TERRY L. MYERS, Chief Judge.
In this adversary proceeding the chapter 7 trustee ("Trustee") seeks to avoid certain
Debtor and Defendant Lisa Gregerson are husband and wife. Together, they own and control two closely-held entities—BW Properties, LLC ("BW") and L & B Properties, Inc. ("L & B").
Debtor organized BW in 2004 as a limited liability company. Although Gregerson was not a member of BW at its inception, she was added as a member of the company some time thereafter and was a member of BW at all times relevant to this proceeding.
Debtor and Gregerson incorporated L & B in April 2005. Debtor and Gregerson have 49% and 51% ownership interests in L & B, respectively, and are listed as secretary and president of the corporation. L & B was created to purchase, hold, and sell real property. When BW received its contractor's license in 2006, L & B began hiring BW to do construction work on properties it owned.
In 2006, Debtor entered into a business relationship with Jonathan and Barbara Ball in order to develop a parcel of real property owned by the Balls. As part of this relationship, Debtor contracted to build a new home for the Balls. During the course of the project, the relationship between Debtor and the Balls deteriorated, resulting in disputes concerning payment for Debtor's work. Debtor, acting through BW, recorded a lien on the Balls' property for money he believed he was still owed under contract. The Balls responded by suing Debtor and BW in state court on January 29, 2007. See Ex. 107. In turn, Debtor and BW filed several counterclaims against the Balls. On November 13, 2008, after a lengthy trial, a jury returned a verdict in the Balls' favor. Based on the jury verdict, on November 28, 2008,
Meanwhile, on August 21, 2008, during the pendency of the state court litigation, Debtor executed a quitclaim deed conveying to Gregerson his interest in real property located in Pony Acres Estates at 11899 Orchard Avenue, Nampa, Idaho ("Orchard Property"). Ex. 114.
Debtor, and Gregerson acting on behalf of Debtor, also effected a number of transfers between the date the jury verdict was returned and entry of judgment on that verdict. On November 15, Debtor personally received a $10,000 check from Kenneth Joe Wheeler as a gift, which Debtor deposited into an L & B bank account two days later. See Ex. 117. On November 17, Gregerson went to the Idaho Department of Motor Vehicles ("DMV") and transferred title to a 1981 Ford dump truck, a 1982 Ford pick-up truck, a 1993 Jeep Wrangler, and a 1998 FTWD travel/camp trailer from BW to L & B. See Exs. 122, 123, 124, and 126. The gross sales price listed on the applications for certificate of title for each of the three vehicles and the trailer was "0.00." Id. At the same time, Gregerson also added her name to Debtor's on the certificates of title for a 1999 Yamaha motorcycle, a 2003 Honda motorcycle, and a 2006 Honda motorcycle. See Exs. 127, 129, and 131.
On December 11, 2008, after the state court judgment had been entered and after Debtor and Gregerson met with bankruptcy counsel, Gregerson returned to the DMV and had Debtor's name removed from the certificates of title for the three motorcycles, leaving her as the sole owner of each. See id.
The following day, on December 12, 2008, Debtor filed an individual petition for relief under chapter 13. In his schedules, Debtor listed an "equitable interest" in the Orchard Property with a value of $225,000, and ownership interests in BW and L & B, to which he ascribed no value.
Debtor later amended his schedules. He removed his interest in the Orchard Property from Schedule A and added the 1999 Yamaha and 2003 Honda motorcycles to Schedule B, with values of "0.00." Debtor also amended his SOFA to reflect the $10,000 gift he received from Kenneth Wheeler. Debtor's amended SOFA lacked any information concerning conveyance of his interest in the Orchard Property, deposit of the $10,000 into the L & B account,
At the time of filing Debtor owned a parcel of commercial real property located at 1116 Garrity Boulevard, Nampa, Idaho ("Garrity Property").
On October 30, 2008, one day before the option was to expire, Wheeler and Tam entered into another option agreement regarding the Garrity Property. See Ex. 210. Tam paid Debtor $20,000 for the option, which had an expiration date of December 1, 2008. Included in the option was a provision that required Debtor to assign to Tam, upon exercise of the option, his interest in a lease with Canyon Outdoor Media, covering a tract of land on the Garrity Property on which Canyon Outdoor Media, LLC maintained an advertising billboard. See Ex. 100.
