Just when you thought it was safe to go back into the water another shark eating shark shows up.
You would think a closing attorney or bank wouldn’t have to pay both the seller and the buyer for a building. Wrong. Not so when bankruptcy allows a trustee to undo a perfectly good property purchase. This normally does not happen when the buyer pays fair market value for the building. But the defense to fraudulent or preferential transfers of paying fair market value only exists when you are buying property with your money. To determine if you are using your own money the dominion test is often used.
Take for example In re Mortgage Store Inc. 773 F.3d 990 (9th Circuit 2014). In this case Mano sold a shopping plaza to the Money Store for 300,000 and a 1.9 million mortgage. The money store was bankrupt when it purchased the property but no bankruptcy had been filed yet and only the owners of the money store knew it. An agent was supposed to just receive the purchase money, distribute the proceeds, record the deed and execute the closing. But almost two years later the Trustee and Court held the closing agent to be an initial transferee.
Under 11 USC 550 a bankruptcy trustee can avoid fraudulent transfers, and may recover property or its value from
(1) the “initial transferee” or “the entity for whose benefit such transfer was made,” or
(2) an “immediate or mediate transferee of such initial transferee.”
“Subsequent transferees” who have acquired property for “fair market value”, in “good faith”, and without “knowledge of the avoidability of the transfer”. Initial transferees are strictly liable and transfers to them can be undone whether they paid fair market value or whether they purchased in good faith or not.
Fair Market Value and Subsequent transferees?
The goal is then to be a subsequent transferee. The Court in this case used the “dominion test to determine if the agent was an initial transferee.” Under this test, the question is whether the recipient has legal title and ability to use the funds as it sees fit. Under this test even if there was no fraud the Trustee can reverse the transaction (give the property back) and recover the funds paid at closing. Now the Trustee can earn a sliding scale starting at 25% of what will now be distributed to creditors. This commission plus expenses is not a bad payday (enough to pay off the Mercedes). You are not talking him into looking the other way widow and orphans or not.
In this case the buyer had the ability to use the funds as he saw fit (had dominion) and his closing agent was the initial transferee (who could not use the funds as he saw fit). The Chapter 7 trustee in this case recognized the agent was using funds from a third party so the defense of paying fair market value for the property could be stripped away. The defense of paying fair market value against a preferential or fraudulent transfer only exists if the buyer has the ability to use the funds in his possession as he sees fit. See Bonded Financial, 838 F.2d 890, 894 (7th Cir. 1988) (a subsequent transferee has dominion if he is “free to invest the whole in lottery tickets or uranium stocks.”)
[Bonded Financial Services, Inc. v. European American Bank, 838 F.2d 890, 892 (7th Cir. 1988)] (citing Douglas G. Baird & Thomas H. Jackson, Fraudulent Conveyance Law and Its Proper Domain, 38 Vand. L. Rev. 829 (1985); Robert Charles Clark, The Duties of the Corporate Debtor to Its Creditors, 90 Harv. L. Rev. 505, 554-60 (1977)); see also Tese-Miller v. Brune (In re Red Dot Scenic, Inc.), 293 B.R. 116, 121 (S.D.N.Y. 2003) (noting that strict liability for initial transferees “lowers the cost of credit”). Id. at 997.