Bankruptcy Case No. 05-15409-CL7 (Bankr. S.D. Cal. Mar. 27, 2014)

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Gladston v. McHaffie (In re UC Lofts on 4th, LLC)

UNITED STATES BANKRUPTCY COURT SOUTHERN DISTRICT OF CALIFORNIA

Mar 27, 2014

Bankruptcy Case No. 05-15409-CL7 (Bankr. S.D. Cal. Mar. 27, 2014)

Opinion

Bankruptcy Case No. 05-15409-CL7 Bankruptcy Case No. 05-15410-CL7 Adversary Proceeding No. 07-90139-CL

03-27-2014

In re: UC LOFTS ON 4TH, LLC UC LOFTS ON 5TH, LLC, Debtors, LESLIE GLADSTON, CHAPTER 7 TRUSTEE, Plaintiff, v. CHARLES MCHAFFIE, ET AL., Defendants.

CHRISTOPHER B. LATHAM

WRITTEN DECISION - NOT FOR PUBLICATION

Chapter 7 MEMORANDUM DECISION AND ORDER

GRANTING JUDGMENT AGAINST

DEFENDANT HALIFAX INVESTMENTS,

LLC AND GRANTING JUDGMENT IN

FAVOR OF DEFENDANTS SHEILA

LEMIRE, FRANK SCHAEFER, FRANK

SCHAEFER CONSTRUCTION, INC.,

FRANK SCHAEFER CONSTRUCTION, INC.

PENSION PLAN AND JOHN SCAFANI

Judge: Christopher B. Latham

MEMORANDUM DECISION AND ORDER GRANTING JUDGMENT AGAINST

DEFENDANT HALIFAX INVESTMENTS, LLC AND GRANTING JUDGMENT IN FAVOR

OF DEFENDANTS SHEILA LEMIRE, FRANK SCHAEFER, FRANK SCHAEFER

CONSTRUCTION, INC., FRANK SCHAEFER CONSTRUCTION, INC. PENSION PLAN

AND JOHN SCAFANI

The court held a trial on Plaintiff Chapter 7 Trustee Leslie T. Gladstone's Complaint against Defendants Frank Schaefer, Frank Schaefer Construction, Inc., Frank Schaefer Construction, Inc. Pension Plan (together the "Schaefer Entities"), John Scafani, Halifax Investments, LLC ("Halifax") and Sheila Lemire. Plaintiffs Complaint seeks to avoid several transfers arising out of a series of loan transactions to finance the acquisition and initial development of real property held by Debtors UC Lofts on 4th, LLC and UC Lofts on 5th, LLC (collectively "Debtors" or "UC Lofts"). Plaintiff has failed to meet her burden to hold the Schaefer Entities, Sheila Lemire or John Scanfani liable. The court therefore awards judgment in their favor. But the Trustee has established that the prepetition settlement payment from Debtors to Halifax is avoidable as a fraudulent transfer. The court therefore awards judgment against Halifax in the mount of $1,100,000 plus interest.

I. JURISDICTION AND VENUE

The court has jurisdiction to hear this matter pursuant to 28 U.S.C. §§ 157(b)(2)(F), (H), (0), (c)(1); 1334(b). Venue is proper under 28 U.S.C. §1409(a). All parties have expressly consented to this court's authority to hear and determine the claims asserted in the Trustee's Complaint and remaining in the pretrial order.

ECF Nos. 434, 435. This memorandum decision may likewise constitute the court's findings of fact and conclusions of law under Federal Rule of Bankruptcy Procedure 7052(a)(1).

II. PROCEDURAL HISTORY

The Trustee has asserted claims against the Schaefer Entities for: (1) avoidance and recovery of fraudulent transfers; (2) avoidance and recovery of a preferential transfers; (3) aiding and abetting breach of a fiduciary duty; (4) declaratory relief that Frank Schaefer was a partner of UC Lofts; (5) equitable subordination of Frank Schaefer Construction, Inc.'s claims; (6) breach of fiduciary duty to UC Lofts; and (7) conversion. Plaintiff also seeks to avoid allegedly fraudulent transfers to, or for the benefit of, Defendants Lemire, Scafani and Halifax.

