- Category: Judge Somers
- Published on 14 October 2011
- Written by Judge Somers
Northern Capital, Inc., v. The Stockton National Bank et al, 09-06011 (Bankr. D. Kan. Sep. 28, 2011) Doc. # 181
SIGNED this 28 day of September, 2011.
Dale L. Somers
UNITED STATES BANKRUPTCY JUDGE
Designated for publication and on-line use
IN THE UNITED STATES BANKRUPTCY COURT
FOR THE DISTRICT OF KANSAS
a Kansas Corporation, et al.,
NORTHERN CAPITAL, INC. ,
THE STOCKTON NATIONAL BANK and
BROOKE CAPITAL ADVISORS , INC.,
ALBERT A. RIEDERER, Chapter 7 Trustee
of Brooke Corporation,
CASE NO. 08-22786
ADV. NO. 09-6011
Case 09-06011 Doc# 181 Filed 09/28/11 Page 1 of 22
ALBERT A. RIEDERER, Chapter 7 Trustee
of Brooke Corporation,
NORTHERN CAPITAL, INC., THE
STOCKTON NATIONAL BANK,
ALLIANT BANK, THE BANK OF
COMMERCE AND TRUST CO.,
MIDWEST COMMUNITY BANK,
MILLEDGEVILLE STATE BANK, IOWA
STATE BANK, FIRST NATIONAL BANK
OF SMITH CENTER, FARLEY STATE
BANK, and FIRST COMMUNITY BANK,
MEMORANDUM OPINION AND ORDER GRANTING
STOCKTON NATIONAL BANK’S
MOTION FOR PARTIAL SUMMARY JUDGMENT
When the Trustee seeks to avoid allegedly preferential transfers that partially
satisfied debtor’s loan held by a lead bank subject to participation agreements and the
lead bank transmitted the payments to the participants in accord with the participation
agreements, is the lead bank the initial transferee under 11 U.S.C. § 550(a)(1)1? This is a
1 Future references in the text to sections of Title 11 shall be to the section only.
Case 09-06011 Doc# 181 Filed 09/28/11 Page 2 of 22
question of first impression presented by third-party defendant Stockton National Bank’s
Motion for Partial Summary Judgment.2 The Court has jurisdiction.3
FINDINGS OF FACT.
The material facts are uncontroverted. On December 28, 2007, Debtor Brooke
Corporation, Inc. (hereafter "Brooke") executed a promissory note, due June 28, 2008, in
favor of Stockton National Bank (hereafter “Stockton”) for $4,500,000 (hereafter
"Note"), with interest at the rate of 10.5%, and a Security Agreement that provided
security for the Note. Brooke had proposed the loan to Stockton, solicited the loan to the
others who were interested in purchasing an undivided interest in the loan, and brought
potential participants to Stockton. On the same date, Stockton entered into eight separate,
but substantially identical forms, entitled Participation Certificate and Agreement
(hereafter "Agreements" or “Certificates”), with Third-Party Defendants Alliant Bank, the
2 Stockton National Bank appears by Terry C. Cupps and Charles R. Curran of Foulston
Siefkin LLP. Third-party defendants Alliant Bank and Bank of Commerce &Trust Co. appear
by William B. Sorensen, Jr. and Ryan M. Peck of Morris, Laing, Evans, Brock & Kennedy,
Chartered. Third party defendants Midwest Community Bank, Milledgeville State Bank, Iowa
State Bank, First National Bank of Smith Center, and First Community Bank appear by Eric L.
Johnson and Nathan A. Orr of Spencer Fane Britt & Browne LLP. Albert A Riederer, Trustee of
Brooke Corporation, appears by John J. Cruciani and Michael D. Fielding of Husch Blackwell
