In re Walldesign, Inc.
| Decision Date | 17 July 2015 |
| Docket Number | Case No. SACV 14-01724-VAP,USBC Case No. 8:12-bk-10105-CB,Case No. SACV 15-00167-VAP |
| Court | U.S. District Court — Central District of California |
| Parties | IN RE: WALLDESIGN, INC., A SUBCHAPTER S CORPORATION. |
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 130individuals 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, 2012.1 The Committee brought 96 separate adversary proceedings to recover payments Bello made from the secret account, including the payments to Buresh & Phillips.
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 thedecision of the Bankruptcy Court, and REMANDS for further proceedings.
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.)2 The Committee, therefore, could not recover the payments from them.
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.").)3
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").)
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 facts are not in dispute.
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.)
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'saddress, 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.)4
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 clubfees 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.)
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.)
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.
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 thetransfer 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).5 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 1070.6
"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.
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