Opinion
Case No. SACV 15-00167-VAP Case No. SACV 14-01724-VAP USBC Case No. 8:12-bk-10105-CB
07-17-2015
IN RE: WALLDESIGN, INC., A SUBCHAPTER S CORPORATION.
ORDER (1) REVERSING THE BANKRUPTCY COURT'S DECISION AND REMANDING FOR FURTHER PROCEEDINGS; AND (2) ADMINISTRATIVELY CLOSING CASE NUMBER 8:14-CV-01724
Michael Bello ("Bello") was the sole shareholder, sole director, and president of Walldesign, Inc. ("Walldesign"), a California corporation. Bello opened a bank account in Walldesign's name but kept it secret from others at Walldesign. He covertly placed Walldesign funds into this account and spent them on his personal expenses.
In total, Bello made approximately $8 million in payments from the account to approximately 130 individuals or entities. None of these payments were for Walldesign. As part of these payments, Bello gave over $220,000 to Appellees Donald F. Buresh and Sharon J. Phillips ("Buresh & Phillips") to purchase the real property where the Bello Family Vineyard, LLC tasting room is located.
Walldesign filed its Chapter 11 petition for relief on January 4, 2012. The Official Committee ("the Committee") of Unsecured Creditors of the Estate of Walldesign, was appointed on January 26, 2012. The Committee brought 96 separate adversary proceedings to recover payments Bello made from the secret account, including the payments to Buresh & Phillips.
Brian Weiss is now the acting trustee of the Walldesign Liquidation Trust, which is the successor-in-interest to the rights of the Committee. (Opening Br. at 4 n.4.) The Court considers the Committee the Appellant for ease of reference.
Buresh & Phillips filed a motion for partial summary judgment against the Committee on June 19, 2014. The Bankruptcy Court granted that motion, and the Committee timely filed the instant appeal.
The Court finds that oral argument is not necessary to resolve the appeal. See Fed. R. Civ. P. 78; L.R. 7-15. After considering the briefs submitted by both sides, and reviewing the record, the Court REVERSES the decision of the Bankruptcy Court, and REMANDS for further proceedings.
I. BACKGROUND
The Bankruptcy Court held that Buresh & Phillips were subsequent transferees under 11 U.S.C. § 550(a)(1), and that they accepted the payments for value, in good faith, and without knowledge of the payments' voidability. (See E.R. at 958-59.) The Committee, therefore, could not recover the payments from them.
Citations to the Committee's excerpts of record (see Doc. Nos. 8-1 to 8-4) are as follows: "E.R. at [page number]."
In this appeal, the Committee filed its opening brief on May 4, 2015. (See Doc. No. 8 ("Opening Br.").) Buresh & Phillips filed their responsive brief on May 18, 2015. (See Doc. No. 9 ("Responsive Br.").) The Committee filed its reply brief on June 1, 2015. (See Doc. No. 12 ("Reply Br.").)
On May 18, 2015, Buresh & Phillips also filed a Motion to Strike Portions of Appellant's Opening Brief. (Doc. No. 10 ("Motion to Strike").) The Committee filed an opposition on May 22. (Doc. No. 11.)
In the Motion to Strike, Buresh & Phillips request that the Court strike a footnote in the Committee's Opening Brief because it references an exhibit that is not a part of the record on appeal. (Motion to Strike at 2.) The exhibit is a transcript of oral argument at the Bankruptcy Court, which did not involve Buresh & Phillips, and which occurred after the Committee filed the original notice of appeal in this case (see Case No. 8:14cv01724VAP).
The footnote and the cited exhibit contain only irrelevant information. Moreover, the cited exhibit was not designated as part of the record on appeal. See, e.g. Credit Alliance Corp. v. Idaho Asphalt Supply, Inc. (In re Blumer), 95 B.R. 143, 147 (B.A.P. 9th Cir. 1988). The Court, therefore, GRANTS the Motion to Strike.
This Court has appellate jurisdiction pursuant to 28 U.S.C. § 158(a)(1). The Bankruptcy Court certified the order as final and immediately appealable pursuant to Federal Rule of Civil Procedure 54(b). (See E.R. at 987-91 ("Order").)
