MEMORANDUM AND ORDER AFFIRMING IN PART AND REVERSING IN PART THE JUDGMENT OF THE BANKRUPTCY COURT AND REMANDING FOR FURTHER PROCEEDINGS

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. 15 ("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 $228,068.78 of the funds in this account on services provided by Appellants in connection with Bello's vineyard, Bello Family Vineyard, LLC. (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 Appellants Aaron Pott and Huis Clos Consulting, LLC (collectively, "Appellants").

Appellee filed a motion for summary judgment against Appellants on April 29, 2015. The bankruptcy court granted Appellee's motion for summary judgment and Appellants 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 in part and REVERSES the bankruptcy court's decision in part.

I. BACKGROUND

The Bankruptcy Court held that Appellants received actual and constructive fraudulent transfers from Walldesign. (See E.R. at 1431-33.)2

In this appeal, Appellants filed their opening brief on May 12, 2016. (See Doc. No. 12 ("Opening Br.").) Appellee filed his responsive brief on June 13, 2016. (Responsive Br.) Appellants filed their reply brief on June 27, 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.

A lower court's denial of a motion for a Rule 56 continuance is reviewed for abuse of discretion. Blough v. Holland Realty, 574 F.3d 1084, 1091 (9th Cir. 2009).

III. FACTS

The following facts are not in dispute.

A. Walldesign

Walldesign is a California corporation that was established in 1983. (Responsive Br. at 6.) 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.)

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"). (Id.) 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 152-68.) 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. at 6-7)3

Bello used the money in the Secret Account to cover expenses unrelated to Walldesign's construction business, 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 6-7.)

C. Aaron Pott and Huis Clos Consulting LLC

Aaron Pott is a professional winemaker and Huis Clos Consulting LLC is his consulting company. (Opening Br. at 5.) In December 2007, Bello hired Pott to provide winemaking services for Bello's vineyard properties. (Id.)

IV. DISCUSSION

A. Actual Fraudulent Transfers

Appellants assert that Appellee failed to provide any direct evidence, or sufficient circumstantial evidence, to establish that Bello's payments to Appellants were made with the intent to hinder, delay, or defraud his creditors. (Opening Br. at 10.) Thus, Appellants contend that the bankruptcy court erred in finding that a number of Bello's payments to Appellants were actual fraudulent transfers and granting summary judgment to Appellee. (Opening Br. at 10-16.)

California Civil Code section 3439.04 provides that:

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:

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, the bankruptcy court relied on three badges of fraud in making its finding that the subject transfers were actual fraudulent transfers: 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 6-7.)

Appellants contend that there is still a genuine dispute of material fact as to whether or not Walldesign received reasonably equivalent value in exchange for the transfers to Appellants. (Opening Br. at 19-20.) In support of this contention, Appellants point to the declaration of Aaron Pott, which states that Bello told Pott that he was the sole owner of Walldesign and Walldesign was entering the winemaking business. (See E.R. at 1071-72.) Pott contends that Bello expressed desire for Walldesign to expand its business into winemaking and that Bello told him that he hoped that Walldesign would establish a reputation as a premier wine producer. (See E.R. at 1071.) Pott also contends that, when he expressed his concerns to Bello regarding working with a start-up company, Bello assured Pott that Pott would be working solely with Walldesign. (See Id.) Pott also contends that Bello referred to Walldesign as Pott's "home" on one occasion when he and Pott were near a building with the Walldesign logo. (See Id.)

To the extent that Walldesign was in fact entering the winemaking business, it is quite possible that Walldesign received reasonably equivalent value in exchange for the transfers to Appellants. Appellee argues that Walldesign was a drywall subcontractor and not in the winemaking business. (Responsive Br. at 13-14.) Thus, Appellee contends that Walldesign received no value from Appellants' services. (Id. at 14.) Given the evidence provided by both Appellants and Appellee, this Court finds that there is a genuine dispute regarding whether or not Walldesign received reasonably equivalent value in exchange for its transfers to Appellants.

