In Re: International Manufacturing Group, Inc.

Filing 1

FINDINGS of FACT and CONCLUSIONS of LAW signed by Bankruptcy Judge Robert S. Bardwil on 2/7/2018 RECOMMENDING that the Bank's motion be granted and that judgment be entered in favor of the bank and against the plan administrator. (Donati, J)

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1 FILED 2 Feb 07, 2018 3 UNITED STATES BANKRUPTCY COURT 4 CLERK, U.S. DISTRICT COURT EASTERN DISTRICT OF CALIFORNIA EASTERN DISTRICT OF CALIFORNIA 5 6 In re: 7 INTERNATIONAL MANUFACTURING GROUP, INC., 8 Debtor. 9 10 BEVERLY N. McFARLAND, Trustee, 11 Plaintiff, 12 v. 13 BATTLE CREEK STATE BANK, 14 Defendant. ) ) ) ) ) ) ) ) ) ) ) ) ) ) ) ) ) ) Case No. 14-25820-D-11 District Court No. 2:18-cv-0289 MCE (BK) Adv. Pro. No. 16-2082-D Docket Control No. MBL-5 DATE: TIME: DEPT: January 31, 2018 10:00 a.m. D 15 16 17 FINDINGS OF FACT AND CONCLUSIONS OF LAW On November 20, 2017, defendant Battle Creek State Bank (the 18 “Bank”) filed a motion for summary judgment against the 19 plaintiff, International Manufacturing Group, Inc., a liquidating 20 debtor (“IMG”), by and through its plan administrator, The 21 Beverly Group, Inc. (the “plan administrator”), pursuant to Fed. 22 R. Civ. P. 56, made applicable in this proceeding by Fed. R. 23 Bankr. P. 7056, or in the alternative, for summary adjudication 24 of certain facts. 25 Bank filed a reply, and the court issued a tentative ruling in 26 advance of the initial hearing. 27 hearing was continued and the parties filed supplemental briefs 28 on the issue of whether the alleged illegality of a particular The plan administrator filed opposition, the Pursuant to that ruling, the 1 agreement necessarily means IMG did not receive reasonably 2 equivalent value in exchange for the challenged transfers. 3 the following reasons, the court submits to the district court 4 the following findings of fact and conclusions of law, pursuant 5 to 28 U.S.C. § 157(c)(1), with the recommendation that the motion 6 be granted.1 7 For Summary judgment is appropriate when there exists “no 8 genuine dispute as to any material fact and the movant is 9 entitled to judgment as a matter of law.” Fed. R. Civ. P. 56(a). 10 The Supreme Court discussed the standards for summary judgment in 11 a trilogy of cases: 12 (1986); Anderson v. Liberty Lobby, Inc., 477 U.S. 242 (1986); and 13 Matsushita Elec. Indus. Co. v. Zenith Radio Corp., 475 U.S. 574 14 (1986). 15 the initial burden of persuasion in demonstrating that no issues 16 of material fact exist. 17 issue of material fact exists when the trier of fact could 18 reasonably find for the non-moving party. 19 may consider pleadings, depositions, answers to interrogatories, 20 and any affidavits. 21 or absence of a genuine dispute, a party must cite to specific Celotex Corp. v. Catrett, 477 U.S. 317 In a motion for summary judgment, the moving party bears Anderson, 477 U.S. at 255. Celotex at 323. A genuine Id. at 248. The court To demonstrate the presence 22 23 24 25 26 27 28 1. In June of 2016, the Bank moved to withdraw the reference of this adversary proceeding; the district court denied the motion without prejudice. The adversary proceeding is now much farther along, the parties do not dispute that the Bank is entitled to a jury trial, and resolution of this motion may well be dispositive of the adversary proceeding. For these reasons, and as the Bank has not consented to entry of final orders or judgment by this court, the court finds it appropriate to make a recommendation to the district court despite that court’s suggestion that pre-trial motions might be resolved by this court. - 2 - 1 materials in the record, or submit an affidavit or declaration by 2 a competent witness based on personal knowledge. 3 Civ. P. 56(c)(1), (4). 4 persuasion as to the claim, it must point to evidence in the 5 record that satisfies its claim. 6 Once the moving party has met its initial burden, the non-moving 7 party must show specific facts demonstrating the existence of 8 genuine issues of fact for trial. See Fed. R. Where the movant bears the burden of Anderson, 477 U.S. at 252. Id. at 256. 9 By its complaint, the plan administrator seeks to avoid and 10 recover, pursuant to California law, as permitted by § 544(b) of 11 the Bankruptcy Code, certain pre-petition payments made by IMG to 12 the Bank as actual and/or constructive fraudulent transfers. 13 Bank’s motion is based on “good faith” and “for value” defenses. 