Bonded Financial Services, Inc. v. European American Bank
| Decision Date | 12 February 1988 |
| Docket Number | No. 87-1551,87-1551 |
| Citation | 838 F.2d 890,17 B.C.D. 299 |
| Parties | 18 Collier Bankr.Cas.2d 155, 17 Bankr.Ct.Dec. 299 BONDED FINANCIAL SERVICES, INC., Debtor-Appellant, v. EUROPEAN AMERICAN BANK, Defendant-Appellee. |
| Court | U.S. Court of Appeals — Seventh Circuit |
Joseph L. Kadison, Kamenear, Kadison & Anderson, Chicago, Ill., for debtor-appellant.
Mark S. Lieberman, Rosenthal & Schanfield, Chicago, Ill., for defendant-appellee.
Before POSNER, EASTERBROOK, and KANNE, Circuit Judges.
Michael Ryan controlled a number of currency exchanges in Illinois. He also owned quite a few horses, doing business as Shamrock Hill Farm. Ryan had borrowed $655,000 from European American Bank to run this business. One of the currency exchanges, Bonded Financial Services, put $200,000 at Ryan's disposal in January 1983. Bonded sent the Bank a check payable to the Bank's order on January 21 with a note directing the Bank to "deposit this check into Mike[ Ryan]'s account." The Bank did this. On January 31 Ryan instructed the Bank to debit the account $200,000 in order to reduce the outstanding balance of the Shamrock loan. The Bank did this. Ryan paid off the loan in two more installments, on February 11 and 14, 1983. The Bank released its security interest in the horses.
The currency exchanges and Ryan paid visits to the judicial system. Bonded filed a petition in bankruptcy on February 10, 1983, along with about 65 other entities that Ryan controlled. Creditors later filed involuntary proceedings against Ryan. Ryan was convicted of mail fraud on account of his irregular administration of the currency exchanges (Bonded was not, for starters) and is in prison. The transfer of $200,000 out of Bonded on January 21, 1983, was a fraudulent conveyance, see 11 U.S.C. Sec. 548(a), and the trustee may recover for the benefit of creditors the value of such a conveyance. The trustee seeks to recover from the Bank, which unlike Ryan is solvent.
The right of recovery depends on 11 U.S.C. Sec. 550:
(a) Except as otherwise provided in this section, to the extent that a transfer is avoided under section ... 548 ... of this title, the trustee may recover, for the benefit of the estate, the property transferred, or, if the court so orders, the value of such property, from--
(1) the initial transferee of such transfer or the entity for whose benefit such transfer was made; or
(2) any immediate or mediate transferee of such initial transferee.
(b) The trustee may not recover under section (a)(2) of this section from--
(1) a transferee that takes for value, including satisfaction or securing of a present or antecedent debt, in good faith, and without knowledge of the voidability of the transfer avoided; or
(2) any immediate or mediate good faith transferee of such transferee.
Bonded's trustee contends in this adversary proceeding that the Bank is the "initial transferee" under Sec. 550(a)(1) because it was the payee of the check it received on January 21; that the Bank is in any event the "entity for whose benefit such transfer was made" because Ryan intended to pay off the loan when he caused Bonded to write the check; that if the Bank is a subsequent transferee under Sec. 550(a)(2) it did not give "value" under Sec. 550(b)(1) because Bonded received nothing; and that the Bank loses even if it gave value because it should have known that something was amiss, given the substantial sum Bonded was transferring to a corporate officer. The bankruptcy court granted summary judgment to the Bank without explicitly discussing Sec. 550. The district court affirmed on appeal under 28 U.S.C. Sec. 158(a). It held that the Bank handled the check of January 21 as a "mere conduit" and so was not the initial transferee; that Ryan was the person "for whose benefit the transfer was made" because he got the benefit of the reduction in the balance of the loan; that the Bank's giving value to Ryan satisfied Sec. 550(b)(1); and that because the trustee presented no evidence that the Bank knew or should have known of Bonded's impending collapse, the Bank took in good faith. Our jurisdiction rests on 28 U.S.C. Sec. 158(d). See In re Morse Electric Co., 805 F.2d 262 (7th Cir.1986); In re Cash Currency Exchange, 762 F.2d 542 (7th Cir.1985).
