August 25, 2020, Colorado – Eric Wagenknecht and his wife, Susan Colbert, filed for relief under Chapter 13 of the Bankruptcy Code on January 19, 2016. The case got converted to Chapter 7 on April 28, 2017. Jared Walters was appointed as the Chapter 7 trustee for the estate. Prior to the Petition Date, the Defendant law firm provided legal services to Eric and Eric owed over $20,000. In January 2016, Eric borrowed $21,672.65 from his mother to pay the law firm. His mother agreed to loan Eric the money for the sole purpose of paying the law firm. On January 11, 2016, Eric executed a promissory note to repay his mother. On January 14, 2016, his mother wrote a check, drawn on her bank account, directly to the law firm in the amount of $21,672.65, and delivered the check directly to the law firm. The law firm cashed the check on January 15, 2016.
In January 2018, the Trustee initiated an adversary proceeding against the law firm. The Trustee alleged that the payment to the law firm was a preferential transfer under 11 U.S.C. § 547. The parties cross-moved for summary judgment, and the bankruptcy court entered an order denying the law firm’s motion for summary judgment and granted the Trustee’s cross-motion for summary judgment. The law firm appealed. The only issue raised in the appeal was whether the payment to the law firm constituted a “transfer of an interest of the debtor in property” as a matter of law under § 547(b).
Relying on Parks v. FIA Card Servs., N.A. (In re Marshall), 550 F.3d 1251, 1255 (10th Cir. 2008), the Court identified two tests to determine whether a debtor has “legal or equitable interests” in the transferred property: the “dominion/control” test and the “diminution of the estate” test.
Under the dominion/control test, “a transfer of property will be a transfer of ‘an interest of the debtor in property’ if the debtor exercised dominion or control over the transferred property.”
Under the diminution of the estate test, “a debtor’s transfer of property constitutes a transfer of ‘an interest of the debtor in property’ if it deprives the bankruptcy estate of resources which would otherwise have been used to satisfy the claims of creditors.
The Court concluded that in the case at bar, neither the dominion/control test nor the diminution of the estate test is satisfied. First, Eric did not, and could not, exercise dominion or control over the funds used to pay the law firm because he did not have “an ability to direct their distribution.” In her sworn affidavit, his mother had indicated that she retained sole control over the disbursement of these funds and that she offered to make the loan with the limited condition that the funds be used to pay the law firm, and Eric accepted that condition. That condition meant that Eric never controlled the funds and could not “direct how those proceeds were used, applied, or distributed.”
Second, the Court stated that the payment to the law firm did not diminish Eric’s bankruptcy estate because the monies, in fact, never became part of the estate. The check for the payment to the law firm was written on an account in mother’s name, in which Eric held no interest. She delivered the check directly to the law firm; it never passed through Eric’s estate at all. The Court added that the funds were never deposited in any accounts in which Eric held an interest, and Eric played no role in delivering the funds to the law firm. Thus, the evidence showed that the monies were never available “to satisfy the claims of creditors.”
Accordingly, the Court held that since Eric did not exercise control or dominion over the payment to the law firm, and because the payment did not diminish Eric’s bankruptcy estate, the payment did not constitute a “transfer of an interest of the debtor in property” under § 547(b). Therefore, the bankruptcy court erred in entering summary judgment in favor of the Trustee. The Court reversed the judgement of the bankruptcy court and remanded for further proceeding.