14 That is, as to the actual fraudulent transfer claims, the Bank 15 contends it took the payments in good faith and for a reasonably 16 equivalent value given to IMG, and therefore, that the payments 17 are not avoidable. 18 constructive fraudulent transfer claims, the Bank contends its 19 evidence demonstrates the plan administrator will be unable to 20 make a prima facie case that the payments were made without IMG 21 receiving a reasonably equivalent value for them, and therefore, 22 that they are not avoidable. 23 See Cal. Civ. Code § 3439.08(a). The As to the See Cal. Civ. Code § 3439.04(a)(2). In September of 2008, five and a half years before IMG’s 24 bankruptcy case was filed, the Bank made a $1,200,000 loan to an 25 individual named Larry Carter and an LLC of which he was the 26 manager, N9FX, LLC (“N9FX”). 27 interest in an airplane owned by Carter or N9FX. 28 testifies in support of the motion that he and IMG’s principal, The loan was secured by a security - 3 - Carter 1 Deepal Wannakuwatte, agreed that Carter would loan IMG the 2 $1,200,000 Carter was borrowing from the Bank and IMG would make 3 the monthly payments on the airplane loan directly to the Bank. 4 Wannakuwatte executed, as president and CEO of IMG, a promissory 5 note for $1,200,000 in favor of Carter, which stated, “Monthly 6 payments in the amount of $9,486.59 will be made to the airplane 7 loan.” 8 exact amount of the monthly payment Carter was to make on the 9 Bank loan. Declaration of Larry Carter, DN 127, Ex. 3. That was the The Bank’s Loan Transaction History Summary Inquiry 10 shows IMG made the payments regularly and on time and the plan 11 administrator does not dispute that.2 12 As to both the actual and constructive fraudulent transfer 13 claims, the Bank contends IMG received reasonably equivalent 14 value for its monthly payments to the Bank because those payments 15 reduced the amount due from IMG to Carter under the IMG/Carter 16 promissory note. 17 antecedent debt, which generally fall within the definition of 18 “value” under California fraudulent transfer law. 19 given for a transfer or an obligation if, in exchange for the 20 transfer or obligation, property is transferred or an antecedent 21 debt is secured or satisfied . . . .” 22 Although the antecedent debt owing by IMG was to someone – Larry In other words, they were payments on an “Value is Cal. Civ. Code § 3439.03. 23 24 25 26 27 28 2. The Bank loan, by its terms, would have been all due and payable on September 2, 2013. In 2011, an individual named Jerry Nelson purchased Carter’s sole member interest in N9FX (and therefore in the airplane), and the balance due on the Bank loan, $1,147,325, was paid off with the sale proceeds. See Declaration of Gerald C. “Jerry” Nelson, filed April 12, 2017, in connection with the motion designated DC No. BJ-1. By this adversary proceeding, the plan administrator seeks to avoid and recover the monthly payments IMG paid the Bank, a total of $246,650. As it was not made by IMG, the balloon payment is not in issue. - 4 - 1 Carter – other than the recipient of the monthly payments – the 2 Bank, the payments resulted in an indirect benefit to IMG in the 3 form of the partial satisfaction of its debt to Carter – in 4 amounts corresponding to the amounts of the monthly payments IMG 5 made to the Bank. 6 “It is well settled that ‘reasonably equivalent value can 7 come from one other than the recipient of the payments, a rule 8 which has become known as the indirect benefit rule.’” 9 Bank v. Brown (In re Northern Merch., Inc.), 371 F.3d 1056, 1058 Frontier 10 (9th Cir. 2004) (citation omitted). 11 shareholders of a company that already owed money to a bank 12 signed a promissory note to the bank for a second loan, the 13 proceeds of which were paid directly to the company which, in 14 turn, granted the bank a security interest in its assets to 15 secure the second loan. 16 trustee sought to avoid the security interest as a fraudulent 17 transfer, the Ninth Circuit held: 18 19 20 21 22 23 24 Thus, for example, the Later, when the company’s bankruptcy Although Debtor was not a party to the October loan, it clearly received a benefit from that loan. In fact, [the bank] deposited the $ 150,000 proceeds of the October Loan directly into Debtor’s checking account. Because Debtor benefitted from the October Loan in the amount of $ 150,000, its grant of a security interest to [the bank] to secure Shareholder[s’] indebtedness on that loan, which totaled $ 150,000, resulted in no net loss to Debtor’s estate nor the funds available to the unsecured creditors. To hold otherwise would result in an unintended $ 150,000 wind-fall to Debtor’s estate. Accordingly, Debtor received reasonably equivalent value in exchange for the security interest it granted to [the bank]. 