If the note accompanying Bonded's check had said: "use this check to reduce Ryan's loan" instead of "deposit this check into [Ryan]'s account", Sec. 550(a)(1) would provide a ready answer. The Bank would be the "initial transferee" and Ryan would be the "entity for whose benefit [the] transfer was made". The trustee could recover the $200,000 from the Bank, Ryan, or both, subject to the rule of Sec. 550(c) that there may be but one recovery. The trustee contends that the apparently formal difference--depositing the check in Ryan's account and then debiting that account--should not affect the outcome. In either case the Bank is the payee of the check and ends up with the money, while Ryan gets the horses free of liens and Bonded is left holding the bag. From a larger perspective, however, the two cases are different.
Fraudulent conveyance law protects creditors from last-minute diminutions of the pool of assets in which they have interests. They accordingly need not monitor debtors so closely, and the savings in monitoring costs make businesses more productive. See Douglas G. Baird & Thomas H. Jackson, Fraudulent Conveyance Law and its Proper Domain, 38 Vand.L.Rev. 829 (1985); Robert Charles Clark, The Duties of the Corporate Debtor to its Creditors, 90 Harv.L.Rev. 505, 554-60 (1977). The original rule, in 13 Eliz. ch. 5 (1571), dealt with debtors who transferred property to their relatives, while the debtors themselves sought sanctuary from creditors. The family enjoyed the value of the assets, which the debtor might reclaim if the creditors stopped pursuing him. In the last 400 years the principle has been generalized to address transfers without either sufficient consideration or bad intent, for they, no less than gifts, reduce the value of the debtor's estate and thus the net return to creditors as a group. 1 The trustee reverses, for the benefit of all creditors, un- or under-compensated conveyances within a specified period before the bankruptcy.
There have always been limits on the pursuit of transfers. If the recipient of a fraudulent conveyance uses the money to buy a Rolls Royce, the auto dealer need not return the money to the bankrupt even if the trustee can identify the serial numbers on the bills. The misfortune of the firm's creditors is not a good reason to mulct the dealer, who gave value for the money and was in no position to monitor the debtor. Some monitoring is both inevitable and desirable, and the creditors are in a better position to carry out this task than are auto dealers and the many others with whom the firm's transferees may deal. The considerations behind the holder in due course rule for commercial paper, Uniform Commercial Code Sec. 3-302, and the bona fide purchaser rule for chattels, UCC Sec. 2-403(1)--the waste that would be created if people either had to inquire how their transferors obtained their property or to accept a risk that a commercial deal would be reversed for no reason they could perceive at the time--also apply to subsequent holders of assets fraudulently conveyed out of bankrupts. Just as the holder in due course rule requires the transferor of commercial paper to bear the risk and burden of inquiry, increasing the liquidity of paper, so Sec. 550(b) leaves with the initial transferee the burden of inquiry and the risk if the conveyance is fraudulent. The initial transferee is the best monitor; subsequent transferees usually do not know where the assets came from and would be ineffectual monitors if they did.
The potential costs of monitoring and residual risk are evident when the transferees include banks and other financial intermediaries. The check-clearing system processes more than 100 million instruments every day; most pass through several banks as part of the collection process; each bank may be an owner of the instrument or agent for purposes of collecting at a given moment. Some of these instruments represent funds fraudulently conveyed out of bankrupts, yet the cost of checking back on the earlier transferors would be staggering. Bonded's trustee dismisses financial intermediaries on the ground that they obviously are not initial transferees, but this is not so clear. Hundreds of thousands of wire transfers occur every day. The sender of money on a wire transfer tells its bank to send instructions to the Federal Reserve System (for a Fedwire transfer) or to a correspondent bank to make money or credit available through still another bank. The Fed or the receiving bank could be called the "initial transferee" of the funds if we disregarded the function of fraudulent conveyance law. Similarly, an armored car company might be called the "initial transferee" if the bankrupt gave it valuables or specie to carry. Exposing financial intermediaries and couriers to the risk of disgorging a "fraudulent conveyance" in such circumstances would lead them to take precautions, the costs of which would fall on solvent customers without significantly increasing the protection of creditors.
The functions of fraudulent conveyance law lead us to conclude that the Bank was not the "initial transferee" of Bonded's check even though it was the payee. The Bank acted as a financial intermediary. It received no benefit. Ryan's loan was fully secured and not in arrears, so the Bank did not even acquire a valuable right to offset its loan against the funds in Ryan's account. Under the law of contracts, the Bank had to follow the instructions that came with the check. The Uniform Commercial Code treats such instructions as binding to the extent any contract binds (see UCC Sec. 3-119). 2...
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