Sonicblue Incorporated et al v. Virtual Transportation Management, Inc.

UNITED STATES BANKRUPTCY COURT
For The Northern District Of California
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MEMORANDUM DECISION AND ORDER
UNITED STATES BANKRUPTCY COURT
NORTHERN DISTRICT OF CALIFORNIA
SONICBLUE INCORPORATED,
Debtor.
Case No.-03-51775-MM
Chapter 11
SONICBLUE INCORPORATED, et al.,
Plaintiffs,
vs.
VIRTUAL TRANSPORTATION
MANAGEMENT, INC,
Defendant.
Adversary No. 05-5106
MEMORANDUM DECISION ON
PLAINTIFFS’ MOTION FOR PARTIAL
SUMMARY JUDGMENT AND
DEFENDANT’S MOTION FOR
SUMMARY JUDGMENT
I NTRODUCTION
In this adversary proceeding, the debtors seek to avoid and recover $578,020.31 that one of the
debtors, Diamond Multimedia Systems, Inc., transferred to defendant Virtual Transportation
Management, Inc. during the ninety day period preceding the petition date. 	The debtors have moved
for partial summary judgment seeking a determination that VTM is an “initial transferee” under § 550
of the Bankruptcy Code from whom debtors may recover any avoided transfers. In response, VTM has
The following constitutes
the order of the court. Signed February 27, 2006
Marilyn Morgan
U.S. Bankruptcy Judge
________________________________________
Entered on Docket
February 27, 2006
GLORIA L. FRANKLIN, CLERK
U.S BANKRUPTCY COURT
NORTHERN DISTRICT OF CALIFORNIA
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MEMORANDUM DECISION AND ORDER
filed a cross-motion for summary judgment asserting that it received the funds as Diamond’s agent and
did not have sufficient dominion or control over the funds to be considered a transferee. Alternatively,
VTM contends that if it is a transferee, it received the funds in the ordinary course of business.
BACKGROUND
Prior to bankruptcy, Diamond sold and distributed consumer electronics that were manufactured
by third parties. As part of this business, Diamond engaged various freight carriers to ship the products
to Diamond and from Diamond to assorted retailers throughout the country.
VTM is a company that provides freight-bill audit, payment and reporting services to customers
like Diamond. VTM’s customers directly hire freight carriers to ship goods, but after the goods are
shipped, the freight carriers send their invoices to VTM, who processes the invoices and verifies that
payment is appropriate. VTM compiles and forwards periodic reports to its customers to inform the
customer about invoices that are ready for payment. The customer then provides the necessary funding
and VTM pays the freight carriers.
This is exactly the type of arrangement that Diamond had with VTM. In June 1999, Diamond
contracted with VTM for assistance with the processing and payment of Diamond’s freight charges.
Under the written contract, VTM received, audited and validated transportation invoices on Diamond’s
behalf. The contract required VTM to submit weekly reports, called funding requests, to Diamond. The
reports listed all invoices that were ready for payment. After reviewing the report, Diamond either
approved or disapproved payment of the compiled invoices. According to Schedule A of the contract,
VTM was then to effect “payment of Customer transportation billings presented by carriers and
approved by [Diamond] and VTM, utilizing funds provided by [Diamond].” Diamond provided the
necessary funds by transferring money into a segregated bank account in VTM’s name. The contract
provided that VTM “will issue payments to carriers upon deposit confirmation notice” from the bank
where VTM maintained the segregated account. The parties expressly agreed that VTM would not
advance its own funds to pay Diamond’s carriers.
VTM charged a percentage fee for its service. It included its fee as part of the weekly funding
requests and retained the portion of the funded amount that was attributable to its fee.
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MEMORANDUM DECISION AND ORDER
During the ninety day period preceding the filing of this bankruptcy case, VTM submitted twelve
funding requests to Diamond, requesting the transfer of $579,689.38 to the segregated bank account.
Diamond funded $578,020.31 of the requests, declining, on two occasions, to fund a total of $1,669.07
owed to FedEx. Of the amount funded, $576,820.31 was paid out to Diamond’s freight carriers and
VTM retained $1,200.00 as its service fee. 	During the preference period, VTM generally paid the
freight carriers’ invoices within two to three days of receiving funds from Diamond. On one occasion
there was one week gap between VTM’s receipt of funds and its subsequent disbursement to Diamond’s
freight carriers. A ten day gap occurred on one other occasion.
LEGAL DISCUSSION
Summary judgment obviates the need for trial where there is no genuine issue as to any material
fact and the moving party is entitled to judgment as a matter of law. Fed. R. Civ. P. 56(c). Here, the
terms of the contract between Diamond and VTM are undisputed. The parties also do not dispute that
VTM handled Diamond’s freight bills as described above. The parties disagree, however, as to whether
the resulting contractual relationship, as a matter of law, makes VTM an “initial transferee” of the funds
it received from Diamond.
