Under the Bankruptcy Code, an “initial transferee” is strictly liable for a fraudulent transfer—there is no good faith, subsequent advance, or similar defense.
Fortunately for some fraudulent transfer defendants, it’s possible to be the “recipient” of a transfer as a mere conduit, without becoming a “transferee” with strict liability, under the Bankruptcy Code.
A recent opinion (Jalbert v. Gryaznova (In re BICOM NY, LLC), Adv. Pro. No. 19-1311, Doc. 52 (Bankry. S.D.N.Y, decided September 21, 2020)) illustrates how a defendant can be a mere recipient/conduit, rather than a transferee in two separate contexts:
- Where the defendant is unaware of what happened; and
- Where the defendant, by contract rights and duties, is a mere pass-through person.
–Gryaznova and the Bank Account
Irina Gryaznova and Alexander Boyko are citizens of the Russian Federation who visit a friend, Veniamin Nilva, in Florida in 2008. Gryaznova and Boyko decide to purchase a condominium in the same complex where Nilva lives.
Additionally, Gryaznova decides to seek permanent residency in the U.S., through its EB-5 program (by investing in a U.S. company to create jobs for U.S. citizens). The EB-5 process required Gryaznova to maintain a U.S. bank account with a minimum balance of $10,000.
Gryaznova contends that:
- She needed a social security number to open a bank account;
- Nilva offered to open a bank account jointly with her (the Nilva-Gryaznova Account);
- Only Gryaznova’s money was to be kept in the account; and
- Nilva was only a “nominal” account holder.
The bankruptcy Trustee, (i) disputes that a social security number was required, (ii) disputes the legal characterization of Nilva as a “nominal” account holder, but (iii) does not contest that only Gryaznova’s money was to be kept in the account.
–Nilva’s Deceptive Actions
Nilva is a managing member of several automobile dealerships and holding companies, including Debtor BICOM NY, LLC.
In 2016 Nilva wants to transfer $1 million from BICOM to another of his entities but knows that his lender would not permit such a transfer. To make a transfer happen and disguise the source of the funds, Nilva draws a $1 million check on BICOM’s bank account payable to Gryaznova.
Without Gryaznova’s knowledge or consent, Nilva endorses the check (using his own signature) and deposits it into the joint Nilva-Gryaznova account.
“Simultaneously,” Nilva writes a check against the joint Nilva-Gryaznova account for the same $1 million amount, payable to his other entity, and deposits the check into the other entity’s account. The two checks are dated the same day (June 26, 2016).
During a Bankruptcy Court hearing, Trustee’s counsel admits that:
- Gryaznova did not actually use any of the transferred funds;
- Gryaznova did not know about the transfers until after this litigation began;
- Nilva intended to make a transfer to his other entity; and
- Nilva used the joint Nilva-Gryaznova account as a device to deceive his lender as to the origin of the transferred funds.
The Trustee argues that Gryaznova had legal “dominion or control” over the funds as a joint account owner and, therefore, became strictly liable as the “initial transferee.”
Gryaznova argues that a “recipient” of funds is not necessarily the same as a a “transferee,” and that her account became a mere conduit for Nilva’s transfer of funds.
Money Laundering Opinions
At a Bankruptcy Court hearing, the Court brings these three money laundering decisions to the attention of the parties and asks for further briefing.
- In re Chase & Sanborn Corp., 813 F.2d 1177 (11th Cir. 1987). A corporation’s sole owner opens a bank account in the company’s name, deposits funds into that account, then transfers the money to a third party, and closes the account. The Court holds that the corporation did not have sufficient control for the funds to become its property. The court found the evidence of the sole owner’s control of the transfer “overwhelming” and the corporation’s connection to the funds “tangential.”
- Walsh v. Townsquare Assocs. (In re Montross), 209 B.R. 943 (9th Cir. 1997). Montross launders funds through Townsquare bank accounts, over which Montross has sole signature authority. Montross conceals the scheme from others, and Townsquare never uses or knows of the funds. The Court holds that Townsquare is not a “transferee” of the funds because it, (i) never had dominion and control, and (ii) had only bare legal possession.
- In re Reeves, 65 F.3d 670 (8th Cir. 1995). Debtor fraudulently puts $65,000 into the account of Reeves Farms, Inc., then transfers the money to the account of another entity. The bankruptcy court holds Reeves Farms liable as an “initial transferee.” The Court of Appeals reverses, noting a lack of evidence that Reeves Farms had received any benefit and finding Reeves Farms a mere conduit.
Despite the three money laundering opinions, the Trustee continues arguing that Gryaznova is strictly liable as a “transferee.”