II. LEGAL STANDARD
A "district court functions as an appellate court in reviewing a bankruptcy decision and applies the same standards of review as a federal court of appeals." In re Crystal Props., Ltd., 268 F.3d 743, 755 (9th Cir. 2001) (quoting another source). Accordingly, "[a] district court reviews a bankruptcy court's conclusions of law and interpretation of the Bankruptcy Code de novo." In re Orange Cnty. Nursery, Inc., 439 B.R. 144, 148 (C.D. Cal. 2010). It reviews factual findings for clear error, and it "must accept the bankruptcy court's findings of fact unless, upon review, the court is left with the definite and firm conviction that a mistake has been committed by the bankruptcy judge." In re Greene, 583 F.3d 614, 618 (9th Cir. 2009) (citing Latman v. Burdette, 366 F.3d 774, 781 (9th Cir. 2004)).
III. FACTS
The facts are not in dispute.
A. Walldesign
Walldesign, established in 1983, is a California corporation. (Responsive Br. at 4.) Until 2012, it installed drywall, insulation, acoustical material, and plaster, and provided construction-related services to single and multi-family housing projects in California, Nevada, and Arizona. (Id. at 5.) It maintained its primary bank account at Comerica Bank in El Segundo, California ("the Comerica Account"). (Id. at 4-5.)
Bello was Walldesign's sole shareholder, sole director, and president. (Opening Br. at 4.)
B. The Secret Account
On November 1, 2002, Bello opened a different bank account in Walldesign's name at Preferred Bank in Irvine, California ("the Secret Account"). (Id. at 4.) He used Walldesign's Federal Tax I.D. Number, a Statement by Domestic Stock Corporation, Walldesign's Articles of Incorporation, a Unanimous Consent of Shareholder of Walldesign to Corporate Action, and a signature card granting him signing authority as an agent of Walldesign to open the Secret Account. (See E.R. at 873-88.) He also used his personal residence as the Account's address, did not disclose the Account in Walldesign's general ledger or other books and records, and made his wife - who was not a Walldesign employee - a signatory to the Account. (Responsive Br. at 5.)
Walldesign purchased materials for its business in bulk, and its suppliers occasionally issued rebates or refunds for these purchases. (Id. at 6.) Rather than deduct the refund or rebate from the total invoice, the suppliers issued checks to Walldesign for the difference. (Id.) Bello did not deposit these checks into the Comerica Account; instead, he deposited them into the Secret Account and actively concealed the deposits from Walldesign's management and employees, its creditors, and the Bankruptcy Court. (Id.)
After it filed a voluntary Chapter 11 petition, Walldesign filed its Schedules and Statements of Financial Affairs, executed by Bello under penalty of perjury, with the Bankruptcy Court. (Opening Br. at 4 n.5.) Bello did not disclose the Secret Account on these Schedules. (Id.)
Bello used the money in the Secret Account to cover expenses unrelated to Walldesign, including operating costs for Bello Family Vineyard, a winery, and Michael Bello LLC, a horseracing stable, as well as other entities he controlled; his Las Vegas casino bills; his personal expenses charged on his American Express credit card; and his homeowners' association and country club fees for two private golf courses. (Id.) In total, Bello made approximately $8 million in payments from the Secret Account to about 130 persons or entities. (Id. at 6-7.) None of the funds from the Secret Account were spent for Walldesign purposes. (Id. at 7.)
C. Buresh & Phillips
Buresh & Phillips are a married couple who owned the real property located at 929 Main Street, St. Helena, California ("the Property"). (Id.) They agreed to sell the Property to Bello so they could pay personal debts and fund their retirement. (Id.)
Between June 24, 2009 and October 29, 2011, Bello made several payments, totaling over $220,000, to Buresh & Phillips to purchase the Property, which became the site of the Bello Family Vineyard tasting room. (Opening Br. at 5.) Bello made these payments using checks drawn on the Secret Account. (Id.) These checks bore the name "WALLDESIGN INCORPORATED." (Id.)
IV. DISCUSSION
The Committee presents two questions on appeal. The first is whether Buresh & Phillips constitute "initial transferees" under § 550(a)(1). Only if they are not initial transferees, and are instead subsequent transferees, must the Court address the second question: whether Buresh & Phillips accepted the payments from Bello in good faith and without knowledge of the voidability of those transfers. (See Opening Br. at 2-3; Responsive Br. at 2-3.)
The Court holds Buresh & Phillips are initial transferees under § 550(a)(1), for the reasons set forth below.