On December 13, 2008, the day following Debtor's bankruptcy filing, Gregerson entered into an agreement to lease the Garrity Property to Liang for an additional three years. Ex. 140 ("Lease"). Under the December 13 Lease, Liang was obligated to pay Gregerson monthly rent of $1,750. Tam and Liang paid rent under the Lease for five months, totaling $8,750. See Ex. 143.
At the same time, Gregerson also granted Liang a 4-year option to purchase the Garrity Property. Ex. 139 ("Option"). Tam and Liang paid Gregerson $16,000 for the Option. Payment of the $16,000 was made in three separate checks of $6,000, $5,000, and $5,000, which Gregerson cashed. See Ex. 139.
In conjunction with the Option and Lease, Tam and Liang also executed an 18-month promissory note ("Note") in favor of Gregerson for $10,417.41 with interest compounded annually at 12%. See Ex. 140. The Note was for unpaid property taxes on the Garrity Property for 2006-2008. It called for monthly payments of $635.27 beginning on or before April 1, 2009. Tam and Liang made two payments on the Note in March and April of 2009. See Ex. 143.
Although Debtor owned the Garrity Property, and according to testimony was present on the day after Debtor's bankruptcy was filed when the Lease, Option, and Note were executed, it was Gregerson, not Debtor, who was listed as "owner" in the documents, and it was Gregerson alone who signed the same.
Debtor listed the Garrity Property in his original and amended Schedule A. In his SOFA Debtor also disclosed $19,200 in yearly rental income for 2007 and 2008. And in his amended SOFA he disclosed the $20,000 he received from Tam and Liang for the October 30 option. He did not, however, list any income from real property in his schedule of current income, Schedule I. Nor did Debtor list any executory contracts, such as the Lease and the
Trustee first seeks to invoke § 548(a)(1)(A) to avoid certain transfers made prior to Debtor's bankruptcy filing.
Trustee bears the burden of proving, by a preponderance of the evidence, each of the elements under § 548(a)(1)(A) in order to avoid a fraudulent transfer. See Murrietta v. Fehrs (In re Fehrs), 391 B.R. 53, 73 (Bankr.D.Idaho 2008).
Courts often look to the circumstances surrounding a transfer to determine whether there was actual intent to hinder, delay or defraud creditors. As the Ninth Circuit has explained:
Acequia, Inc. v. Clinton (In re Acequia, Inc.), 34 F.3d 800, 805-06 (9th Cir.1994) (quoting Max Sugarman Funeral Home v. A.D.B. Investors, 926 F.2d 1248, 1254-55 (1st Cir.1991)).
Trustee asserts that the August 21, 2008, quitclaim deed conveying all of Debtor's interest in the Orchard Property to Gregerson was a fraudulent transfer under § 548(a)(1)(A).
Here, several badges of fraud surrounded execution of the quitclaim deed. First, the marital relationship between Debtor and Gregerson, while not creating a presumption of fraudulent intent, certainly invites close scrutiny of the transfer. Second, Debtor was defending against the Balls' lawsuit, a lawsuit in which Gregerson was not personally a party, at the time the deed from Debtor to Gregerson was executed. Third, Debtor's transfer of his interest in the property was on paper only. Debtor received no consideration for the transfer and he retained possession and use of the property with Gregerson. In fact, Debtor's original schedules indicate that at the time of filing Debtor considered himself to have an "equitable interest" in the property, the August 22, 2008, quitclaim deed notwithstanding. Lastly, there is no mention of the transfer in either Debtor's original or amended SOFA.
Gregerson and Debtor claim that the purpose of the quitclaim deed was to obtain a residential construction loan secured by the equity in the Orchard Property, arguing that this was a loan they would have been unable to obtain had Debtor's name been on the title to the property given his credit history and the pending lawsuit.
Next, the Court addresses the $10,000 Debtor received from Kenneth Wheeler, and subsequently transferred to L & B on November 17, 2008. The transfer to L & B shares many of the badges of fraud that accompanied execution of the quitclaim deed. As a 49% owner, with Gregerson owning the other 51%, Debtor had a close relationship with L & B. At the time the $10,000 was deposited in the L & B account, the jury in the Ball state court litigation had returned a verdict against Debtor. As co-owner of L & B, Debtor continued to exercise control over the $10,000, though those funds were nominally held by L & B. And, although Debtor disclosed the $10,000 gift in his amended SOFA, there is no disclosure of the subsequent transfer to L & B in either his original or amended SOFA. When considered together, these circumstances evidence an actual intent to remove the $10,000 from the reach of Debtor's creditors and, in particular, the Balls.
