Bowers v. Kuse Enterprises Inc ( 1998 )

UNPUBLISHED
UNITED STATES COURT OF APPEALS
FOR THE FOURTH CIRCUIT
In Re: FLORIDA HOTEL PROPERTIES
LIMITED PARTNERSHIP PLAN TRUST
AGREEMENT,
Debtor.
EDWARD P. BOWERS, Trustee,
Plaintiff-Appellant,
No. 97-2507
v.
KUSE ENTERPRISES, INCORPORATED,
Defendant-Appellee,
and
J. R. KUSE,
Defendant.
In Re: FLORIDA HOTEL PROPERTIES
LIMITED PARTNERSHIP PLAN TRUST
AGREEMENT,
Debtor.
EDWARD P. BOWERS, Trustee,
Plaintiff-Appellee,
No. 97-2583
v.
KUSE ENTERPRISES, INCORPORATED,
Defendant-Appellant,
and
J. R. KUSE,
Defendant.
Appeals from the United States District Court
for the Western District of North Carolina, at Charlotte.
Graham C. Mullen, Chief District Judge.
(CA-93-410-3-MU, BK-91-31425-C, AP-93-3080)
Argued: May 7, 1998
Decided: September 22, 1998
Before ERVIN and HAMILTON, Circuit Judges, and
BLAKE, United States District Judge for the
District of Maryland, sitting by designation.
_________________________________________________________________
Affirmed in part and reversed in part by unpublished opinion. Judge
Ervin wrote the opinion, in which Judge Hamilton and Judge Blake
joined.
_________________________________________________________________
COUNSEL
ARGUED: Joseph Williamson Grier, III, GRIER, BELTHOFF &
FURR, P.A., Charlotte, North Carolina, for Appellant. Brad Alexan-
der Baldwin, JONES, DAY, REAVIS & POGUE, Atlanta, Georgia,
for Appellee. ON BRIEF: J. Cameron Furr, K. Lane Klotzberger,
GRIER, BELTHOFF & FURR, P.A., Charlotte, North Carolina, for
Appellant. R. Matthew Martin, JONES, DAY, REAVIS & POGUE,
Atlanta, Georgia, for Appellee.
_________________________________________________________________
Unpublished opinions are not binding precedent in this circuit. See
Local Rule 36(c).
_________________________________________________________________
2
OPINION
ERVIN, Circuit Judge:
The parties to a bankruptcy proceeding cross-appeal the district
court's decisions below. Kuse Enterprises, Inc. ("Kuse") appeals the
district court's affirmance of the bankruptcy court's finding that it
was the initial transferee of an unapproved post-petition transfer made
by means of a cashier's check, and the court's subsequent entry of
summary judgment in favor of the Trustee for the bankruptcy debtor
Florida Hotel Properties Limited Partnership ("FHP"). The Trustee
appeals the district court's finding, reversing the bankruptcy court,
that Kuse is entitled to a set-off for the transfer in question because
of a settlement agreement between the Trustee and the bank that
issued the cashier's check. For the reasons stated herein, we agree that
Kuse was the initial transferee and affirm the grant of summary judg-
ment, but reverse the district court and reinstate the bankruptcy
court's finding that Kuse was not entitled to a set-off for settlement
funds received by the Trustee.
I.
FHP owned ten Days Inn Hotels in Florida. Commercial Manage-
ment Corporation ("CMC") managed FHP and controlled its operat-
ing bank accounts. At all times relevant to this case, Sam McMahon,
III, was the president and one-third owner of CMC.
On July 2, 1991, FHP filed a voluntary petition under Chapter 11
of the Bankruptcy Code and operated as a debtor-in-possession until
a special examiner was appointed on December 13, 1991. On October
4, 1991, while FHP was still debtor-in-possession, McMahon caused
CMC to write two checks, each from a separate FHP operating
account, in the respective amounts of $295,000 and $300,000, to
Southern National Bank ("the Bank"). McMahon then instructed the
Bank to issue two cashier's checks to J.R. Kuse in like amounts. Each
cashier's check showed FHP as the remitter.
