In re Harwell Case Analysis

In Martinez v. Hutton (In re Harwell), 628 F.3d 1312 (11th Cir. 2010), the Eleventh Circuit held that good faith is a requirement of its mere-conduit defense to bankruptcy transferee liability. It reversed summary judgment for a Florida lawyer, Steven Hutton, whose trust account received $500,000 of Billy Jason Harwell’s settlement money, which Hutton paid out to Harwell, his family, and selected creditors ahead of a $1.396 million judgment creditor.

The court made no finding that Hutton controlled the money or acted in bad faith; it sent both questions back to the bankruptcy court. Settlement money that moves through a lawyer’s trust account is, the court said, usually just like a bank transfer: the lawyer is a mere conduit who need not investigate the sender’s intentions.

How $500,000 Passed Through Hutton’s Trust Account

Thomas Clay Hill won a $1.396 million Colorado judgment against Billy Jason Harwell on July 12, 2005. Harwell, a Colorado resident, owned interests in two Florida businesses, Center for Endoscopy (CFE) and Sarasota Endo Investors (SEI), and Hutton was his lawyer in the disputes with their other investors. Hill began domesticating the judgment in Sarasota County on July 27; Hutton defended that too.

Harwell settled with both companies on August 11, 2005. CFE would pay $100,000 cash and SEI $400,000 cash, plus a $46,837 promissory note, and Harwell would give up his interests. Fifteen days later he answered Hill’s post-judgment interrogatories without disclosing the settlement. Hutton played no part in those answers.

CFE’s $100,000 arrived in Hutton’s trust account on September 1. Hutton knew about Hill’s judgment and collection efforts. That same day, at Harwell’s direction, he wrote five checks: Harwell got $60,000, Harwell’s wife $5,000, a company called ASC Partners $25,000, and Hutton’s own law firm $10,000.

SEI’s $400,000 reached the trust account on September 9, and Hutton disbursed all of it the same day in seventeen checks. Harwell received $125,000 in two checks, his wife $33,700, and his father $19,436; the rest went to creditors Harwell selected. Before those checks cleared, the Colorado court ordered Harwell to turn over any SEI payments and any other post-judgment funds he still controlled.

Hill then served Hutton, on September 19, with a writ of garnishment covering any money he held for Harwell. Hutton stopped payment on the two checks to Harwell, $125,000 in all, but not on the other checks that had not yet cleared. He and Harwell moved to quash the writ because Hill’s domestication was technically defective, and the Florida court agreed on September 28.

That same day Hutton wrote a $125,000 trust account check to the Bank of Commerce and carried it to the bank himself. He came back with seven cashier’s checks, including $30,062.96 for Harwell’s wife and $30,000 each for Harwell’s father and a creditor called Montana Tractor. He testified that he wanted the money out of his trust account before Hill could serve another writ, and that the transactions were unusual and unlike his normal handling of trust funds.

Harwell filed chapter 11 in Colorado on October 10, 2005; the case later converted to chapter 7. After the filing, Hutton helped Harwell convert the $30,000 Montana Tractor cashier’s check into a check payable to Harwell himself.

The Trustee’s Suit and the Two Courts That Sided With Hutton

Lynn Martinez, Harwell’s chapter 7 trustee, sued Hutton and his firm in the Colorado bankruptcy court to recover the $500,000 as an actual-intent fraudulent transfer under sections 548(a)(1)(A) and 550(a)(1) of the Bankruptcy Code. She also pleaded Florida-law claims for aiding and abetting a fraudulent transfer, civil conspiracy, and legal malpractice. The Colorado court transferred the case to the Middle District of Florida bankruptcy court, where everything had happened.