3 This Court has jurisdiction over the parties and the subject matter pursuant to 28 U.S.C.
§§ 157(a) and 1334(a) and (b), and the Standing Order of the United States District Court for the
District of Kansas that exercised authority conferred by § 157(a) to refer to the District's
bankruptcy judges all matters under the Bankruptcy Code and all proceedings arising under the
Code or arising in or related to a case under the Code, effective July 10, 1984. Furthermore, this
Court may hear and finally adjudicate this matter because it is a core proceeding pursuant to §
157(b)(2)(F). There is no objection to venue or jurisdiction over the parties. The Court has
Case 09-06011 Doc# 181 Filed 09/28/11 Page 3 of 22
Bank of Commerce and Trust Co., Midwest Community Bank, Milledgeville State Bank,
Iowa State Bank, First National Bank of Smith Center, Farley State Bank, and First
Community Bank (hereafter collectively "Participants"). The Participants' aggregate
percentage ownership of the Note and all related security entitle them to 94.44% of
Brooke's payments on the Note (less applicable fees and expenses), and Stockton’s
retained ownership interest entitles it to 5.56% of any Brooke payment. On August 7,
2008, with the consent of the Participants, Brooke executed and delivered to Stockton an
extension of the Note and a revision to the security agreement.
Each Agreement identifies Stockton as the "Originating Lender (Seller)" and
the participant as "Participating Lender (Purchaser)." It then describes the Brooke Note
as evidencing the “Loan” in favor of Seller and provides that in "consideration of the sum
of $ . . . (Purchaser's Investment) Seller hereby sells and certifies to Purchaser an
undivided . . . percent interest (Share), without recourse to Seller, in the Principal and
interest hereafter accruing from the Loan." Each sale includes the Purchaser’s share in all
notes and other instruments evidencing indebtedness of Borrower in the Loan, together
with all security interests in the Property securing such indebtedness. Each participant
agrees to fund its portion of the Loan by forwarding the investment to Stockton and is
entitled to interest at 10.25 percent on its participation interest. “Purchaser and Seller
agree that Purchaser will be considered for all purposes the legal and equitable owner of
the above Share in the Loan, related documents, and Property and will possess all
applicable rights, privileges and remedies, subject to other provisions of this Agreement."
Case 09-06011 Doc# 181 Filed 09/28/11 Page 4 of 22
Seller retains the duties of holding the Loan documentation and of administering the
Loan; it is entitled to an administrative fee of 25 basis points. Such administration may
be undertaken as if Seller were the sole owner and holder of the Loan. Seller’s duty to
the Purchasers is to use the same degree of care in servicing and collecting the Loan as it
would for its own account, with liability only for acts in bad faith or willful misconduct.
As to payments on the Loan, the Certificates provide that "Seller will receive all
Payments and apply them to Borrower's account. Payments received by Seller under the
Loan will be held for the benefit of Seller and Purchaser until the payments are actually
paid to and received by Purchaser." Stockton is required to make such distributions no
later than the close of the tenth business day following receipt, subject to a penalty if
funds were not remitted in accord with the Agreement.
At issue are three payments in the total amount of $487,973.29 which Stockton
received from Brooke within 90 days before Brooke filed its bankruptcy petition. The
payments were comprised of wire transfers of $150,000.00 and of $38,835.62 received on
August 4, 2008; a check dated August 15, 2008 for $260,000 received on August 18,
2008; and a check for $39,137.67 dated August 29, 2008 received on August 29, 2008,
which did not clear until September 3, 2008. Stockton retained $27,958.58 for its share
of the participation and for administrative fees and timely distributed $460,014.71 to the
Participants within one day of receiving the wire transfers or within one day of the checks
clearing. At the time of the payments, Stockton maintained a correspondent banking
relationship with Bankers’ Bank of Kansas. All payments from Brooke and distributions
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to the Participants were processed through Stockton’s account at Banker’s Bank, without
segregation of the funds attributable to the Loan from other transactions of Stockton.
Stockton filed a proof of claim on November 25, 2008 in the Debtor’s
bankruptcy in the amount of $4,179,399.95 based upon a default judgment on the Note.
THE TRUSTEE’S CLAIM, STOCKTON’S MOTION FOR PARTIAL SUMMARY
JUDGMENT, AND THE POSITIONS OF THE PARTIES.
