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On Behalf of | Dec 15, 2014 | Bankruptcy Appellate Panel

In Mano-Y&M Ltd. v. Field (In re Mortgage Store, Inc.), 2014 U.S. App. LEXIS 22981 (9th Cir. Haw. Dec. 5, 2014), the Ninth Circuit explicitly rejected the control test’s flexible, equitable approach and embraced the pure “dominion test” adopted in Universal Serv. Admin. Co. v. Post-Confirmation Comm. of Unsecured Creditors of Incomnet Commc’n Corp. (In re Incomnet), 463 F.3d 1064, 1071 (9th Cir. 2006). In so doing, the Ninth Circuit clarified that the touchstones in the Ninth Circuit for initial transferee status are legal title and the ability of the transferee to freely appropriate the transferred funds. The Court explicitly rejected the reasoning in McCarty v. Richard James Enters. (In re Presidential Corp.), 180 B.R. 233, (9th Cir. B.A.P. 1995), insofar as the Bankruptcy Appellate Panel’s ruling conflicts with the pure dominion test articulated in Incomnet

In Mortgage Store, the Ninth Circuit acknowledged that its holding may seem harsh. The Ninth Circuit reasoned, however, that in the case of a debtor’s fraudulent conveyance, injury must fall on either the transferee of the conveyance or the debtor’s creditors. The aim of 11 U.S.C. § 550 must be to allocate risk such that the parties tending to have the lowest monitoring costs bear the costs of a debtor’s failings. The Ninth Circuit found that in distinguishing between initial and subsequent transferees, Congress determined that, as between creditors and transferees, “[t]he initial transferee is the best monitor.” In re Mortgage Store, Inc., 2014 U.S. App. LEXIS at *14 (citing Bonded Fin. Serv., 838 F.2d 890, 892 (7th Cir. 1988)). Unlike subsequent transferees, who “usually do not know where the assets came from and would be ineffectual monitors if they did,” initial transferees tend to have relationships and influence with the debtor. Id. By placing the risk on initial transferees rather than creditors, Congress ensured that creditors “need not monitor debtors so closely; ” the idea being that “savings in monitoring costs make businesses more productive.” In re Mortgage Store, Inc., 2014 U.S. App. LEXIS at *15. To see the full opinion, please click here