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In re of Walldesign, Inc.

United States Court of Appeals, Ninth Circuit

October 2, 2017

In the Matter of Walldesign, Inc., a subchapter S. Corporation, Debtor,
v.
Official Committee of Unsecured Creditors of Walldesign, Inc., Appellee. Lisa Anne Henry, DBA Henry West Designs, Appellant, In the Matter of Walldesign, Inc., a subchapter S. Corporation, Debtor, Donald F. Buresh, an individual; Sharon J. Phillips, an individual, Appellants,
v.
Official Committee of Unsecured Creditors of Walldesign, Inc., Appellee.

          Argued and Submitted March 10, 2017 Pasadena, California

         Appeals from the United States District Court for the Central District of California D.C. No. 8:14-cv-01725-VAP, 8:15-cv-00167-VAP Virginia A. Phillips, District Judge, Presiding

          Steven J. Katzman (argued) and Anthony Bisconti, Bienert Miller & Katzman PLC, San Clemente, California, for Appellants.

          John P. Reitman (argued) and Jack A. Reitman, Landau Gottfried & Berger LLP, Los Angeles, California, for Appellees.

          Before: A. Wallace Tashima and Jacqueline H. Nguyen, Circuit Judges and Algenon L. Marbley, [*] District Judge.

         SUMMARY[**]

         Bankruptcy

         The panel affirmed the district court's reversal of the bankruptcy court's summary judgments in favor of the defendants in two adversary proceedings seeking recovery of fraudulent transfers.

         Applying the "dominion test, " the panel held that creditors who received misappropriated funds from the debtor corporation's sole shareholder, director, and president were initial transferees under 11 U.S.C. § 550(a)(1). They therefore were not entitled to the safe harbor of § 550(b)(1) for subsequent transferees, and the Committee of Unsecured Creditors could recover the funds both from the corporate cheat and those parties to whom he first made payments from the corporate account.

         The panel affirmed the district court's judgments in favor of the Committee and remanded with instructions to remand both cases to the bankruptcy court for further proceedings.

         Dissenting, Judge Nguyen wrote that the result of the majority's decision was not equitable. She wrote that the court should consider adopting the "control test" used by other circuits, or at least returning to a hybrid "dominion and control" approach. In addition, even applying the dominion test, the defendants were not initial transferees.

          OPINION

          MARBLEY, District Judge

         It is said that bad facts make bad law. These appeals test that maxim against the often esoteric backdrop of the Bankruptcy Code. More specifically, the court must decide who is liable for voidable payments in bankruptcy proceedings when a debtor corporation's sole shareholder, director, and president misappropriates company funds to fuel his own version of "lifestyles of the rich and famous."

         The bankruptcy court held that the Committee of Unsecured Creditors ("the Committee") could recover the fraudulently transferred funds solely from the corporate cheat, because the appellants were subsequent transferees who accepted the payments for value, in good faith, and without knowledge of their voidability. See 11 U.S.C. § 550(b)(1) (the "safe-harbor" provision).

         The district court reversed, concluding that the appellants were initial transferees under § 550(a)(1) and, therefore, not entitled to the safe harbor under § 550(b)(1) for subsequent transferees. Under the district court's view, the Committee could recover the funds from both the corporate cheat and those parties to whom he first made payments from the corporate account.

         Although the equities seem harsh at first glance, our reading of the statute and the case law persuades us that the district court was correct. By enacting 11 U.S.C. § 550, Congress assigned liability for repaying voidable transfers to both the "good guys" (initial transferees, like the appellants) and the "bad guys" (those for whose benefit the transfer was made, like corporate cheats), because "good guys" who are party to those transfers generally stand in a better position to guard against corporate fraud than do unsuspecting creditors. We therefore AFFIRM the judgments of the district court in favor of the Committee[1] and REMAND these cases to the bankruptcy court for further proceedings.

