United States: The Sixth Circuit Finds That A Bank Is Not A Transferee For Deposits Made In Excess Of The Amount Owed

The Sixth Circuit held that a bank does not have "dominion and control" over funds deposited at the bank that its borrower later withdrew or the government seized.¹ The court reversed the bankruptcy court's holding that the bank was a subsequent transferee of these deposits because the bank had the ability to use the deposits while they were in the borrower's deposit account.

Background

In Meoli v. The Huntington National Bank, the borrower (Cyberco Holdings) received a loan totaling approximately $16 million from the bank. The borrower also maintained a deposit account at the bank. The borrower's principal represented to the bank that the borrower was in the business of selling computer equipment. He also represented that an affiliated company (Teleservices Group/the debtor) was collecting the borrower's accounts receivable and remitting them to the borrower. As it turned out, the debtor was simply a shell company used to perpetuate the borrower's fraud. The borrower was not selling computer equipment. Instead, the debtor fabricated invoices showing the purchase of computer equipment in order to borrow funds from equipment financing companies, which would transfer funds to the debtor. The debtor, in turn, would transfer the funds to the borrower's deposit account at the bank. The borrower would use those funds for various purposes, including paying down the borrower's loan from the bank.

After the scheme was revealed, the debtor filed for bankruptcy. The chapter 7 trustee sought to avoid and recover from the bank under a fraudulent transfer theory three types of transfers made by the debtor: (i) loan repayments made by the debtor directly to the bank to pay down the borrower's loan, (ii) indirect loan repayments made by the debtor to the borrower's deposit account, which funds were later used to pay down the borrower's loan, and (iii) transfers made by the debtor to the borrower's deposit account that were not used to pay down the loan (the "excess deposits"). The excess deposits totaled approximately $48 million. The bankruptcy and district courts held that the bank was a transferee of the excess funds and therefore liable because the bank was free to use these funds while they were in the borrower's deposit account. In other words, the bankruptcy court did not cap the bank's fraudulent transfer exposure to the amount received to pay off the borrower's loan.

Analysis

The Sixth Circuit reversed, holding that the bank was not a transferee with respect to the excess deposits. Citing its prior precedent and following the Seventh, Ninth, Tenth and Eleventh Circuits, the court found that the bank did not have "dominion and control" over the excess deposits, which is required to be considered a transferee under the fraudulent transfer statutes. Simply put, the borrower's right to withdraw funds from the deposit account prevented the bank from having dominion and control over the funds. It was immaterial that the bank had the legal right to put the deposited funds to its own use (such as by using the deposited funds to make a loan at a higher interest rate than the interest being paid to the deposit holder). Nor did the bank's security interest in the deposit account change the analysis. The bank's security interest did not provide the bank with dominion and control over the excess deposits because a security interest is limited to the amount of the underlying debt. Notably, the bank's security interest did not even grant the bank dominion and control over the deposits equal to the $16 million loan amount because the loan documents themselves provided that the borrower owned the deposits, subject to the bank's lien.

Takeaway

This decision marks a victory for banks when a trustee seeks to avoid and recover transfers made to a borrower's deposit account at the bank when the funds are not used to pay down bank debt.

Footnote

1 Moeli v. The Huntington National Bank, 2017 U.S. App. LEXIS 2248 (6th Cir. Feb. 8, 2017)

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