The claims asserted in this adversary proceeding include a Third-Party
Complaint by the Trustee which, among other things, seeks to avoid and recover from
Stockton the foregoing payments of $478,973.29 paid by Brooke on the Note as
preferential transfers under § 547 from Stockton. The matter before the Court is
Stockton’s Motion for Partial Summary Judgment.4 Stockton asserts that even if the
Trustee could prove that the $487,973.29 in payments made to Stockton were preferential
payments, Stockton had no legal dominion and control over $460,014.71 of the payments
received and, with respect to these payments which were disbursed to the Participants,
acted as a mere conduit so that it does not have liability to the Trustee as to these transfers
as an initial transferee under § 550(a)(1).5
The Participants oppose the Motion, asserting that Stockton was the initial
transferee as to all the payments and not a mere conduit for various reasons, including the
4 Dkt. 64. Stockton does not challenge the Trustee’s position that it is the initial
transferee as to $27,958.58, which it retained for its share of the participation in the Note and
administrative fees. Dkt. 65.
5 Dkts. 65 and 159.
Case 09-06011 Doc# 181 Filed 09/28/11 Page 6 of 22
fact the Stockton was the payee of the Note.6 The Trustee in his initial brief opposed the
Motion,7 but in a sur-reply brief changed his position and stated, “[T]o the extent this
Court determines that the Certificates divested Stockton of the legal ability to exercise
dominion and control over the funds paid to the Participants, such divestiture precludes
Stockton from becoming an initial transferee to the extent of the funds it was
contractually obligated and did actually transfer to the Participants.”8
ANALYSIS AND CONCLUSIONS OF LAW.
Section 550(a)(1) of the Code provides “to the extent that a transfer is avoided
under section . . . 547 . . . of this title, the trustee may recover, for the benefit of the estate,
the property transferred . . . from the initial transferee of such transfer . . ..” The Code
does not define initial transferee. This absence and “the harsh result of an overly literal
approach to” § 550 has given rise to the conduit theory.9 Under this theory, as
authoritatively formulated by the Seventh Circuit in Bonded10 which formulation has been
adopted in the Tenth Circuit,11 “the minimum requirement of status as a ‘transferee’ is
6 Dkt. 148.
7 Dkt. 149.
8 Dkt. 165, p. 6.
9 4 Norton Bankr. L. & Prac. 3d § 70:2 (Thompson/West 2011), citing In re Montross,
209 B.R. 943, 948 (9th Cir. BAP 1997).
10 Bonded Fin. Serv., Inc. v. European Amer. Bank, 838 F.2d 890, 893 (7th Cir.
11 Malloy v. Citizens Bank of Sapulpa (In re First Security Mortg. Co.), 33 F.3d 42, 43-44
(10th Cir. 1994), quoting Bonded, 838 F.2d at 893.
Case 09-06011 Doc# 181 Filed 09/28/11 Page 7 of 22
dominion over the money or other asset, the right to put the money to one’s own
purposes.”12 This approach recognizes that the term “transferee” must mean something
different from anyone who simply touches the money, such as a “‘possessor’ or ‘holder’
or ‘agent,’”13 and provides a basis to hold that “those who act as mere ‘financial
intermediaries,’ ‘conduits’ or ‘couriers’ are not initial transferees under § 550.”14 “A
person or entity is not the initial transferee under Bonded if it received no benefit from the
transferred funds, had to follow instructions on how to use the funds, and would have
been liable to the transferor if it had used the funds for its own purposes.”15 The Seventh
Circuit has recently characterized the Bonded definition as an “approach that tracks the
function of the bankruptcy trustee’s avoiding powers: to recoup money from the real
recipient of preferential transfers.”16 Whether a transferee is an initial transferee or
conduit is a fact intensive inquiry.
For purposes of § 550(a), is a lead bank holding a note of the debtor an initial
transferee or a conduit when it receives allegedly preferential payments from the debtor
13 Bonded, 838 F.2d at 894.
14 Bailey v. Big Sky Motors, Ltd. (In re Ogden), 314 F.3d 1190, 1202 (10th Cir. 2002),
quoting Rupp v. Markgraf, 95 F.3d 936, 941 (10th Cir. 1996).
15 CLC Creditors’ Grantor Trust v. Howard Savings Bank (In re Commercial Loan
Corp.), 396 B.R. 730, 742 (Bankr. N.D. Ill. 2008).
