Opinion
NOT FOR PUBLICATION
Argued and Submitted at Phoenix, Arizona: October 19, 2006
Appeal from the United States Bankruptcy Court for the District of Arizona. Bk. No. 02-15508-GBN, Adv. No. 05-00720. Honorable George B. Nielsen, Jr., Bankruptcy Judge, Presiding.
Before: KLEIN, PAPPAS and DUNN, Bankruptcy Judges.
MEMORANDUM
The chapter 7 trustee appeals a summary judgment in favor of the appellee law firm based upon the bankruptcy court's conclusion that the appellee was not an " initial transferee" of an avoided transfer for purposes of 11 U.S.C. § 550(a)(1). Guided by the construction given this statute in a decision by the Ninth Circuit entered after the summary judgment, we REVERSE.
FACTS
In May 2001, Jorge Arias executed a Client Retainer Agreement (" Fee Agreement") with appellee, Mancini & Associates, P.C., to file a defamation action against the debtor, Gonzalez, Inc. Arias agreed that the appellee's fee would constitute 50 percent of any amount recovered from the debtor, plus costs. The Fee Agreement also granted the appellee a lien for fees and costs and authorized payment from funds recovered.
The appellee commenced suit in California state court on behalf of Arias against the debtor in December 2001, seeking damages in excess of $100,000.
In June 2002, mediation led to an agreement between the parties to settle the lawsuit for $15,000.
In accordance with the settlement agreement, on June 28, 2002, the debtor transmitted to the appellee a $15,000 settlement check that was made payable to " Mancini & Associates, P.C." The appellee deposited the entire amount of the check into its attorney client trust account (" CTA").
Pursuant to the terms of the Fee Agreement, the appellee then withdrew from the CTA its 50 percent contingency fee ($7,500).
On September 30, 2002, the debtor filed a chapter 11 case that was converted to chapter 7 in September 2004.
Appellant chapter 7 trustee filed an adversary proceeding against the appellee and Arias to avoid and recover the $15,000 payment as a preferential transfer under 11 U.S.C. § § 547 and 550(a).
The appellant filed a motion for summary judgment directed at the $7,500 the appellee retained from the settlement proceeds as its attorney's fees. In addition to opposing the appellant's summary judgment motion, the appellee filed a cross-motion for summary judgment arguing that it was a " mere conduit" and not an " initial transferee" of the " allegedly preferential settlement payment" under § 550(a)(1).
A hearing on the cross-motions for summary judgment was held on April 7, 2006. The court ruled that the settlement amount paid by the debtor was an avoidable preference under § 547(b).
After ruling that the transfer was avoided under § 547, the court turned to the issue of whether the appellant could recover from the appellee the $7,500 attorney's fee under § 550(a)(1). The court agreed with the appellee that it was not an " initial transferee" of the transfer from the debtor. Since it also was established that the appellee satisfied the requirement for the " good faith" defense that is available to a " mediate transferee" under § 550(a)(2), the court granted appellee's cross-motion for summary judgment.
The court did not, and was not asked to, consider whether the appellee might also qualify as a person for " whose benefit such transfer was made, " which would also trigger § 550(a)(1).
Judgment was entered pursuant to Federal Rule of Civil Procedure 54(b). This timely appeal ensued.
JURISDICTION
The bankruptcy court had jurisdiction via 28 U.S.C. § § 1334 and 157(b)(2)(F). We have jurisdiction under 28 U.S.C. § 158(a)(1).
ISSUE
Whether the $7,500 fee that appellee law firm withdrew from funds in its CTA paid by the debtor pursuant to a settlement agreement between the debtor and the appellee's client rendered the firm an " initial transferee" and is recoverable by the chapter 7 trustee under 11 U.S.C. § 550(a)(1).
STANDARD OF REVIEW
The bankruptcy court's grant of summary judgment is reviewed de novo. Soldano v. United States, 453 F.3d 1140, 1143 (9th Cir. 2006.)
DISCUSSION
We agree with the bankruptcy court and the parties that there are no genuine issues of material fact, but disagree as to which party is entitled to judgment as a matter of law.
The question posed by the assigned error is whether the appellee is an initial transferee of a $7,500 transfer by way of a check payable to the appellee that was deposited into the appellee's CTA and from which account the appellee took half of the funds as its attorney's fee. The bankruptcy court ruled that because the appellee's access to the funds in the CTA was restricted by state law, by ethical rules, and by contract, the appellee lacked sufficient dominion over the funds and thus could not be considered an initial transferee under § 550(a)(1).