Debtor contends that the $10,000 transfer to L & B was a "loan." However, he
The Court concludes that Trustee may avoid the $10,000 transfer to L & B under § 548(a)(1)(A).
The evidence demonstrates, and the Court concludes, that the removal of Debtor's name from the certificates of title for the 1999 Yamaha, 2003 Honda, and 2006 Honda motorcycles the day before Debtor filed his petition also constitute fraudulent transfers under § 548(a)(1)(A).
By having his name removed from the certificates of title, Debtor parted with, and thus transferred, his interests in the motorcycles.
The final category of transfers Trustee seeks to avoid include those of BW's interests in certain vehicles and equipment—i.e., the 1981 Ford dump truck, 1982 Ford pick-up truck, 1993 Jeep Wrangler, and 1998 FTWD travel/camp trailer—to L & B, effected by Gregerson on November 17, 2008. Trustee acknowledges that his avoidance powers under § 548(a)(1)(A) are limited to transfers of Debtor's interests in property, and that BW, not Debtor, was listed as owner on the certificates of title for the subject vehicles and trailer at the time of transfer. However, Trustee seeks to "pierce the veil" of BW and have the LLC form of that entity disregarded. Trustee argues that if BW and Debtor are treated as one and the same, the transfers of BW's interests in the vehicles and trailer to L & B would constitute transfers of Debtor's interests for purposes of § 548(a)(1). Thus, as a threshold issue the Court must consider Trustee's veil piercing claim.
State law controls whether it is appropriate to pierce the corporate veil. Miller Ave. Prof'l & Promotional Servs., Inc. v. Brady (In re Enterprise Acquisition Partners, Inc.), 319 B.R. 626, 634 (9th Cir. BAP 2004). Under Idaho law, courts may disregard the corporate form if two requirements are met. First, there must be a unity of interest and ownership such that the separate personalities of the corporation and the individual no longer exist, and second, failure to treat the acts of the corporation as those of the individual would lead to an inequitable result or
"[A]n action to pierce the corporate veil is `not itself an independent . . . cause of action, but rather is a means of imposing liability on an underlying cause of action.'" Semmaterials, L.P. v. Alliance Asphalt, Inc., 2008 WL 161797, at *3 (D.Idaho Jan.15, 2008) (quoting Peacock v. Thomas, 516 U.S. 349, 354, 116 S.Ct. 862, 133 L.Ed.2d 817 (1996)); see also Ahcom, Ltd. v. Smeding, 623 F.3d 1248, 1251-52 (9th Cir.2010) (interpreting California law). As the Idaho Supreme Court has explained:
VFP VC, 109 P.3d at 723 (internal citations omitted).
Here, Trustee is not attempting to use veil-piercing in the traditional sense. He does not seek to impose personal liability on Debtor for the acts of BW. Nor is he alleging that the assets of BW should be used to satisfy a particular personal liability of Debtor. Indeed, Trustee is not seeking to recover, under § 548, from either Debtor or BW at all. Instead, Trustee urges the Court to treat the assets of BW, a non-debtor entity, as coextensive with Debtor's assets in order to avoid prepetition transfers of BW's assets. The true essence of Trustee's claim is further evidenced by his representation at trial that his intent is to bring the assets of BW, as well as L & B, into Debtor's bankruptcy estate. Trustee's approach— collapsing the assets of a non-debtor entity into those of the Debtor—is tantamount to a request for substantive consolidation of Debtor's estate with that of a non-debtor, BW.
Substantive consolidation is an equitable remedy, derived from a bankruptcy court's general equity powers under § 105, that "enables a bankruptcy court to disregard separate corporate entities, to pierce their corporate veils in the usual
In Bonham, the seminal Ninth Circuit case regarding substantive consolidation, the debtor was an individual who had operated a Ponzi scheme through two closely-held, non-debtor corporations. 229 F.3d at 759. After discovering that liquidation of the debtor's personal assets would produce minimal net proceeds and that the two corporations had no material assets, the trustee filed several adversary proceedings against investors of the non-debtor corporations seeking to avoid prepetition transfers from the non-debtor corporations to those investors. The investors challenged the trustee's standing to avoid transfers made by the corporations because those corporations were not debtors in the bankruptcy proceeding. Id. at 759-60. The trustee responded by filing a motion for substantive consolidation of the debtor's bankruptcy estate with the non-debtor estates of the corporations. The bankruptcy court granted the trustee's motion and ordered substantive consolidation. Id. at 760. On appeal, the Ninth Circuit affirmed the bankruptcy court's order. Id. at 771.
