REPORT AND RECOMMENDATION TO GRANT ATN'S MOTION FOR PARTIAL SUMMARY JUDGMENT ON COUNT I (Flaster may not use the mere conduit defense as an initial transferee.)

KAREN S. JENNEMANN, Bankruptcy Judge.

Plaintiff, Advanced Telecommunication Network, Inc. ("ATN"), requests1 partial summary judgment2 on Count I of its Second Amended Complaint3 that seeks recovery of a $6 million transfer under § 550 of the Bankruptcy Code.4 The Eleventh Circuit Court of Appeals already has avoided the transfers made by ATN to its shareholders, brothers—Daniel and David Allen (the "Allens")—as constructively fraudulent under § 544 of the Bankruptcy Code.5 The specific issue raised by ATN's Motion for Partial Summary Judgment is whether one of the Defendants,6 a law firm, Flaster/Greenberg, P.C. ("Flaster"), who represented the Allens, may rely upon the affirmative defense of "good faith" in alleging they were "mere conduits" of the transferred monies and not the "initial transferee." The Bankruptcy Court recommends that the District Court grant ATN's Motion for Partial Summary Judgment and conclude that Defendants are not mere conduits.

Summary Judgment Standard

Rule 56(a) provides that "[t]he court shall grant summary judgment if the movant shows that there is no genuine dispute as to any material fact and the movant is entitled to judgment as a matter of law."7 The moving party must establish the right to summary judgment.8 A "material" fact is one that "might affect the outcome of the suit under the governing law."9 A "genuine" dispute means that "the evidence is such that a reasonable jury could return a verdict for the nonmoving party."10 Once the moving party has met its burden, the nonmovant must set forth specific facts showing there is a genuine issue for trial.11 In determining entitlement to summary judgment, "facts must be viewed in the light most favorable to the nonmoving party only if there is a `genuine' dispute as to those facts."12

Background

Because the transfers occurred in 1999, almost 20 years ago, and because substantial litigation precedes this dispute, a brief discussion of the past litigation is merited. Daniel Allen and Gary Carpenter, who equally shared all of ATN's voting shares, founded ATN in 1989 as a long-distance reseller of telecommunication services.13 The company purchased long distance telephone service in bulk from larger carriers and resold it to their customers. A bitter management dispute erupted between Carpenter, ATN's President, and Daniel Allen resulting in hard fought litigation in New Jersey. A trial commenced in November 1998. Flaster represented Daniel Allen.

Daniel Allen and Carpenter signed a handwritten settlement agreement on December 23, 1998, and then a more formal written settlement agreement on January 12, 1999. ATN was to pay Flaster $1.35 million for the Allen attorney fees and costs in the New Jersey litigation. ATN also paid the Allens an additional $6.25 million in settlement of their dispute with Carpenter.14 The monies were paid directly by ATN to the Flaster law firm who kept $1.35 million for its fees and sent the balance to the Allens. (It is this money received by the Allens that ultimately was avoided as a constructive fraudulent transfer (the "Avoided Transfer")).

After the settlement, Carpenter was the sole shareholder of ATN and remained President for a short time. Beginning in 1995 and simultaneously with the shareholder litigation, ATN had disputed a contract with a competitor, WATS/800, Inc., a company controlled by Damian Freeman. In October 2000, Carpenter settled this dispute relinquishing his interest in ATN to Damian Freeman, who still controls ATN today.

ATN/Freeman filed this Chapter 11 bankruptcy on January 10, 2003, and confirmed a Plan of Reorganization15 contemplating litigation against the Allens16 and their lawyers to recover the monies paid in the 1999 settlement between the Allens and Carpenter. Freeman relentlessly has pursued his lawsuits beginning first with the Allens and now turning his attention to Flaster. The multi-year dispute has traveled to the Eleventh Circuit Court of Appeals twice17 and, for the Allens' individual bankruptcy cases in New Jersey, the Third Circuit Court of Appeals.18 But, to summarize, no dispute exists that the Avoided Transfer order is final. The Allens and Daniel's wife Stacy Allen have received discharges of any liability to ATN and now are assisting Freeman in pursuing his claims in this adversary proceeding.

[space intentionally left blank]

Flaster Is Not a Mere Conduit of the Avoided Transfer

ATN argues Flaster is the initial transferee of the Avoided Transfer. If so, ATN may recover the transfer from Flaster under § 550(a) of the Bankruptcy Code. Flaster argues it acted as a "mere conduit" when it accepted the $6 million Avoided Transfer into the firm's bank account.