That same day, McMahon's administrative assistant delivered the
checks to Scott Starnes, an employee of Starnes Aviation. Starnes in
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turn delivered the checks to Michael Kuse, an employee of Kuse
Enterprises and son of J.R. Kuse. Michael Kuse delivered to Starnes
a bill of sale dated October 3, 1991, transferring an Augusta 109A
helicopter from Kuse Enterprises to Starnes Aviation. J.R. Kuse
deposited the two checks into Kuse Enterprises' operating account.
In another bill of sale dated October 3, 1991, Starnes Aviation
transferred title to the helicopter to Southland Realty Associates, Inc.,
a corporation wholly owned by McMahon. While Southland Realty
owned the helicopter, it was used by Team III Racing. Team III Rac-
ing owned and operated a NASCAR racing team, and was also wholly
owned by McMahon. On October 31, 1991, Southland Realty trans-
ferred the helicopter to Leasing Consultants, Inc., which in turn leased
the helicopter to Team III Racing. The helicopter was at no time titled
in the name of FHP or used by or for the benefit of FHP. The
$595,000 payment by FHP for the helicopter was not approved by the
bankruptcy court.
On February 22, 1993, FHP's trustee in bankruptcy, Edward P.
Bowers ("the Trustee"), brought an adversary proceeding against
Kuse Enterprises and J.R. Kuse under §§ 549 and 550 of the Bank-
ruptcy Code ("the Kuse proceedings"), seeking to recover the
$595,000 unauthorized post-petition transfer. See 11 U.S.C. § 549(giving trustee authority to avoid unauthorized post-petition transfers
of property out of estate); id. § 550 (authorizing trustee to recover
property transferred to extent transfer is avoided under § 549). Both
parties moved for summary judgment. The bankruptcy court held a
hearing, and on December 14, 1993 entered findings of fact and con-
clusions of law which determined that the money Kuse had received
was an avoidable transfer under § 549 and that Kuse was liable for the
transfer under § 550(a)(1) as the "initial transferee." The bankruptcy
court further concluded that J.R. Kuse was a "mere conduit" for the
funds from whom the Trustee could not recover. Kuse appealed.
On July 2, 1993, while the Kuse proceedings were underway, the
Trustee also filed a complaint against the Bank on behalf of FHP,
alleging 18 causes of action and seeking to recover numerous trans-
fers totaling over $14 million. Two of these causes of action alleged
that the Bank was the initial transferee of the $595,000 Kuse transfer.
On August 12, 1993, the Trustee filed a similar suit against the Bank
4
on behalf of another debtor, Southeast Hotel Properties Limited Part-
nership ("SEHP"). In May 1995, after the bankruptcy court had
granted summary judgment for the Trustee in the Kuse proceedings,
the Bank and the Trustee agreed to settle all claims between them
with respect to both FHP and SEHP for a lump sum of $1.5 million.
The settlement agreement expressly stated that it settled "any and all
. . . claims, actions or causes of action . . . whether in law or in equity,
whether known or unknown, whether in tort or contract, of any kind
or character, which [the Trustee] now has . . ., or could have asserted,
or may hereafter accrue . . . ." The agreement itself did not provide
for any allocation of the settlement proceeds among the various
claims listed in the Trustee's 18-count suit against the Bank; however,
when the bankruptcy court approved the settlement agreement on
June 20, 1995, it allocated 60.85% of the $1.5 million settlement to
FHP's estate and 39.15% to SEHP's estate.
While this settlement agreement was being finalized, the Kuse pro-
ceedings remained on appeal in the district court. On November 14,
1995, the district court remanded the Kuse proceedings to the bank-
ruptcy court for further consideration of certain affirmative defenses.
On remand, the bankruptcy court conducted a hearing and concluded
that none of those defenses barred summary judgment for the Trustee,
and Kuse, as the initial transferee, therefore remained liable for the
avoided transfer. At this hearing, however, Kuse raised the question
of whether it was entitled to a credit or set-off for funds received by
the Trustee from its settlement with the Bank under§ 550(d) of the
Bankruptcy Code, which prevents double recovery. See § 550(d)
(stating that trustee is entitled to only single satisfaction of claims
under § 550(a)). The bankruptcy court concluded that Kuse was not
entitled to any set-off.