16 Paloian v. LaSalle Bank, N.A., 619 F.3d 688, 691 (7th Cir. 2010).
Case 09-06011 Doc# 181 Filed 09/28/11 Page 8 of 22
and, in accord with the participation agreement, immediately forwards the payments to
the participants? Although the case law concerning the conduit exception to initial
transferee status is voluminous, research by the parties and the Court has not produced
any cases answering this question. The Court therefore will examine the legal rights and
obligations arising from a loan participation, the Agreements in this case, and the
distinctions between a conduit and an initial transferee to resolve the status of Stockton
and the Participants under § 550.
“A loan participation is an agreement in which ‘two or more banks join a loan
with each bank lending a portion of the amount to the borrower.’”17 As stated by the
Tenth Circuit, “[i]n a typical participation, the ‘lead’ [bank] . . . divides large loans into
shares which it then offers for sale to other participating financial institutions,”18 the
participants. The participation agreement governs the participation relationship.19
Participations have been classified by the courts into two large groups - those which
17 Patrick J. Ledwidge, Loan Participations Among Commercial Banks, 51 Tenn. L. Rev.
519, 520 (1984), quoting Black’s Law dictionary 1008 (5th Ed. 1997); see First Bank of
Wakeeney v. Peoples State Bank, 12 Kan. App.2d 788, 790, 758 P.2d 236, 238 (1988) (“A true
participation is a shared loan, an undertaking by one financial institution, usually called the
‘lead’, to divide a large loan which it has or will put on its books into shares which it then offers
for sale to other ‘participant’ financial institutions.”); Richard E. Weiner, Rights of a Participant
Bank Against a Lead Bank in a Participation Loan Agreement, 104 Banking L.J. 529, 529 (1987)
(defining loan participations as evidencing a joint venture by financial institutions designed to
provide funds to “large corporate clients in cases in which it would be impossible for any single
financial institution to supply the necessary amount of funds”).
18 Hibernia Nat’l Bank v. F.D.I.C., 733 F.3d 1403, 1407 (10th Cir. 1984).
19 First Bank of Wakeeney v. Peoples State Bank, 12 Kan. App.2d at 790, 758 P.2d at
238; Continental Ill. Nat’l Bank and Trust Co. of Chicago v. F.D.I.C. (In re Continental
Resources Corp.), 799 F.2d 622, 624 (10th Cir. 1986).
Case 09-06011 Doc# 181 Filed 09/28/11 Page 9 of 22
constitute sales by the lead bank to the participating banks and those which are loans to
the lead bank by the participants.20 Where the participation agreement uses the words
sale, transfer, or assignment, the transactions falls into the first category. Under
regulations of the Comptroller of the Currency, a sale permits the lead lender to subtract a
participated loan, to the extent of the participation, from its loans outstanding for lending
limit restrictions if the interests are sold without recourse and the participation results in a
pro rata sharing of the credit risk.21
In this case, the Agreements unambiguously establish that Stockton sold
undivided partial interests in the Brooke loan to the Participants. Stockton is identified as
the “Originating Lender” and “Seller.” The Participants are identified as “Participating
Lenders” and “Purchasers.” Section 2 of the Agreements is labeled “Sale of
Participation” and provides that in consideration of the Purchaser’s investment, the Seller
sells, without recourse to the Seller, an undivided interest in the principal and interest
accruing from the Brooke loan. The Purchasers agree to fund their respective portions of
the loan by transmitting funds to the Seller. Purchasers and Seller agree that “Purchaser
will be considered for all purposes the legal and equitable owner” of the respective share
of the Loan, related documents, and property.
The legal effect of the sale of interests in the Brooke loan is that each
participant is “deemed to ‘own’ a portion of the loan and to acquire (by assignment from
20 Weiner, 104 Banking L.J. at 529-530.
21 12 C.F.R. § 32.2.
Case 09-06011 Doc# 181 Filed 09/28/11 Page 10 of 22
the lead bank) all of the rights attendant thereto.”22 The result is that the participant
receives legal title to the portion of the proceeds due under the loan that relate to its
interest, and the lead bank acts as agent to collect and service the loan on behalf of the
participant.23 The Stockton Agreements provide that Stockton will receive all payments
on the loan, apply them to Brooke’s account, and hold the payments for the benefit of the
“Seller and Purchaser until the payments are actually paid to and received by the
Purchaser.” They require that such payments be remitted to the Purchaser “no later than
the close of the tenth business day following receipt.”
