R-E-C-O-V-E-R: Find Out What It Means to the Third Circuit

Contributed by Danielle Donovan
Because we couldn’t possibly top Judge Fisher’s opening line, we’re borrowing it for our introduction of In re Daniel W. Allen, Sr., a recent decision from the Third Circuit: “Although the facts of this case include details of money transfers and offshore asset protection trusts in sunny South Pacific locales, its ultimate resolution involves nothing more exotic than the interpretation of the Bankruptcy Code.” In Allen, the Third Circuit addressed Bankruptcy Code provisions defining “property of the estate” and determined what is required for a trustee to “recover” property that has been fraudulently transferred. The court also considered some interesting questions regarding subject matter jurisdiction along the way.
I’m About to Give You All of My Money and All I’m Asking in Return Is . . . Reasonably Equivalent Value.
About 25 years ago, Daniel W. Allen, Sr. and Gary Carpenter founded Advanced Telecommunication Network (“ATN”), a company engaged in reselling long-distance telephone service. Carpenter eventually terminated Allen’s employment, and Allen responded with a lawsuit against Carpenter and ATN asserting several claims with respect to the management of ATN. The parties settled the lawsuit in exchange for a $1.25 million payment to Allen’s attorneys and an approximately $6 million payment to Allen and his brother.
Just shy of four years after the settlement payments were made, ATN filed for chapter 11 relief in the Bankruptcy Court for the Middle District of Florida. ATN commenced an adversary proceeding against the Allens, seeking to avoid the $6 million transfer under sections 544 and 550 of the Bankruptcy Code and under the New Jersey Uniform Fraudulent Transfer Act.
Wisely, ATN sought a preliminary injunction to freeze the funds that had been transferred to the Allens. The Allen brothers, however, obtained a continuance from the bankruptcy court and seized that window of opportunity to transfer the funds to two Cook Islands self-settled asset protection trusts. The bankruptcy court then granted preliminary injunctive relief and ordered that the funds be repatriated. Steadfast in their efforts to keep hold of the money, the Allen brothers did not comply with the order, and Daniel Allen was twice held in contempt of court.
Almost seven years after ATN commenced its adversary proceeding, the bankruptcy court entered a judgment, and ATN then attempted to collect on the judgment pursuant to Bankruptcy Rule 7069. The bankruptcy court once again directed Allen to repatriate the funds and also ordered him to provide an accounting of all monies deposited in and transferred from the trusts within 60 days of entry of the order and to otherwise immediately freeze the funds in the trusts. Do you think Allen complied with that repatriation order? Of course not. What he did instead was file a chapter 7 petition in the Bankruptcy Court for the District of New Jersey. (Now you can stop wondering how the Third Circuit got involved)
ATN commenced an adversary proceeding in Allen’s chapter 7 case, seeking a determination that Allen’s bankruptcy filing had not stayed the litigation in ATN’s bankruptcy case because ATN was seeking to collect its own estate assets and not Allen’s. Alternatively, ATN requested relief from the automatic stay to continue with the Florida bankruptcy court litigation and collection of its judgment.
What ATN Wants, the Third Circuit’s Got.
In denying ATN’s motion, the New Jersey bankruptcy court concluded that any property in the Cook Islands trusts was not property of ATN’s bankruptcy estate pursuant to section 541, but was instead property of Allen’s estate and therefore subject to the automatic stay. Further, the New Jersey bankruptcy court held that, despite ATN having avoided the transfer, the funds were not included in the definition of “property of the estate” under section 541 of the Bankruptcy Code because ATN did not actually recover tangible possession of the funds. The district court affirmed.
On appeal, the Third Circuit addressed two issues: (1) whether the New Jersey federal courts had subject matter jurisdiction over ATN’s adversary proceeding and (2) whether the $6 million was part of ATN’s bankruptcy estate such that it was not subject to the automatic stay imposed by Allen’s bankruptcy filing.
(1) All I’m Asking Is for a Little Res When You’re In Rem!