Here, as in Bonham, Trustee is attempting to avoid transfers made by a non-debtor entity owned and controlled by Debtor. But, rather than seeking substantive consolidation, Trustee relies upon a veil-piercing theory to support his assertions under § 548(a). While substantive consolidation includes a veil-piercing element, it is more than that. It has potential economic consequences for both the entity being consolidated into the bankruptcy estate, as well as that entity's creditors. As a result, "resort to consolidation should not be Pavlovian, but . . . should be used sparingly," with a heightened degree of due process and due consideration for the harm or economic prejudice that such a remedy would occasion. Bonham, 229 F.3d at 767 (quoting Union Sav. Bank v. Augie/Restivo Baking Co. (In re Augie/Restivo Baking Co.), 860 F.2d 515, 519 (2d Cir.1988) and Flora Mir Candy Corp. v. R.S. Dickson & Co. (In re Flora Mir Candy Corp.), 432 F.2d 1060, 1062-63 (2d Cir.1970)); see also In re Luth/In re Worley Grain Co., Inc., 28 B.R. 564, 566-67 (Bankr.D.Idaho 1983).
Trustee further seeks from the Court an order denying Debtor's discharge under § 727(a)(2)(A). Section 727(a)(2)(A) provides that, in a chapter 7 case,
Plaintiff's burden of proof on an objection to discharge under § 727(a)(2) is preponderance of the evidence. See Wolkowitz v. Beverly (In re Beverly), 374 B.R. 221, 243 (9th Cir. BAP 2007).
Trustee contends that Debtor's prepetition transfers—the quitclaim deed to Gregerson, deposit of the $10,000 check in the L & B account, removal of Debtor's name from the certificates of title for the Yamaha and Honda motorcycles, and the transfer of the vehicles and trailer from BW to L & B—also support a denial of Debtor's discharge under § 727(a)(2)(A).
First, the Court will dismiss Trustee's § 727(a)(2)(A) claim as to the transfers from BW to L & B because those transfers were not of Debtor's property, but of property owned by BW, as discussed and determined supra. The record clearly demonstrates, however, that the remainder of the subject transfers were both of Debtor's property and occurred within one year before Debtor filed his petition. Thus the question is whether those transfers were made with "intent to hinder, delay, or defraud" creditors. The Court finds that they were.
The § 548(a)(1)(A) fraudulent transfer and § 727(a)(2) denial of discharge provisions share the requirement of "intent to hinder, delay, or defraud" creditors. Although § 548(a)(1)(A) requires "actual intent" while § 727(a)(2) requires only "intent," the Ninth Circuit has used "intent" and "actual intent" interchangeably, making no meaningful distinction between the two. See Beverly, 374 B.R. at 243 (citing Emmett Valley Assocs. v. Woodfield (In re Woodfield), 978 F.2d 516, 518 (9th Cir. 1992) and First Beverly Bank v. Adeeb (In re Adeeb), 787 F.2d 1339, 1342
Trustee also seeks a denial of Debtor's discharge under § 727(a)(2)(B). Section 727(a)(2)(B) provides for the denial of a debtor's discharge under chapter 7 where
Trustee contends that Debtor's post-petition Lease transaction involving the Garrity Property—effected through Gregerson—involved the transfer and concealment of property of the estate with intent to hinder, delay, or defraud creditors and Trustee.
It is undisputed that the Lease was executed the day after Debtor filed his petition. At the time of filing, Debtor's prior lease agreement with Tam and Liang had expired. All of Debtor's property rights in the Garrity Property, including the right to use and possess the property, became property of the estate upon filing. See § 541(a)(1). By having Gregerson enter into the Lease, Debtor transferred, or permitted the transfer of, the right to use and possess the Garrity Property, a right that was property of the estate.
