Memorandum and Order Affirming the Order of the U.S. Bankruptcy Court
VIRGINIA A. PHILLIPS, Chief District Judge.
Michael Bello ("Bello") was the sole shareholder, sole director, and president of Walldesign, Inc. ("Walldesign"), a California corporation. (See Doc. No. 21 ("Responsive Br.") at 6.) Bello opened a bank account in Walldesign's name but kept it secret from others at Walldesign. (Id.) He covertly placed Walldesign funds into this account and spent them on his personal expenses. (Id. at 6-7.) Bello spent approximately $83,711.63 of the funds in this account on services provided by Appellant, Bella Casa Property Services, LLC, in connection with Bello's residential property in Napa, California. (Id. at 7.)
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, 2012.1 The Committee brought a number of separate adversary proceedings to recover payments Bello made from the secret account, including the payments to Appellant.
Appellee filed a motion for summary judgment against Appellant on April 29, 2015. The bankruptcy court granted Appellee's motion for summary judgment and Appellant timely filed the instant appeal.
After consideration of the papers filed by the parties in this appeal, the Court AFFIRMS the bankruptcy court's decision.
I. BACKGROUND
The Bankruptcy Court held that Appellant received actual and constructive fraudulent transfers from Walldesign and that Bella Casa Property Services, LLC ("Bella Casa") was the initial transferee. (See E.R. at 1283-85.)2
In this appeal, Appellant filed its opening brief on January 15, 2016. (See Doc. No. 15 ("Opening Br.").) Appellee filed his responsive brief on February 26, 2016. (Responsive Br.) Appellant filed its reply brief on March 17, 2016. (See Doc. No. 23 ("Reply Br.").)
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)).
The bankruptcy court's decision to grant summary judgment is reviewed de novo. In re Raintree Healthcare Corp., 431 F.3d 685, 687 (9th Cir. 2005). "Summary judgment is to be granted if the pleadings and supporting documents, viewed in the light most favorable to the non-moving party, show that there is no genuine issue as to a material fact and the moving party is entitled to judgment as a matter of law." Id.
III. FACTS
The following facts are not in dispute.
A. Walldesign
Walldesign is a California corporation that was established in 1983. (Responsive Br. at 5.) 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.) Bello was Walldesign's sole shareholder, sole director, and president. (Id. at 6.)
B. The Secret Account
On November 1, 2002, Bello opened a bank account in Walldesign's name at Preferred Bank in Irvine, California ("the Secret Account"). (Responsive Br. at 6.) 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 authority as an agent of Walldesign to open the Secret Account. (See E.R. at 151-168.) He did not disclose the Account in Walldesign's general ledger or other books and records, and did not disclose the Secret Account to Walldesign's management or creditors. (Responsive Br. at 6.)
Walldesign purchased materials for its business in bulk, and its suppliers occasionally issued rebates or refunds for these purchases. (Id.) Rather than deduct the refund or rebate from the total invoice, the suppliers issued checks to Walldesign for the difference. (Id.) Bello deposited these checks into the Secret Account and actively concealed the deposits from Walldesign's management and employees, its creditors, and the Bankruptcy Court. (Id.)3
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. at 7.)
C. Bella Casa
Bella Casa Property Services, LLC ("Bella Casa") is a small business that provides services related to secondary residences in Napa, California and the surrounding area. (Opening Br. at 10.) These services include the management and maintenance of residential properties. (Id.)
In 2007, Bello hired Bella Casa to provide estate-keeping services for his property located at 8434 St. Helena Highway in Napa, California ("Bello Family Vineyards Estate"). (See E.R. at 1000.) Between 2007 and 2011, Bello disbursed approximately $83,711.63 in funds from the Secret Account to Bella Casa for services provided in connection with Bello Family Vineyards Estate. (Id.)
IV. DISCUSSION
A. The Initial Transferee
Appellant asserts that the bankruptcy court erred in finding that Appellant was the initial transferees as a matter of law. (Opening Br. at 2.)
1. 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 Hilton 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 Appellant is the initial transferee, 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).4 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.
"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, focused on policy considerations. 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)).5 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.
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.
2. 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).
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."
Appellant points to several facts to show that the Secret Account was Bello's personal account: Bello used his personal address to open the Secret Account; the account was never included on Walldesign's financial statements; and Bello's wife — who was not a Walldesign employee — was a signatory to the Account. (Opening Br. at 25).
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 284-94.) 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.
3. Nancy Bello
Appellant contends that Nancy Bello was the initial transferee because her signatory authority on the Secret Account gave her dominion over the funds in her personal capacity. (Opening Br. at 17-23.)