A. Defining "Initial Transferee"
Under the Bankruptcy Code, a trustee of the debtor may recover a fraudulent transfer of estate property from either "(1) the initial transferee of such transfer or the entity for whose benefit such transfer was made; or (2) any immediate or mediate transferee of such initial transferee." See Schafer v. Las Vegas Hilston Corp. (In re Video Depot, Ltd.), 127 F.3d 1195, 1197 (9th Cir. 1997) (quoting 11 U.S.C. § 550(a)).
The distinction between an "initial transferee" and a subsequent transferee is critical. See id. "The trustee's right to recover from an initial transferee is absolute." Id. at 1197-98 (quoting Danning v. Miller (In re Bullion Reserve), 922 F.2d 544, 547 (9th Cir. 1991)). A subsequent transferee, on the other hand, has a defense. A trustee may not recover from a subsequent transferee if "the subsequent transferee accepted the transfer for value, in good faith, and without knowledge of the transfer's voidability." Id. at 1198; see also 11 U.S.C. § 550(b)(1). Therefore, if Buresh & Phillips are initial transferees, the Committee has an absolute right to recover the transfers at issue.
"Section 550(a) does not define the phrase 'initial transferee.'" In re Incomnet, Inc., 463 F.3d 1064, 1069 (9th Cir. 2006). Over the years, judges have crafted two distinct tests to determine whether a party is an "initial transferee" under § 550(a)(1): the "dominion test" and the "control test." Id. The Ninth Circuit has explicitly adopted the dominion test; it has declined to adopt the control test. See id. at 1070.
The Bankruptcy Code defines "transfer" broadly to mean "each mode, direct or indirect, absolute or conditional, voluntary or involuntary, of disposing of or parting with: (i) property; or (ii) an interest in property." 11 U.S.C. § 101(54). Courts generally do not, however, treat the terms "transfer" and "initial transferee" as conterminous. See, e.g. Bonded Fin. Servs. Inc. v. European Am. Bank, 838 F.2d 890, 894 (7th Cir. 1988) ("'Transferee' is not a self-defining term; it must mean something different from 'possessor' or 'holder' or 'agent'. To treat 'transferee' as 'anyone who touches the money' and then to escape the absurd results that follow is to introduce useless steps . . . .").
Buresh & Phillips contend that In re Incomnet only "adopted the dominion test in the context of determining whether a defendant was a 'transferee' or 'mere conduit,'" and therefore the dominion test "is irrelevant in the instant case." (Responsive Br. at 16.) In In re Incomnet, however, the Court stated that "the dominion test remains a test to determine whether a recipient of funds is a transferee for purposes of the bankruptcy code, and this inquiry is not limited to the context of 'conduit cases.'" In re Incomnet, Inc., 463 F.3d at 1073 n.11.
"Under the dominion test, a transferee is one who has dominion over the money or other asset, the right to put the money to one's own purposes." Id. (citation, quotation marks, and alterations omitted). The test focuses on whether someone "had legal authority over the money and the right to use the money however" desired - for example, to invest the money in "lottery tickets or uranium stocks." Id. at 1070, 1073. The control test, on the other hand, "takes a more gestalt view of the entire transaction to determine who, in reality, controlled the funds in question." Id. at 1071.
The leading case on the dominion test, Bonded Financial Services, crafted it with policy considerations in mind. See Bonded Fin. Servs. Inc. v. European Am. Bank, 838 F.2d 890, 893 (7th Cir. 1988). Initial transferees are "the best monitor[s]" of fraudulent conveyances, it stated. Id. at 892-93. This status renders them defenseless to a trustee's right to recover fraudulent conveyances. Id. "[S]ubsequent transferees," on the other hand, "usually do not know where the assets came from and would be ineffectual monitors if they did." Id. They, therefore, have a defense.
In its most recent statement on the issue, the Ninth Circuit Court of Appeals echoed these considerations. See Mano-Y&M, Ltd. v. Field (In re The Mortgage Store), 773 F.3d 990 (9th Cir. 2014). In In re The Mortgage Store, the Ninth Circuit noted that "[i]n virtually every case involving a bankrupt entity, a third party will be injured because the debtor's obligations to creditors, by definition, outstrip its assets." Id. at 997. The "injury must fall on either the transferee of the conveyance or the debtor's creditors." Id. A court's aim in these cases "must be to allocate risk such that the parties tending to have the lowest monitoring costs [] bear the costs of a debtor's failings." Id. (citing Bonded Fin. Servs., 838 F.2d at 892-93). Congress determined that initial transferees have the lowest monitoring costs, and it therefore placed the risk of fraudulent conveyances on them rather than creditors. Id.