The Florida bankruptcy court denied a motion to dismiss, then granted Hutton summary judgment. It assumed the worst: that Hutton was “the mastermind and the marionette that was driving all the pieces” of the fraudulent conveyance, funneling the money through his trust account to preferred creditors and insiders. Even so, it held Hutton was not an initial transferee under section 550(a)(1): he never had dominion and control over money held in trust for Harwell. Because he was not a transferee, Freeman v. First Union National Bank barred the aiding-and-abetting and conspiracy claims as well.

The district court affirmed in Martinez v. Hutton (In re Harwell), 414 B.R. 770 (M.D. Fla. 2009). Judge Moody read the Eleventh Circuit’s cases as using the control test to decide who is a transferee at all, with good faith playing no part. Hutton received the money as a fiduciary, could disburse it only as Harwell instructed, and never owned it; personally delivering the checks did not change that.

A footnote added that good faith would not have changed the result: Hutton took no part in the false interrogatory answers and did not know of the turnover order. The court would not say that no facts could make a lawyer who assists a fraud liable for civil conspiracy. It named two acts that might count as furtherance of a conspiracy, helping the debtor falsely answer collection interrogatories or violating the turnover order, while declining to decide whether the claim exists. It wrote that “a warning bell has sounded for parties involved in ‘asset preservation.'”

What the Eleventh Circuit Held

The Eleventh Circuit reversed the summary judgment for Hutton on December 29, 2010, in an opinion by Judge Hull. Section 548 lets a bankruptcy trustee avoid a transfer the debtor made with actual intent to hinder, delay, or defraud creditors within two years before the bankruptcy petition. Section 550(a)(1) then lets the trustee recover the property or its value from “the initial transferee,” a term the Bankruptcy Code does not define. Read literally, the court said, the first recipient of the debtor’s money is the initial transferee.

Its earlier decisions had carved out an equitable exception for mere conduits with no control over the funds, a “flexible, pragmatic, equitable approach” that looks at the whole transaction. From those cases the court drew the rule it now made explicit: good faith is a requirement of the mere-conduit or control test.

An initial recipient who wants the exception must prove two things. First, it must show that it did not control the assets and was merely a conduit for funds under the debtor’s actual control. Second, it must show that it acted in good faith and as an innocent participant in the transfer. Hutton argued that the earlier references to good faith were dicta. The court answered in a footnote: “we now explicitly hold that good faith is a requirement under this Circuit’s mere conduit or control test.”

Applying that rule, the court held that Hutton was an initial transferee under the statute’s language. He did not dispute that he was the first recipient of Harwell’s money: both settlement payments went straight into his trust account, and writing twenty-two checks afterward did not change who received the money first.

The mere-conduit test exists to protect an innocent transferee, and a lawyer assumed to be the mastermind of the scheme cannot claim its protection as a matter of law. The bankruptcy court had assumed Hutton’s role and had never made findings about his good or bad faith, so the Eleventh Circuit sent the case back for evidence and argument on both control and good faith.

What the Court Did Not Decide

The Eleventh Circuit did not hold that Hutton controlled the money, and it did not find that he acted in bad faith. Both questions went back to the bankruptcy court.

A lawyer who receives settlement money and pays it out as instructed is, in the usual case, no different from a bank moving a deposit. Lawyers and banks in that position “do not have an affirmative duty to investigate the underlying actions or intentions of the transferor,” the court wrote. Hutton could not claim conduit status on summary judgment, on the assumed facts, because he knew about the judgment and the collection effort and was treated as the scheme’s mastermind.

Hutton Failed the Good-Faith Test on Remand

On remand the bankruptcy court applied the two-part test and ruled against Hutton on good faith. Judge Williamson later described that ruling in Hyman v. Bast Amron LLP (In re Cargo Transportation Services, Inc.), 502 B.R. 875 (Bankr. M.D. Fla. 2013). Hutton “could make no credible argument that he was an unwitting or innocent participant” in the transfers.

He knew a judgment had been entered against Harwell. He knew the payments to Harwell and his family were meant to keep the money away from the creditor. He also obtained cashier’s checks on his own initiative, something he had never done for anyone he represented, to make sure nothing was left that could be applied to the judgment. Because both elements are required, that finding left Hutton as the initial transferee of whatever the trustee could avoid.