Debtor also concealed estate property after filing his petition. Property of the estate includes "[p]roceeds, product, offspring, rents, or profits of or from property of the estate." Section 541(a)(6). The Garrity Property was owned by Debtor and was thus clearly property of the estate. Therefore, the rents Debtor and Gregerson collected from Tam and Liang for the lease of the Garrity Property also constitute estate property under § 541(a)(6). However, Debtor did not include rental income from the Garrity Property in Schedule I, which was filed after the December 13 Lease was executed.
The final inquiry under § 727(a)(2)(B) is whether execution of the Lease and concealment of the Option payment and rental income were accompanied by the requisite intent to hinder, delay, or defraud creditors. The circumstances presented convince the Court that Debtor acted with such intent.
Debtor contends that he entered into the Lease with Liang in the "ordinary course of business," and that he had no intent to hinder, delay, or defraud creditors. Indeed, he claims that his intent was to fund his chapter 13 plan, at least in part, with the rental income from the Garrity Property Lease. The Court finds Debtor's arguments unpersuasive.
Section 1304 permits a chapter 13 debtor that is self-employed to operate his business unless the court orders otherwise. This permission includes the ability to enter into transactions, including the sale or lease of property of the estate, if in the ordinary course of business, without notice or a hearing. See §§ 363(c)(1) and 1304(b).
A determination of whether a transaction falls inside or outside the ordinary course of business is a question of fact. Aalfs v. Wirum (In re Straightline Invs., Inc.), 525 F.3d 870, 879 (9th Cir. 2008). It requires inquiry into the nature of industry practice and into a debtor's prepetition business conduct. Courts apply two tests for determining whether a transaction is within the ordinary course of business for purposes of § 363(c)(1)—the vertical dimension test (sometimes characterized the "creditor's expectation test"), and the horizontal dimension test. Id. A transaction that meets both tests is in the ordinary course of business. Id.
The vertical dimension test "views the disputed transaction from the vantage point of a hypothetical creditor and inquires whether the transaction subjects a creditor to economic risks of a nature different from those he accepted when he decided to extend credit." Id. (quoting Burlington N. R.R. Co. v. Dant & Russell, Inc. (In re Dant & Russell, Inc.), 853 F.2d 700, 704 (9th Cir.1988)). In determining whether a transaction meets this test, courts often compare the debtor's prepetition business practices to his postpetition business activities. Id.
"Under the horizontal dimension test, the question is `whether the postpetition transaction is of a type that other similar businesses would engage in as ordinary business.'" Id. at 880-81 (quoting Dant & Russell, 853 F.2d at 704). The purpose of this test is "to assure that neither the debtor nor the creditor did anything abnormal to gain an advantage over other creditors." Id. at 881.
The Court finds that the Lease transaction was not made in the "ordinary course of business." Though Debtor is the undisputed owner of the Garrity Property, Gregerson was listed as "owner" of the Garrity Property in the December 13 Lease and Option, and it was Gregerson, not Debtor, who executed each of those documents. This was despite Gregerson's testimony that Debtor was personally present when the Lease and Option were executed, and despite the previous agreements with Tam and Liang, in which Debtor identified himself as, and signed as, "owner" of the Garrity Property. Debtor claims that he
Furthermore, Debtor did not disclose the post-petition Lease transaction or the income generated from that transaction to the chapter 13 trustee, Trustee, or this Court.
The unusual structuring of the Lease transaction, when coupled with the omission of rental income in Schedule I and Debtor's subsequent failure to disclose or report the Lease transaction, Option payment, and rental income, manifest an intent to hinder, delay, or defraud creditors and the trustee. In particular, the failure to disclose the rental income, either in Schedule I or otherwise, belies Debtor's contention that his intent was to fund a chapter 13 plan with those funds. Instead, the evidence suggests, and the Court finds, that Debtor's intent was to conceal the income from the Option and Lease, thereby shielding it from the reach of creditors in Debtor's bankruptcy case. Consequently, Debtor's discharge will also be denied under § 727(a)(2)(B).
Based on the foregoing, Debtor will be denied discharge of his debts under § 727(a)(2)(A) and § 727(a)(2)(B). Further, Trustee may avoid the transfers of Debtor's interest in the Orchard Property, the $10,000 gift from Kenneth Wheeler, and the 1999 Yamaha, 2003 Honda, and 2006 Honda motorcycles under § 548(a)(1)(A). The remainder of Trustee's claims will be dismissed.
Trustee shall submit a judgment and order consistent with this Decision.