The In re The Mortgage Store Court further noted that "it is unreasonable to assume" a long-time president of a corporation from where a transfer came "has the proper incentives to monitor [that corporation] for fraud. . . . Charging a party with monitoring for fraud the entity that pays its debts would undermine the very structure of § 550." Id. at 998 n.1.
This notion is not novel. The Ninth Circuit in In re Video Depot earlier adopted the view that "[t]he mere power of a principal to direct the allocation of corporate resources does not amount to legal dominion and control." 127 F.3d at 1199 (citing Bowers v. Atlanta Motor Speedway, Inc. (In re Se. Hotel Properties Ltd. P'ship), 99 F.3d 151, 156 (4th Cir. 1996)). Many principals of corporations "exercise de facto control over the funds of the corporations they manage," it stated. Id. (quoting Bowers, 99 F.3d at 156). These principals "can choose to cause their corporations to use those funds appropriately or inappropriately. The distinction is only relevant to the question whether the principal's conduct amounted to a breach of duty to the corporation." Id. (quoting Bowers, 99 F.3d at 156). It is not relevant to whether the principal is an initial transferee. A rule making "every agent or principal of a corporation . . . the initial transferee when he or she effected a transfer of property in his or her representative capacity" would give "too much power to an unscrupulous insider to effect a fraudulent transfer." Id.
Although the In re Video Depot Court made this statement while summarizing other decisions, it sided with these decisions, and therefore adopted their reasoning. In re Video Depot, Ltd., 127 F.3d at 1199 (declining "to depart from the considered judgment of the[se] other circuits"). --------
The In re Video Depot Court "conclude[d] that [a principal's] control over the business operations of [the corporation] does not, in itself, compel a finding that [the principal] had dominion and control over the funds transferred from the [the corporation] to [a third party]." Id. at 1199-1200.
As these cases demonstrate, a corporation's principal who effects a transfer from the corporation in his representative capacity does not have dominion over those funds in his personal capacity, and therefore does not constitute an initial transferee of those funds under the Bankruptcy Code.
B. Applying the Definition of "Initial Transferee"
Applying this definition of "initial transferee," the Court holds that Bello was not the initial transferee. Bello did not have dominion over the funds in the Secret Account except in his capacity as a Walldesign representative. Moreover, he was the sole shareholder and president of Walldesign, and he therefore did not have the proper incentives to monitor Walldesign for fraud. Considering him the initial transferee of a transfer from Walldesign would undermine the structure of § 550(a)(1). Accordingly, the initial transferee mantle does not belong to Bello - it belongs to Buresh & Phillips.
Courts have suggested that a corporate principal's transfer of corporate funds into a personal bank account may afford the principal dominion over those funds. See In re Video Depot, 127 F.3d at 1199. The Secret Account was not, however, Bello's personal bank account. Bello opened it in Walldesign's name as a Walldesign representative, and he deposited Walldesign funds into the Account. The checks issued from the Secret Account bore the title, "WALLDESIGN INCORPORATED."
Buresh & Phillips point to several facts to show that the Secret Account was Bello's personal account: nobody from Walldesign except Bello knew about the Secret Account; Bello used his personal address to open it; and his wife - who was not a Walldesign employee - was a signatory to the Account.
On the other hand, Bello used Walldesign's Federal Tax I.D. Number, a Statement by Domestic Stock Corporation, Walldesign's Articles of Incorporation, a Unanimous Consent of Shareholder of Walldesign to Corporate Action, and a signature card granting him signing authority as an agent of Walldesign to open the Secret Account. (See E.R. at 873-88.) Hence, the Secret Account was a Walldesign account.
Although the transfers Bello made from the Secret Account were improper and breached his duty to the corporation, he effected them in his capacity as a Walldesign representative. He did not, therefore, have dominion over the funds in the Secret Account in his personal capacity, i.e., he was not the initial transferee.