As explained above, the Secret Account was a Walldesign account and contained Walldesign funds, despite Nancy Bello's signatory authority. Nancy Bello's signatory authority on the Secret Account gave her the ability to appropriate the Walldesign funds for personal use in exactly the same way that Bello could. As the Court explains in more detail above, this is not enough to establish that Nancy Bello took dominion over the funds. Appellant has not provided any evidence demonstrating that Nancy Bello had a legal right to use the Walldesign funds in the secret account without approval from Walldesign, and the Court has found none. Thus, Nancy Bello was not the initial transferee.
Appellant also contends that the bankruptcy court's failure to make a factual finding as to whether Nancy Bello was the initial transferee was a procedural error and argues that it is a basis for reversal. (Opening Br. at 18.) The bankruptcy court made a factual finding that Bella Casa was the initial transferee. (See E.R. at 1285.) Accordingly, the bankruptcy court also found that no other party, including Nancy Bello, was the initial transferee of funds that were transferred from Walldesign to Bella Casa. As explained above, the bankruptcy court correctly found that Bella Casa was the initial transferee, and thus did not err in finding that Nancy Bello was not.
4. Preferred Bank
Appellant also contends that Preferred Bank was the initial transferee because Preferred Bank played an essential role in how the Secret Account was opened and took dominion over the funds that Bello transferred into the Secret Account. (Opening Br. at 24-27.)
"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." In re Incomnet, Inc., 463 F.3d at 1070. As explained by the Ninth Circuit, "[t]he focus on `dominion' is useful for those unusual situations in which legal title to funds and the right to put those funds to use have been separated." Id. at 1073-74. The court in Incomnet further elaborated on two situations where this might occur: "(1) when an entity has legal title as a formal matter, but legally does not have any discretion in the application of funds; and (2) when an entity does not possess legal title, but nevertheless has sufficient authority over the funds to direct their disbursement." Id. at 1074. In order to illustrate the first situation, the Incomnet court looked to the decision in Bonded Financial Services, 838 F.2d 890. Id. at n. 12.
In Bonded Financial Services, a person that controlled a currency exchange effected a transfer from the currency exchange into his personal bank account. See Bonded Fin. Srvs., 838 F.2d at 891. The court in Bonded Financial Services held that the bank was a mere "conduit" and not the initial transferee because the bank was directed to deposit the funds into the individual's account and had no discretion over how the funds were used. See Id. at 891-893.
Appellant contends that the present case is distinguishable from the situation analyzed by the Incomnet and Bonded Financial Services courts because Bello did not deposit the money with Preferred Bank with the specific instructions to transfer the funds to a third party, but instead merely deposited the funds in the Secret Account. (Reply Br. at 17-18.) Appellant asserts that, absent instructions to deposit funds in a third party's account, Preferred Bank could use Bello's deposits in the Secret Account as it saw fit, including making investments with the funds or fulfilling other withdrawals. (Id.)
Appellant's logic fails to distinguish the present case from the situation in Bonded Financial Services that was addressed by the Ninth Circuit in Incomnet. Here, Bello directed money from the Walldesign corporate account into the Secret Account, which was a Preferred Bank account. (Responsive Br. at 16-17.) In Bonded Financial Services, the bank deposited funds into a third-party account that was also managed by the bank. See Bonded Fin. Srvs., 838 F.2d at 891. Therefore, the bank in Bonded Financial Services had the same ability to use the funds to make investments or fulfil other withdrawals as Preferred Bank did in the instant case. The Ninth Circuit adopted the logic of the Bonded Financial Services court that a bank that merely accepts a deposit of funds and effectuates their transfer into another account does not have dominion over those funds, and thus cannot be the initial transferee. In re Incomnet, Inc., 463 F.3d at 1074. Therefore the bankruptcy court did not err in declining to find that Preferred Bank was the initial transferee in the instant case.
Appellant also contends that the bankruptcy court's failure to make a factual finding as to whether Preferred Bank was the initial transferee was a procedural error and argues that it is a basis for reversal. (Opening Br. at 27.) The bankruptcy court made a factual finding that Bella Casa was the initial transferee. (See E.R. at 1285.) Accordingly, the bankruptcy court also found that no other party, including Preferred Bank, was the initial transferee of funds that were transferred from Walldesign to Bella Casa. As explained above, the bankruptcy court correctly found that Bella Casa was the initial transferee, and thus did not err in finding that Preferred Bank was not.
B. Actual Fraudulent Transfers
Appellant asserts that the bankruptcy court erred in finding that a number of Bello's payments to Bella Casa were actual fraudulent transfers and granting summary judgment to Appellee. (Opening Br. at 5.)
California Civil Code section 3439.04 provides that: [a] transfer made or obligation incurred by a debtor is voidable as to a creditor, whether the creditor's claim arose before or after the transfer was made or the obligation was incurred, if the debtor made the transfer or incurred the obligation . . . . [w]ith actual intent to hinder, delay, or defraud any creditor of the debtor.
