Avoided Preference Repaid Prepetition– Trustee Can’t Recover

Judge Hyman’s recent decision in In re Sawran, __ B.R. ___, 2007 WL 101841 (Bkrtcy. S.D. Fla.) presents an analysis of the common fact pattern. If a debtor made a prepetition preferential payment to an initial transferee, but the initial transferee or immediate transferee repays the involved amount to the debtor prepetition, may the trustee in bankruptcy still recover the preference?

The Sawran case presented a situation where the trustee obtained a judgment to avoid a preferential transfer under section 547. The trustee then filed an action under section 550 to recover the amount of the avoided transfer from an immediate transferee of the initial transferee.

The Court began its analysis with a review of section 550(d) which provides that a trustee is only entitled to a single recovery under 550(a)–the single satisfaction rule. That is, the trustee cannot recover from the various transferees more than the actual amount avoided. The Court further pointed out that the avoidance of a voidable transfer and the recovery from the transferee are distinct from one another.

The Court held that a trustee is prohibited under section 550(d) from recovering the amount avoided from a transferee who has already returned to the estate that which was avoided. To allow the trustee to collect the amount would result in a windfall to the trustee that violates the single satisfaction rule of section 550(d).

The Court found an alternative basis for its holding pursuant to the use of the Court’s equitable powers under section 105(a) by finding that it had the power to grant the initial transferees an “equitable credit” even if there was no defense available under the provisions of the Code. The initial transferees were innocent of wrongdoing and deserved protection to the extent that they repaid the involved amount. The equitable credit prevented the estate from receiving a windfall.
The Court noted that the Court’s equitable powers under section 105(a) are also used in other contexts to prevent a trustee from being able to recover from a party who is innocent of wrongdoing and deserves protection, such as when the initial recipient is a “mere conduit” of funds and therefore not an “initial transferee” under section 550(a)(1).

Jordan E. Bublick, Attorney at Law, Practice Limited to Bankruptcy Law, Board Certified Specialist in Consumer Bankruptcy Law (American Board of Certification), Member of the Florida Bar since 1983

Federal Taxation of Individual Chapter 11 Debtor

The IRS released Internal Revenue Bulletin 2006-40, Notice 2006-83 on October 2, 2006 to provide guidance to individuals filing bankruptcy under Chapter 11 on or after October 17, 2005. It further provides guidance for the employers of these individuals, persons filing Forms W-2, 1099 or other information returns that report payment to these individuals, and Chapter 11 trustees in cases filed by an individual.

The bankruptcy estate of an individual who files under Chapter 11 is a separate taxable entity under section 1398 of the Internal Revenue Code. In general, the estate, rather than the individual, must include in its gross income all of the debtor’s income to which the estate is entitled under the Bankruptcy Code. As a result of the enactment of section 1115 of the Bankruptcy Code by BAPCPA, the bankruptcy estate rather than the individual must include in its gross income both 1. the debtor’s gross earnings from post-petition services and 2. the gross income from post-petition acquired property. IRC Section 1398(e)(1).

Because the bankruptcy estate is a separate taxable entity, the trustee or debtor in possession must obtain an employer identification number for the estate and use it on any tax returns filed for the estate.

The individual must continue to file his own individual tax returns during the bankruptcy proceedings. IRC Section 6012(a)(1). The trustee or debtor in possession must prepare and file the income tax returns of the bankruptcy estate if required under IRC Section 6012(a)(9).

Although post-petition wages earned by a debtor are generally treated for income tax purposes as gross income of the estate rather than the individual, the reporting and withholding obligations of a debtor’s employer however have not changed as a result of the enactment of section 1115 of the Bankruptcy Code. Section 1115 has no effect on the determination of wages under FICA, FUTA, or for income tax withholding purposes. See IRC Section 3306(b) and 3401(a). An employer should continue to reflect such wages and accompanying tax withholding on a Form W-2 issued to the debtor under the debtor’s name and social security number.

Jordan E. Bublick, Attorney at Law, Practice Limited to Bankruptcy Law, Board Certified Specialist in Consumer Bankruptcy Law (American Board of Certification), Member of the Florida Bar since 1983