The bankruptcy court made a finding that Walldesign did not receive reasonably equivalent value in exchange for the transfers to Appellants despite the existence of a genuine dispute on that issue. (ER at 1431.) The bankruptcy court relied on this "badge of fraud" in determining that the transfers from Walldesign to Appellants were actual fraudulent transfers. (Id. at 1431-32.) Therefore, the bankruptcy court erred in finding that the transfers from Walldesign to Appellants were made with actual fraudulent intent. Accordingly, this Court REVERSES the bankruptcy court's grant of summary judgment in favor of Appellee on the issue of actual fraudulent transfers.

B. Constructive Fraudulent Transfers

Under California Civil Code § 3439.05, a transfer may be set aside and recovered as a constructive fraudulent transfer if the debtor was insolvent at the time of the transfer, or became insolvent as a result of the transfer, and the debtor did not receive reasonably equivalent value in exchange for the transfer. See Cal. Civ. Code § 3439.05

The bankruptcy found that Walldesign was insolvent by no later than October 31, 2008, which was the opinion of Appellee's expert. (See E.R. at 1428, 912-975.) Appellants point to Walldesign's balance sheets, which show that the company was solvent through 2010, and argue that these balance sheets demonstrate that there is a genuine issue of material fact regarding the date of Walldesign's insolvency. (Opening Br. at 21.)

Under California law, the solvency of a debtor can be determined by the application of one of three tests. "A debtor is insolvent if, at fair valuations, the sum of the debtor's debts is greater than all of the debtor's assets." Cal. Civ. Code § 3439.02(a). Additionally, "[a] debtor who is generally not paying his or her debts as they become due is presumed to be insolvent. Cal. Civ. Code § 3439.02(c). The third test for insolvency requires a determination of whether the debtor "was engaged or was about to engage in a business or a transaction for which the remaining assets of the debtor were unreasonably small in relation to the business or transaction." Cal. Civ. Code § 3439.04(a)(2)(A).

Here, Appellee's expert's methodology addressed the "Balance Sheet Test" under California Civil Code §3439.02(a), and determined that the sum of Walldesign's debts was greater than all of its assets by no later than October 31, 2008. (See E.R. at 917.) In determining the date of Walldesign's insolvency, Appellee's expert used the "fair value" method as required by California Civil Code 3439.02(a), using the balance sheet reports on which Appellants rely. (Id. at 917-918).

Appellants rely solely on Walldesign's balance sheets, which were created using generally accepted accounting principles ("GAAP") in order to demonstrate that Walldesign was solvent through 2010. (Opening Br. at 21.) California Civil Code section 3439.02(a) is clear that "fair valuation" rather than GAAP is the appropriate methodology to employ in a determination of insolvency. Cal. Civ. Code § 3439.02(a); See also In re Richmond Produce Co., Inc., 151 B.R. 1012, 1019 (Bankr. N.D. Cal. 1993), aff'd, 195 B.R. 455 (N.D. Cal. 1996)(explaining that generally accepted accounting principles do not control the determination of solvency because certain assets that are recognized under GAAP cannot be sold to satisfy a creditor's claim, and thus are not a component of fair value). Appellants have not challenged the methodology of Appellee's expert nor have they provided an analysis of Walldesign's insolvency that comports with the requirements of California Civil Code § 3439.02(a). Thus, Appellants have failed to demonstrate that there is a genuine issue of material fact concerning Walldesign's date of insolvency. Accordingly, the bankruptcy court did not err in holding the same.

Although the bankruptcy court correctly determined that there was no genuine dispute regarding the date of Walldesign's insolvency, the bankruptcy court also determined that Walldesign did not receive any value in exchange for the transfers to Appellants. (ER at 1432-33.) As explained above, there is a genuine dispute as to whether or not Walldesign received reasonably equivalent value in exchange for transfers that it made to appellants. Thus, the bankruptcy court erred in finding that Appellee was entitled to summary judgment on the issue of constructive fraudulent transfers. Accordingly, this court REVERSES the bankruptcy court's grant of summary judgement in favor of Appellee on the issue of constructive fraudulent transfers.