As stated above, for purposes of § 550(a)(1), the “minimum requirement of
status as a ‘transferee’ is dominion over the money or other asset, the right to put the
money to one’s own purposes.”24 “Dominion or control means legal dominion or
control.”25 It requires both control and the legal right to use the funds. Hence, a courier
delivering financial documents,26 a bank receiving a check drawn to its order with
directions to place the proceeds in the depositor’s account,27 an attorney receiving funds
22 Weiner, 104 Banking L.J. at 530.
23 Id. at 530-531.
24 Bonded, 838 F.2d at 893 (emphasis added).
25 Security First Nat’l Bank v. Brunson (In re Coutee), 984 F.2d 138, 141, n. 4 (5th Cir.
26 Rupp v. Markgraf, 95 F.3d at 941.
27 Bonded, 838 F.2d at 890.
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which were placed in the firm’s trust account,28 an escrow agent,29 and a bank receiving
funds with instructions to issue a cashier’s check30 have been found to be conduits and not
initial transferees for purposes of § 550(a)(1). The Bonded definition of initial transferee
has been held to mean that if the entity receiving the funds is not permitted - by law,
contract, or otherwise -from using the funds as it desires, it is a mere conduit and not an
The Court finds that Stockton was a conduit and not the initial transferee of the
$460,014.71 of the allegedly preferential payments made by Brooke on the loan which
were transmitted by Stockton to the Participants. Under the Agreements, Stockton had an
unequivocal legal duty to distribute the funds to the Participants within 10 days of receipt.
It complied with that duty. Stockton could not, without breach of the Agreements and its
legal obligation to the Purchasers, use the funds for its own purposes. As to the interests
in the Loan which had been sold, when receiving the payments from Brooke, Stockton
acted as administrator or agent. Since Brooke proposed the loan, solicited the loan to
others who were interested in purchasing an undivided interest in the loan, and brought
the participants to Stockton, it cannot be said that Brooke intended only Stockton to
28 In re Coutee, 984 F.2d at 138.
29 In re Ogden, 314 F.3d at 1190.
30 Rupp v. Markgraf , 95 F.3d at 936.
31 Tese-Milner v. Moon (In re Moon), 385 B.R. 541, 552 (Bankr. S.D.N.Y. 2008), citing
In re Coutee, 984 F.3d at 138, n.4.
Case 09-06011 Doc# 181 Filed 09/28/11 Page 12 of 22
benefit from the Loan payments. Rather, the Participants were entitled to 94.44% of the
payments as owners of undivided interests. Finding that Stockton was a conduit, not an
initial transferee, facilitates the Trustee’s recovery of the money from the Participants, the
real recipients of allegedly preferential transfers.
The Court rejects the four arguments made by the Participants in opposition to
Stockton’s memorandum.32 First, the Participants argue that Stockton had dominion and
control over the funds because of discretion retained by the lead bank under the
Agreements. They provide Stockton could administer the Loan using its sole judgment
and had discretion to “make additional advances for taxes, insurance premiums, and other
items deemed necessary by Seller to collect, enforce or protect the Loan and any Property
securing the Loan.” This discretion does not equate to control under the Bonded conduit
test. Stockton’s discretion is related to the administration of the Loan, not to the
distribution of Loan payments, which is the focus of the dominion test. Stockton had no
discretion regarding the distributions; they were governed by specific terms of the
Agreements stating the duty to make distributions, the time distributions were to be made,
and imposing a penalty if payments were not timely. The provision regarding advances is
likewise irrelevant to whether Stockton had dominion and control of the funds distributed
32 Dkt. 148. Participants at page 8 cite In re Potter, 386 B.R. 306, 314 (Bankr. D. Colo.
2008) for the proposition “the proper inquiry to determine status of initial transferee is directed
at the first party who ‘could have’ exercised control.” To the extent that Participants suggest that
Potter’s “could have” inquiry focuses on physical ability to control without legal right to control,
the Court rejects this reading. Potter was concerned with whether a debtor could be an initial
transferee with respect to a postpetition transfer. The contractual right of the debtor to exercise
control was not an issue.