Kuse appealed to the district court. The district court affirmed the
bankruptcy court's grant of summary judgment for the Trustee, find-
ing that Kuse was the initial transferee. However, the district court
reversed the bankruptcy court on the set-off issue, finding that Kuse
was entitled to a reduction in judgment based on settlement proceeds
the Trustee received from the Bank, and thus reduced Kuse's liability
to zero. Both parties now appeal the district court's rulings.
5
II.
Our review of the district court's decision is plenary; we apply the
same standard of review as the district court applied to the bankruptcy
court's decision. Findings of fact are reviewed for clear error and con-
clusions of law are reviewed de novo. Bowers v. Atlanta Motor
Speedway, Inc. (In re Southeast Hotel Properties), 99 F.3d 151, 154
(4th Cir. 1996).
III.
The first issue we must decide is whether the district court and
bankruptcy court correctly determined that Kuse was the "initial
transferee" of the avoidable transfer under § 550 of the Bankruptcy
Code. According to Kuse, it cannot be considered the initial transferee
because the Bank that issued the cashier's checks at FHP's directions
is the initial transferee. We disagree and find that Kuse was indeed
the initial transferee. We therefore affirm the lower courts' grants of
summary judgment for the Trustee.
Section 549 of the Bankruptcy Code entitles a trustee in bankruptcy
to avoid unauthorized post-petition transfers. See 11 U.S.C. § 549.
The persons from whom the trustee may recover property where a
transfer has been avoided under § 549 are set out in § 550 of the
Code, which states that:
[T]he trustee may recover, for the benefit of the estate, the
property transferred, or if the court so orders, the value of
such property, from--
(1) the initial transferee of such transfer or the
entity for whose benefit such transfer was made.
11 U.S.C. § 550(a). According to § 550, the trustee's power to
recover from an "initial transferee" is absolute. See Bowers v. Atlanta
Motor Speedway, Inc. (In re Southeast Hotel Properties), 99 F.3d
151, 154 (4th Cir. 1996) (hereinafter "Bowers I") (noting § 550 pro-
tects a good faith mediate or immediate transferee who has taken for
value without knowledge of the avoidability of the transfer, but that
6
the statute does not extend this same protection to either the "initial
transferee" or "the entity for whose benefit such transfer was made").
The Bankruptcy Code does not define "initial transferee." How-
ever, in Bowers I, a case related to this one and involving similar
facts, this court explicitly adopted the "dominion and control" test set
out in Bonded Financial Services, Inc. v. European American Bank,
838 F.2d 890 (7th Cir. 1988), to determine whether an entity is an
"initial transferee" under § 550(a). Bowers I, 99 F.3d at 156. The
dominion and control test, as we apply it, requires that in order to be
an initial transferee, a party must exercise legal dominion and control
over the property -- physical possession of the property is not suffi-
cient. Thus, a party who is acting as a "mere conduit" for the transfer
of the property and who has no legal right to use the funds for its own
purposes is not the "initial transferee" for purposes of § 550(a). See,
e.g., Bowers I, 99 F.3d at 155 ("[T]he initial transferee of property is
not always the initial recipient of the property, and . . . a party cannot
be an initial transferee if he is a ``mere conduit' for the party who had
a direct business relationship with the debtor." (citations omitted));
Rupp v. Markgraf, 95 F.3d 936, 941 (10th Cir. 1996) (stating that
dominion and control test requires that initial transferee have control
over the funds and "the right to put those funds to one's own pur-
pose").
Applying the dominion and control test to the facts here, we con-
clude that Kuse was the initial transferee of the $595,000 transferred
from FHP's operating accounts. Although the funds were put in the
Bank's possession, they were placed there solely to enable the Bank
to issue the cashier's checks to Kuse. The Bank had no right to use
the funds for other purposes and therefore lacked the authority to
exercise legal dominion and control over the funds. Accordingly,
under the dominion and control test as adopted by this court in
Bowers I, the Bank was not the "initial transferee" of the funds under
§ 550 of the Bankruptcy Code. Accord Rupp v. Markgraf, 95 F.3d 936(10th Cir. 1996) (applying dominion and control test and finding bank
that issued cashier's check not initial transferee because bank acted
only as financial intermediary).
