Must An Avoidance Lawsuit Against A Subsequent Transferee Under § 550(a) Name The Initial Transferee As Defendant? (Phillips v. SS Associates)

The initial transfer? (photo by Marilyn Swanson)

“[T]o the extent that a transfer is avoided . . . , the trustee may recover . . . the property transferred, or . . . the value of such property, from—(1) the initial transferee of such transfer . . . , or (2) any immediate or mediate transferee of such initial transfer.” 11 U.S.C. § 550(a).

Hypothetical

Debtor pays $100,000 to Relative, and Relative gifts that same $100,000 to Relative’s Adult Child. Then:

Debtor files Chapter 7 bankruptcy;
Chapter 7 Trustee sues Relative’s Adult Child, alleging:
- the $100,000 payment to Relative is an avoidable transfer under § 548; and
- Relative’s Adult Child is liable to Debtor’s bankruptcy estate as the subsequent transferee of the initial transfer; but
Relative is not included in the lawsuit, because Relative has already filed personal bankruptcy and obtained a discharge.

Question

Should Chapter 7 Trustee’s suit against Relative’s Adult Child be dismissed because Relative is not included as a party in the lawsuit?

Answer

The answer is:

“Yes,” if the suit is brought in the Tenth Circuit, based on a 1992 opinion;
“No,” if the suit is brought in the Delaware Bankruptcy Court, based on a February 4, 2026, opinion; and
“No,” when the suit is brought in most other courts that have addressed the question”.

Tenth Circuit Opinion

In In re Slack-Horner Foundries Co., 971 F.2d 577 (10th Cir. 1992), the debtor’s Chapter 7 Trustee sues to recover the value of property received by the Purchaser at a tax lien foreclosure sale of real estate—the purchase price is $66,134 and the real property is valued in Trustee’s Complaint at $170,000.

The Tenth Circuit dismisses the Trustee’s Complaint for failing to state a claim because: (i) the first transfer was to the State of Colorado, who thereafter transferred the property to the Purchaser, and (ii) the Trustee’s Complaint fails to name the State of Colorado as a party defendant.

The Tenth Circuit explains:

“the debtor’s interest in property was transferred to the state”;
“The state is the initial transferee of the debtor’s property”;
“Under the Bankruptcy Code, [the Purchaser] is considered an immediate transferee of the initial transferee”;
§ 550 “authorizes the trustee . . . to recover the value of the property transferred from either the initial transferee or a subsequent transferee”; but
“in order to recover from a subsequent transferee the trustee must first have the transfer of the debtor’s interest to the initial transferee avoided under § 548.”

Since the trustee made no attempt to have the transfer from the debtor to the state avoided, “the trustee has not demonstrated any basis for recovering the property from [the Defendant]” under § 550.

Delaware Bankruptcy Court Opinion

In Phillips v. SS Associates LLC (In re ONH AFC CS Investors, LLC), Adv. Pro. No. 25-51090 (Bankr. D. Del.; decided February 4, 2026; Doc. 23), the Bankruptcy Court cites the Tenth Circuit’s In re Slack-Horner opinion and its progeny, declaring:

“Those cases are wrongly decided.”

The Delaware Bankruptcy Court explains its view like this:

when an avoidance action is being pursued against a subsequent transferee, “there is no reason why the initial transferee needs to be a party to that action” because “the concepts of avoidance and recovery are separate and distinct”;
in a California case, a bankruptcy trustee avoided a transfer and recovered its value from a subsequent transferee without naming the initial transferee, who had filed a separate bankruptcy and obtained a discharge and could not be named as a party in the avoidance action; and
the “central analytic flaw” in cases like In re Slack-Horner is that they treat the transfer, not as an element of a claim that must be established, but “as if it were a physical object existing somewhere in the universe, and a bright orange sticker with the word ‘avoided’ either has or has not been affixed to it.”

The facts of the Delaware case are:

Debtor is an investment firm;
one of Debtor’s representatives misappropriated investor funds (as the initial transferee), who then transferred $250,000 to the named Defendant (the subsequent transferee) for no consideration; and
Debtor’s bankruptcy trustee:
- sues Defendant as subsequent transferee; but
- does not sue the initial transferee because a global settlement had been reached that included a full release of the initial transferee.

So, Defendant, as subsequent transferee, moves to dismiss the Trustee’s Complaint for failing to name the initial transferee as a party defendant.

The Delaware Bankruptcy Court’s opinion rejects Defendant’s motion and adds:

under § 550(a) the transfer to the initial transferee must be avoided before recovery can be had from the subsequent transferee; but
the initial transferee need not be a party to the lawsuit to do so.

Conclusion

Very interesting!

Can’t wait to see what happens next on the question—in both Delaware and other courts.

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