How Courts Have Applied the Harwell Test

The Eleventh Circuit applied the test in Menotte v. United States (In re Custom Contractors, LLC), 745 F.3d 1342 (11th Cir. 2014), and reached only the control element. A construction company had paid its owner’s estimated income taxes to the IRS, which later refunded the overpayment to him, and the company’s bankruptcy trustee sued the IRS as the initial transferee. The court held the IRS was a mere conduit: federal law obligated it to refund the overpayment, so it did not control the money, just as a bank does not control a deposit.

Judge Williamson, who decided the Harwell remand, came out the other way for a different law firm. In Cargo Transportation Services, a firm representing a liquidating trust’s trustee received six $5,000 payments into its trust account, paid its court-approved fee, and sent the balance to the trust. When the payor went bankrupt, its plan trustee sued to recover the payments as preferences. The court held the firm was a mere conduit that acted in good faith: court orders governed every step, and paying its own approved fee changed nothing.

Where Harwell Leaves the Freeman Rule

Under Florida law, a creditor cannot sue the lawyers, bankers, or advisers who helped a debtor make a fraudulent transfer unless they were transferees. The Florida Supreme Court held in Freeman v. First Union National Bank, 865 So. 2d 1272 (Fla. 2004), that Florida’s fraudulent transfer statute creates no cause of action for aiding and abetting a fraudulent transfer against a non-transferee.

The Fifth District held in BankFirst v. UBS Paine Webber, Inc., 842 So. 2d 155 (Fla. 5th DCA 2003), that neither the fraudulent-conversion statute nor chapter 726 creates a claim against someone who assists a transfer without possessing the property. The Florida question is control: in Freeman itself the bank had held the debtor’s account and wired the money out, and it was still the non-transferee.

The bankruptcy question is different. Section 550(a)(1), read literally, makes whoever first receives the debtor’s money the initial transferee; a lawyer whose trust account receives it escapes only by proving the equitable defense, lack of control plus good faith. Advice and document drafting make a lawyer neither a transferee under Florida’s statute nor an initial recipient under the Bankruptcy Code; a trust account that takes in the money makes the lawyer the initial recipient.

The Florida Supreme Court in Freeman left open whether theories other than the fraudulent transfer statute might reach a professional, and Harwell left that door open too. The Eleventh Circuit returned the Florida-law claims against Hutton without ruling on them, and the district court had already said a lawyer who helped falsify interrogatory answers or violated a turnover order might face a conspiracy claim.

What Harwell Means for Planning

A lawyer’s trust account is the wrong place to move money ahead of a judgment creditor. The bankruptcy court assumed actual intent in Harwell, and the facts supplied it: Harwell had a $1.396 million judgment against him and concealed the settlement from the creditor’s interrogatories. The money then went to Harwell, his wife, his father, and creditors he selected, on the day it arrived. Routing it through a lawyer protected none of it and made the lawyer a defendant for the full $500,000.

Settlement money that arrives and goes out as instructed, with no reason to suspect a fraud, is conduit activity, and there is no duty to investigate the sender’s intentions. Once the lawyer knows a judgment creditor is chasing the money, every disbursement carries that knowledge, and the good-faith element the recipient must prove becomes hard to carry. Hutton’s cashier’s checks, obtained to beat a second writ of garnishment, were the fact the bankruptcy court singled out on remand.

Florida’s fraudulent transfer statute lets a creditor undo a transfer made to hinder, delay, or defraud and take a money judgment against the first transferee, and sections 548 and 550(a) do the same work in bankruptcy on a two-year lookback. Among the Florida fraudulent transfer decisions, Harwell answers what happens to the professional who received the money, and it sits beside Freeman and BankFirst in the Florida asset protection case law as the other side of their line.