C. The Initial Transferee

Appellants assert that the bankruptcy court erred in finding that Appellants were the initial transferees as a matter of law. (Opening Br. at 21-27.)

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 Appellants 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).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, focuses 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."

Appellants point 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 24-25).

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 152-68.) 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. Accordingly, the bankruptcy court did not err in finding that Appellants were the initial transferees.

D. Affirmative Defenses

Appellants contend that the bankruptcy court erred in its application of available affirmative defenses under the California Uniform Fraudulent Transfers Act and the Bankruptcy Code.

As written at the time of the relevant transfers,6 the California Uniform Fraudulent Transfers Act stated that an actual fraudulent transfer is not voidable "against a person who took in good faith and for a reasonably equivalent value or against any subsequent transferee or obligee." Cal. Civ. Code § 3439.08(a) (2005)(effective July 7, 2005). Before the 2015 amendment, the Ninth Circuit stated that a court's analysis of the availability of affirmative defenses under section 3439.08 "require[s] the determination of whether `reasonably equivalent value' was transferred from the transferee to the debtor." In re AFI Holding, Inc., 525 F.3d 700, 707 (9th Cir. 2008).

As explained above, Appellants have presented evidence that demonstrates that there is a genuine dispute regarding whether or not Walldesign received reasonably equivalent value in exchange for its transfers to Appellants.

The bankruptcy court also found that Appellants did not receive the transfers in good faith because they were accepting checks from Walldesign for "a non-Walldesign purpose." (See E.R. at 1431.) For the reasons stated above, the evidence provided by Appellants demonstrates a genuine dispute about whether or not Walldesign was entering the winemaking business, and thus whether or not Appellants' services were for a Walldesign purpose. (See E.R. at 1071-72.) Therefore, the bankruptcy court erred in granting summary judgment on the issue of whether or not Appellants received the transfers from Walldesign in good faith.

E. Request for a Continuance

Appellants assert that the bankruptcy court erred by denying Appellant's request for a continuance under Rule 56. (Opening Br. at 29.)

A lower court's denial of a motion for a Rule 56 continuance is reviewed for abuse of discretion. Blough v. Holland Realty, 574 F.3d 1084, 1091 (9th Cir. 2009). A reviewing court will only find that a lower court abused its discretion if the movant diligently pursued its previous discovery opportunities, and if the movant can show how allowing additional discovery would have precluded summary judgment. Qualls By & Through Qualls v. Blue Cross of California, Inc., 22 F.3d 839, 844 (9th Cir. 1994).

Here, Appellants concede that the adversary proceedings in this case had been pending for two years. (Opening Br. at 30.) Appellants had a significant period in which to conduct discovery during those two years, and it does not appear that they diligently pursued their discovery opportunities. Thus, the bankruptcy court did not abuse its discretion in its denial of Appellants motion for a continuance.

V. CONCLUSION

The Court holds that the bankruptcy court erred in finding that the transfers to Appellants were actual fraudulent transfers because there was a genuine dispute as to whether or not Walldesign received reasonably equivalent value in exchange for the transfers. The Court also holds that the bankruptcy court erred in finding that the transfers to Appellants after October 31, 2008 were constructive fraudulent transfers for the same reason. Additionally, the Court holds that the bankruptcy court did not err in finding that Appellants were the initial transferees. Further, the Court holds that the bankruptcy court erred in its analysis of the available affirmative defenses because there is a genuine dispute regarding whether Appellants received the transfers in good faith and whether Walldesign received reasonably equivalent value in exchange for the transfers. The Court REMANDS the case to the bankruptcy court for further proceedings regarding whether or not Appellants received the transfers in good faith and whether or not Walldesign received reasonably equivalent value in exchange for the transfers to Appellants.

IT IS SO ORDERED.