Cal. Civ. Code § 3439.04(a)(1).
In cases of fraudulent transactions, where the real intent of the parties is solely within their own knowledge, "[d]irect proof of a transfer and of a fraudulent intent is often an impossibility. Hence proof indicative of a transfer and of fraud may come by inference from circumstances surrounding the transaction, the relationship and interest of the parties." Menick v. Goldy, 131 Cal.App.2d 542, 548, (1955). California Civil Code section 3439.04 includes the following circumstantial factors for a court to consider in making a determination regarding the intent of the debtor:
(1) Whether the transfer or obligation was to an insider.
(2) Whether the debtor retained possession or control of the property transferred after the transfer.
(3) Whether the transfer or obligation was disclosed or concealed.
(4) Whether before the transfer was made or obligation was incurred, the debtor had been sued or threatened with suit.
(5) Whether the transfer was of substantially all the debtor's assets.
(6) Whether the debtor absconded.
(7) Whether the debtor removed or concealed assets.
(8) Whether the value of the consideration received by the debtor was reasonably equivalent to the value of the asset transferred or the amount of the obligation incurred.
(9) Whether the debtor was insolvent or became insolvent shortly after the transfer was made or the obligation was incurred.
(10) Whether the transfer occurred shortly before or shortly after a substantial debt was incurred.
(11) Whether the debtor transferred the essential assets of the business to a lienor that transferred the assets to an insider of the debtor.
Cal. Civ. Code §§ 3439.04(b)(1)-(11).
This list of relevant factors "provides neither a counting rule, nor a mathematical formula." In re Beverly, 374 B.R. 221, 236 (B.A.P. 9th Cir. 2007), aff'd in part, dismissed in part, 551 F.3d 1092 (9th Cir. 2008). "No minimum number of factors tips the scales toward actual intent." Id.
Here, three badges of fraud are particularly relevant: the transfers were concealed from Walldesign; Walldesign did not receive reasonably equivalent value in exchange for the transfers; and the transfers and Secret Account were concealed from Walldesign's creditors.
As explained below, the Secret Account was a Walldesign account. Further, Bello did not disclose the Account in Walldesign's general ledger or other books and records, and did not disclose the Secret Account to Walldesign's management or creditors. (Responsive Br. at 6.) Further, no facts have been presented to suggest that the services provided by Appellant to Bello Family Vineyard provided any value to Walldesign.
There is no minimum number of factors required for the bankruptcy court to make a finding of fraudulent intent. In re Beverly, 374 B.R. at 236. This Court finds that because the subject transfers were concealed from Walldesign and its creditors, and no evidence has been presented that Walldesign received any value from Bella Casa's services, there is no genuine dispute as to whether or not the subject transfers were made with actual intent to hinder, delay, or defraud Walldesign's creditors. Accordingly, the bankruptcy court did not err in finding that the transfers were made with the requisite fraudulent intent to be classified as actual fraudulent transfers.
C. Evidentiary Objections
Appellant asserts that the bankruptcy court erred in admitting the declarations of Jack Reitman and Brian Weiss. (Opening Br. at 12-14.) Appellee contends that the declarations were admissible as summaries of voluminous documents under Federal Rule of Evidence 1006.
A district court reviews a "bankruptcy court's evidentiary rulings for an abuse of discretion." In re Slatkin, 525 F.3d 805, 811 (9th Cir. 2008)(citations omitted). "To reverse on the basis of an erroneous evidentiary ruling, [the reviewing court] must conclude not only that the bankruptcy court abused its discretion, but also that the error was prejudicial." Id.
Federal Rule of Evidence 1006 provides that:
The proponent may use a summary, chart, or calculation to prove the content of voluminous writings, recordings, or photographs that cannot be conveniently examined in court. The proponent must make the originals or duplicates available for examination or copying, or both, by other parties at a reasonable time and place. And the court may order the proponent to produce them in court.
Fed. R. Evid. 1006.
This court has reviewed Appellant's evidentiary objections and agrees with the bankruptcy court that the Reitman and Weiss declarations were properly admissible under Rule 1006. It appears that these declarations were summaries of the case background and shortened the record by over 2,000 pages. (Responsive Br. at 16.) This court finds that the bankruptcy court did not abuse its discretion in admitting the Reitman and Weiss Declarations, and even if it did, any potential abuse of discretion was not prejudicial.
V. CONCLUSION
The Court holds that the bankruptcy court did not err in finding that Bella Casa was the initial transferee. The Court also holds that the bankruptcy court did not err in finding that the transfers to Bella Casa before October 31, 2008 were actual fraudulent transfers. Further, the Court holds that the bankruptcy court did not err admitting the Weiss and Reitman declarations. The Court therefore AFFIRMS the bankruptcy court's judgement against Bella Casa.
IT IS SO ORDERED.
