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Decided: July 28, 2014

The Fourth Circuit held that Railworks could not recover a premium payment transfer under 11 U.S.C. § 550, nor avoid the transfer under 11 U.S.C. § 547, following a Chapter 11 bankruptcy filing.

Railworks, a national provider of railway services, filed for Chapter 11 bankruptcy. TIG provided insurance to Railworks, and CPG was TIG’s managing general underwriter. According to the agreement between CPG and TIG, CPG would hold all premiums collected in trust for TIG as the property of TIG. Guttman, the Chapter 11 Litigation Trustee for Railworks, filed to avoid and recover premium payments that had been paid to CPG within ninety days of Railworks bankruptcy filing.

Under the preference avoidance statute, § 547, a trustee may avoid transfers made out of the debtor’s estate before the bankruptcy petition is filed. These transfers are known as “preferences.” The trustee must show that the transfer was:

(1) of an interest of the debtor in property; (2) to or for the benefit of a creditor; (3) for or on account of an antecedent debt owed by the debtor before the transfer was made; (4) made while the debtor was insolvent; (5) made on or within ninety days of the filing of the bankruptcy petition; and (6) it must enable the creditor to receive a greater percentage of its claim than it would under the normal distributive provisions in a liquidation case under the Bankruptcy Code.

Morrison v. Champion Credit Corp., 952 F.2d 795, 798 (4th Cir. 1991). Under the recovery statute, § 550, a transfer may be recovered from “the initial transferee of such transfer or the entity for whose benefit such transfer was made.” § 550(a)(1). Because the Bankruptcy Code does not define “initial transferee,” the Fourth Circuit determined whether an entity is an “initial transferee” using the “dominion and control” test. The initial transferee must: “(1) have legal dominion and control over the property…and (2) exercise this legal dominion and control.” The initial transferee is not a “‘mere conduit’ for the party who had a direct business relationship with the debtor.” The Court further distinguished between avoidance of a transfer and recovery from the transferee. In order to recover from a transferee, a trustee must avoid a transfer; however, a trustee does not automatically recover under § 550 by avoiding the transfer. Thus in order for funds to be avoidable under § 547, the funds must first be recoverable under § 550.

The Fourth Circuit rejected CPG’s argument that Guttman failed to properly plead his claims under §§ 547 and 550 because a plaintiff is not limited by one specific legal theory in a complaint. The Court then proceeded to determine whether Guttman could recover the premium payment transfers under § 550. The Fourth Circuit reasoned that a party cannot be the entity for whose benefit the transfer was made if that entity is only a mere conduit for the party that had a direct business relationship with the debtor. The Court noted that according to the agreement between CPG and TIG, CPG, as a trustee for TIG, only had physical control of the transfers, but did not have the freedom to use the funds as CPG wished. If the extinguishment of contingent liability benefitted CPG, then there would be no conduit defense. The Court expressly noted that it was unwilling to eliminate the conduit defense. Because CPG was unquestionably a mere conduit, and a party cannot be both a conduit and a benefitting entity, the Fourth Circuit held that Guttman could not recover the premium payment under § 550.

Full Opinion

Verona Sheleena Rios