The United States Bankruptcy Appellate Panel of the Sixth Circuit recently clarified whether a trustee could rely upon 11 U.S.C. § 542, and in the process side-step 11 U.S.C. § 549, to recover an unauthorized post-petition payment of attorney’s fees. In re Bruner, No. 15-8031, 2017 WL 33514, — B.R. — (B.A.P. 6th Cir. Jan. 4, 2017). In In re Bruner, the chapter 7 trustee brought an adversary proceeding against the debtor’s criminal attorney seeking turnover, under 11 U.S.C. § 542, of a fee paid to the attorney post-petition from a joint bank account shared with the debtor’s mother. Id. at *1. At trial, the bankruptcy court ruled for the attorney, holding that “once the funds were transferred to the attorney, they no longer belonged to the debtor, and turnover was not an appropriate remedy since the fees were no longer property of the estate.” Id.
On appeal, the trustee argued that § 542 was an appropriate vehicle to recover funds paid to a debtor’s criminal attorney post-petition because the law allowed her to pursue post-petition fraudulent conveyances without first avoiding the transfer under § 549. Id. at *5. The trustee also argued that the court erred by not finding that the fee remained property of the estate, and thus subject to turnover under § 542, because it failed to consider that the estate retained an interest in the fee at the time it was transferred to defendants. Id. The Panel ultimately held that the trustee did not meet her burden of establishing that the attorney’s fee remained property of the estate after being transferred to the attorney. Id. at *7.
In reaching this holding, the Panel disagreed with the trustee’s position that she could pursue post-petition fraudulent conveyances without first avoiding the transfer under § 549. Id. The Panel found that “[i]t is not until the transfer is avoided under § 549(a) that the property becomes property of the estate.” Id. at *6. Thus, as the Panel reasoned, a trustee cannot use “§ 542’s turnover provision to supplant the remedy provided by § 549 to recover unauthorized post-petition transfers and, in the process,…by-pass the time limitations provided by §549(d) merely by alleging the property was fraudulently transferred post-petition.” Id.
Further, while the Panel agreed with the trustee that § 542 may be used if state law dictates that a debtor retains an interest in the transferred property at the time that the defendant takes possession of it, the Panel found that the trustee failed to present proof to substantiate her claim that the debtor retained an interest at the time of transfer. Id. at *9.
Ultimately, this case outlines the appropriate use of § 542 versus § 549 to recover post-petition transfers. As stated by the Panel, “when a post-petition transfer completely divests a debtor’s interest in property, that property is not subject to turnover under § 542, but that transfer may still be avoided under § 549.” Id. at *8.