ATN contested the New Jersey federal courts’ jurisdiction under the doctrine espoused in Princess Lida of Thurn and Taxis v. Thompson. The Princess Lida doctrine bars a court from exercising jurisdiction when another court in a previously filed action is exercising control over the same property the second court would have to control in order to grant the relief sought in the second action. The Princess Lida doctrine “applies when: (1) the litigation in both the first and second fora are in rem or quasi in rem in nature, and (2) the relief sought requires that the second court exercise control over the property in dispute and such property is already under the control of the first court.”
Therefore, the $6 million question was whether the Florida bankruptcy court exercised in rem jurisdiction over the Cook Islands trust funds (in which case the Princess Lida doctrine might apply) or simply in personam jurisdiction over Allen (in which case the doctrine would not apply).
In Central Virginia Cmty. Coll. v. Katz, the Supreme Court distinguished between bankruptcy proceedings, which are in rem, and ancillary orders entered during the course of those proceedings, which may be in personam. Additionally, in United States v. Nordic Vill., Inc., the Supreme Court considered a postpetition transfer of property that had been avoided under section 549, recovered pursuant to section 550(a), and reduced to a monetary judgment. In dictum, the Court rejected an in rem argument, clarifying that the respondent in that case had sought to recover a sum of money and not specific dollars, “so there was no res to which the court’s in rem jurisdiction could have attached.”
Following the Supreme Court’s lead, the Third Circuit held that the Florida bankruptcy court had not exercised in rem jurisdiction over the $6 million because the Florida bankruptcy court’s judgment was not directed at particular dollars. Rather, the Florida bankruptcy court entered the judgment against the Allens in the amount of $6 million, which granted relief pursuant to sections 544 and 550 and falls into the zone identified by Katz – a court’s ancillary power to use the “in personam process” to effect its in rem bankruptcy jurisdiction.
What you need is a little res when you’re in rem!
(2) Take Care, ISC (Interpret Statutes Consistently)!
Nevertheless, and despite a circuit split on the underlying issue, the Third Circuit quickly and easily concluded that the $6 million payment was property of the ATN estate. Resolution of the issue depended upon an interpretation of section 541(a)(3) of the Bankruptcy Code, which includes within “property of the estate” “[a]ny interest in property that the trustee recovers under section . . . 550” of the Bankruptcy Code. The court rejected the New Jersey federal courts’ definition of “recovers” as being too restrictive because it required actual, tangible possession of the funds before considering them part of the ATN estate.
In In re MortgageAmerica Corp., the Fifth Circuit held that because a debtor retains a “legal or equitable” interest in fraudulently transferred property, such property remains property of the debtor’s estate even if it remains in the possession of third parties. In In re Colonial Realty Co., the Second Circuit reached a different result and concluded that the Fifth Circuit’s reading of section 541(a)(1) effectively rendered section 541(a)(3) futile. In Rajala v. Gardner, the Tenth Circuit weighed in on the split between the Fifth and Second Circuits and concluded that the Second Circuit’s holding in Colonial Realty was correct because otherwise mere allegations of fraudulent transfer could bring property into a debtor’s estate.
According to the Third Circuit, the fatal flaw in each of the Second, Fifth, and Tenth Circuit decisions is that none of them addresses the critical question – what it means to “recover” fraudulently transferred property within the meaning of section 541(a)(3) – and, instead they erroneously focus on whether funds remain property of the debtor’s estate under section 541(a)(1) absent the recovery provision in section 541(a)(3).
The Third Circuit reversed the district court’s judgment because (1) ATN did, in a legal sense, recover the $6 million by securing the section 550 recovery order from the Florida bankruptcy court, and (2) the New Jersey federal courts’ interpretation of “recovers” renders section 541 internally inconsistent. Section 541(a) provides that a debtor’s estate includes property “wherever located and by whomever held.” If “recovers,” as used in section 541(a)(3), required actual possession, the “wherever located and by whomever held” language would be rendered meaningless.
Aretha Franklin couldn’t have spelled it out better herself. R-E-C-O-V-E-R: actual, tangible possession not required; section 550 recovery order sufficient (in the Third Circuit, at least).