Case 09-06011 Doc# 181 Filed 09/28/11 Page 13 of 22
to the Participants.33 The Participants’ argument that Stockton had dominion and control
of the Loan payments because it had administrative discretion ignores the mandatory,
specific terms of the Agreements under which Stockton acted when making the
distributions to the Participants.
As their second position, the Participants argue that Stockton’s debtor-creditor
relationship with Brooke, as evidenced by the fact Stockton is the payee of the Brooke
Note, requires characterization of Stockton as the initial transferee. They argue that “[a]s
a result of the relationship, when Stockton received funds from the Debtor it received a
direct benefit in that the outstanding loan balance of Debtor was reduced. . . . The benefit
it received as a creditor indicates dominion and control for purposes of an initial
transferee.”34 The Court and Stockton agree that this analysis is correct as to 5.56% of the
payments, or $27,958.58. This is the sum retained by Stockton for its share of the Brooke
loan which was not sold to third parties and for administrative expenses. Stockton
benefitted from this portion of the transfers and after receipt had dominion over the
payments, the right to use the funds for is own purposes. Stockton seeks summary
judgment only as to the remaining 94.44% of the payments which it transferred to the
Participants. “[T]he majority rule is that ‘where a mere conduit’ retains possession of
33 Further, there is no evidence that expenses were advanced by Stockton.
34 Dkt. 148, p. 9.
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some portion of the funds, he will be held liable up to the amount which he retains,”35 but
not the portion of the funds transferred to the conduit for the purpose of fulfilling an
obligation to make the funds available to someone else.
Contrary to the Participants’ position, “the existence of a commercial
relationship” between the debtor and the recipient of the transfers does not determine the
issue.36 Rather, the examination is of the transfers themselves.37 Examination of the
transfers shows that Stockton did not have dominion as to the remaining 94.44% of the
payments which Stockton, as administrative agent for the Participants, in accord with the
Agreements, forwarded to the Participants. Since the undivided interests in the Note had
been sold to the Participants, Stockton was not a creditor of Brooke as to these interests.
As to these payments the analysis is like that applied in General Mortgage.38 In that case,
the debtor was the original holder of a note and mortgage which it assigned to the
defendant Washington Mutual, who then assigned it to Bank of America. Neither of the
assignments were recorded. The trustee sought to recover from Washington Mutual
prepetition and postpetition transfers made by the debtor to Washington Mutual, which
35 In re Moon, 385 B.R. at 553, n. 34, quoting In re 360networks (USA) Inc., 338 B.R.
194, n. 11 (Bankr. S.D.N.Y. 2005).
36 Christy v. Alexander & Alexander of New York, Inc. (In re Finley, Kumble, Wagner
Heine, Underberg, Manley, Myerson & Casey), 130 F.3d 52, 58 (2nd Cir. 1997).
37 Id. at 59.
38 Jensen v. Washington Mutual Bank, F.A. (In re General Mortg. Corp. of Amer., Inc.),
384 B.R. 617 (Bankr. M.D. Fla. 2008).
Case 09-06011 Doc# 181 Filed 09/28/11 Page 15 of 22
Washington Mutual then paid to Bank of America, with Washington Mutual retaining
only a servicing fee. The debtor had no contractual relationship with Bank of America,
the only direct contractual relationship was with Washington Mutual. Based on these
facts the court concluded that Washington Mutual was acting as a conduit because it “had
no legal right to use the funds for its own purposes.”39
This distinction between the portion of the funds retained by Stockton for its
retained ownership in the Brooke Note and the funds transmitted to the Participants is
consistent with the cases cited by the Participants in support of its second argument.
None of them consider the status of a lead bank when a loan is subject to a participation
agreement or even an analogous situation. In Granada,40 the trustee brought an action
against a bank to recover preference payments made by the debtor general partner
through partnerships. Because the debtor was a creditor of the partnerships, the
partnerships were the initial transferees, not conduits. The partnerships received
something from the debtor which “they could call their own.”41 In this case, the only
thing which Stockton received from the Debtor which it could call its own was the
$27,958.58. The Participants cite Kaiser Steel42 for the proposition that the Court may
39 Id. at 621.
40 Billings v. Key Bank of Utah (In re Granada, Inc.), 156 B.R. 303 (D. Utah 1990).
41 Id. at 308.
42 Kaiser Steel Resources, Inc. v. Jacobs (In re Kaiser Steel Corp.), 110 B. R. 514, 521
(D. Colo. 1990).
