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Seventh Circuit Reverses 'Inconsistent' District Court Fraudulent Transfer and Equitable Subordination Ruling

By Michael L. Cook
October 28, 2013

The U.S. Court Appeals for the Seventh Circuit held on Aug. 26, 2013, that an investment manager's “failure to keep client funds properly segregated” and subsequent pledge of those funds “to secure an overnight loan” to stay in business may have constituted: 1) a fraudulent transfer to the lender; and 2) grounds for equitably subordinating the lender's $312 million secured claim. In re Sentinel Management Group, Inc., 2013 WL 4505152, *1 (7th Cir. Aug. 26, 2013) (Sentinel II). Reversing and remanding the case to the district court for further litigation because of “inconsistencies” in that court's opinion, the Seventh Circuit found that the debtor-manager's “pledge of segregated funds as collateral for loans” was likely a fraudulent transfer based on an “actual intent to hinder, delay or defraud” creditors under Bankruptcy Code (Code) ' 548(a)(1)(A). Id. at *6.

The court stressed that a “good faith-for-value” defense by the lender on remand will be “very difficult because it will have to prove that it was not on inquiry notice of [the debtor's] possible insolvency.” Id. at *6-*7n.2. On remand, the lower court also must, because of “inconsistencies throughout” its opinion, “clarify ' exactly” what the lender knew and whether its “failure to investigate” the debtor was “reckless” or “deliberately indifferent.” Id. at *11.

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