On appeal, it is undisputed that the $15,000 transfer is an avoidable transfer under § 547(b). Because the concept of avoidance is separate from that of recovery, the issue on appeal focuses only on the recovery based on the concededly-avoided transfer. See H. Rep. No. 95-595 at 375-76 (1977); S. Rep. No. 95-989 at 90 (1978); Lippi v. City Bank, 955 F.2d 599, 605 (9th Cir. 1992); Plotkin v. Pomona Valley Imports, Inc. (In re Cohen), 199 B.R. 709, 718 (9th Cir. BAP 1996).
Hence, once a transfer is avoided the question becomes: from whom can the preferential transfer be recovered?
11 U.S.C. § 550(a)(1) provides:
Except as otherwise provided in this section, to the extent that a transfer is avoided under section 544, 545, 547, 548, 549, 553(b), or 724(a) of this title, the 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[.]
The trustee has, in effect, an absolute right to recover the avoided transfer from an initial transferee or from the entity for whose benefit such transfer was made. Schafer v. Las Vegas Hilton Corp. (In re Video Depot, Ltd.), 127 F.3d 1195, 1197-98 (9th Cir. 1997). The appellant argues that the appellee was an initial transferee when it paid itself $7,500 as its attorney's fees from the avoided transfer and cannot escape liability by " laundering money" through its CTA.
Although the appellee argued that it was a mere conduit and that one must have " dominion and control" of funds in order to be an initial transferee for purposes of § 550, the controlling question is whether the appellee had " dominion" over the funds.
In the Ninth Circuit, an initial transferee of funds is one who has " dominion" in the sense of sufficient legal control to invest the funds as one chooses. Danning v. Miller (In re Bullion Reserve of N. Am.), 922 F.2d 544, 548 (9th Cir. 1991), following Bonded Fin. Servs., Inc. v. European Am. Bank, 838 F.2d 890, 893 (7th Cir. 1988). This is the so-called " dominion" test.
In contrast, the Ninth Circuit has not adopted the so-called " control" test according to which one steps back and evaluates the transaction in its entirety in quest of a logical and equitable solution. Abele v. Modern Fin. Plans Servs., Inc. (In re Cohen), 300 F.3d 1097, 1102 n.2 (9th Cir. 2002). " Control" only figures in the Ninth Circuit in the sense of the legal control needed to invest funds as one chooses. Id. at 1102.
In a decision rendered after the judgment in the present appeal was entered, the Ninth Circuit clarified the dominion-control analysis of who is an " initial transferee" for purposes of § 550(a)(1) in Universal Serv. Admin. Co. v. Post-Confirmation Comm. of Unsecured Creditors of Incomnet Commc'ns Corp. (In re Incomnet, Inc.), 463 F.3d 1064, 1068-76 (9th Cir. 2006) (" Incomnet"), aff'g, 299 B.R. 574 (9th Cir. BAP 2003).
The Ninth Circuit emphasized that " dominion" and " control" are distinct concepts. Under the " dominion" test applicable in the Ninth Circuit, the inquiry " focuses on whether the recipient of funds has legal title to them and the ability to use them as he sees fit." Id. at 1071. Under the more flexible " control" test, which does not apply in the Ninth Circuit, the inquiry focuses on the " entire transaction as a whole to determine who truly had control of the money." Id. at 1070.
The Incomnet court explained that dominion " strongly correlates with legal title." Id. at 1073. In most cases, those with legal title to the funds will satisfy the dominion test. However, dominion may also occur in situations where there is a separation between legal title and the right to put those funds to use. Id. at 1073-74.
In such situations, the focus on dominion becomes more important. The court of appeals gave two examples of cases where title and right to use are separated. The first situation is when an " entity has legal title as a formal matter, but legally does not have any discretion in the application of funds, " which it illustrated as follows:
Consider a bank that receives currency from a depositor with instructions to deposit those funds into the account of a third party. In such a case, the bank will initially take title over the depositor's funds, but it will not have dominion over them because it has no discretion over the uses to which the depositor's money is to be put. Thus, the bank is not the transferee, but the conduit or agent for a general deposit.
Id. at 1074.
The second situation involves a case where an entity lacks legal title to the funds, but nevertheless has power over them. To illustrate, the court gave another example:
The second scenario, where an entity lacks legal title to funds, but nevertheless has power over them, may be illustrated by a trustee who is able to direct the disbursement of the funds in a trust account he manages, even though he does not own them. Such a trustee would therefore exercise dominion over the funds without holding title to them.
Id.
