Opinion
Case No.-98-60056-MM, Adversary No. 00-5453.
April 11, 2008
MEMORANDUM DECISION AND ORDER FOLLOWING TRIAL
INTRODUCTION
Suzanne Decker, the trustee of the bankruptcy estate of Antovich Construction, Inc., filed this adversary proceeding to recover over $300,000 that defendant Dorothy Antovich transferred from ACI to herself in the two years prior to ACI's bankruptcy. The trustee asserts that Dorothy made the transfers with either actual or constructive fraudulent intent and therefore, the transfers are avoidable under California's Uniform Fraudulent Transfer Act. Cal. Civ. Code § 3439 et. seq. Dorothy asserts that the transfers were not fraudulent. To the contrary, the transfers were proper payments on loans that she and her deceased husband, Dan Antovich, had made to ACI.
Following a two day trial, the court took the matter under submission. Based on the evidence adduced and the arguments of counsel, and for the reasons explained, the court concludes that the trustee has failed to satisfy her burden of proof, and judgment is awarded in favor of Dorothy and against the trustee.
FACTS
Many facts related to this matter are recounted in the court's Memorandum Decision and Order dated December 28, 2006, which was issued following an evidentiary hearing on several preliminary matters. While some facts may be repeated here, they are a limited version as needed for a proper understanding of the events at hand.
Dorothy is the widow of Dan Antovich, a businessman who founded and served as the sole shareholder of ACI, a company that provided excavating contract services. Radomir "Rocky" Antovich is Dan's adult son and Dorothy's step-son. Dan formed ACI in October 1985. From its inception, Rocky was closely involved in ACI's operations. Dan discussed business decisions with Rocky, and Rocky was familiar with every detail of the business enterprise. According to Rocky, Dan told Rocky that he wanted Rocky to take over the business someday.
ACI's business office was located in a building owned by "Dan Antovich Construction," a fictitious business name for Dan. The office space was leased from DAC, and ACI paid rent as well as its share of utilities for the building.
By the late 1980's, ACI was no longer profitable. Dan and Dorothy found it necessary to loan money to the company to keep it operating. Dorothy testified that she and Dan refinanced their home to fund the loans. She recalls that there were at least two separate loans during the early 1990s and that the aggregate outstanding balance of the loans was around $500,000. For each loan, Dan wrote out the terms of the notes by hand. From his notes, she typed up the actual notes that were executed. Two promissory notes, payable to Dan and Dorothy, in the amounts of $300,000 and $520,000 are part of ACI's business records. ACI's books for the fiscal year ending September 30, 1995 reflect that the remaining balance due to Dan and Dorothy as of that date was $516,600. This amount is repeated in the 1995 tax return prepared by ACI's accountants.
In 1995, Dan was diagnosed with leukemia, and he passed away in October of that year. At the time of Dan's death, Dorothy knew that ACI was insolvent. Dorothy testified that, shortly before Dan's death, he advised Dorothy that the business was in trouble and that there was no money. He told her that the only income source would be progress payments from a large project being managed by Rocky in Hayward, California. Dan warned Dorothy that she would probably have to sell some equipment to keep the company running.
After Dan's death, Dorothy became ACI's sole shareholder and took over running the business on a day to day basis. Rocky demanded that Dorothy make good on Dan's promise to give Rocky the business. He advised her that if she did not transfer ownership of ACI to him, he would leave the company. Dorothy refused to make the transfer and Rocky left the company, leaving the Hayward job that he was managing unfinished. In January 1996, Rocky filed a state court action against ACI and Dorothy that seeks specific performance of Dan's promise to transfer the business to Rocky and damages for unpaid wages.
Following Rocky's departure, Dorothy had to retain an outside contractor to complete the Hayward job. To keep the business operating until the project could be finished, Dorothy from time to time transferred additional funds, aggregating $173,000, from her personal account to ACI. The parties dispute whether or not these new transfers constituted loans, but they agree that the transfers were secured by security agreements and UCC-1 financing statements. In approximately April 1996, the Hayward project was completed, and Dorothy began to wind down ACI's business. By September 1996, ACI had no business other than paying outstanding bills and defending Rocky's lawsuit against the company.
On several occasions beginning in February 1996 through February 1997, Dorothy made large withdrawals from ACI's bank account. Dorothy characterizes these withdrawals, totaling $266,500, as repayments on the various loans she and Dan made to ACI. Dorothy never allocated the lump sum payments between principal and interest. However, she believes that the company's accountants would have made this allocation. She never received any Internal Revenue Service forms reflecting an amount of interest paid by or received from ACI.