Kuse makes two separate arguments why it cannot be the initial
transferee of the funds in question. First, it contends that the cashier's
7
checks constituted funds of the Bank, rather than of the estate. In
reaching this conclusion, Kuse relies heavily on the bankruptcy
court's decision in Ellis v. State Bank of Towner (In re Archie Camp-
bell, Inc.), 45 B.R. 416 (Bankr. D.N.D. 1984), which held that a cash-
ier's check is a transfer of funds of the issuing bank rather than funds
of the debtor. Id. at 419. The reasoning of the Archie Campbell bank-
ruptcy court was rejected by the district court that heard the case on
appeal, however, with that court holding that payment by cashier's
check did not preclude a finding that there had been a transfer of the
debtor's property. Ellis v. Dakota Bank & Trust (In re Archie Camp-
bell, Inc.), 54 B.R. 116, 118 (D.N.D. 1985) (remanding case to bank-
ruptcy court to determine whether under facts of the case cashier's
check in question involved a transfer of the bank's or debtor's prop-
erty).
Here, the checks written on FHP's account depleted the bankruptcy
estate by the not inconsiderable sum of $595,000. Kuse, in turn,
received $595,000 -- upon receipt of which it transferred the Augusta
109A helicopter to a third party. We therefore find that the payment
by cashier's check was a transfer, albeit indirect, of the debtor's funds
rather than of the Bank's funds. In reaching this conclusion, we join
numerous courts, including our own decision in Bowers I, that have
treated payment made by cashier's checks as transfers of a debtor's
property. See, e.g., 99 F.3d 151 (assuming without discussion that
payment by cashier's check was transfer of debtor's property);
Schafer v. Las Vegas Hilton Corp. (In re Video Depot, Ltd.), 127 F.3d
1195 (9th Cir. 1997) (same); IRS v. Nordic Village, Inc. (In re Nordic
Village, Inc.), 915 F.2d 1049 (6th Cir. 1990) (same).
Kuse's second argument is that the Bank acted in bad faith in its
handling of the debtor's funds, and is therefore not eligible for the
"mere conduit" exception to the strict application of § 550(a). Kuse
bases this argument on our decision in Huffman v. Commerce Security
Corp. (In re Harbour), 845 F.2d 1254 (4th Cir. 1998), in which we
held that when an "initial recipient is asking the court to ignore the
literal meaning of section 550(a)(1) on essentially equitable grounds,
this party must have acted in ``good faith' with respect to the relevant
transaction in order to be spared the effects of this code provision."
Id. at 1258. This case, however, is readily distinguishable from
Harbour on its facts.
8
In Harbour, the debtor made a number of avoidable transfers to a
friend of his. These transfers were made through a third party, who
happened to be a close family friend of the debtor and the mother of
the recipient of the funds. Claiming to have been entirely ignorant of
the reasons behind the financial maneuverings of the debtor and her
son, this third party argued that she should be considered a "mere con-
duit" for the funds and not the initial transferee. We rejected her argu-
ment, finding that she was at best a "willing dupe" in the transaction
and her failure to act in good faith prohibited us from finding her a
"mere conduit" in the transfer. However, as we noted in our Harbour
opinion, "the likelihood of bad faith on [a] defendant's part is less-
ened where the defendant is a commercial enterprise handling trans-
actions in a routine manner." Id. We find this case distinguishable on
those grounds. The Bank here, in contrast to the defendant in
Harbour, is a commercial entity that is in the business of issuing
cashier's checks in the course of its normal commercial transactions,
and Kuse has presented no evidence -- other than the allegations con-
tained in the Trustee's complaint against the Bank-- that the Bank's
issuance of the cashier's checks in question were other than routine
commercial transactions. We therefore see no basis for viewing the
Bank as other than a conduit for the funds transferred to Kuse, and
agree with the bankruptcy court's and district court's conclusion that
Kuse was the initial transferee of the unauthorized $595,000 transfer.
Accordingly, we affirm the grant of summary judgment for the
Trustee.
IV.