         I. BACKGROUND

         Sections 544 and 548 of the Bankruptcy Code empower a liquidating trustee to enlarge the debtor's estate by invalidating fraudulent transfers of property, including money, thereby making the property a part of the debtor's estate again. 11 U.S.C. §§ 544(b)(1), 548(a)(1)(B).

         Section 550, in turn, dictates who must reimburse the trustee and, through the trustee, the debtor's creditors, for those fraudulent and "avoided" transfers. Id. § 550. These appeals hinge on § 550 and determining whether the appellants were initial transferees of fraudulent payments under § 550(a)(1), and thus strictly liable to the Committee, or subsequent transferees, who may avail themselves of the safe-harbor provision of § 550(b)(1).

         A. Factual Background

         Michael Bello served as the sole shareholder, director, and president of Walldesign, Inc., a California corporation that installed drywall, acoustical material, and plaster in construction projects in California, Nevada, and Arizona. Bello oversaw Walldesign's day-to-day business operations, as well as the company's finances.

         Walldesign maintained its primary bank account at Comerica Bank in El Segundo, California. Walldesign generally deposited its accounts receivable in and paid its expenses from this primary account. The primary account was disclosed in the general ledger and other books and records of Walldesign. And, when Bello signed the Schedules and Statement of Financial Affairs in Walldesign's bankruptcy case, he disclosed the company's primary account in those filings.

         In 2002, Bello opened a different bank account in Walldesign's name at Preferred Bank in Irvine, California. When he opened this account, 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 authority as an agent of Walldesign to open the account. That said, Bello used his home as the secondary account's address; he did not disclose the account in Walldesign's general ledger or other records; and he later made his wife- who was not a Walldesign employee-a signatory to the account. Bello, moreover, tried to conceal the secondary account during Walldesign's bankruptcy proceedings.

         Although most of Walldesign's income and expenses flowed through its primary account, Bello devised a system whereby rebates from the company's suppliers were deposited into the secondary account instead. Rather than deduct the rebates from Walldesign's invoice, suppliers issued checks to Walldesign for the difference. Bello then deposited the rebate checks into Walldesign's secondary account, without disclosing the deposits to the company's management, its creditors, or even the bankruptcy court. Bello channeled nearly $8 million of Walldesign funds into the secondary account in the ten years he operated it.

         Bello then used the funds in Walldesign's secondary account to support his own lavish lifestyle rather than for legitimate business purposes. You name it, Bello spent it, including paying for the following: (1) to operate Bello's family vineyards; (2) to operate Bello's horseracing stable; (3) to operate other unrelated business entities Bello controlled; (4) Bello's Las Vegas casino bills; (5) Bello's personal expenses charged on his American Express credit card; (6) Bello's homeowners association and country club fees for two private golf courses; and (7) to pay for a "tasting room" property purchased by RU Investments, one of Bello's other business ventures. In total, Bello paid nearly $8 million from the secondary account to roughly 130 individuals and entities. All of the payments that Bello caused Walldesign to make from this secondary account were for his personal expenses and not for the benefit of the company or its creditors.

         Bello's actions ultimately impacted the appellants, Donald Buresh and Sharon Phillips ("the Bureshes") and Lisa Anne Henry. The Bureshes are a married couple who owned real property in St. Helena, California ("the Property"). In 2009, they sold the Property to a Bello-controlled entity, RU Investments, for roughly $220, 000. The Bureshes sold the Property for a fair value and at arms' length. Over the next two years, Bello made payments to the Bureshes from checks drawn on Walldesign's secondary account. These checks all bore the name "WALLDESIGN INCORPORATED." Ultimately, Bello located a Bello Family Vineyard "tasting room" on the Property. Aside from the sale of the Property, the Bureshes had no preexisting relationship and have no ongoing relationship with Bello, his family, or any of his businesses.

