Exercising Dominion and Control; An Initial Transferee’s Liability for Avoidable Transfers

(Excerpt) Under section 550(a)(1) of the Bankruptcy Code, a bankruptcy trustee may collect the full amount of an avoidable transfer from the initial transferee of a fraudulent or avoidable transfer. Specifically, it provides that, “[e]xcept as otherwise provided in this section, to the extent that a transfer is avoided…the trustee may recover, for the benefit of the estate, the property transferred or…the value of such property, from the initial transferee of such transfer or the entity for whose benefit such transfer was made.” This section of the Bankruptcy Code gives power to bankruptcy trustees seeking to collect improperly transferred funds, for the benefit of creditors, where a debtor in bankruptcy has attempted to insulate the funds from distribution. In order for section 550(a)(1) to be applicable, the underlying transfer at issue must have been avoidable. Additionally, the language of section 550(a)(1) makes clear that not only can the bankruptcy trustee go after the initial transferee for the full amount of the transferred funds, but the trustee is still free to go after the party or entity for whose benefit the transfer was made. The power this grants to the bankruptcy trustee is substantial because it gives them two distinct avenues to collect improperly transferred funds, protecting the rights of creditors and favoring an equitable distribution of the debtor’s assets. This rule imposes strict liability on the initial transferee. Once a party is determined to be an initial transferee, the fact that they accepted the fraudulent transfer in good faith does not protect them from liability for the full amount of the transfer. For these reasons, the test to determine whether a party is an initial transferee is of utmost importance, both to the bankruptcy trustee and the party accused of being an initial transferee. The Bankruptcy Code does not define “initial transferee.” Courts have adopted a number of tests to determine whether a party is an initial transferee. The prevailing test now used in a majority of U.S. circuit courts is the Dominion and Control Test, created by the 7th Circuit Court of Appeals. First, this Article will explain the elements underlying section 550(a)(1) applicability in greater detail. Secondly, this Article will discuss the Dominion and Control Test and show how the test is applied in bankruptcy cases. Finally, this Article will compare the Dominion and Control Test to the tests used in other courts