Paloian v LaSalle Bank, NA, 619 F.3d 688 (7th Cir. 2010)


The Seventh Circuit examined the merits of a preference action filed against LaSalle Bank in its capacity as the trustee of a securitized investment pool, and determined – as a matter of first impression – that the trustee of a securitized investment pool could be a “transferee” as that term is used under Section 550(a)(1) of the Bankruptcy Code. In addition, the Seventh Circuit rejected the Bankruptcy Court’s determination that the debtor was insolvent because of the Bankruptcy Court’s finding that (in the context of determining the debtor’s current value, and acting with 20/20 hindsight) the debtor’s contingent liabilities were given 100 percent credit, but the debtor’s contingent assets were valued at $0.00. As such, the Seventh Circuit remanded the case for further findings regarding the debtor’s solvency, in order to resolve the ultimate merits of the fraudulent transfer claims.


Doctors Hospital of Hyde Park was initially founded to provide medical care as a fringe benefit for railroad workers. Between 1999 and 2000, the hospital’s owner, James Desnick, paid civil penalties of approximately $18.5 million to Medicare and Medicaid for excessive billing practices. In addition, the hospital was inefficient with respect to patient care standards, and its inefficiencies created cash flow problems. In order to compensate for these problems, the hospital created a “bankruptcy remote vehicle” that took out loans from third parties and used those funds to “purchase” the hospital’s accounts receivable. This bankruptcy remote entity had no office, checking account or stationery. It prepared no financial statements or tax returns. Prior the hospital’s petition date, the loans to the bankruptcy remote entity were securitized, and LaSalle Bank became the trustee of the securitized asset pool.

In addition to the bankruptcy remote entity, the hospital held its real estate in a separate legal entity, HPCH, LLC. HPCH took out loans from Nomura Asset Capital Corporation and, as part of the transaction, the hospital agreed to pay HPCH additional rent. HPCH gave Nomura a security interest in the additional rent. In adversary actions not on appeal, a bankruptcy court concluded that the additional rent was actually debt service on the real estate financing.

The primary issues for adjudication by the Circuit Court included: (i) whether LaSalle Bank, in its capacity as the trustee of a securitized investment fund, was a transferee under the terms of Section 550 of the Bankruptcy Code; (ii) whether the Bankruptcy Court properly evaluated the question of the debtor’s insolvency; and (iii) whether the bankruptcy remote entity was, in fact, “remote” so as to prevent recovery of the transfers made by it.


The Seventh Circuit began its analysis by considering whether LaSalle Bank constituted a transferee so as to be subject to a preference action, even if it was not the ultimate beneficiary of the monies transferred. Although the Seventh Circuit expressed that it was unaware of any other appellate court that had considered the issue, it easily determined that LaSalle Bank, in its capacity as trustee of the securitized investment fund, was a “transferee” for the purposes of a preference action. In doing so, the Seventh Circuit relied on authority holding that “any entity that receives funds for use in paying down a loan, or passing money to investors in a pool, is an ‘initial transferee’ even though the recipient is obliged by contract to apply the funds according to a formula.”

The Circuit Court next considered whether the Bankruptcy Court had properly evaluated the hospital’s solvency when it determined that preference exposure existed. Specifically, it noted that the Bankruptcy Court had found that the hospital was consistently paying its creditors when due, and it had consistently positive financials and EBIDTA. The Bankruptcy Court next had considered testimony regarding the hospital’s discounted cash flow analysis, which projects net cash flow into the future, and then discounts that asset stream to current-day value. In the instant case, the Bankruptcy Court subtracted from this discounted cash flow the $18.5 million it knew that the hospital would have to pay in Medicare and Medicaid reimbursements, but gave no credit to the probability that those claims were reimbursable by Mr. Desnick (in reality, Mr. Desnick reimbursed the hospital for the entire balance). As such, the Circuit Court found that the Bankruptcy Court erred in determining the present value of the hospital’s business because of its failure to treat contingent assets and contingent liabilities consistently. Instead, the appellate court found that, once contingent assets were factored in, the debtor was solvent during the time that at least a portion of the alleged transfers took place. It therefore remanded the case to the Bankruptcy Court for further determinations as to when, exactly, the hospital became insolvent so as to subject its creditors to potential preference claims.

In addition, because of the scant evidence regarding whether the bankruptcy remote entity was, in fact, remote, the Seventh Circuit noted that – in the event the hospital was deemed insolvent at some point in time – the Bankruptcy Court should further evaluate the claims as to the remote status of the bankruptcy remote entity. Indeed, because there was little evidence the entity even existed – apart from the inclusion of its name on the loan documents – the appellate court challenged the Bankruptcy Court to further determine the independent status, or lack thereof, of the bankruptcy remote entity.


There are two important holdings of the Circuit Court in this opinion: (i) a trustee of a securitized investment pool can constitute a transferee under Section 550 of the Bankruptcy Code and can, therefore, be subject to preference exposure; and (ii) when determining the value of a debtor for purposes of establishing insolvency, contingent assets and contingent liabilities must be evaluated equally.


Although only mentioned briefly in the opinion, the court gave an important warning to parties who set up “bankruptcy remote entities” without observing the proper formalities. When considering whether to establish such an entity, parties should ensure that they have done so properly in order to provide the greatest amount of protection.