The Bankruptcy Code does not define "transferee" or "initial transferee." The Eleventh Circuit Court of Appeals has "observed that a literal or rigid interpretation of the statutory term `initial transferee' in § 550(a) means that the first recipient of the debtor's fraudulently-transferred funds is an `initial transferee.'"19 The Eleventh Circuit, however, has "carved out an equitable exception to the literal statutory language of `initial transferee,' known as the mere conduit or control test, for initial recipients who are `mere conduits' with no control over the fraudulently-transferred funds."20 The Eleventh Circuit concluded that:

"The Eleventh Circuit has stressed [also] that `courts must look beyond the particular transfers in question to the entire circumstance of the transfers.' In other words, courts must step back and evaluate a transaction in its entirety to make sure that the court's conclusions are logical and equitable."22

Lawyers representing clients rarely are deemed "initial transferees." As the Eleventh Circuit noted:

This equitable doctrine however has limits. A professional who has demonstrated a lack of good faith cannot rely on the mere conduit exception to escape liability as an initial transferee.24 For example, a bank that has "extensive knowledge of the debtor's [transferor's] deteriorated financial condition and voidablity of the transfer" forfeits its good faith status if they are first in line to receive a transfer.25 The test is an objective standard requiring courts to analyze what a transferee "knew or should of known" not the transferee's actual knowledge from a subjective standpoint.26 A person cannot act in "good faith" if he knows or should have known of the transferor's unfavorable financial condition at the time of the transfer.27

Flaster Cannot Objectively Demonstrate Good Faith

Flaster's own words and actions demonstrate that they had extensive knowledge of ATN's deteriorating financial condition when they received the $6 million Avoided Transfer. Relying exclusively on the trial brief prepared by Flaster28 and the trial transcript from the trial held on November 11, 1998,29 the Court finds that Flaster said or acted to:

These are merely selected excerpts from an extensive trial brief, dated October 23, 1998, and trial testimony/colloquy from November 11, 1998, that overwhelmingly demonstrates Flaster had detailed information repeatedly published to the trial court, and that ATN was in "dire financial straits" and was facing probable insolvency and closure.

Yet, a few weeks later, on December 23, 1998, and January 12, 1999,35 Flaster assisted their clients with a settlement agreement requiring ATN to pay substantial monies to Flaster and the Allens. These payments were paid directly by ATN to Flaster between January 12, 1999, and June 2, 1999. Flaster accepted these monies with full knowledge of ATN's precarious financial condition. By doing so, the firm lost any right to claim "good faith" or to rely on the equitable exception, allowing a "mere conduit" to escape liability as the initial transferee of a fraudulent transfer.

Flaster argues it was just zealously representing its clients. The Eleventh Circuit Court of Appeals, however, already has said that a lawyer crosses the line and is not a mere conduit when he or she is no longer "an innocent participant in the transfers."36 Here, Flaster's own words in its trial brief are damning, showing a detailed knowledge that ATN had significant losses, extensive creditors, limited cash reserves, and was on the verge of closing its doors. Yet, they still agreed to accept millions in payments from ATN, of which they kept $1.35 million.

Flaster next argues good faith is a factual issue requiring courts to consider the totality of circumstances surrounding the parties' actions. Although this is a correct standard and summary judgment is rare in this circumstance, Flaster ignores that the good faith test is an objective, not subjective, test. No further factual investigation is needed when any reasonable third party would conclude, based exclusively on Flaster's own statements, that ATN was financially failing37 and could not afford the questionable transfers under the settlement agreement. Nor does it matter that Flaster did not believe ATN was insolvent because the test is not a subjective inquiry. Defendants affirmatively stated, repeatedly, the impoverished condition of ATN when the questionable transfers were made. Their statements, standing alone, are more than sufficient to objectively find the Defendants were not acting in good faith when they accepted the settlement monies.

Flaster lastly challenges the authenticity of the documentary evidence submitted by ATN, specifically the forty-seven page Verified Statement of Facts signed by Damian Freeman. The Verified Statement of Facts also attaches hundreds of pages of documents.38 Given that the Court relied exclusively on the Defendants' own admissions and statements, this evidentiary objection is a red herring. Flaster cannot escape the consequences of its own statements by challenging the admissibility of an affidavit and supporting documents that the Court never considered. Again, Flaster's own words are all that is needed to conclude that, as a matter of law, Flaster was more than the "mere conduit" of the Avoided Transfer.

This report and recommendation, however, does not resolve all issues raised by Count I of ATN's Second Amended Complaint. Defendants assert that ATN is judicially estopped from asserting Flaster is the initial transferee of the Avoided Transfer. ATN previously took a contrary position with prior courts repeatedly arguing the Allens were initial transferees. Defendants assert ATN now is judicially estopped from changing positions. The parties do not seek summary judgment on this issue. As such, even though the Bankruptcy Court recommends that the District Court enter partial summary judgment finding that Flaster is not a "mere conduit," the firm still may not be the "initial transferee."

Conclusion and Recommendation

By credibly arguing that Flaster was not an "innocent participant" and did not act in "good faith," Flaster may not use the mere conduit equitable exception under § 550(a) of the Bankruptcy Code. The Court recommends that the District Court enter partial summary judgment for ATN and against Flaster as a matter of law, finding no material facts in dispute.

ORDERED.