Cross v. Lasalle Bank, s. 09-2011, 09-2012, 09-2013, 09-2026.

• Decision Date: 27 August 2010
• Docket Number: Nos. 09-2011, 09-2012, 09-2013, 09-2026.,s. 09-2011, 09-2012, 09-2013, 09-2026.
• Citation: 619 F.3d 688
• Parties: Gus A. PALOIAN, as Trustee in bankruptcy for Doctors Hospital of Hyde Park, Inc., Plaintiff-Appellee, Cross-Appellant, v. LaSALLE BANK, N.A., as Trustee for the Certificate Holders of Asset Securitization Corporation Commercial Pass-Through Certificates, Series 1997, D5, Defendant-Appellant, Cross-Appellee.
• Court: U.S. Court of Appeals — Seventh Circuit

619 F.3d 688

Gus A. PALOIAN, as Trustee in bankruptcy for Doctors Hospital of Hyde Park, Inc., Plaintiff-Appellee, Cross-Appellant,

v.LaSALLE BANK, N.A., as Trustee for the Certificate Holders of Asset Securitization Corporation Commercial Pass-Through Certificates, Series 1997, D5, Defendant-Appellant, Cross-Appellee.

Nos. 09-2011, 09-2012, 09-2013, 09-2026.

United States Court of Appeals,Seventh Circuit.

Argued Dec. 8, 2009.

Decided Aug. 27, 2010.

Rehearing Denied Oct. 15, 2010.

John E. Frey, Attorney (argued), Wildman, Harrold, Allen & Dixon, Chicago, IL, for Plaintiff-Appellee, Cross-Appellant.

David T.B. Audley, Attorney (argued), Chapman & Cutler, Howard L. Adelman, Attorney, Adelman, Gettleman & Merens, Chicago, IL, for Defendant-Appellant, Cross-Appellee.

Before EASTERBROOK, Chief Judge, and ROVNER and TINDER, Circuit Judges.

EASTERBROOK, Chief Judge.

Doctors Hospital of Hyde Park was founded (as “Illinois Central Hospital”) to provide medical care as a fringe benefit for workers of the Illinois Central Railroad. Construction began in 1914; the architects were Schmidt, Garden & Martin. The building is on several lists of memorable designs. But the Illinois Central, like other railroads, eventually decided that it did not have a comparative advantage in providing medical care and sold the business.

Between 1992 and 2000 the Hospital was a Subchapter S corporation controlled by James Desnick, an ophthalmologist with a checkered past. Desnick once operated a chain of eye-care clinics, whose business practices garnered adverse publicity. See Desnick v. American Broadcasting Cos., 233 F.3d 514 (7th Cir.2000). Following charges of misconduct during the 1980s, Desnick gave up his medical practice in 1991 and bought the Hospital the next year. In 1999 and 2000 Desnick paid civil penalties of some $18.5 million to the Medicare and Medicaid programs on account of the Hospital's excessive bills-not only “upcoding” to put services in categories that led to greater reimbursement, but also claims for medically unnecessary procedures or work never done at all. The Hospital also was inefficient, and not only because the old building's design is not well suited to modern medicine: patient stays were significantly longer than the national average. Because third-party payments often cover a particular procedure rather than the number of days spent in a hospital room, this led to lower average revenues per patient-day. Doctors Hospital closed its doors in 2000; the building has been vacant since then. (There are plenty of other hospital beds in or near Hyde Park at the University of Chicago's sprawling medical center plus the Jackson Park Hospital and Medical Center.)

Like other medical providers, the Hospital furnished services well before it received payment from patients or their insurers. This created a cash-flow problem, which the Hospital addressed by borrowing money. The current dispute arises from two of these loans. The Hospital's trustee in bankruptcy proposes to recover, as fraudulent conveyances, some of the payments made during the last years before the Hospital entered bankruptcy.

In March 1997 Daiwa Healthco extended a revolving $25 million line of credit to MMA Funding, L.L.C., which made the money available to the Hospital for operating expenses. (Desnick owned 99% or more of MMA Funding and all other Hospital-related entities mentioned in this opinion. Anyone interested in details can consult the lengthy opinions of the bankruptcy judge and district judge. To make this opinion manageable, we simplify the facts ruthlessly.) The Hospital transferred all of its current and future accounts receivable to MMA Funding, which gave Daiwa a security interest in them. The plan of this transaction was to use MMA Funding as a “bankruptcy-remote vehicle” so that Daiwa could be assured of repayment even if the Hospital entered bankruptcy.

In August 1997 Nomura Asset Capital Corporation loaned $50 million to the Hospital through HPCH LLC, which owned the Hospital's building and land. As part of this transaction, the Hospital promised to pay HPCH additional rent. HPCH gave Nomura a security interest in the incremental rent, which was to be transferred to MMA Funding.