Although Kuse is deemed to be the initial transferee of the
$595,000 payment, the Bankruptcy Code's prohibition against double
recovery means that Kuse is entitled to offset its liability for the trans-
fer by any amount that the Trustee has already received for it from
another source. See 11 U.S.C. § 550(d). The second issue before this
court, therefore, is whether the $595,000 Kuse transfer was included
in the $1.5 million settlement agreement between the Trustee and the
Bank. If it was, then Kuse is entitled to a set-off. We find that the
transfer at issue was not included in the settlement agreement between
the Trustee and the Bank, and Kuse is not therefore entitled to any
set-off.
9
As noted above, in his attempt to recover the property of the estate,
the Trustee claimed, in separate litigation, both that Kuse was the ini-
tial transferee of the $595,000 payment (in its suit against Kuse), and
that the Bank was the initial transferee of the same payment (in two
counts of its suit against the Bank). The bankruptcy court ruled that
Kuse was the initial transferee two years prior to the settlement agree-
ment between the Trustee and the Bank; however, this ruling remains
on appeal to this day and the Trustee never formally amended his
complaint against the Bank to remove his claim for the $595,000
transfer.
Nonetheless, the bankruptcy court found that there had been no
merit in the Trustee's claim against the Bank under§§ 549 and 550
for the $595,000 Kuse transfer at the time of the settlement. Bankr.
Ct. Order, Oct. 7, 1996, at 3, in J.A. 914. Furthermore, in the alterna-
tive, the court noted that the Trustee and the Bank based their settle-
ment negotiations on "a theory for potential recovery from [the Bank]
based on transfers about which [the Bank] might have had actual
knowledge of impropriety," and that "[d]uring the parties' settlement
negotiations, the parties did not consider the Kuse Transfer as a trans-
fer for which [the Bank] might be liable under that theory." Id. Based
on this, the bankruptcy court made a finding of fact that "[t]he settle-
ment amount agreed [to] by the parties did not include recovery for
the funds transferred to Kuse." Id. The bankruptcy court therefore
concluded that the Trustee would not receive a double recovery for
the $595,000 Kuse transfer and Kuse was not entitled to a set-off
based on the Trustee's settlement with the Bank. Id.
The district court disagreed with this analysis, holding that the
bankruptcy court had committed clear error in finding that the settle-
ment agreement did not include the Kuse transfer because the agree-
ment expressly stated that it settled "any and all . . . claims, actions
or causes of action" asserted by the Trustee against the Bank. The dis-
trict court noted that at the time the settlement was reached, Kuse was
appealing the bankruptcy court's finding that it was the initial trans-
feree of the $595,000 payment and, because the Trustee had not
amended his complaint to remove his claim against the Bank for the
identical transfer, the Bank still faced the risk that it could be held lia-
ble for the $595,000 Kuse transfer. The district court therefore con-
cluded that, "[d]espite what the Trustee and[the Bank] may have
10
contemplated," the language of the settlement agreement encom-
passed the Kuse transfer and Kuse was therefore entitled to a full set-
off from the settlement proceeds. District Ct. Order of Sept. 30, 1997,
at 7-8, in J.A. at 1007-08.
We agree with the district court that whether or not the parties to
the settlement intended to include the Kuse transfer in their settlement
agreement is not dispositive. In a closely analogous case involving a
trustee's attempt to recover a preferential transfer claim under § 550
of the Bankruptcy Code, the Ninth Circuit warned of the "collusive
forces at play in these situations." Sims v. De Armond (In re Lendvest
Mortgage, Inc.), 42 F.3d 1181, 1182 (9th Cir. 1994). In Lendvest
Mortgage, the debtor had transferred $50,000 to an entity called Fund
II on behalf of the De Armonds. This $50,000 was deemed to be a
preferential transfer, and the trustee in bankruptcy sought recovery of
it from the De Armonds, for whose benefit the transfer had been
made. The trustee also brought an adversary proceeding against Fund
II, on grounds unrelated to the $50,000 preferential transfer. The
trustee and Fund II settled, and as part of the settlement the trustee
agreed to withdraw his claim (filed as part of Fund II's bankruptcy
proceedings) relating to the $50,000 transfer. The trustee then went
after the De Armonds for the transfer. See Sims v. De Armond (In re
Lendvest Mortgage, Inc.), 123 B.R. 623, 624 (Bankr. N.D. Cal. 1991).
