Opinion
NOT FOR PUBLICATION
ORDER ON CROSS MOTIONS FOR SUMMARY ADJUDICATION
PETER W. BOWIE, Chief Judge United States Bankruptcy Court
This matter came on regularly for hearing on both the trustee's motion for summary adjudication and Bank of America's motion for summary judgment. Many of the underlying facts are not in dispute and are simply stated. David Winick was the sole member of Creative Capital Leasing from around May 1, 1999 forward. David Winick applied for five credit cards, in his own name and, ostensibly, for his own purposes. So far as appears from the records in this matter, the card issuers relied only on Mr. Winick's credit status in making its determinations to extend credit to him through the accounts. There was a sixth account set up in the names of Winick and the debtor, as joint applicants. That account is not at issue in this proceeding.
What is at issue is that Mr. Winick used monies he borrowed on the credit accounts to put into Creative Capital's accounts, although not always. Then, periodically he would cause Creative Capital to make payments to the card issuers on the respective accounts. Those prepetition payments by Creative Capital to the card issuers totalled $952, 377.54, on accounts Creative Capital had no obligation to pay. The instant motions turn on whether Creative Capital received reasonably equivalent value for those transfers, such that the bank has no obligation to refund them to the bankruptcy estate. Obviously, the trustee contends Creative Capital did not receive reasonably equivalent value because it had no obligation to make any payments to the bank on those accounts. The bank counters that Creative Capital did receive equivalent value because almost all the funds Mr. Winick borrowed on the five accounts can be traced to deposits made by Winick to Creative Capital's accounts. The bank then advances two arguments: 1) the deposits by Winick to Creative Capital's accounts were loans by Winick, not capital contributions; and 2) Creative Capital received the indirect benefit of those borrowed funds and should not be allowed to say it did not receive reasonably equivalent value.
The Court has subject matter jurisdiction pursuant to 28 U.S.C. § 1334 and General Order No. 312-D of the United States District Court for the Southern District of California. This is a core proceeding under 28 U.S.C. § 157(b)(2)(H).
The trustee relies on the First Circuit's decision in In re Rowanoak Corp., 344 F.3d 126 (2003). There, debtor's principal, Ms. Murphy, ran the Rowanoak Corporation, which acted as a general contractor while subcontracting out all the work. During Rowanoak's Chapter 7 case, the trustee learned of prepetition payments made by Rowanoak to Ms. Walsh, who was Ms. Murphy's mother. The trustee sued to recover those payments as fraudulent conveyances, while mother and daughter contended Ms. Walsh had made loans to Rowanoak and the payments by Rowanoak were repayments of some of those loans. After taking evidence, the court found that all the cancelled checks issued by the mother were payable to the daughter, not to Rowanoak Corporation. There was no evidence of any promissory note, security interest, mortgage or other documents evidencing a loan from Ms. Walsh to the corporation. Rowanoak's tax returns did not show any loan liability owed by the corporation to Ms. Walsh. The appellate court also noted that even if there were bank statements showing deposits to the corporation's account traceable in some way to Ms. Walsh's checks to her daughter:
Walsh could have given or loaned money to Murphy individually. Simply because Murphy then chose to deposit the funds into Rowanoak's bank account would not prove that Walsh loaned the funds to Rowanoak. Rowanoak and Murphy are two separate legal entities, and a gift or loan to one does not equate to a loan to the other.
The bank, in turn, relies on a Fourth Circuit decision, In re Jeffrey Bigelow Design Group, Inc., 956 F.2d 479 (1992). There, the facts were quite different. Debtor's 50% equity interest holder acquired its interest by a combination of a cash payment and arrangement with the bank for a line of credit for the express benefit of the debtor. The line of credit was personally guaranteed by the principals of the equity interest holder, and while the equity interest holder was nominally the borrower, "only the debtor received the draws and all payments were made directly from the debtor to [the bank]." 956 F.2d at 481. About five months after the line of credit was set up with the bank, the debtor executed a promissory note in favor of the equity interest holder, on substantially the same terms as the line of credit. When the debtor made payments directly to the bank on the line of credit, the balance due on the note to the equity interest holder was decreased. The appellate court summed up the factual circumstances as follows:
Technically, a tripartite relationship exists, where Donatelli & Klein [equity interest holder] is a creditor of the debtor and First American is a creditor of Donatelli & Klein. The debtor, in making its payments, in effect skips its true creditor and sends the money to First American, to whom it has no direct obligation.
Interestingly, the Bigelow opinion discusses the concept of "reasonably equivalent value" in very broad terms - much broader than the facts of the case support. The court quoted one writer as stating:
Reasonably equivalent value is not susceptible to simple formulation .... The focus is on the consideration received by the debtor, not on the value given by the transferee.
