained control over

the funds since he controlled the three non-debtor

entities. The TRUSTEE'S focus is misdirected. The

proper focus is on the extent of the transferee's right

and power to use the funds. This is the so-called

“dominion and control” test established by the Seventh Circuit in Bonded Financial Services, Inc.,

supra, to determine whether a transfer has occurred

for purposes of section 550, holding that the minimum requirement for status as a transferee is dominion over the funds such that the transferee has the

right to put the money to its own purposes. 838

F.2d at 893. Mere possession of funds as a depository, an agent, an intermediary, or a trustee is not

enough to make one liable as a transferee.

The TRUSTEE'S argument, that since the

DEBTOR made the decisions on behalf of the separate entities, that they should thus not be treated as

separately existing entities, does not hold water.

Every closely held corporation or limited liability

company with a sole or majority owner is necessarily controlled by that owner. While the organization's conduct and activity is controlled by the person in charge, the conduct and activity is still that

of the organization. The TRUSTEE'S argument

says nothing more than that artificial entities act via

real persons. The correct question is one of the entity's dominion and control. Power Trading was not

a mere depository, agent, intermediary or trustee

whose legal authority over the funds was limited by

some agreement or statute. The TRUSTEE makes

no such allegation. Power Trading's dominion and

control over the funds deposited into its account

was absolute and unrestricted. As a validly formed

and existing limited liability company, it had the

authority to own and expend the funds for its own

purposes. That the DEBTOR caused the funds to be

expended for his personal benefit is not material to

the dominion and control inquiry, which focuses on

the entity's power over the funds.FN7 Under the

Seventh Circuit's dominion and control test, Power

Trading is a transferee under section 550, further

supporting the conclusion that the grain proceeds at

issue, owned by Power Trading, were never property of the estate. It follows directly from Power

Trading's status as a transferee that SPEAKEASY

is a downstream transferee, not an initial transferee

of the DEBTOR, and is entitled to avail itself of the

good faith transferee defense of section 550(b)(1).

FN7. In this Court's experience, it is not

uncommon for funds of closely held entities to be used to pay the personal expenses

of the owners, which payments are treated

as income to the individual.

Alter Ego Doctrine must be Rejected

*8 The TRUSTEE uses the state law alter ego

doctrine, a common law doctrine arising out of

equity jurisprudence, to achieve a result that directly contradicts the statutory scheme adopted by

Congress: the expungement of the good faith transferee defense to a downstream transferee who gave

fair value in good faith and without knowledge of

the voidability of the payments. No federal court

has permitted the doctrine to be used for this purpose. Because it runs afoul of the plain language of

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section 550, this Court is of the opinion that the alter ego doctrine may not be used for this purpose as

a matter of federal bankruptcy law. Neither does

applicable state law help the TRUSTEE. In Casey's,

this Court determined that Indiana law governs the

application of the alter ego doctrine and predicted

that the Indiana Supreme Court would not countenance use of the doctrine for such a purpose, since it

would not serve to remedy the fraud perpetrated by

the DEBTOR against his secured creditors and it

would cause an inequitable result for Casey's (and

for SPEAKEASY here) as an innocent party. An

equitable remedy should not be used where it would

work an injustice. Matter of Cassidy, 892 F.2d 637,

642 (7th Cir.1990).

In reliance on the separation of the concepts of

the avoidance of a transfer and the recovery of an

avoided transfer, the TRUSTEE regards any consideration of the fairness of the proceeding upon

SPEAKEASY as irrelevant to the application of the

doctrine of alter ego in the first instance. This Court

disagrees as a matter of federal bankruptcy law and

state law. Before applying an equitable doctrine,

courts require consideration of the result upon all

affected parties. Innocent transferees like Casey's

and SPEAKEASY deserve to have their statutory

rights and defenses protected.

The TRUSTEE discounts any unfairness to

SPEAKEASY, maintaining that the creditors of the

bankruptcy estate have been harmed by the transfers.FN8 However, it is not incumbent upon innocent downstream transferees like Casey's and

SPEAKEASY to give up or be deprived of statutory

defenses in order to enhance the estate. As noted by

the TRUSTEE in his motion for summary judgment, this Court in Casey's questioned whether the

estate was depleted by the DEBTOR'S transfers of

the fully encumbered grain proceeds. Apparently in

response to that question, along with his summary

judgment motion filed on February 11, 2013, the

TRUSTEE filed two releases, one by SBT and one

by MICHLIG, whereby those parties purport to release (1) their security interests in the funds of the

DEBTOR, Lighthouse Farms, Midwest Farms and/

or Power Trading that were paid to SPEAKEASY,

and (2) any interest they have in funds recovered

from SPEAKEASY.FN9 These releases are meaningless and are properly ignored in this proceeding.

FN8. This is not a situation where a debtor

fraudulently transferred unencumbered assets to the direct detriment of his general

creditors. The DEBTOR'S fraud was directed at his secured creditors. It is only because the landlord liens are statutory liens

for rent avoidable under section 545(3)

that the estate can claim to have been

harmed at all. The Court is not, however,

basing its decision on a lack of harm to the

estate. In fact, the DEBTOR has been punished for committing bankruptcy fraud. His

discharge has been denied, a large money

judgment has been entered against him,

and he has been imprisoned.

