Thursday, November 15, 2018

"Mere Conduits" of Fraudulently Conveyed Funds Continue to Face Scrutiny

By Bill Siegel

There are two basic ways of proving a fraudulent conveyance under the United States Bankruptcy Code (sometimes referred to as the “Code”) and the Uniform Fraudulent Transfer Act.  The first is known as the subjective test, i.e. showing an intent to hinder, delay, or defraud the transferor’s creditors.  The second is known as the objective test, i.e. showing that the transferor did not receive reasonably equivalent value and was either insolvent or the transfer rendered the transferor insolvent.  However, what if the transferee is a “mere conduit” and exercises no control over the transfer of the funds and has no knowledge of the fraud?

“Mere Conduit”
Banks holding funds for a debtors are generally found to be mere conduits, but courts are split as to whether a non-bank transferee qualifies as a mere conduit.  To qualify as a “mere conduit,” Judge Colton, in Taylor Bean, said the transferee must show that (1) it did not have control over the asset it received, and (2) it “acted in good faith and as an innocent participant in the fraudulent transfer.”1

In Taylor Bean, the debtor was a mortgage lender that had perpetrated a Ponzi scheme.  A liquidating plan was confirmed, and the plan trustee filed numerous fraudulent transfer lawsuits alleging transfers by the debtor were made with the intent to hinder, delay and defraud creditors.  One of the suits was asserted against the debtor’s payroll service provider for $34 million.  The trustee contended that the payroll service provider was the initial transferee and as such should be liable, even though it had no knowledge it was receiving fraudulently-transferred funds.  The payroll service provider argued it was a “mere conduit” and the judge agreed. 

The court  analogized the obligations of the payroll service provider and its control over the funds to that of a bank and found that the payroll service provider did not control the funds coming in and out of the account and it was “neither logical nor equitable [for the service provider to] be held liable for the funds that passed through . . . to employees, taxing authorities, and garnishors.”2  

Having found that the payroll service provider did not exercise control over the transfers, the court next analyzed whether the defendant had “actual knowledge” of the fraud or “had knowledge of facts or circumstances that would have put [it] on inquiry notice.”3   The court found no such record.  Mere suspicions were not good enough as the record reflected that the debtor had duped its auditors.4

The case was dismissed.  Equity and fairness won out. 

The take-away for those who believe they may be mere conduits of funds is to exercise as little control as possible over the segregated accounts.  Fees should be paid separately and deposited into a different account.  If, in managing the account, you have an ancillary duty to review, audit, or evaluate transfers in and out of the account, then you may be under a duty to investigate.
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  1. Luria v. ADP Inc. (In re Taylor Bean & Whitaker Mortgage Corp.), page 4. Citing See Martinez v. Hutton (In re Harwell), 628 F.3d 1312, 1323 (11th Cir. 2010). 
  2. Luria v. ADP Inc. (In re Taylor Bean & Whitaker Mortgage Corp.), page 28.
  3. Luria v. ADP Inc. (In re Taylor Bean & Whitaker Mortgage Corp.), page 28.
  4. Luria v. ADP Inc. (In re Taylor Bean & Whitaker Mortgage Corp.), pages 32-33.

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