25 26 Id. at 1059. 27 The plan administrator contends, however, that because IMG 28 was actually the front for a sizeable Ponzi scheme, and because - 5 - 1 the plan administrator claims to have established or to be able 2 to establish that Carter was deeply involved in that scheme, the 3 agreement between them - the IMG/Carter promissory note - was an 4 illegal contract, and therefore, void and unenforceable as 5 between Carter and IMG. 6 enforced the note as against IMG and when IMG made the monthly 7 payments to the Bank pursuant to the note, IMG was not satisfying 8 a valid antecedent debt owed to Carter. 9 received nothing of value in exchange, notwithstanding that IMG, Therefore, Carter could not have Accordingly, IMG 10 not Carter, received the consideration for the payments – the 11 $1.2 million proceeds of the Bank loan. 12 the doctrine that the courts will not enforce an illegal 13 contract.3 The argument is based on 14 The plan administrator frames the issue as follows: 15 Here, Battle Creek is attempting to retain the benefits of fraudulent transfers made by IMG in furtherance of its illegal enterprise and pursuant to a contract that is illegal under Ninth Circuit law [later citing Donell v. Kowell, 533 F.3d 762 (no pin cite) (9th Cir. 2008)]. The contract between IMG and Carter is the “groundwork” for Battle Creek’s claim that the payments were made for reasonably equivalent value. Battle Creek elected to rely on the validity of whatever transaction existed between IMG and Carter when it accepted payments from IMG without evaluating the payor, without conducting any underwriting regarding the payor, and without examining the underlying transaction. Allowing Battle Creek to retain the payments made by IMG here effectively insulates the contract between IMG and Carter despite the disputed facts raised in the opposition as to 16 17 18 19 20 21 22 23 24 25 26 27 28 3. “It is well established that no recovery can be had by either party to a contract having for its object the violation of law. The courts refuse to aid either party, not out of regard for his adversary but because of public policy. Where it appears that a contract has for its object the violation of law, the court should sua sponte deny any relief to either party.” Smith v. California Thorn Cordage, Inc., 129 Cal. App. 93, 99-100 (1933) (citation omitted). - 6 - 1 2 3 Carter’s right to enforce the illegal contract or recover based on rescission. IMG received no genuine, legitimate, tangible value from paying money to Battle Creek. It only deepened the problems and losses to creditors from facilitating the Ponzi scheme. 4 Plan Administrator’s Supplemental Memorandum, filed January 17, 5 2018, at 4:10-20. 6 The court does not agree. First, the determination of reasonably equivalent value 7 “must be made as of the time of the transfer” (Greenspan v. 8 Orrick, Herrington & Sutcliffe LLP (In re Brobeck, Phleger & 9 Harrison LLP), 408 B.R. 318, 341 (Bankr. N.D. Cal. 2009), citing 10 BFP v. Resolution Trust Corp., 511 U.S. 531, 546 (1994)), whereas 11 the plan administrator has not focused its analysis on the time 12 period in which IMG made the monthly payments. 13 the documents filed by the plan administrator as exhibits in 14 support of its Ponzi scheme argument are dated after April of 15 2011, when the Bank loan was paid off in full. 16 In fact, most of Second, the plan administrator has cited no authority for 17 the proposition that the doctrine of unenforceability of illegal 18 contracts is or should be applied against one who was not a party 19 to the illegal contract and who committed no wrongdoing himself.4 20 In other words, the plan administrator has cited no case applying 21 22 23 24 25 26 27 28 4. As indicated above, the plan administrator has attempted to inject alleged wrongdoing on the part of the Bank into the analysis. As quoted above, the plan administrator maintains that “Battle Creek elected to rely on the validity of whatever transaction existed between IMG and Carter when it accepted payments from IMG without evaluating the payor, without conducting any underwriting regarding the payor, and without examining the underlying transaction.” This argument is more appropriately considered on the issue of the Bank’s good faith, discussed below. For present purposes, it is enough to say there was no wrongdoing on the part of the Bank in the formation or execution of the allegedly illegal contract – the IMG/Carter promissory note. - 7 - 1 the doctrine of unenforceability of illegal contracts to defeat a 2 “for value” defense to a fraudulent transfer action, and in fact, 3 cases involving Ponzi schemes have rejected the plan 4 administrator’s position. 