Under § 550(a)(1) of the Bankruptcy Code, a trustee or debtor-in-possession may recover
avoided transfers from an “initial transferee” of the transfer. 	11 U.S.C. § 550(a)(1). 	Neither the
Bankruptcy Code nor its legislative history defines the term “transferee.” In many situations, the initial
transferee will be the first entity to whom the debtor transmits money or other assets. However, where
a two step transaction is present in which the initial recipient is an intermediary between the debtor and
the intended transferee of the asset, the ninth circuit has adopted the view that a mere recipient or
conduit that does not have dominion over money or other asset is not a “transferee” within the meaning
of § 550(a). In re Cohen, 300 F.3d1097, 1102 (9th Cir. 2002); In re Bullion Reserve of North America,
922 F.2d 544, 548-49 (9th Cir. 1991). 	This so-called “dominion test” was first enunciated in In re
Bonded Financial Services, Inc., 838 F.2d 890, 893 (7th Cir. 1988), where Judge Easterbrook reasoned
that as a matter of definition, a “transferee” within the meaning of § 550 must be something more than
a mere recipient of transferred funds. Instead, the seventh circuit held, “the minimum requirement of
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MEMORANDUM DECISION AND ORDER
status as a ‘transferee’ is dominion over the money or other asset, the right to put the money to one’s
own purposes.” Id. Since Bonded, the distinction between a mere recipient or conduit and a transferee
within the meaning of § 550 has become the generally accepted view of the circuit courts. Dominion
or control over an asset has been consistently required before a recipient constitutes an initial transferee.
See e.g., In re Hurtado, 342 F.3d 528, 533 (6th Cir. 2003); In re Finley, Kumble, Wagner, Heine,
Underberg, Manley, Myerson & Casey, 130 F.3d 52, 56-57 (2nd Cir. 1997); Rupp v. Markgraf, 95 F.3d
936, 942 (10 th Cir. 1996); In re Reeves, 65 F.3d 670, 676 (8 th Cir. 1995); In re Coutee, 984 F.2d 138,
140-41 (5th Cir. 1993); In re Chase & Sanborn Corp., 848 F.2d 1196, 1199 (11 th Cir. 1988).
Under the dominion test, the determinative factor is whether the entity that receives an asset has
the right to put the asset to its own use. Dominion requires legal control over, not just mere possession
of, the asset. Cohen, 300 F.3d at 1102. To be a transferee under § 550, a recipient must have the ability
to use funds or other assets freely. 	Id. 	Thus, in Bullion, the ninth circuit found that a defendant’s
contractual obligation to use the money it received to purchase stock and pledge the stock in favor of
another prevented the defendant from having dominion or control of the money. Bullion, 922 F.2d at
549. In Cohen, a debtor purchased a cashier’s check payable to one of her husband’s creditors and gave
the check to her husband. The court determined that the husband’s limited right to retain, destroy or
deliver the check to his creditor, the payee of the check, was not sufficient to satisfy the dominion test.
300 F.3d at 1107.
In light of the ninth circuit’s approval of the dominion test, I am not persuaded by the debtors’
assertion that, under Bullion’s formulation of the test, a recipient of funds only avoids being a transferee
if the recipient demonstrates that it was an agent of the creditor that ultimately receives the funds. In
other words, debtors assert as a matter of law that VTM is an initial transferee because there is no
evidence that VTM was an agent of the various freight carriers that VTM ultimately paid. 	While the
dominion test is used to distinguish between mere conduits and true transferees, nothing in the test
requires a recipient to be the agent of anyone, much less of a transferee, before the recipient can avoid
liability under § 550. Although the Bullion court restated a hypothetical example from Bonded “if A
gives a check to B as agent for C, then B is not a transferee,” the court did not hold, or even suggest, that
this hypothetical represents the only set of facts that would prevent transferee liability under § 550.
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MEMORANDUM DECISION AND ORDER
Significantly, the ninth circuit never determined whether the defendant in Bullion was anyone’s agent.
The court’s analysis was limited to whether the defendant had the ability to use the funds freely.
Because the defendant therein was contractually obligated to use the money in a particular way, it did
not have dominion and was not a transferee of the funds.
Debtors’ reliance on 	In re Incomnet, Inc., 299 B.R. 574 (B.A.P. 9 th Cir. 2003) to inject an
agency requirement into the dominion test is similarly unconvincing. In that case, the Universal Service
Administrative Company administered a federally regulated program under which telecommunication
providers had to contribute a percentage of their revenues to USAC for the purpose of developing a
universal telecommunication system. USAC argued that it was not a transferee of money it collected
because Federal Communications Commission regulations restricted the USAC’s use of the collected
funds. In deciding that USAC was a transferee, the appellate panel reiterated the hypothetical example
originally described in Bonded, but the court did not base its decision on the absence of an agency
relationship. The crucial fact for the appellate panel was that Incomnet involved a one step transaction
rather than a two step transaction where payment is made first to an intermediary followed by a second
payment to the ultimate transferee. Because the USAC was not a conduit to any other entity, the court
believed that the dominion test was inappropriate. Here, there is no question that a two step transaction
is involved. The undisputed evidence establishes that Diamond transmitted funds to VTM with the
expectation that VTM would then channel the money through to pay Diamond’s freight carriers.