956 F.2d at 4 84. The court continued:
Hence, the proper focus is on the net effect of the transfers on the debtor's estate, the funds available to the unsecured creditors. As long as the unsecured creditors are no worse off because the debtor, and consequently the estate, has received an amount reasonably equivalent to what it paid, no fraudulent transfer has occurred.
With all due respect, this Court is persuaded that taken on its face, the foregoing statement is way over broad, and ignores the legal implications of how the funds came into the debtor's possession. A classic example is the capital contribution of an equity interest holder, who borrowed the money to purchase the equity interest, and then causes the debtor to repay the loan when the debtor has no obligation to pay that amount to either the borrower or the lender. The equity interest holder who makes a capital contribution receives the appropriate consideration in the entity's reflection on its books of the capital account contribution. Any further pay out by the debtor entity to the lender is a depletion of the debtor's assets that the debtor had no obligation to make, thereby reducing the estate to which the unsecured creditors could look, to borrow the vernacular of Bigelow.
The bank also relies on the Ninth Circuit's decision in Bauer v. C.I.R, 748 F.2d 1365 (1985). There, the issue was whether payments made "by two stockholders to their wholly-owned corporation were loans or contributions to capital." 748 F.2d at 1366. The important facts were that the books of the corporation showed the funds as loans, and "periodic payments by the corporation as principal and interest payments to the stockholders." Id. Further: "The corporation deducted the interest payments and the stockholders declared the interest payments as income and treated the principal payments as a return of capital." Id. The court elaborated:
The parties treated all of the transactions as loans and repayments. Each advance to Federal was evidenced by a negotiable promissory note that was unsecured and was payable on demand.
748 F.2d at 1367. The notes all carried a specified per annum interest rate. Moreover:
For each advance made to Federal, an amount representing "accrued interest payable" was entered in the corporate ledger at the end of each month as an addition to liabilities in the form of "outstanding loans payable - officers." . . . On its financial statements, Federal included the outstanding balances as a current liability labeled "loan payable - officers."
Id.
The Bauer court noted that Congress had authorized the Secretary of the Treasury to adopt regulations establishing factors to be used in deciding whether a payment was for debt or equity. Because the regulations were not issued until after the payments at issue, the court looked to the factors the Congress set out in its enabling legislation, and to the factors the court had identified in prior years. The court repeated 11 factors:
(1) the names given to the certificates evidencing the indebtedness; (2) the presence or absence of a maturity date; (3) the source of the payments; (4) the right to enforce the payment of principal and interest; (5) participation in management; (6) a status equal to or inferior to that of regular corporate creditors; (7) the intent of the parties; (8) "thin" or adequate capitalization; (9) identity of interest between creditor and stockholder; (10) payment of interest only out of "dividend" money; and (11) the ability of the corporation to obtain loans from outside lending institutions.
748 F.2d at 1368. The court explained: "No one factor is controlling or decisive, and the court must look to the particular circumstances of each case. . . . 'The object of the inquiry is not to count factors, but to evaluate them.' . . . The burden of establishing that the advances were loans rather than capital contributions rests with the taxpayer." Id.
Ultimately, in Bauer, the Ninth Circuit had little difficulty reversing the Tax Court's finding that the advances to the corporation were not loans but rather contributions to capital. In doing so, it noted that even "the Tax Court conceded: the existence of notes; fixed and reasonable interest rates; actual timely payment of interest, corresponding treatment of the interest as income by Bauer and Himmelfarb; . . .." 748 F.2d at 1370-71.
Simply stated, the Court disagrees with the bank's argument that somehow the Bauer factors support its claim that the funds winick deposited to Creative Capital's account were really loans, not capital contributions. To the contrary, the Court is persuaded by the uncontroverted evidence that Creative Capital booked the deposits as capital contributions. There is no evidence of any promissory notes or security interests granted to Winick in return for the deposits. There is no evidence of any terms of a hypothetical note, such as interest rate, duration, and repayment of principal. Looking at the Bauer factors, they strongly support the conclusion that winick's deposits into Creative Capital were capital contributions, not loans.
Conclusion
Because the Court finds and concludes, without any-controverting evidence, that Winick's deposits into Creative Capital from the funds he borrowed from the bank through his personal credit lines were contributions to capital, not loans, the payments made by Creative Capital to the bank on Winick's accounts depleted the assets available to Creative's unsecured creditors while not paying on any obligation owed by Creative Capital. Creative Capital, therefore, did not receive reasonably equivalent value for the payments it made to the bank.
Accordingly, the trustee's motion for summary adjudication on that issue shall be, and hereby is granted. For the same reasons, the bank's cross-motion for summary judgment is hereby denied.
The Court will separately notice a continued status conference in this matter.
IT IS SO ORDERED.