5 In Image Masters, Inc. v. Chase Home Fin., 489 B.R. 375 6 (E.D. Pa. 2013), the debtor, operating what turned out to be a 7 $65 million Ponzi scheme, sold wrap-around mortgages to 8 homeowners, who then made their total monthly mortgage payments 9 to the debtor, who, in turn, contractually promised to make the 10 monthly payments on the underlying first mortgages. 11 scheme collapsed, the trustee sued the holders of the first 12 mortgages to recover the monthly payments that had been made by 13 the debtor on behalf of the homeowners. 14 granted the mortgage holders’ Rule 12(b)(6) motion, holding the 15 trustee had failed to plausibly state a claim that the transfers 16 were made without reasonably equivalent value to the debtor. 17 re Image Masters, Inc., 421 B.R. 164, 177-80 (Bankr. E.D. Pa. 18 2009). When the The bankruptcy court In 19 The district court affirmed, holding that each monthly 20 payment made by the debtor to a first mortgage holder resulted in 21 a dollar-for-dollar reduction in the debtor’s liability to the 22 homeowner. 23 was no depletion to Image Masters’ estate as a result of this 24 transaction because the payment to the lender was matched by an 25 equivalent reduction in Image Masters’ obligation to the 26 homeowner. 27 transaction was a wash.” 28 was a Ponzi scheme did not change the analysis. Image Masters, Inc., 489 B.R. at 389. “Thus, there From the perspective of estate preservation, the Id. at 390. - 8 - The fact that the debtor Id. “The proper 1 focus of the reasonably equivalent value inquiry is the specific 2 transaction sought to be avoided, not the transfer’s collateral 3 effects on the welfare of a debtor’s business.” 4 the court found that 5 6 7 8 9 10 11 Id. Finally, the practical implications of the Trustee’s approach – that is, focusing on the overall effect on a debtor’s business rather than the specific transaction – would render constructively fraudulent all transfers made by a Ponzi scheme debtor within the statutory time period. This does not comport with the relevant statutory language, nor the cases within this circuit, which intimate that transfers made by Ponzi scheme debtors may confer reasonably equivalent value. Image Masters, Inc., 489 B.R. at 390.5 6 The trustee in Balaber-Strauss v. Sixty-Five Brokers (In re 12 Churchill Mortg. Inv. Corp.), 256 B.R. 664 (Bankr. S.D.N.Y. 13 2000), aff’d Balaber-Strauss v. Lawrence, 264 B.R. 303, 308 14 15 16 17 18 19 20 21 22 23 24 25 26 27 28 5. Simply because a debtor conducts its business fraudulently does not make every single payment by the debtor subject to avoidance. If so, every vendor supplying goods to the debtor would receive an avoidable fraudulent transfer when the debtor paid the vendor’s invoice. Every employee, even lower-level custodial and clerical employees, would be required to return their wages, regardless of the work they performed. Landlords would have to return rent payments, even if the debtor actually occupied the leased premises. No one conducting business with a debtor operating a Ponzi scheme could prevent the avoidance of payments they received from the debtor, regardless of the extent of the transferee’s knowledge or culpability or the actual services provided. The law does not require this result. Cuthill v. Greenmark, LLC (In re World Entm’t, Inc.), 275 B.R. 641, 658 (Bankr. M.D. Fla. 2002). 6. The Ninth Circuit has also held that transfers by Ponzi scheme debtors to their investors may confer reasonably equivalent value, in the form of satisfaction of the investors’ restitution claims. See In re United Energy Corp., 944 F.2d 589, 595 (9th Cir. 1991). - 9 - 1 (S.D.N.Y. 2001), made an argument very similar to the plan 2 administrator’s argument in the present case. 3 adversary proceedings to avoid and recover commissions paid by 4 the debtors to the brokers who originated mortgages and solicited 5 investments in the debtors’ businesses, which turned out to be a 6 Ponzi scheme. 7 knowledge of the Ponzi scheme or that they had themselves acted 8 wrongfully in any way. 9 fueled and perpetuated by the Brokers’ activities in soliciting She brought 61 The trustee did not assert the brokers had any Rather, she claimed the Ponzi scheme “was 10 investors. 