         Ms. Henry is the owner of Henry West Design, a small interior design firm. She met Bello through a client, who referred her to Bello for design services on a building he (not Walldesign) owned. She provided design- and construction-related services for Bello over nine years, always at her standard rates, in arms' length transactions. Bello did not personally pay for these services; instead, he drew checks from Walldesign's secondary account, as well as from other businesses he operated. In total, Bello spent over $230, 000 on Ms. Henry's design services. Aside from providing these services, Ms. Henry had no pre-existing or ongoing relationship with Bello, his family, or any of his businesses.

         B. Procedural Background

         Walldesign petitioned for bankruptcy on January 4, 2012. The Committee was appointed to represent creditors' interests a few days later. The Committee eventually brought ninety-six separate adversary proceedings to recover payments Bello made from the secondary account, including the payments to the Bureshes and Ms. Henry. All told, the Committee sought to recover $220, 350.00 from the Bureshes and $232, 948.16 from Ms. Henry.

         The Committee also filed a complaint against Bello, his wife, and various other Bello-related individuals and entities-seeking to recover an amount equal to all identified payments made from the secondary account, including the payments made to the Bureshes and Ms. Henry.

         In June 2014, the Bureshes and Ms. Henry filed motions for partial summary judgment against the Committee. The Bureshes and Ms. Henry argued that they were not liable to the Committee for any fraudulent transfers because they were not "initial transferees" under 11 U.S.C. § 550(a)(1) but, rather, were subsequent transferees entitled to the safe harbor under § 550(b)(1). The bankruptcy court granted the motions for partial summary judgment, first in an oral order on July 31, 2014, and later issued brief written orders in both cases. The Committee then appealed both orders to the district court.

         On July 17, 2015, the district court reversed the decision of the bankruptcy court in the Bureshes' case (the lead case). In re Walldesign, Inc., No. SACV 15-00167-VAP, 2015 WL 4399843 (C.D. Cal. July 17, 2015). The district court found the Bureshes strictly liable to the Committee because they qualified as "initial transferees" of the fraudulent payments that Bello made from Walldesign's secondary account under § 550(a)(1). Id. at *7. In the same order, the court administratively closed Ms. Henry's appeal for the same reason, thereby remanding both cases to the bankruptcy court for further proceedings. Id.

         The Bureshes and Ms. Henry timely filed their notices of appeal of the district court orders.

         II. STANDARD OF REVIEW

         We review the district court's decision on an appeal from a bankruptcy court de novo. Barclay v. Mackenzie (In re AFI Holding, Inc.), 525 F.3d 700, 702 (9th Cir. 2008). Because these appeals stem from the grant of summary judgment, we must determine whether the pleadings and supporting documents show that there is no genuine dispute as to a material fact and that the moving parties are entitled to judgment as a matter of law. Id.

         III. ANALYSIS

         A. Statutory Scheme: The Bankruptcy Code Draws a Critical Distinction Between Initial and Subsequent Transferees.

         The Bankruptcy Code draws a critical distinction between initial and subsequent transferees when it comes to the recovery of fraudulent transfers. When a trustee has proven the avoidability of a fraudulent transfer, the trustee may recover the property (or its value) from "(1) the initial transferee of such transfer or the entity for whose benefit such transfer was made; or (2) any [subsequent] transferee of such initial transferee." 11 U.S.C. § 550(a). The trustee, however, may not recover the property or its value from a subsequent transferee if that transferee accepted the property "for value . . ., in good faith, and without knowledge of the voidability of the transfer." Id. § 550(b)(1).

         This distinction between initial and subsequent transferees is "critical." Schafer v. Las Vegas Hilton Corp. (In re Video Depot, Ltd.), 127 F.3d 1195, 1197 (9th Cir. 1997). Trustees have an absolute right of recovery against the "initial transferee" and any "entity for whose benefit such transfer was made." Danning v. Miller (In re Bullion Reserve of N. Am.), 922 F.2d 544, 547 (9th Cir. 1991). While trustees "[t]heoretically" can recover from subsequent transferees as well, subsequent transferees who accepted the property "for value, in good faith, and without knowledge" of the voidability of the transfer may avail ...


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