FN9. The releases are not dated and have

no apparent purpose outside of the context

of this adversary proceeding. The Court

presumes they were executed on or about

February 11, 2013, at the request of the

TRUSTEE to aid his efforts in this litigation. The record contains nothing to indicate why SBT and MICHLIG agreed to give

these releases to the TRUSTEE.

As the TRUSTEE acknowledges, this Court has

previously determined that SBT held a validly created and existing security interest in the grain. Although this determination has been appealed by the

TRUSTEE, it is the law of the case for the purpose

of this Opinion. When the DEBTOR sold the grain

for cash, the liens of the landlords, SBT and MICHLIG, attached to the cash proceeds. See 810 ILCS

5/9–315(a)(2). When those proceeds were transferred to and among Lighthouse Farms, Midwest

Farms and Power Trading, the funds remained encumbered by those liens. See 810 ILCS 5/9–332.

When the case was filed, the funds held in Power

Trading's account were subject to the same liens.

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*9 When Power Trading transferred the funds

in its accounts to various good faith transferees

such as SPEAKEASY and Casey's, at that point and

only at that point would the liens against the proceeds have been lost. See 810 ILCS 5/9–332. By

purporting to now “release” their liens in the funds

paid to SPEAKEASY, SBT and MICHLIG signed

off on a paper tiger. Their liens were lost shortly

after the petition was filed when the DEBTOR defrauded them by spending their collateral at

SPEAKEASY'S establishment. Moreover, a lien on

cash proceeds continues to exist only so long as the

proceeds are identifiable. See 810 ILCS

5/9–315(b)(2). Not even the TRUSTEE claims that

SPEAKEASY continues to hold identifiable proceeds.

As for the purported “release” of their interest

in any funds recovered by the TRUSTEE from

SPEAKEASY, it is axiomatic that a prepetition security interest does not encompass a trustee's avoiding powers or proceeds recovered therefrom. FN10

See 11 U.S.C. § 552(a); In re TekAids Industries,

Inc., 145 B.R. 253, 256–57 (Bankr.N.D.Ill.1992).

So that portion of the release is equally dumbfounding. From the Court's perspective, the TRUSTEE'S

theories asserted in this case are an ill-conceived attempt to engineer a result that the facts don't support. The meaningless releases appear to be one last

half-court heave in that effort. The belated gifting

of a purported benefit to the estate, at no cost to the

secured party, rendered at the expense of an unsuspecting third party, is a transparent ruse that does

not achieve the effect aimed for by the TRUSTEE.

FN11

FN10. It follows that a trustee will not attempt to avoid a transfer of a fully encumbered asset. See In re Teleservices

Group, Inc., 469 B.R. 713, 763 n. 157

(Bankr.W.D.Mich.2012).

FN11. None of the cases cited by the

TRUSTEE affect this determination. For

example, in Deckelbaum v. Cooter, Mangold, Tompert & Chapman, P.L.L.C., 275

B.R. 737 (D.Md.2001), the court allowed

the chapter 11 trustee to recover legal fees

which were paid by various alter ego entities, as postpetition transfers, noting that

the defendant law firm represented the

debtor in the creation of the entities making the transfers. The court did not discuss

section 550 and unlike SPEAKEASY, the

defendant was closely associated with the

debtor.

CONCLUSION

The grain proceeds paid to SPEAKEASY were

transferred before bankruptcy to and among three

non-debtor entities, lawfully organized and validly

existing under state law, and were ultimately deposited in a bank account in the name of one of those

entities, Power Trading. The deposited funds were

under the dominion and control of Power Trading, a

transferee under section 550. Power Trading, not

the DEBTOR, held legal title to the deposited funds

when the DEBTOR filed his bankruptcy petition.

Assuming that the prepetition transfers are avoidable under section 548, fraudulently transferred

property is not property of the estate until and unless recovered, and the TRUSTEE cannot claim an

equitable title interest. So the TRUSTEE cannot

prove the necessary element for a section 549

claim, that the property transferred was property of

the estate.

As defined in section 550, SPEAKEASY is not

an initial transferee from the DEBTOR. Instead,

SPEAKEASY is a mediate transferee eligible for

the good faith transferee defense of section

550(b)(1), the elements of which the TRUSTEE

does not contest. Thus, even if the postpetition payments made to SPEAKEASY would otherwise be

avoidable under section 549, SPEAKEASY is not

liable to return the funds or their value by operation

of section 550(b)(1).

The TRUSTEE'S reliance on the alter ego doctrine to readjust the property of the estate analysis,

and to eliminate the good faith transferee defense,

is misguided. Principles of federal and state law

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prohibit the use of the alter ego doctrine for that

purpose. Summary judgment will be awarded in favor of SPEAKEASY.

*10 This Opinion constitutes this Court's findings of fact and conclusions of law in accordance

with Federal Rule of Bankruptcy Procedure 7052.

A separate Order will be entered.

Bkrtcy.C.D.Ill.,2013.

In re Duckworth

Slip Copy, 2013 WL 1397456 (Bkrtcy.C.D.Ill.)

END OF DOCUMENT

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