11 actual revenues and in fostering the appearance of legitimate 12 business operations, the Debtors’ mortgage origination activities 13 played an essential role in the Ponzi scheme.” 14 Thus, the trustee’s position was that the commissions paid by the 15 debtors to the brokers, “although reasonably equivalent in value 16 to the services provided in a marketplace sense, were 17 constructively fraudulent simply because the commissions were 18 paid by an entity engaged in a Ponzi scheme.” 19 court phrased the issue this way: 20 21 22 23 24 25 In providing a substantial portion of Churchill’s 256 B.R. at 667. Id. at 674.7 The May the Brokers be held liable to repay commissions, which they earned in good faith and in fair exchange for services actually rendered, merely because the Debtors’ management was independently engaged in a fraudulent enterprise? Stated differently, may the Brokers’ services, as a matter of law, be deemed of no value to the Debtors because the Debtors’ operation as a Ponzi scheme was facilitated or prolonged by the funds received by the Debtors through those services? Id. at 675. The court’s answer was no. 26 27 28 7. Although the trustee apparently did not use the term “illegal” contract, her argument was the same as the plan administrator’s here. - 10 - 1 The court concluded, “The statutes are quite clear. The 2 focus of the inquiry in both [state and federal law] is the 3 specific transaction the trustee seeks to avoid, i.e., the quid 4 pro quo exchange between the debtor and transferee, rather than 5 an analysis of the transaction’s overall value to a debtor as it 6 relates to the welfare of the debtor’s business.” 7 678. 8 – “to preserve the assets of the estate” (id.), the court 9 concluded that “the analysis which must be used to determine 256 B.R. at Emphasizing the purpose of the fraudulent transfer statutes 10 value is a commercial equation which looks to the actual 11 transaction between the debtor and the transferee, and the Court 12 must measure ‘what was given and received’ in that transaction.” 13 Id. at 679. 14 The court cited Merrill v. Allen (In re Universal Clearing 15 House Company), 60 B.R. 985 (D. Utah 1986), in which the court 16 rejected the trustee’s position that “because the [brokers’] 17 services deepened the debtors’ insolvency and furthered a 18 fraudulent [Ponzi] scheme, the services were ‘without legally 19 cognizable value.’” 20 Universal Clearing House, 60 B.R. at 998. 21 House court, as in Churchill, held that the reasonably equivalent 22 value analysis “should focus on the value of the goods and 23 services provided rather than on the impact that the goods and 24 services had on the bankrupt enterprise.” 25 Thus, the court held the services of the debtors’ sales agents 26 constituted value for the payments they received. 27 28 Churchill, 256 B.R. at 679, quoting The Universal Clearing 60 B.R. at 1000. Id. The fatal legal flaw in [the trustee’s position], as a matter of fraudulent conveyance analysis, is that it focuses not on a comparison of the values of the mutual - 11 - 1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 consideration actually exchanged in the transaction between the Broker and the Debtor, but on the value, or more accurately stated, the supposed significance or consequence of the Broker-Debtor transaction in the context of the Debtors’ whole Ponzi scheme. But the statutes and case law do not call for the court to assess the impact of an alleged fraudulent transfer in a debtor’s overall business. The statutes require an evaluation of the specific consideration exchanged by the debtor and the transferee in the specific transaction which the trustee seeks to avoid, and if the transfer is equivalent in value, it is not subject to avoidance under the law. Churchill, 256 B.R. at 680. Thus, the Churchill court held: Fraudulent conveyance law is grounded in equity and is designed to enable a trustee or creditors to avoid a transfer in a transaction where the transferee received more from the debtor than the debtor received from the transferee. The remedy of avoidance seeks to rectify the disparity between that which the transferee gave and that which the transferee got in the transaction. It is this disparity that makes it equitable to require the transferee to repay the excess in value of what he received over what he gave up in the transaction. [¶] In this case there was no disparity between the commissions and the value of the Brokers’ services. Equity, and the law, would be ill-served by granting relief on these complaints. 