Pursuant to § 550(a)(1), the trustee was entitled to recover the pref-
erential transfer claim from either Fund II, as the initial transferee, or
the De Armonds, as the persons for whose benefit the transfer was
made. Section 550(c) [now § 550(d)], however, limited the trustee to
a single satisfaction of the amount in question. The trustee argued that
its settlement with Fund II did not include any recovery on the
$50,000 transfer, because that claim had simply been dropped. The
Ninth Circuit approved of the bankruptcy court's refusal to accept the
allocation urged by the trustee, observing:
The settling defendant only cares about the total amount of
the settlement, but the plaintiff [trustee] greatly prefers that
the settlement be allocated to non-joint liabilities so as to
allow the plaintiff to recover more from other defendants.
Because of the lack of truly adverse interests, . . . the par-
11
ties' allocation is virtually meaningless and may not reason-
ably reflect the parties' relative liabilities.
Lendvest Mortgage, 42 F.3d at 1184. The Ninth Circuit, however,
rejected the bankruptcy court's proposed antidote to the collusive
forces at play in such a situation, which would have required a trustee
to give prior notice of the settlement to the affected non-settling par-
ties and get judicial approval of the allocation of the settlement in
order to prevent a non-settling party from using the settlement to off-
set for its own liability. Id. at 1183. Rather, the Ninth Circuit held,
"the bankruptcy court must undertake an independent allocation of the
settlement before it may conclude that the . . .[avoidable] transfer
claim has been completely or partially satisfied." Id. at 1185.
Here, as in Lendvest Mortgage, the interests of the Trustee and the
Bank were not truly adverse when they drafted their settlement agree-
ment: the Bank cared only about the total amount of the settlement,
while the Trustee would of course have preferred that the settlement
be structured so as to allow him to recover from other defendants,
such as Kuse. We therefore agree with the district court that, although
the parties to the settlement apparently did not consider the $595,000
Kuse transfer to be a part of their settlement, given the collusive
potential of such an agreement and the subsequent risk of prejudice
to the interests of non-settling parties, the court is not compelled to
accept the Trustee's assertion that its settlement with the Bank did not
include the Kuse transfer, but must undertake an independent alloca-
tion of the settlement.
The bankruptcy court did precisely that. Based on its knowledge of
the settlement negotiations and terms of the settlement agreement
between the Trustee and the Bank, it concluded as a matter of fact that
the Kuse transfer claim was not part of the settlement. We cannot say
that this finding is clearly erroneous. The amount of the settlement,
its terms, as well as the negotiations between the parties to the settle-
ment all indicate that no portion of the settlement was allocated to the
Kuse transfer. The Trustee simply received no recovery on the Kuse
transfer as a result of his settlement with the Bank.
Furthermore, we agree with the bankruptcy court that the Trustee's
claim against the Bank, which was based on its contention that the
12
Bank was the "initial transferee" for the Kuse transfer, was never
strong to begin with. Every court that has considered this claim has
rejected Kuse's argument that the Bank be held liable as the initial
transferee, and while the Trustee obviously attempted to make the
same argument in his complaint against the Bank, there was little
merit to it. At best there was never more than an attenuated risk that
the Bank might be liable for the Kuse transfer. Without any real risk
of liability on the Bank's part, the bankruptcy court did not clearly err
in finding the settlement did not cover this claim. Consequently, we
reverse the district court and reinstate the bankruptcy court's order
that Kuse not receive any credit or set-off against the court's judg-
ment based on the Trustee's subsequent settlement with the Bank.
V.
We find that Kuse Enterprises, as the first party to have legal
dominion and control over the unauthorized post-petition transfers
from the debtor's accounts, was the initial transferee under 11 U.S.C.
§ 550(a), and affirm the district court's grant of summary judgment
for the Trustee. Because the settlement agreement and receipt of
funds by the Trustee from the Bank does not constitute a double
recovery for the Trustee on the avoided transfer in question, Kuse
Enterprises is not entitled to any set-off against the settlement pro-
ceeds. Accordingly, we reverse the district court's order granting a
set-off and direct the district court to reinstate the bankruptcy court's
order denying a set-off.
AFFIRMED IN PART AND REVERSED IN PART
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