Case 09-06011 Doc# 181 Filed 09/28/11 Page 16 of 22
consider whether the alleged conduit received consideration, had a beneficial interest in
any of the property, and had the ability to control the disposition of the property.
Applying those factors, Stockton received only $27,958.58 for its own account, had a
beneficial interest in only that amount, and had the ability to control only the small
percentage of the payments which it was not obligated to transfer to the Participants.
Columbia Data Products, 43 also cited by the Participants, states, “When a creditor
receives money from its debtor to pay a debt, the creditor is not a mere conduit.” The
Court agrees, but here that principal applies only to the portion of the Loan held by
Stockton. Here Stockton received money in payment of the Brooke Note, but only 5.56%
of the payment was applied to Stockton’s interest in the Note. Stockton was not a
creditor of Brooke as to the interests sold to the Participants.
The Participants’ third argument is that Stockton is an initial transferee because
it commingled the funds received from Brooke and did not hold the funds in trust. It cites
Liberty Livestock 44 in support of the proposition that when an alleged conduit who was
obligated to hold the funds in trust, commingles the funds with its own, it loses the ability
to argue that it is a mere conduit.45 It is argued that the commingling of the loan payment
43 Lowry v. Security Pacific Business Credit, Inc. (In re Columbia Data Products, Inc.),
892 F.2d 26, 28 (4th Cir. 1989).
44 Redmond v. Ellis County Abstract & Title Co. (In re Liberty Livestock Co.), 198 B.R.
365, 372 (Bankr. D. Kan. 1996).
45 Dkt. 148, p. 9.
Case 09-06011 Doc# 181 Filed 09/28/11 Page 17 of 22
funds with unrelated funds in Stockton’s account at Bankers’ Bank is sufficient to
eliminate any possibility that it could be a conduit.
This objection fails for two reasons: Stockton did not agree to hold the funds in
trust; and a bank’s use of a correspondent bank to clear checks and to initiate and receive
wire transfers on its behalf is not commingling for purposes of the conduit rule. A
participation agreement defines whether the parties to a sale of an interest also intended to
create a trust or fiduciary relationship.46 The Agreements between Stockton and the
participants is devoid of language evidencing intent to create a trust or fiduciary
relationship. Stockton was not required to segregate the payments received on the Loan
from other bank assets, but was obligated to make distributions within ten days of receipt.
Stockton as seller was granted permission to administer the Loan as though it were the
sole owner thereof. Stockton’s duty to the Participants was the “use the same degree of
care in servicing and collecting the Loan as it would for its own accounts. Seller will not
be liable to Purchaser for any action taken or omitted or for any error in judgment, except
for bad faith or willful misconduct.” There was no trust relationship and therefore no
basis to argue that there was improper commingling. Further, the commingling which is
alleged arises from Stockton’s use of a correspondent bank clearinghouse for wire
transfers and other payments. This is ordinary business practice and has no bearing on
the conduit question as applied to Stockton.
46 Weiner, 104 Banking L.J. at 531-533.
Case 09-06011 Doc# 181 Filed 09/28/11 Page 18 of 22
Finally, the Participants argue that Stockton’s contractual relationships with the
Participant Banks do not impact its status as an initial transferee.47 The rationale is that a
contract of a creditor of the debtor requiring it to apply funds received from the debtor to
pay the creditor’s own creditors does not change the fact that the debtor’s creditor is using
the funds for its own purposes.48 This principle does not apply here because the
Participants are not creditors of Stockton. The Participants are owners of a partial interest
in the Brooke Note. They funded their respective interests in the Note. Rather than
having no impact, the Participation Agreements determine Stockton’s status as a conduit
with respect to the $460,014.71 at issue. As stated above, under the Bonded definition of
initial transferee, if the entity receiving the funds is not permitted - by law, contract, or
otherwise -from using the funds as it desires, it is a mere conduit and not an “initial
transferee.” As a consequence of the Agreements, Stockton did not exercise dominion
over the payments which were legally the property of the Participants. Like an attorney
who places settlement funds in a trust account, to be divided between the attorney and the
client,49 Stockton would have been subject to contractual liability if it had attempted to
use the Participants’ portion of the funds for its own purposes. Since dominion means
47 This argument is essentially a reformulation of a the Participants’ second argument that
Stockton’s debtor-creditor relationship with Brooke requires characterization of Stockton as the
initial transferee. The Court therefore rejects this argument for the same reasons as discussed