16 17 18 Churchill, 256 B.R. at 682. In the present case, the Bank gave consideration, in the 19 form of a $1.2 million loan, the proceeds of which were 20 immediately received by IMG, and IMG gave consideration in the 21 form of the monthly payments on the loan. 22 economic reality, and as a matter of the net worth of IMG’s 23 estate, IMG received reasonably equivalent value in exchange for 24 the payments. 25 the proposition that the injection of Carter into the transaction 26 as, in essence, an intermediary for the $1.2 million, should Thus, as a matter of The plan administrator has cited no authority for 27 28 - 12 - 1 change the outcome.8 2 note as an arguably illegal contract for the purpose of negating 3 the value of the $1.2 million IMG received would not serve the 4 policies underlying the illegal contract doctrine. 5 Further, viewing the IMG/Carter promissory “The [doctrine] is grounded on two premises: first, that 6 courts should not lend their good offices to mediating disputes 7 among wrongdoers;[fn] and second, that denying judicial relief to 8 an admitted wrongdoer is an effective means of deterring 9 illegality.” Bateman Eichler, Hill Richards, Inc. v. Berner, 472 10 U.S. 299, 306 (1985). 11 between two wrongdoers; in fact, as discussed below, the court 12 finds the Bank has made a showing it acted in good faith and the 13 plan administrator has not demonstrated there is a disputed issue 14 of material fact on that point. 15 Bank’s motion, would not be granting relief to an admitted 16 wrongdoer. 17 in that neither party to the allegedly illegal agreement – 18 neither Carter nor IMG, when they arranged for IMG to make the 19 payments, considered the impact on the Bank as the possible Here, the court is not resolving a dispute Thus, the court, in granting the And granting this motion would not deter illegality 20 21 22 23 24 25 26 27 28 8. Under the plan administrator’s theory, Carter’s presence as a party to the IMG/Carter promissory note makes all the difference. That is, the plan administrator argues that if the note was an illegal contract, Carter would have had against IMG not only no breach of contract claim but also no claim for restitution. The Bank’s exhibits reveal, however, that IMG knew in advance that Carter would be borrowing the $1.2 million and would then turn around and loan it to IMG. “Deepal, Here is the loan offer on the airplane and I think it looks as good as any other. . . . Shall I take the loan? Larry.” Bank’s Ex. 4. Arguably, the Bank, having been induced to make the loan to Carter by IMG’s promise, through Carter, to make the monthly payments, would have had a direct claim against IMG for restitution if IMG had not made the payments. Thus, when IMG made the payments to the Bank, it was arguably reducing its own obligation to the Bank for restitution. - 13 - 1 recipient of fraudulent transfers years after the monthly 2 payments were made. 3 to consider such matters. 4 Nor are parties to future contracts likely In short, the plan administrator’s argument is a stretch too 5 far. 6 an innocent party for the alleged illegality of two other parties 7 by depriving it of an otherwise valid “for value” defense as to 8 the monthly payments IMG made on the $1.2 million it received. 9 Concomitantly, applying the rule here would result in a windfall 10 to the estate in that IMG received and retained the $1.2 million 11 and the estate would also recover the monthly payments IMG made 12 in exchange for the use of those monies. 13 Bank has met its initial burden of persuasion in demonstrating 14 that there are no triable issues of material fact as to whether 15 IMG received reasonably equivalent value in exchange for the 16 monthly payments it made to the Bank; that is, the Bank has made 17 a showing sufficient for summary judgment IMG did receive such 18 value. 19 administrator has not shown specific facts demonstrating the 20 existence of genuine issues of fact for trial. 21 Application of the illegal contract doctrine would punish The court concludes the Despite the opportunity for further briefing, the plan As for the good faith issue, the court finds the Bank has 22 satisfied its initial burden of persuasion in demonstrating that 23 no genuine issues of material fact exist. 