C. The Cases Relied on by Buresh & Phillips Do Not Require a Different Outcome
Buresh & Phillips rely primarily on two cases decided by the Ninth Circuit Bankruptcy Appellate Panel ("B.A.P."): In re Dominion Corp., 199 B.R. 410 (B.A.P. 9th Cir. 1996); and In re Dietz, 94 B.R. 637 (B.A.P. 9th Cir. 1988), aff'd on other grounds, 914 F.2d 161 (9th Cir. 1990). Decisions of the B.A.P. are subordinate to decisions of the Ninth Circuit Court of Appeals. See In re The Mortg. Store, 773 F.3d at 995-96 ("Although we treat the BAP's decisions as persuasive authority, we are not bound by its decisions. In fact, as the BAP has recognized, our decisions are binding precedent that the BAP must follow."). To the extent these decisions conflict with In re The Mortgage Store and In re Video Depot, the Court declines to follow them.
In any event, these decisions are distinguishable. In re Dominion Corp. relies on In re Dietz in relevant part, see In re Dominion Corp., 199 B.R. at 415, so the Court focuses on In re Dietz.
In In re Dietz, Lelon D. Dietz, doing business as ("DBA") both Com-Group Portland ("Com-Group") and Airbrush Digest Publishing ("Airbrush"), filed for bankruptcy protection. In re Dietz, 94 B.R. at 638. "[T]he designation [DBA] means 'doing business as' but is merely descriptive of the person or corporation who does business under some other name. Doing business under another name does not create an entity distinct from the person operating the business." Pinkerton's, Inc. v. Superior Court, 49 Cal. App. 4th 1342, 1348 (1996) (citing Providence Washington Ins. Co. v. Valley Forge Ins. Co., 42 Cal. App. 4th 1194, 1200 (1996)) (citations, internal quotations, and emphasis omitted).
The bankruptcy court authorized the trustee to operate Com-Group and Airbrush. In re Dietz, 94 B.R. at 638. The trustee chose to operate only Com-Group. Id. Dietz then secretly "opened a checking account with a Virginia bank," deposited funds he borrowed from his fiancé into the account, and began operating Airbrush. Id. at 638-39. He deposited Airbrush funds into the account. Id. at 639.
The B.A.P. concluded Dietz constituted the initial transferee of those funds. Since Dietz was "doing business as" Airbrush, there was no truly separate corporate entity. The account was, therefore, properly considered his personal checking account.
As discussed above, the Secret Account in this case was not Bello's personal checking account. In re Dietz is distinguishable and does not support the position advanced by Buresh & Phillips.
D. The Proper Role of Equitable Principles
Buresh & Phillips argue that equitable principles are relevant to the determination of who is the initial transferee, and that the consequences of considering them initial transferees are too harsh. (See Responsive Br. at 17 n.88.) The Supreme Court in discussing the Bankruptcy Code has, after all, declined to "read the[] statutory words with the ease of a computer. There is an overriding consideration that equitable principles govern the exercise of bankruptcy jurisdiction." Bank of Marin v. England, 385 U.S. 99, 103 (1966).
Although "the result this case produces may seem harsh," the Ninth Circuit has stated that "Congress' intent in enacting § 550" must govern. In re The Mortg. Store, 773 F.3d at 997. Congress placed the risk of fraudulent conveyances on initial transferees because they are in the best position to monitor fraud. Id. Bello - as a Walldesign principal - did not have the proper incentives to monitor Walldesign for fraud. Id.
Moreover, as the Bonded Financial Services Court stated,
We have serious doubts . . . about the propriety of judges' declining to enforce statutes that produce inequitable results. Bankruptcy statutes are not special cases. . . . [T]his appeal to "equity" - to deny recovery against an "initial transferee" within the statute - is different in source and scope from the way in which we have employed considerations of policy to define "transferee" under § 550(a)(1).Bonded Fin. Servs., 838 F.2d at 894-95 (internal citations omitted) (emphasis in original); see also Richardson v. FDIC (In re M. Blackburn Mitchell, Inc.), 164 B.R. 117, 131-32 (Bankr. N.D. Cal. 1994).
Courts have considered equitable principles in defining the term "initial transferee" under § 550(a)(1), and this Court has taken those principles into account. It cannot employ equitable principles to reach a particular result, despite the statute's terms and in contravention of Congress' intent, as Buresh & Phillips request.
V. CONCLUSION
The Court holds Buresh & Phillips (and not Bello) constitute initial transferees under § 550(a)(1). The Court REMANDS the case to the Bankruptcy Court for further proceedings. This Order administratively closes the related case, case number 8:14-cv-01724. Dated: July 17, 2015
/s/_________
VIRGINIA A. PHILLIPS
United States District Judge