In Re: Video Depot, Ltd., Debtor. Kenneth Schafer v. Las Vegas Hilton Corporation

Citations: 127 F.3d 1195; 97 Cal. Daily Op. Serv. 8472; 38 Collier Bankr. Cas. 2d 1759; 97 Daily Journal DAR 13709; 1997 U.S. App. LEXIS 30307; 31 Bankr. Ct. Dec. (CRR) 872; 1997 WL 684935Docket: 96-35283

Court: Court of Appeals for the Ninth Circuit; November 5, 1997; Federal Appellate Court

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Kenneth Schafer, as trustee for Video Depot, Ltd., initiated a fraudulent conveyance action to reclaim a $65,000 cashier's check paid to the Las Vegas Hilton, which was intended to settle gambling debts of Video Depot's principal, Jeffrey Arlynn. The Hilton contested the bankruptcy court's ruling in favor of Schafer. The Ninth Circuit Court of Appeals, presided over by Judges WRIGHT, D.W. NELSON, and KOZINSKI, affirmed the lower court's decision.

Key facts established that Arlynn, who primarily managed Video Depot, had a longstanding gambling relationship with Hilton, accumulating significant debts. In May 1990, he incurred a debt of $225,000 without making a prior payment. Subsequently, Video Depot purchased a cashier's check for $65,000 payable to Hilton, which Arlynn presented alongside a personal check for $10,000 when he returned to Las Vegas.

Following Video Depot's bankruptcy filing on September 14, 1990, Schafer filed a suit to recover the check's proceeds. Both parties acknowledged the transaction as a fraudulent transfer under 11 U.S.C. § 548. The bankruptcy court ruled that Hilton was not the initial transferee of the check but allowed for a trial on whether Hilton lacked good faith knowledge of the transfer's voidability under 11 U.S.C. § 550(b). Before trial, the court requested additional briefs regarding the initial transferee issue, which both parties declined to expand upon.

The bankruptcy court ruled that Hilton was the initial transferee of a $65,000 cashier's check from Video Depot and was therefore strictly liable to the bankruptcy estate under 11 U.S.C. § 550(a)(1). Even if considered a subsequent transferee, Hilton could not establish a defense under 11 U.S.C. § 550(b). The district court upheld the bankruptcy court's finding that Hilton was the initial transferee and did not evaluate the § 550(b) defense. Hilton is appealing both determinations.

In reviewing the district court's decision, this court applies a de novo standard for legal conclusions while upholding factual findings unless clearly erroneous. The central issue is whether Hilton qualifies as the initial transferee of the fraudulent transfer, as stipulated by the parties under 11 U.S.C. § 548. The statutory framework permits the trustee to recover fraudulent transfers from either the initial transferee or any subsequent transferee, with the distinction being vital. Initial transferees have absolute liability, while subsequent transferees can defend themselves if they received the transfer in good faith, for value, and without knowledge of its voidability.

This legal structure aims to protect creditors from last-minute asset reductions while preventing unnecessary burdens on subsequent transferees who are unlikely to be aware of the transfer's origins. The bankruptcy court determined that Hilton was indeed the initial transferee, a decision supported by the district court. Hilton argues against this designation, claiming that Arlynn, who controlled Video Depot, was the true initial transferee, or alternatively, that the transaction was recorded as a loan to Arlynn in Video Depot's ledger. Each of these arguments will be examined.

Arlynn's involvement with Video Depot was scrutinized in relation to the $65,000 check issued to Hilton. The bankruptcy court found that Arlynn lacked dominion over the funds, as he only controlled Video Depot’s operations and arranged for the check, which was considered a direct transfer from Video Depot to Hilton. Once issued, Arlynn had no legal control over the funds, limiting his authority to directing their payment to Hilton. Hilton argued that Arlynn, as Video Depot's principal, had dominion because he instructed the company to procure the cashier's check.

The legal landscape features divided opinions on whether a corporate principal is the initial transferee of corporate funds used for personal obligations. Some courts (e.g., General Electric Capital Auto Lease and Richardson v. FDIC) determined that a principal does not become a transferee merely by facilitating a fraudulent transfer, while others (e.g., Ross v. United States and Still v. American Nat'l Bank) held that such a principal can be an initial transferee if they arranged for the corporate funds to satisfy personal debts. 

The Ninth Circuit has not definitively ruled on this matter, but other circuits, including the Eleventh Circuit in Nordberg v. Arab Banking Corp, concluded that a principal directing a corporate transfer for personal debts does not equate to being the initial transferee. The court emphasized that the principal's control over the corporation does not affect the initial transferee determination. Further, other circuits have supported the notion that a principal must have legal dominion over the funds to be considered an initial transferee, reinforcing that mere control over corporate resource allocation is insufficient.

Principals of corporations typically have de facto control over corporate funds, allowing them to decide whether to use those funds appropriately or not, which is relevant when assessing breaches of duty to the corporation. In this case, Video Depot purchased a cashier's check directly payable to Hilton, indicating that legal control over the funds transitioned directly from Video Depot to Hilton. Hilton argues that this distinction prioritizes form over substance, claiming that whether Video Depot paid Hilton directly or via Arlynn, the outcome is the same—Arlynn used corporate funds for personal debts. However, the rationale for differentiating between initial and subsequent transferees is critical; initial transferees, like Hilton, bear greater liability and have a greater obligation to assess the legitimacy of the transfer. Consequently, Hilton's receipt of the cashier's check imposed a greater responsibility to investigate the transaction than if the funds had come from Arlynn's personal account.

Furthermore, adopting Hilton’s perspective would unfairly empower unscrupulous insiders to execute fraudulent transfers, limiting trustees’ ability to reverse such transfers for creditors’ benefit. While some circuits have shown tentative support for Hilton's view, no court has definitively ruled in its favor, leading to a conclusion that Arlynn's operational control over Video Depot does not equate to dominion over the funds transferred to Hilton. Additionally, Hilton's assertion that the transfer constituted a loan to Arlynn, thereby making him the initial transferee, was dismissed by the bankruptcy court due to a lack of evidence. The conclusion maintains that there is insufficient support for the claim that Arlynn had control over the funds post-disbursement by Video Depot.

Hilton's motion for summary judgment is supported by two key documents: a ledger tracking payments by Video Depot for Arlynn and an affidavit from Arlynn. In the affidavit, Arlynn states that on June 15, 1990, he borrowed $65,000 from Video Depot to purchase a cashier's check for the Las Vegas Hilton, which was used to partially satisfy a debt. He asserts he repaid this loan before any involuntary bankruptcy proceedings commenced against Video Depot. The ledger records payments of $10,000 and $65,000 to Arlynn on June 15, alongside a $75,000 payment from him. However, the court found that merely labeling a transfer as a "loan" does not demonstrate that Arlynn had independent control over the funds, as his access to the money was limited by his obligations to the corporation and its creditors. The funds were disbursed specifically for payment to Hilton, making Arlynn merely a courier rather than a transferee. The bankruptcy court provided Hilton with opportunities to present evidence of Arlynn's control over the funds, which Hilton failed to do. Consequently, the bankruptcy court correctly determined Hilton was an initial transferee under section 550(a), leading to the affirmation of the district court's decision. The court did not address Hilton's argument under section 550(b) as it was unnecessary. The ruling is affirmed.