The Bankruptcy Court rejects the Trustee’s legal argument. Here’s why:
- It is true that, if a person is an initial transferee, then there is strict liability for transfers;
- It is emphatically not the case, however, that every “recipient” of funds is automatically liable as an “initial transferee,” since the statutory term at issue is ‘transferee’ – not “recipient”;
- The Trustee is trying to apply strict liability standards in deciding whether someone is a transferee in the first place; and
- The Second Circuit Court of Appeals has already, (i) rejected the idea that “the owner of the first pair of hands to touch the property is the initial transferee,” and (ii) declared that “a more functional” rule must be applied (In re Finley, Kumble, Wagner, Heine, Underberg, Manley, Myerson & Case, 130 F.3d 52 (2d Cir. 1997)).
–In re Finley, Kumble
The Second Circuit’s In re Finley, Kumble opinion involves an insurance broker receiving payments and depositing them into his own bank account.
But the broker had performed a service and received the payments for the sole purpose of forwarding the funds on to the insurance company—and the broker did so within 5 to 14 days after receipt.
The Court of Appeals declares in Finley, Kumble:
- The broker’s receipt of the funds did not automatically make the broker a “transferee”; and
- The actual “transferee” is “the one to whom the funds ultimately should go”—which is the insurance company.
The Bankruptcy Court rejects the legal argument that any person who has legal “dominion and control” over an account into which funds are deposited is automatically a “transferee.” What Finley, Kumble actually holds is that “dominion and control” are “minimum” requirements to become transferee—not sufficient requirements by themselves.
While the Finley, Kumble broker may have owned the bank account into which the funds were deposited and exercised control over movement of the funds, he had also agreed to transfer the funds to another party. So, the broker is, functionally, a mere conduit for the intended transfer from the client to the insurance company.
–Rejecting the Trustee’s Arguments
The Bankruptcy Court says that the Trustee’s Finley, Kumble position pushes legal fictions to extremes that make no sense:
- The whole point of a “dominion and control” test is to ensure that a “transferee” distinction is grounded in the realities of the transaction;
- The Trustee asserts that Gryaznova’s ownership of the account gives her unfettered control, though she has no such control;
- Gryaznova has no knowledge of the deposit until the money was long gone; and.
- Gryaznova actually has far less actual “control” over the use of the funds at issue than the broker had in Finley, Kumble.
Gryaznova’s alleged theoretical discretion over the funds ignores the “simultaneously” written check: Nilva “simultaneously” issued a second check in the same amount that, (i) created a legal obligation to be honored, and (ii) denied Gryaznova any right to put the money to her own purposes.
No real-world transfer of funds to Gryaznova was intended, and none was accomplished. Nilva used the joint account solely to facilitate a transfer from BICOM to his other entity.
Gryaznova did not endorse, participate in or know about this use of her account (which was supposed to be used only for her own funds), and she received no benefit from it.
Distinguishing Multiple Cases
The Trustee relies on decisions involving parties who, (i) knowingly act as transferees of funds for the purpose of hiding the funds from creditors, and (ii) then argue they lacked “control” because they merely followed instructions from other people. For example:
- In re Hurtado, 342 F.3d 528 (6th Cir. 2003)—Mother knowingly deposits her son’s money into her own account, where the money stays for many months, and Mother becomes a “transferee” by accepting the funds to conceal them from creditors, though she only followed her son’s instructions.
- Richardson v. United States, IRS (In re Anton Noll, Inc.), 277 B.R. 875, 881-82 (1st Cir. 2002)—corporate owner transfers corporate funds to his own account, uses the funds to pay owner’s debts to the IRS, and becomes a “transferee”;
- Helms v. Roti (In re Roti), 271 B.R. 281, 296 (Bankr. N.D. Ill. 2002)—Father transfers funds to his daughters to shield the funds from creditors, and daughters become “transferees” despite using the money only at their father’s instructions;
- 718 Arch St. Assocs., Ltd. v. Blatstein (In re Blatstein), 260 B.R. 698, 718 (E.D. Pa. 2001)—Husband transfers money to his wife to shield the funds from creditors, and wife becomes a “transferee” despite using the money only as her husband directed.
The Jalbert v. Gryaznova opinion reveals that the initial recipient of an insolvent debtor’s funds into his/her/its own bank account can avoid being an “initial transferee” under the Bankruptcy Code in two separate contexts:
- When the recipient has no knowledge of what happened (that’s the Jalbert v. Gryaznova facts); and
- When the recipient receives the funds as a broker, with contract obligations to pass such funds on to another person (that’s the In re Finley, Kumble facts).
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