Opinion ID: 4208266
Heading Depth: 5
Heading Rank: 1

Heading: The Majority Approach

Text: Under the majority approach, or “one-step transaction” approach, courts hold that a principal of a debtor corporation who misappropriates company funds to satisfy personal obligations is not an initial transferee. In re Video Depot, 127 F.3d at 1198–99 (collecting cases); Sklar v. Susquehanna Bank (In re Global Prot.), 546 B.R. 586, 622– 23 (Bankr. D. N.J. 2016) (same). These courts reason that “[t]he mere power of a principal to direct the allocation of corporate resources does not amount to legal dominion and control,” which is required for initial-transferee status. In re Video Depot, 127 F.3d at 1199 (emphasis added). IN THE MATTER OF WALLDESIGN 15 As the Tenth Circuit has explained, “[m]any principals presumably exercise de facto control over the funds of the corporations they manage” and “can choose to cause their corporations to use those funds appropriately or inappropriately.” Id. (quoting Rupp v. Markgraf, 95 F.3d 936, 941 (10th Cir. 1996)). But “[this] distinction is only relevant to the question whether the principal’s conduct amounted to a breach of duty to the corporation.” Id. (quotation omitted). The distinction is not relevant to whether the principal qualifies as an initial transferee. Id. Thus, a principal’s control over the business operations of a corporation “does not, in itself, compel a finding that [the principal] had dominion . . . over the funds transferred from [the corporation] to [a third party].” Id. at 1200. Three reasons support the majority approach and viewing direct corporate misappropriations as “single-step transactions.” First, the text of § 550(a)(1) compels this result: Determining the initial transferee of a transaction is necessarily a temporal inquiry; there must be a transfer before there can be a transferee. The extent to which a principal has de facto control over the debtor before the funds are transferred from the debtor, and the extent to which the principal uses this control for his or her own benefit in causing the debtor to make a transfer, are not relevant considerations in determining the initial transferee under § 550. See Rupp, 95 F.3d at 941. In other words, the “flow of funds” matters, and “receipt of the transferred property is a necessary element for that 16 IN THE MATTER OF WALLDESIGN entity to be a transferee under § 550.” Id. at 942 (emphasis added) (quotation omitted). But “[s]imply directing a transfer, i.e., such as directing a debtor to transfer funds, is not enough.” Id. (emphasis added) (quotation omitted). A principal, therefore, may establish dominion “by first directing a transfer into his or her personal bank account and then making the payment from his personal account to the creditor.” See In re Video Depot, 127 F.3d at 1199. But a principal does not establish dominion by misdirecting company funds directly to a third party for personal gain. See id. In that situation, the principal is not a transferee at all but, rather, is the party for whose benefit the transfer was made. In re Global Prot., 546 B.R. at 624. Second, the structure of § 550(a)(1) indicates that a principal does not become an initial transferee simply by using his or her control over corporate assets to effect a fraudulent transfer. See Gen. Elec. Capital Auto Lease, Inc. v. Broach (In re Lucas Dallas), 185 B.R. 801, 809–10 (B.A.P. 9th Cir. 1995); In re Global Prot., 546 B.R. at 624; In re Red Dot Scenic, Inc., 293 B.R. 116, 121 (Bankr. S.D.N.Y. 2003), aff’d, 351 F.3d 57 (2d Cir. 2003). Section 550 imposes strict liability on both initial transferees and any beneficiaries of the fraudulent transfers. 11 U.S.C. § 550(a)(1). From that starting point, the Ninth Circuit Bankruptcy Appellate Panel (“BAP”) has reasoned: [I]f the distinction between an initial and a subsequent transferee turns on whether the party benefitting from the transfer “forced” the debtor to make the transfer, then the scope of liability under section 550 is unduly narrowed. Section 550(a)(1) subjects to strict liability not only the initial transferee, but also “the entity for whose benefit such IN THE MATTER OF WALLDESIGN 17 transfer was made.” 11 U.S.C. § 550(a)(1). The party who forces a debtor to make a transfer is almost always “the entity for whose benefit such transfer was made,” and thus is generally always subject to strict liability. Yet Congress intended to make initial transferees also strictly liable . . . . “The implication is that the entity for whose benefit the transfer was made is different from a transferee, immediate or otherwise.” Bullion Reserve, 922 F.2d at 548. Consideration of whether the beneficiary of the transfer “forced” the debtor to make the transfer would collapse the two prongs of strict liability into a single party. . . . There is nothing in the statute or otherwise to justify this result. In re Lucas Dallas, 185 B.R. at 809–10. This distinction between the beneficiaries of a transfer and initial transferees “thus strongly indicates that, as a general rule, beneficiaries and initial transferees are separate parties to a fraudulent transfer.” In re Red Dot, 293 B.R. at 121. Third, the policy concerns underlying § 550 counsel in favor of treating beneficiaries, initial transferees, and subsequent transferees separately and requiring “legal control” over the funds as opposed to mere “de facto” control for initial-transferee status. In re Mortg. Store, 773 F.3d at 997–98 & n.1; In re Video Depot, 127 F.3d at 1199. The alternative approach—by which “every agent or principal of a corporation [is] deemed the initial transferee when he or she effected a transfer of property in his or her representative capacity”—both misallocates the monitoring costs that § 550 sought to impose and deprives the trustee of a 18 IN THE MATTER OF WALLDESIGN potential source of recovery for creditors. See In re Video Depot, 127 F.3d at 1199; In re Red Dot, 293 B.R. at 121. After all, foxes (like corporate cheats) rarely guard henhouses (like corporate treasuries) with much success. In re Mortg. Store, 773 F.3d at 998 n.1. And Congress likely decided that “recovery from [an] embezzling principal would be difficult, thus it also made the first recipient of those funds liable to returning them.” See In re Global Prot., 546 B.R. at 625. As these cases demonstrate, a corporate principal (whether a shareholder, director, officer, or other insider) who effects a transfer of company funds in his or her representative capacity does not have dominion over those funds in his or her personal capacity. Therefore, such a principal does not qualify as an initial transferee under § 550(a)(1) of the Bankruptcy Code.