The Daiwa line of credit lasted through March 2000; its termination caused insuperable cash-flow problems that led the Hospital to file for bankruptcy. The Nomura loan was securitized before the end of 1997. It was sold to a third party that packaged several billion dollars of commercial credit for resale to investors. The assets-borrowers' notes and the security interests backing them up-were transferred to a trust, of which LaSalle National Bank is the trustee and Orix Capital Markets the servicer. (On the role of the servicer in securitization, see CWCapital Asset Management, LLC v. Chicago Properties, LLC, 610 F.3d 497 (7th Cir.2010).) Nomura was reimbursed and has no stake in the current dispute, except to the extent that it may be an investor in the pool. Because two trustees are opponents in this appeal-LaSalle Bank as trustee of the investment pool, and Gus Paloian as trustee of the Hospital's estate in bankruptcy-we refer to each by name, while recognizing that each is a litigant only in a trustee's capacity.

In multiple adversary proceedings, a bankruptcy judge concluded after a trial that the Hospital was insolvent no later than August 1997 and that the increased rental rate for the lease of the building and grounds was in reality debt service by the Hospital. See, e.g., United Airlines, Inc. v. HSBC Bank USA, N.A., 416 F.3d 609 (7th Cir.2005) (discussing the circumstances under which a lease may be recharacterized as a secured loan). The judge concluded that the repayments on the Nomura loan were fraudulent conveyances, which must be returned to the estate. The investment pool then would receive the same fraction of its claims as other creditors. Although 11 U.S.C. § 550(b)(1) prevents recovery by a bankruptcy estate when the transfer satisfies an antecedent debt, LaSalle Bank has not relied on this provision. Its briefs do not say why, and we do not speculate.

The conclusion about the Hospital's insolvency led to only partial victory for trustee Paloian, however. The bankruptcy court concluded that as of July 1998, when the Hospital and its affiliates finally started using the precise cash-routing instructions in the loan agreements by sending the lease payments directly to LaSalle Bank, the payments were being made with MMA Funding's assets rather than the Hospital's and thus could not be avoided in the bankruptcy. The judge concluded that all payments from July 1998 forward are outside the bankruptcy. Paloian accepts this conclusion with respect to repayments on the Daiwa loan but not with respect to repayments on the Nomura loan.

The bankruptcy judge's findings and conclusions appear at 360 B.R. 787 (Bankr.N.D.Ill.2007), additional findings made and reconsideration denied, 373 B.R. 53 (Bankr.N.D.Ill.2007). A district judge affirmed. 406 B.R. 299 (N.D.Ill.2009). Both the bankruptcy judge and the district judge issued several additional opinions, but these three are the only decisions that matter now. Paloian and LaSalle Bank have filed cross-appeals. A related opinion of this court appears at In re Doctors Hospital of Hyde Park, Inc., 474 F.3d 421 (7th Cir.2007) (holding that the bankruptcy and district judges did not abuse their discretion in approving a settlement under which Desnick and entities he controls paid $6 million in exchange for a release of further liability to the bankruptcy estate).

LaSalle Bank's principal argument on appeal is that it is not an “initial transferee” of the funds, for the purpose of § 550(a)(1). Section 550(a) allows preferential transfers to be recouped from initial transferees, recipients from initial transferees, or “the entity for whose benefit such transfer was made”. Relying on Bonded Financial Services, Inc. v. European American Bank, 838 F.2d 890 (7th Cir.1988), LaSalle Bank contends that it was simply a conduit for placing the money in the trust. We held in Bonded Financial Services that, when a debtor's check transfers money to a checking account, the “initial transferee” is the bank's customer, who possesses control over the funds, rather than the bank that holds money subject to its customer's orders. LaSalle Bank sees itself as agent of the pool's investors and therefore as a similarly inappropriate target of a turnover order. And if, as it contends, the Bank is not the “initial transferee,” this whole proceeding is at an end.

The Bankruptcy Code does not define “initial transferee”; Bonded Financial Services adopted an approach that tracks the function of the bankruptcy trustee's avoiding powers: to recoup money from the real recipient of preferential transfers. In Bonded Financial Services, that recipient was the bank's customer, who had full control over the balance in the checking account. In this situation, the real recipient is LaSalle Bank, which is the trustee of the securities pool. In American law, a trustee is the legal owner of the trust's assets. Wellpoint, Inc. v. CIR, 599 F.3d 641, 648 (7th Cir.2010); Restatement (Third) of Trusts § 2 comment d, § 42. Although LaSalle Bank has duties to the trust's beneficiaries (the investors) concerning the application of funds, the assets' owner remains the appropriate subject of a preference-avoidance action. If LaSalle Bank must hand $10 million over to the bankruptcy estate, it will draw that money from the corpus of the trust, not from the Bank's corporate assets. This means that the money really comes from the trust's investors-the persons “for whose benefit [the] transfer was made”. Instead of requiring the bankruptcy trustee to sue thousands of investors who may have received interest payments that were increased, slightly, by money from the Hospital's coffers, a single suit suffices. If the Hospital had made a...