At the earlier trial, ACI's former accountant testified that ACI often paid for personal expenses of Dan and Dorothy. On ACI's books, these payments were coded with the identifying number "286." At the end of each year, when the accountants reconciled the books, the total amount of category 286 payments were set off against the loan amounts that the company owed to Dan and Dorothy. Dorothy testified that she continued this practice after Dan's death. Rocky, however, was not aware of the practice either before or after Dan's death.
The trustee offered a spreadsheet prepared by Rocky, which summarizes all payments following Dan's death and before the filing of ACI's bankruptcy that Rocky believes were, at least partially, payments attributable to Dorothy's personal expenses. Based on the spreadsheet, Dorothy may have received $59,163.95 in personal expense reimbursement.
The spreadsheet also indicates that, in addition to the expense reimbursement, Dorothy indirectly received $17,181.79 in rent that ACI paid to the fictitious business entity, Dan Antovich Construction, following Dan's death. According to the parties' Joint Pre-Trial Statement, the trustee contends that the amounts paid as rent exceeded the rent actually due by at least $8,430.79 and maybe as much as $11,400. At trial, however, Rocky conceded that he did not know what portion of the rent was an overpayment.
Although the trustee's complaint originally set forth nine claims for relief, she has dismissed the first through fourth and the ninth claims. The sole remaining claims are the fifth claim for relief, which alleges that the transfers from ACI to Dorothy were actually fraudulent under the California Uniform Fraudulent Transfer Act, and the sixth through eighth claims, which seek avoidance of the transfers based on constructive fraud.
LEGAL DISCUSSION
I. Because The Evidence Establishes That Dan and Dorothy Provided Loans To ACI, None of the Transfers to Dorothy Was Constructively Fraudulent.
Section 544(b) of the Bankruptcy Code allows a trustee to avoid any transfers of a debtor's property that would be avoidable by an unsecured creditor under applicable state law. 11 U.S.C. § 544(b). Under California law, a transfer is avoidable as constructively fraudulent where the debtor does not receive reasonably equivalent value and the transfer either is made when the debtor is insolvent or will make the debtor insolvent. To prove that the transfers to Dorothy were constructively fraudulent, the trustee here must establish that: 1) transfers of ACI's property occurred; 2) ACI did not receive reasonably equivalent value in exchange; and, at the time of the transfers, 3) ACI was insolvent, was made insolvent by the transaction, was operating or about to operate without property constituting reasonably sufficient capital, or was unable to pay debts as they become due. Cal. Civ. Code §§ 3439.04(a)(2) and 3439.05. Dorothy does not dispute that she caused ACI to transfer money to her following Dan's death. Moreover, the evidence establishes that, even before Dan's death, ACI was unable to pay its debts. As a result, the only disputed issue is whether ACI received reasonably equivalent value in exchange for the transfers made to Dorothy.
The trustee has conceded that if the amounts reflected in ACI's books as loans owing to Dan and Dorothy are valid loans, she cannot establish any claim based on constructive fraud. This concession makes sense because the transfers received were set off against the balance due on the loans. Extinguishment of otherwise valid debt would provide ACI with reasonably equivalent value for the transfers. The trustee argues, however, that the trustee should prevail on her constructive fraud claims because Dorothy cannot establish that the loans reflected on ACI's books and records were bona fide loans. This argument is not persuasive for two reasons.
First, as the plaintiff, it is the trustee's burden to establish each and every element of her claim, including the requirement that ACI did not receive reasonably equivalent value in exchange for the transfer. As a result, it is the trustee's obligation to demonstrate that the loans reflected in ACI's books are not bona fide loans. The trustee's attempt to shift the burden of proof to Dorothy is inappropriate. Second, the evidence before me indicates that it is more likely than not that the amounts that Dan and Dorothy, or later, Dorothy alone, transferred to ACI were loans. The early loans to ACI from Dan and Dorothy together are supported by promissory notes and are treated as loans both on ACI's books and by ACI's accountants. I find no reason to distrust ACI's business records, which were prepared and kept in the ordinary course of ACI's business by ACI's controller until her death in August 1995. The trustee asserts that ACI had a history of very loose financial dealings and, therefore, the books and records should not be accorded great weight. However, the books were reconciled by accountants at least through 1996. Further, even if some of Dan's business dealings were "loose" there is nothing in the record to suggest that the actual business records are inaccurate.
The trustee also contends that there is no proof that the consideration for the notes was ever paid. Although no check stubs are in evidence to document the actual transfer of the loan funds, Dorothy credibly testified that on at least two occasions, she and Dan transferred proceeds from a refinancing of their home to ACI. Similarly, Dorothy testified that over the course of the year following Dan's death, she transferred a total of $173,000 to ACI. Although there are no promissory notes in evidence for these transfers, it is apparent that Dorothy did not provide this money to ACI as an additional capital contribution. If she had, there would have been no reason to enter into security agreements or to file UCC-1 financing statements with respect to the $173,000 that she gave to ACI.
