Now Updating

Summarizing by Jaden Banks


Summarizing by Amir Shachmurove


Case Type:
Case Status:
22-2436 (7th Circuit, Jun 22,2023) Published
The United States Court of Appeals for the Seventh Circuit (“7th Cir.”) affirmed the entry of summary judgment in favor of creditor LSQ Funding Group, L.C. (“LSQ”) and against Douglas Mann, the chapter 7 trustee (“Trustee”) of the estate of Engstrom, Inc. (“Debtor”), finding that the alleged preferential and fraudulent transfer from Millennium Funding (“Millennium”) to LSQ did not involve “an interest of the debtor in property.”
Procedural context:
The bankruptcy court granted summary judgment to LSQ on the Trustee’s complaint, seeking to avoid the payment of $10.3 million from Millennium to LSQ as a preferential transfer under § 547(b) or as a § 548(a)(1) fraudulent transfer, based upon the “earmarking doctrine.” In applying the doctrine, “where one creditor gives a debtor ‘earmarked’ funds to pay off a specific debt in full, thereby assuming the original creditor’s position,” the bankruptcy court found that Millennium’s payment to LSQ was neither a preferential nor fraudulent transfer, and therefore not avoidable. The district court affirmed the bankruptcy court’s ruling. Rather than focus on the “earmarking doctrine,” the 7th Cir. concentrated on the language of § 547(b), specifically that “the trustee may . . . avoid any transfer of an interest of the debtor in property.” In reviewing its precedent, the 7th Cir. relied upon a two-prong test from Matter of Smith, 966 F.2d 1527, 1535 (7th Cir. 1992): “(1) whether the debtor can exercise control over the funds transferred; and (2) whether the transfer diminishes the property of the estate.” In other words, did the transfer take away assets “from the pool of assets that would otherwise have gone to creditors.” While the 7th Cir. expressed confidence that a jury could find that the Debtor chose LSQ as the beneficiary of the Millennium payment, there was scant evidence that the Debtor had the ability to determine disposition of the funds or the accounts. Further, the parties agreed that neither the $10.3 million nor the accounts transferred from LSQ to Millennium were part of the Debtor’s estates, and that the funds never passed through any of the Debtor’s accounts. Most tellingly, the Trustee admitted that the transaction had “no adverse effect, no diminution . . . on the other creditors.” The 7th Cir. concluded that since the transfer did not involve “an interest of the debtor in property,” it was not avoidable under § 547(b). The 7th Cir. also dismissed the Trustee’s argument that the Debtor’s alleged fraud was sufficient cause to avoid the transfer as fraudulent under § 548(a)(1), finding that the plain language of § 548(a)(1), like that of § 547, requires the existence of “an interest of the debtor in property.” The Trustee failed to explain how avoidance of Millennium’s payment to LSQ would make those funds part of the Debtor’s estate or that Millennium would have paid the Debtor directly had its deal with LSQ collapsed; avoidance would only benefit Millennium and no other creditor. In agreeing with other circuits, the 7th Cir. concluded that “even in the Ponzi scheme context, outright fraud along cannot bring a transaction within the avoiding powers of the Bankruptcy Code.”
Debtor entered into an invoice-factoring agreement with LSQ in June 2018. As alleged by the Trustee, the Debtor’s CEO was running a Ponzi scheme based upon bogus invoices. According to Millennium, LSQ terminated its agreement with the Debtor in January 2020 upon learning of the fraudulent scheme, leaving a debt of $10.3 million owed to LSQ by the Debtor. Thereafter, Millennium paid $10.3 million directly to LSQ, upon which LSQ immediately relinquished its rights in the Debtor’s invoices, leaving those to Millennium. Debtor filed its petition within three months of the transaction between LSQ and Millennium.
Ripple, Scudder, and St. Eve (opinion author)

ABI Membership is required to access the full summary. Please Sign In using your ABI Member credentials. Not a Member yet? Join ABI now - it is absolutely worth it!

About us in numbers

3585 in the system

3469 Summarized

10 Being Processed