48 Dkt. 148, p. 10, citing Columbia Data Products, Inc., 892 F.2d at 28.
49 See In re Moon, 385 B.R. at 553.
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legal dominion and control, the fact that Stockton could have violated its contractual duty
to the Participants by taking the payments and spending them as it pleased makes “no
difference in the analysis.”50
The fact that Stockton filed a proof of claim for the full amount owed by
Brooke on the Note does not evidence that Stockton could legally exercise dominion and
control over the Brooke payments. The proof of claim was filed by Stockton to fulfill its
duty to the Participants to administer the Loan “as though it were the sole owner and
At oral argument, counsel for the Participants brought the Court’s attention to
Paloian,51 a recent Seventh Circuit opinion by Chief Judge Easterbrook, who also was the
author of the Bonded opinion. Paloian held that a securitized asset pool trustee, although
contractually bound to disperse the trust’s property to investors, when it received funds in
payment of notes held in the trust, was not a mere conduit and could be an initial
transferee. Participants argued that Paloian requires denial of Stockton’s motion for
partial summary judgment, but the Court disagrees. The facts in Paloian are clearly
distinguishable from the facts in this case. In 1997, Nomura had loaned the debtor
hospital $50 million through HPCH, which owned the hospital’s building and land. As a
part of the transaction, the hospital agreed to pay HPCH additional rent and gave Nomura
a security interest in the incremental rent. The Nomura loan was securitized by selling it
50 In re Coutee, 984 F.2d at 141, n. 4.
51 Paloian v. LaSalle Bank, N.A., 619 F.3d at 699.
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to a third party that packaged several billion dollars of commercial credit for resale to
investors. The notes and the security interests were transferred to a trust, of which
LaSalle Bank was the trustee. An adversary complaint, filed against the LaSalle Bank, as
trustee, alleged that rent payments made by the debtor pursuant to the lease and paid to
LaSalle were fraudulent transfers. LaSalle contended it was a conduit and not an initial
transferee. The Seventh Circuit disagreed holding that as trustee of the securities pool,
the bank trustee was the legal owner of the trust’s assets. The court observed that if found
to have liability for the transfers, the Trustee would draw the money from the corpus of
the trust, so that the money would really come from the trust’s investors, the persons for
whom the transfers were made. “Instead of requiring the bankruptcy trustee to sue
thousands of investors who may have received interest payments that were increased,
slightly, by money from the Hospital’s coffers, a single suit suffices.”52 In this case,
Stockton is not a trustee of the Brooke Note. The Participants, not Stockton, are owners
of the interests in the Brooke Note which were satisfied by the Brooke transfers to
Stockton. Stockton holds no assets for the benefit of the Participants from which it could
deduct any payments for which it might be found liable to the Trustee. The Participants
are already parties to this litigation, and requiring the Trustee to recover from them rather
than Stockton will not impose an administrative burden.
52 Id. at 692.
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For the foregoing reasons, the Court grants Stockton’s Motion for Partial
Summary Judgment. There are no material facts in controversy. As a matter of law
Stockton is entitled to a ruling that, assuming that the Trustee prevails on his contention
that Brooke’s payments of $487,973.29 to Stockton were preferential, Stockton acted as a
mere conduit with respect to $460,014.71 of the payments. As to these payments, by
entering into the Participation Agreements and selling interests in the Note, Stockton
contracted away its legal ability to exercise dominion over the funds. For purposes of §
550(a)(1), Stockton is not the initial transferee of $460,014.71 of the transfers which the
Trustee seeks to recover.
IT IS SO ORDERED.
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