Second Circuit Defines a Prohibited Double Recovery on Fraudulent Transfers

Affirming Bankruptcy Judge Alan S. Trust, the Second Circuit explained when a trustee is prohibited from making a double recovery following an avoided transfer. Basically, a trustee can recover from multiple transferees until the cash taken in by the trustee equals the value of the avoided transfer. Creditors filed an involuntary petition against the debtor, who owned a home with her husband as tenants by the entireties. The home was worth $260,000 above the first mortgage. The debtor hired a lawyer to represent her in bankruptcy. Six months after the order for relief, the debtor was indicted for defrauding her creditors. The debtor then retained the same lawyer and two others to represent her in the criminal proceedings. To fund her legal defense, the debtor and her husband borrowed $250,000 from a friend, secured by a second mortgage on their home. The original lawyer drafted the note and mortgage loan documents. The friend transferred $250,000 cash to the debtor’s original lawyer, who in turn gave slightly more than half to the other two criminal lawyers. The chapter 7 trustee sued the friend for avoidance of the second mortgage as an unauthorized post-petition transfer under Section 549. The friend settled by allowing the second mortgage to be avoided and preserved for the benefit of the estate.

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