Other cases confirm that liability under § 550 can be avoided regardless of whether VTM was
an agent of the freight carriers. In Finley, Kumble, an insurance broker acted on behalf of the debtor
when it received debtor’s funds and used them to purchase insurance for the debtor. The broker was
not an initial transferee because the broker had no discretion to do anything other than transmit the
money to the insurance provider. Finley, Kumble, 130 F.3d at 56-57. Similarly, a check courier hired
by a debtor was not an initial transferee because it was contractually bound to deliver the check to the
debtor’s creditor. Rupp v. Markgraf, 95 F.3d at 940. Likewise, a port agent was not an initial transferee
where it acted as a “disbursing agent” for the debtor shipping company by paying third party vendors
with debtor’s funds. 	In re Timber Line, Inc., 59 B.R. 728 (Bankr. S.D.N.Y. 1986). 	From these
examples, it is apparent that in a two step transaction, the tag assigned to the relationship between the
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MEMORANDUM DECISION AND ORDER
intermediary and the debtor or creditor is unimportant. The conduit may be an agent, a trustee, a courier
or simply a party bound by the terms of a contract. It is the freedom or lack of freedom to control the
funds that is determinative of an intermediary’s status as a transferee.
Based on the authorities discussed above, I conclude that VTM is not an initial transferee of the
funds that were ultimately paid to Diamond’s freight carriers. Although debtors claim that there is
nothing in the contract to require VTM to pay the freight carrier invoices, they are incorrect. A careful
reading of the contract reveals that VTM was to effect payment of all invoices approved by Diamond.
Further, payment was to issue “upon receipt of deposit confirmation” verifying that Diamond had
transferred the funds needed to pay the invoices. This contractual obligation distinguishes this case
from Hurtado on which the debtors heavily rely. In Hurtado, the debtors, a married couple, transferred
legal title to their money to the husband’s mother who maintained a separate bank account for the funds
and used the funds at the debtors’ direction. In finding the mother to be an initial transferee, the court
specifically noted that there was no evidence of any formal contractual arrangement that required the
mother to obey the debtors’ commands or that provided recourse to the debtors if the mother chose not
to follow their instructions. Hurtado, 342 F.3d at 535. Here, by contrast, there is a specific contractual
provision that required VTM to pay Diamond’s freight carriers. The debtors would have had recourse
under the contract if VTM had failed to make the payments. VTM’s legal obligation to disburse funds
as set forth in the contract, blocked any dominion it might otherwise have had over the funds.
Consistent with its legal obligations, VTM paid the carriers within a several days of receiving funds
from Diamond. The undisputed facts establish that VTM was nothing more than a station stop along
the route to the money’s ultimate destination. Because VTM did not have the necessary dominion to
be an initial transferee under § 550 of the Bankruptcy Code, VTM is entitled to summary judgment in
its favor with respect to the funds ultimately paid to the freight carriers.
In light of the conclusion that VTM was not an initial transferee, it is unnecessary to address
VTM’s ordinary course of business defense with respect to the funds that went to the freight carriers.
However, VTM did receive $1,200 from Diamond as a fee for its freight auditing services. Based on
the record before me, it is apparent that VTM had dominion over the funds attributable to its fee. It
retained those funds and was able to use them without restriction. VTM asserts that it is entitled to
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MEMORANDUM DECISION AND ORDER
summary judgment even with respect to its fee because the fee was paid in accordance with the business
terms and practices that the parties had followed for four years prior to the bankruptcy filing. Debtors
reply that it has not had the opportunity to properly investigate the facts surrounding the ordinary course
of business defense. Debtors’ counsel has provided a declaration indicating that he believed the only
issue to be addressed in the motions for summary judgment would be the dispute over VTM’s status as
an initial transferee. As a result, counsel states, he deferred discovery related to the ordinary course of
business defense until after the court ruled on the motions for summary judgment. Pursuant to Fed. R.
Civ. P. 56(f), the debtors request that any counter motion based on the ordinary course of business
defense be denied pending further discovery on that issue. In light of the debtors’ Rule 56(f) request,
it is appropriate to deny VTM’s counter motion for summary judgment, without prejudice, as to the fees
it received from debtors during the ninety day period preceding this bankruptcy case.
For the reasons explained, plaintiffs’ motion for partial summary judgment is denied. 	The
defendant’s cross-motion for summary judgment is granted with respect to the $576,820.31 that VTM
ultimately paid out to the debtors’ freight carriers and is denied, without prejudice, as to the $1,200.00
that VTM received as a fee for its services.
Good cause appearing, IT IS SO ORDERED.
**** END OF ORDER ****
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MEMORANDUM DECISION AND ORDER
Adv. P. 05-5106
UNITED STATES BANKRUPTCY COURT
FOR THE NORTHERN DISTRICT OF CALIFORNIA
SERVICE LIST
Matthew S. Walker
William B. Freeman
Pillsbury Winthrop Shaw Pittman, LLP
101 West Broadway, Suite 1800
San Diego, CA 92101-8219
Linda M. Gonsalves
Stephen F. Heller
Gonsalves & Kozachenko
1133 Auburn Street
Fremont, CA 94538
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