The court bifurcated the issues for trial into: (1) insolvency; and (2) all others. The court held a trial in February 2012 on insolvency and issued a memorandum decision finding that the Trustee had failed to prove Debtors were insolvent on February 12, 2004. The Schaefer Entities then moved for summary judgment, which the court granted as to two of the Plaintiffs usury claims and denied in all other respects.

The court conducted an eight-day bench trial on the remaining issues in this adversary proceeding. On the seventh day of trial, Plaintiff orally moved to conform the pretrial order to proof by adding a claim for fraudulent transfer against the Schaefer Entities and Lemire. Finding that relevant and material evidence had come in without objection, and that Defendants faced no substantial prejudice, the court granted the motion.

III. FACTUAL BACKGROUND AND FINDINGS

A. The Debtors' Structure and Real Property

At all relevant times, Urban Coast, LLC ("Urban Coast") was the sole owner and managing member of UC Lofts on 4th, LLC and UC Lofts on 5th, LLC. Urban Coast's only assets were its membership interests in the Debtors. Before February 12, 2004 and until December 2006, UC Lofts on 4th, LLC owned two parcels of real property on Fourth Avenue in San Diego, California. UC Lofts on 5th, LLC owned a single parcel of real property located on Fifth Avenue, San Diego, California, which is contiguous with the two parcels owned by UC Lofts on 4th, LLC (the three parcels are collectively referred to as the "UC Lofts Real Property"). UC Lofts' stated purpose was to develop a mixed-use facility on the UC Lofts Real Property known as the Atmosphere Project.

Pretrial Order, ECF No. 435, pp. 7-10. The court incorporates the stipulated facts contained in the pretrial order and only mentions those necessary to support this decision.

B. Charles McHaffie's Acquisition of the Urban Coast, LLC Membership Interests

Before February 12, 2004, Defendant Halifax held a forty-nine percent stake in Urban Coast. Defendant John Scafani wholly owned and managed Halifax. A consortium made up of 6th and Broadway Corporation, Broadsmore Capital, LLC, Peter Kostopoulos and Matthew Gordon (the "Broadsmore Group") owned the majority 51 percent interest. In February 2004, Charles McHaffie purchased 100 percent of the membership interests in Urban Coast in two contemporaneous sale agreements with Halifax and the Broadsmore Group. McHaffie paid $2,452,803 for the Broadsmore Group's interests: $1,899,625 in cash and $552,803 in a promissory note secured by a deed of trust on real property held by La Bella Vida, L.P.

Pl.'s Ex. 4.

As consideration for Halifax's membership interest, Urban Coast executed and delivered to Halifax a $1,600,000 promissory note ("Halifax Sale Agreement"). The Halifax Sale Agreement lists McHaffie as the "Buyer," John Scafani as the "Broker," Urban Coast as the "Company" and Halifax as the "Seller." The Halifax Sale Agreement required McHaffie and Urban Coast to pay the purchase price, which the parties intended to be secured by the UC Lofts Real Property. The agreement granted Scafani: (1) exclusive rights to broker sales of condominium units, parking and commercial space in the Atmosphere Project; (2) commissions; and (3) options to purchase units in the Atmosphere Project. Halifax and Scafani promised to refrain from recording the security instrument until Urban Coast obtained construction financing. But the agreement stated that Halifax's note should enjoy the same priority as the eventual construction loan.

Pl.'s Ex. 4, 5.

Pl.'s Ex. 4.

Both the Halifax Sale Agreement and accompanying note expressly provided that the obligations run to Urban Coast and McHaffie personally. Although McHaffie pledged the UC Lofts Real Property as collateral for the note, the UC Lofts were not parties to the Halifax Sale Agreement. Consequently, the court finds that the Halifax Sale Agreement and accompanying note did not impose obligations on the Debtors.