Finally, the trustee urges that the loan payments, whether by lump sum payment or reimbursement of personal expenses, were never allocated between principal and interest as they should have been if the loans were real. The evidence on this issue is minimal at best. Dorothy testified that she never allocated the loan repayments between principal and interest, and she never received any IRS 1099 forms evidencing interest income from ACI. However, she also testified that she believed the company's accountants made any necessary allocations. On the whole, this limited evidence is insufficient to overcome the other evidence indicating that Dan and Dorothy loaned money to ACI in an effort to keep it operating.
For all of these reasons, I conclude, based on a preponderance of the evidence, that the amounts that Dan and/or Dorothy transferred to ACI constitute valid loans. In light of this conclusion and the trustee's concession that, if there were loans, she cannot avoid any transfer from debtor to Dorothy as constructively fraudulent, Dorothy is entitled to judgment in her favor as to the sixth through eighth claims for relief set forth in the trustee's complaint.
II. The Evidence Fails To Demonstrate That Dorothy Antovich Transferred Funds With Actual Intent To Hinder, Delay Or Defraud Any Creditors Of ACI.
California law also authorizes the avoidance of transfers that are actually fraudulent. Cal. Civ. Code § 3439.04(a)(1). An actually fraudulent transfer is one made with "actual intent to hinder, delay, or defraud any creditor of the debtor." The focus of this provision is on the intent of the debtor. In re Beverly, 374 B.R. 221, 235 (9th Cir. B.A.P. 2007). As long as the debtor has the requisite state of mind, a transaction may qualify as actually fraudulent even if adequate consideration is provided. Plotkin v. Pomona Valley Imps., Inc. (In re Cohen), 199 B.R. 709, 717 (9th Cir. B.A.P. 1996). Because the statutory language is disjunctive, intent to defraud is not required; it is also enough if the debtor intended either to hinder or to delay a creditor. Beverly, 374 B.R. at 235. Finally, there is no requirement that the debtor intend to affect all of its creditors because the statute penalizes transfers with intent to hinder, delay, or defraud "any creditor." See In re Adeeb, 787 F.2d 1339, 1343 (9th Cir. 1986) (interpreting similar language in § 727(a)(2)).
To prevail in her claim based on actual fraud, the trustee must establish the requisite intent by a preponderance of the evidence. Because direct evidence of intent to hinder delay or defraud is rarely available, intent must often be inferred from the circumstances surrounding the transaction. Beverly, 374 B.R. at 235. The California Civil Code expressly incorporates eleven non-exclusive factors that may be considered in determining actual intent. See Cal. Civ. Code § 3439.04(b). While these so-called "badges of fraud" were not codified as part of California's Uniform Fraudulent Transfer Act until 2005, beginning in 1986, they were included in the comments to the statute and, historically, have been considered probative of actual intent. Nevertheless, the factors do not create a formula for demonstrating actual intent. No one factor is determinative, and no minimum or maximum number of factors is required. Filip v. Bucurenciu, 129 Cal. App. 4th 825, 834 (2005). Rather, a court must consider all the circumstances of the case as a whole. A court is entitled to conclude that actual intent exists even where no badges of fraud are present, or that no actual intent exists despite the presence of several badges.
A. The Preponderance of the Evidence Does Not Establish that Funds Withdrawn as Loan Repayments or the Amounts Paid as Expense Reimbursments Were Actually Fraudulent Transfers
With respect to the $266,500 in loan repayments and the $59,163.95 in personal expense reimbursements that Dorothy transferred from ACI to herself, the trustee relies on three badges of fraud to establish actual fraudulent intent. First, all the transfers at issue went to an insider of ACI. Second, Dorothy began making the large lump sum withdrawals approximately one month after Rocky filed his lawsuit against ACI. Third, even though Dorothy was aware that ACI was insolvent, she pulled out virtually all of ACI's cash assets.
