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Fourth Circuit Holds Trustee Cannot Recover Preferential Transfer from “Mere Conduit”

A.        Case Summary and Holding

In Guttman v. Constr. Prog. Grp. (In re Railworks Corp.), 760 F.3d 398 (4th Cir. 2014), the Fourth Circuit Court of Appeals held that a “mere conduit” cannot be an entity for whose benefit a preferential transfer is made and, therefore, is not liable for repayment of the preferential transfer.  Prior to the bankruptcy filing, Railworks Corporation (the “Debtor”) had obtained insurance from TIG Insurance Company (“TIG”), which used Construction Program Group (“CPG”) to act as an insurance underwriter.  CPG acted as the intermediary between the Debtor and TIG.  Pursuant to the agreement between CPG and TIG, CPG was liable to TIG for all insurance premiums, regardless of whether CPG actually collected the premiums from the Debtor.  Within the 90 days prior to filing, the Debtor made payments to CPG on account of the insurance obligations owed to TIG.  After the Debtor filed for bankruptcy, a Chapter 11 litigation trustee sought to recover these allegedly preferential payments from CPG.

Under section 550(a)(1) of the Bankruptcy Code, the trustee may recover an avoidable transfer from “the initial transferee of such transfer or the entity for whose benefit such transfer was made.”  11 U.S.C. § 550(a)(1).  An “initial transferee” is defined as an entity that “(1) ha[s] legal dominion and control over the property—e.g., the right to use the property for its own purpose—and (2) exercise[s] this legal dominion and control.”  In re Railworks Corp., 760 F.3d at 403 (quoting Grayson Consulting, Inc. v. Wachovia Sec., LLC (In re Derivium Capital LLC), 716 F.3d 355, 362 (4th Cir. 2013)).  Because a mere conduit has no legal dominion or control over the property, a mere conduit cannot be an initial transferee.  See id.  An “entity for whose benefit such transfer was made” is “a guarantor or debtor – someone who receives the benefit but not the money.”  Id. (quoting Lowry v. Sec. Pac. Bus. Credit, Inc. (In re Columbia Data Prods., Inc.), 892 F.2d 26, 29 (4th Cir. 1989)).

The Fourth Circuit rejected the holding of the District Court and the argument of the Chapter 11 litigation trustee that, because “the remittance of [the Debtor’s] premium payments to TIG extinguished CPG’s contingent liability to TIG, CPG was an entity for whose benefit such transfer was made.”  Id. at 404-405.  The Fourth Circuit, without much comment, held that such a finding would eviscerate the mere conduit defense – “because a conduit, by definition, has an obligation to pass these funds on to a third party,” “a conduit would always be contingently liable – and thus an entity for whose benefit a transfer is made.”  Id. at 405.

B.        Practice Pointer

Under the holding in In re Railworks, a preference defendant may avoid liability for repayment of the avoidable transfer if the defendant is able to show that it is a mere conduit and had no legal dominion or control over the avoidable transfer.  If the defendant qualifies as a mere conduit, it can be neither an initial transferee nor an entity for whose benefit such transfer was made and, thus, is not the proper subject of a section 550 recovery action.

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Luis F. Ruiz

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