As to restrictions imposed from sources other than the transferor, Incomnet is also instructive. In analyzing the Incomnet situation, the Ninth Circuit twice invoked the notion of whether the funds in the hands of the putative initial transferee were vulnerable to " direct seizure or discretionary spending" by a third party. Id. at 1071 & 1074.
The Incomnet transferee was legally obligated to use the funds only as directed by the Federal Communications Commission, which lacked the ability to control the funds through " direct seizure or discretionary spending." Noting a prior circuit decision in which legal restrictions on the use of funds did not preclude initial transferee status, the Ninth Circuit explained:
[I]t is of no consequence that USAC cannot invest funds in - to use the Seventh Circuit's colorful phrase - 'lottery tickets or uranium stocks.' See Bonded Fin. Servs., Inc., 838 F.2d at 894. Here, USAC received the funds from Incomnet without any restrictions from Incomnet on their use. USAC commanded those funds and, like other individuals, its use of those funds was restricted by law. These legal restrictions merely limit how USAC will exercise its dominion over the funds; they do not preclude USAC from having dominion at all.
Id. at 1075 (emphasis in original), citing Kupetz v. United States (In re Cal. Trade Technical Sch., Inc.), 923 F.2d 641, 647 (9th Cir. 1991).
Based upon the guidance provided by the Ninth Circuit, we now turn to the facts of the case on appeal. Here the debtor and Arias settled their state court litigation claims for $15,000. In accordance with the settlement agreement, the debtor wrote a $15,000 check payable to the appellee. The appellee deposited the entire amount into its CTA. The appellee then withdrew from the CTA the $7,500 owed to it pursuant to its Fee Agreement with the debtor. Within ninety days after the settlement check was honored by the drawee bank, the debtor filed for bankruptcy. The trustee filed an adversary proceeding seeking recovery of the funds as a preferential transfer.
The bankruptcy court concluded that the appellee was not an initial transferee, but rather a mere " conduit" of the $7,500 it retained from the settlement funds paid to Arias. On appeal, the appellant argues only that the appellee is the initial transferee with respect to the $7,500 it retained as its fee. The appellant is not alleging that appellee is the initial transferee of the remainder of the $15,000. Hence, that issue is not before us and we need not decide it. We focus only on the $7,500 retained by the appellee.
The Fee Agreement that Arias entered into with the appellee stated that the appellee was entitled to " 50% of any amount that is recovered" from the lawsuit between Arias and the debtor. When Arias executed the settlement agreement and thereby " recovered" $15,000, the condition precedent to the appellee's contractual right to 50 percent of its client's monetary recovery was satisfied. In other words, the appellee's interest in its attorney's fees became due or fixed.
Under California Rule of Professional Conduct 4-100(A)(2), the portion of the funds belonging to the appellee as its fee was required to be " withdrawn at the earliest reasonable time after [the appellee's] interest in that portion [became] fixed, " unless disputed by the client. Arias did not dispute the appellee's right to the fees. Therefore, upon recovery of the settlement funds, the appellee became the legal owner of the $7,500 and was entitled to withdraw the money from the CTA.
Even though Arias may have retained an equitable interest in the settlement amount collected and may have been able to limit the appellee's control over the funds as a whole, the absence of any dispute over the amount of the fees left Arias with no beneficial interest in the funds the appellee retained as its fee. See Commercial Recovery, Inc. v. Mill St., Inc. (In re Mill St., Inc.), 96 B.R. 268, 269-270 (9th Cir. BAP 1989) (under § 550(a)(1), the court must separately analyze the fees retained from the total amount of the preferential transfer).
Because the appellee obtained legal title to the $7,500 fee it retained and, by contract, had the power to pay itself, the appellee had legal control over that portion of the settlement amount and had sufficient authority to direct disbursement to itself. That squares with dominion. Hence, the appellee is an initial transferee under § 550(a)(1). As noted, we are not asked to assess whether the appellee qualifies as an " entity for whose benefit such transfer was made" for purposes of § 550(a)(1). Incomnet, 463 F.3d at 1076; Cohen, 300 F.3d at 1102; Mill St., 96 B.R. at 269.
CONCLUSION
The bankruptcy court erred when it granted the appellee's cross-motion for summary judgment. Because the appellee obtained legal title to the funds pursuant to the fee agreement with its client (Arias), it is an initial transferee of the $7,500 it retained as attorney's fees from the debtor's funds deposited into the appellee's CTA. Since there are no genuine issues of material fact and since Incomnet makes clear that the appellant is entitled to judgment as a matter of law, we REVERSE and REMAND with instructions to enter judgment in favor of the appellant.