While the presence of these three factors, under some circumstances, might be adequate to demonstrate actual intent, viewed in light of all the circumstances surrounding this case, I conclude that the evidence falls short of satisfying the trustee's burden of proof. The record before me establishes that after Dan's death, Dorothy was ill-equipped to run the business of ACI on a long-term basis. Her immediate concern was to preserve the company's single source of income and to avoid breaching the company's only contract by completing the project that was underway in Hayward, California. To accomplish this goal, over the course of the next year she loaned a substantial amount of her personal funds to the company but also withdrew money to pay herself back when money was available. Although the trustee would like to ascribe an evil intent to this movement of funds into and out of ACI, it is equally reasonable that this unsophisticated businesswoman was just trying to make ends meet, for herself and for ACI. The fact that all but one of the lump sum withdrawals occurred after Rocky sued ACI does little to establish that she withdrew the funds with actual intent to hinder, delay or defraud Rocky or any other creditor. If Dorothy's intent was to prevent creditors' access to the company's funds, one would expect to see quick and virtually complete withdrawal of all funds from ACI's accounts. In this case, however, Dorothy withdrew funds on several occasions over the two years following Dan's death. Moreover, during that same time period, Dorothy also loaned ACI approximately $173,000. The fact that Dorothy made deposits as well as withdrawals weakens any inference that Dorothy was acting to hinder, delay or defraud ACI's creditors.
At trial, the trustee's counsel argued that, as an insider, Dorothy owed a fiduciary duty to ACI's creditors once the company became insolvent. In light of that duty, he urged, any payment to Dorothy in advance of other creditors would constitute a fraudulent conveyance. I do not agree with this attempt to graft fiduciary requirements onto the fraudulent conveyance laws. Breach of fiduciary duty and fraudulent conveyance are separate and independent rules of law, and the trustee's reliance on Commons v. Schine, 35 Cal. App. 3d 141 (1973), does not convince me otherwise. In Commons, the bankruptcy trustee sued the dominating partner of the debtor partnership for damages arising out of a breach of fiduciary duty because the partner sold some property and used the proceeds to pay himself before other creditors, all while the partnership was insolvent. The trustee did not, however, seek to recover the transfer as a fraudulent conveyance. The defendant partner tried to persuade the court that the trustee's remedy was limited to recovery under the fraudulent conveyance laws, a cause of action that was not alleged in that case. The court concluded, however, that the common law governing breach of fiduciary duty could be applied even if the transfer could also be characterized as a fraudulent conveyance law. In this case, unlike Commons, the only claims for relief that the trustee has alleged are fraudulent conveyance claims. As a result, whether or not Dorothy breached any fiduciary duties that she owed to ACI's creditors is not material to the issues at hand.
Finally, the trustee asks the court to apply the doctrine of spoliation of evidence to draw an inference regarding Dorothy's wrongful intent based on a "laundry list of documents which inexplicably have disappeared." I decline to make this negative inferences based on the record before me. Under the spoliation of evidence doctrine, a trier of fact may draw an adverse inference from the destruction of evidence that is relevant to a case. Akiona v. United States, 938 F.2d 158, 161 (9th Cir. 1991). There are two rationales for this doctrine. First, from an evidentiary perspective, a party who has notice that certain documents are relevant to litigation and who proceeds to destroy the documents is more likely than not to have been threatened by the documents. Second, as a prophylactic measure, allowing an adverse inference will presumably deter parties from destroying evidence before it can be used. Id. Neither of these rationales justifies drawing an adverse interest in this case. Although Rocky prepared a list of missing documents related to ACI's business, there is no evidence in the record suggesting that Dorothy destroyed any of the records. At most, the list constitutes evidence that some documents are missing — nothing more. In fact, when shown several of the allegedly missing documents on cross-examination, Rocky had to concede that at least some of the listed documents were produced after he prepared his list and were not missing at all. Even if there was some evidence that the listed records had been destroyed, there is no evidence that Dorothy destroyed them with knowledge that the records were relevant to this litigation. Without the requisite knowledge, it is inappropriate to draw an adverse interest even from the destruction of the documents. Id.
For all the reasons explained, I conclude that the trustee has failed to establish by a preponderance of the evidence that either the loan repayments or the expense reimbursements paid to Dorothy were transfers made with actual intent to hinder delay or defraud a creditor of ACI.
B. The Preponderance of the Evidence Does Not Establish that ACI Overpaid Rent or that Any Overpayment of Rent Was an Actually Fraudulent Transfer to Dorothy.
The trustee offered evidence of three payments from ACI to its landlord, DAC, that the trustee claimed to be improper overpayments of rent. There is no evidence, however, to establish how much of the rental expenditures were overpayments. When Rocky was questioned as to why the rental payments were included in his spreadsheet of improper payments to Dorothy, he responded that he believed the amounts paid were overpayments, but he admitted that he could not tell how much was legitimate rental expense and how much was excessive. This failure of proof as to whether any particular amount of rent was an overpayment is fatal to the trustee's claim based on overpaid rent.
CONCLUSION
For the reasons explained, the court concludes that defendant Dorothy Antovich is entitled to judgment in her favor and against the trustee, Suzanne Decker, as to the fifth through eighth claims for relief set forth in the trustee's complaint. The parties are directed to confer and submit a proposed judgment consistent with this decision.
Good cause appearing, IT IS SO ORDERED.