On June 22, 2023, the U.S. Court of Appeals for the Seventh Circuit affirmed summary judgment in favor of LSQ Funding Group, L.C., a creditor in the Engstrom, Inc. bankruptcy case. Summary judgment was entered against Douglas Mann, chapter 7 trustee for the bankruptcy estate. The case revolved around an alleged preferential and fraudulent transfer from a third party, namely Millennium Funding, to LSQ, which the court determined did not involve “an interest of the debtor in property.”
Engstrom had entered into an invoice-factoring agreement with LSQ. The trustee alleged that the CEO of Engstrom was running a Ponzi scheme based on fraudulent invoices. LSQ terminated its agreement with Engstrom upon discovering the scheme. This left Engstrom in debt to LSQ for a sum of $10.3 million. To rectify this, Millennium paid LSQ this sum directly, and LSQ then released its rights in Engstrom’s invoices to Millennium. Engstrom declared bankruptcy within three months of the transaction.
The trustee filed a complaint against LSQ, seeking to avoid the payment made by Millennium as a preferential or fraudulent transfer. The bankruptcy court, however, granted summary judgment in LSQ’s favor. This decision was upheld by the district court.
On further appeal, the Seventh Circuit focused on the language of the bankruptcy code, in particular, the phrase “an interest of the debtor in property.” The court applied a two-pronged test considering whether the debtor had control over the funds transferred and whether the transfer reduced the property of the estate. The Seventh Circuit found that, while a jury could conclude that Engstrom selected LSQ to receive the payment from Millennium, there was little evidence suggesting that Engstrom had control over the disposition of the funds or the accounts.
Moreover, all parties agreed that neither the $10.3 million nor the accounts transferred from LSQ to Millennium were part of Engstrom’s estate, and the funds never passed through any of Engstrom’s accounts. Also, the trustee admitted that the transaction did not negatively affect other creditors. The trustee could not establish that reversing the payment would make the funds part of Engstrom’s estate. Therefore, the Seventh Circuit concluded that the transfer did not involve “an interest of the debtor in property,” and thus it was not avoidable under the bankruptcy code.