24 been the Bank’s president since 1993 testifies the Bank knew 25 nothing about IMG or Wannakuwatte at the time it made the loan; 26 that the Bank does not unilaterally decide where to send account 27 statements; that in this case, at Carter’s request, the 28 statements were addressed to N9FX and Carter and sent in care of - 14 - The person who has 1 JTS Communities, Inc; that between October of 2008 and April of 2 2011, the Bank received the monthly payments and was paid off in 3 April of 2011; that at no time between those dates did the Bank 4 know of IMG’s and Wannakuwatte’s fraud, or have knowledge of any 5 facts that would suggest the payments the Bank was receiving from 6 IMG were made with the intent to defraud its creditors, or have 7 knowledge of any facts that would have suggested IMG was 8 insolvent at the time it made the payments, or receive any 9 information suggesting there was any suspicious activity on the 10 part of IMG. 11 unusual about the way Battle Creek received the payments on the 12 fully secured Loan with Carter. 13 numerous situations where a payment from a third party is 14 entirely acceptable. 15 documentary evidence indicating that there was an issue, we did 16 not suspect that any issues existed as to the payments received 17 from IMG.” The Bank’s president concludes: “There was nothing In my experience, there are Having received no calls from anyone, no Declaration of Roger Brestel, DN 128, ¶ 15. 18 The plan administrator’s only argument in opposition is that 19 the single fact that the loan payments were made by someone (IMG) 20 other than the Bank’s obligor (Carter/N9FX) was enough of a red 21 flag to put the Bank on inquiry notice that something suspicious, 22 and possibly fraudulent, was going on. 23 administrator states, “Battle Creek’s files are devoid of any 24 information regarding why it was receiving payments on its note 25 from a third party not obligated on the debt” and 26 27 28 Thus, the plan the mere receipt by a financial institution of payments on a loan from a third party not obligated on the debt is a red flag warranting inquiry by the bank, since on its face, without any information or investigation into the basis for the third party to be making the - 15 - 1 2 3 4 5 payments, the payments appear to be gifts by the payor that would be subject to avoidance as fraudulent transfers unless (a) based on an investigation into the underlying relationship of the parties and transactions between them, the party making the payments is somehow receiving reasonable value in exchange for the transfers, or (b) an investigation into the financial status of the payor shows that entity, IMG, was fully solvent and could legitimately donate its assets for the benefit of Carter. 6 7 8 9 Plaintiff’s Opp., DN 132, at 18:21-19:6. The plan administrator has cited a single case for this proposition. In that case, Development Specialists, Inc. v. 10 Hamilton Bank, N.A. (In re Model Imperial, Inc.), 250 B.R. 776 11 (Bankr. S.D. Fla. 2000), the bank made a loan to a company it 12 knew had no assets and it knew the company the money was actually 13 going to was maxed out on its line of credit with and subject to 14 borrowing restrictions by a group of other banks. 15 senior vice president knew the real borrower’s inability to incur 16 additional debt was the only reason the “paper company” was used 17 as the bank’s nominal borrower. 18 more in the nature of red flags than a bank receiving payments 19 from someone other than its named borrower. 20 The bank’s In other words, there was a lot In short, the court is not persuaded that the mere receipt 21 of regular and timely monthly payments from someone other than a 22 bank’s borrower is, in and of itself, sufficient to put the bank 23 on inquiry notice of something irregular going on with the payor. 24 Further, the plan administrator has not suggested there are 25 additional facts it might present showing there were any other 26 red flags that should have put the Bank on inquiry notice.9 27 28 9. The discovery bar date and the deadline to disclose (continued...) - 16 - 1 Thus, in response to the Bank’s prima facie case as to its good 2 faith defense, the plan administrator has failed to show specific 3 facts demonstrating that there are genuine issues of fact for 4 trial. 5 For the reasons stated, the court submits these findings of 6 fact and conclusions of law to the district court with the 7 recommendation that the Bank’s motion be granted and that 8 judgment be entered in favor of the Bank and against the plan 9 administrator. 10 Dated:February 07, 2018 February __, 2018 11 ROBERT S. BARDWIL United States Bankruptcy Judge 12 13 14 15 16 17 18 19 20 21 22 23 24 25 26 27 28 9.(...continued) experts have passed. - 17 -

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