Pl.'s Ex. 4, 5.

c. The Loan Transactions and Transfers

1. The First Loan Transaction in February 2004

McHaffie borrowed acquisition capital to finance his purchase of Urban Coast and leveraged the UC Lofts Real Property to secure these loans. The First Loan transaction occurred in February 2004, and was comprised of: (1) $4,000,000 from the Barth Family to UC Lofts (the "Barth Note"); and (2) $1,750,000 from Frank Schaefer Construction Inc. Pension Plan to UC Lofts. A first position deed of trust secured the Barth Note, and a second position deed of trust secured the Schaefer Entities' note.

At that time, two separate deeds of trust securing a purported $3,400,000 obligation in favor of Urban Coast (the "UC DOT") and a $100,000 obligation in favor of SD Lofts, LLC (the "SD Lofts DOT") encumbered the UC Lofts Real Property. But Defendant Scafani testified credibly that no accompanying note existed to support the UC DOT. Nor did Plaintiff provide any evidence of a signed note. Further, McHaffie signed for SD Lofts, LLC in all relevant transactions. Ultimately, both the SD Lofts DOT and the UC DOT were reconveyed. Neither SD Lofts, LLC nor Urban Coast ever demanded payment on these purported obligations during the relevant period between February 13, 2004 and November 24, 2004. The court therefore finds that the UC DOT and SD Lofts DOT were not liabilities owed by Debtors. Nevertheless, to facilitate the First Loan transaction, Urban Coast and SD Lofts, LLC agreed to subordinate their respective trust deeds.

McHaffie applied $4,527,600 from the First Loan proceeds to purchase his interests in Urban Coast and deposited the remaining $1,222,400 into a fund control account (the "First Fund Control") to hold advanced loan proceeds until Schaefer approved disbursements. At roughly the same time, the parties entered into an agreement to govern disbursements out of the fund control account (the "Fund Control Agreement"). The parties based the $1,222,400 figure on a proposed budget for the project. Specifically, the budget accounted for:

Defs.' Ex. A-X. Only McHaffie executed this particular document. But the parties stipulated to its admissibility. The subsequent loan transaction documents presumably refer back to this Fund Control Agreement.

Pl.'s Ex. 98, 102; Trial Tr. vol. 5, 36-37, Dec. 13, 2013, ECF No. 450.

• Fund Control Fee:	$1,000
• Management & Supervision:	$200,000
• Shoring / Concrete:	$350,000
• Architect / Engineering:	$78,000
• Excavate / Haul / Recycle:	$250,000
• Model:	$21,000
• Legal:	$25,000
• Barricades:	$34,000
• Equipment Rental:	$61,300
• Contingency:	$202,100.

Pl.'s Ex. 102.

Between February 12, 2004 and April 2, 2004, the Debtors made the following transfers with the First Loan proceeds from the First Fund Control, which the Trustee alleges did not benefit Debtors or were unrelated to the Atmosphere Project:

• $20,000 on February 23,2004 to Frank Schaefer Construction, Inc. Pension Plan for "Reimbursement-Management;"
• $5,000 on March 5, 2004 to James Warner, Esq. for "Legal;"
• $20,000 on March 5, 2004 to Charlemagne McHaffie for "Funds to Borrower;"
• $50,000 on March 8, 2004 to Ron Bedell for "Commission;" and
• $20,000 on April 1, 2004 to Charlemagne McHaffie with no stated purpose.

Pl.'s Trial Br., ECF No. 429, p. 8; Pl.'s Ex. 14.

2. The April 2, 2004 Loan Transaction

On April 2, 2004, Frank Schaefer Construction Inc. extended UC Lofts another $1,200,000 loan (the "April 2, 2004 Loan"). This loan was secured by a third position deed of trust on the UC Lofts Real Property. And Urban Coast and SD Lofts, LLC again agreed to subordinate their deeds of trust to the April 2, 2004 Loan.

Although the $1,200,000 never entered a bank account for the Debtors, Schaefer testified that he sent the funds through escrow. Plaintiff offered no contradictory evidence to rebut this assertion. The court therefore accepts that the funds entered escrow before Debtors first took possession of them.

Trial Tr. vol. 5, 44, ECF No. 450.

McHaffie used the April 2, 2004 Loan proceeds to exercise an option to purchase a Nevada limited liability company, Tropicana Partners, LLC. Tropicana Partners, LLC's primary asset was commercial real property in Las Vegas, Nevada. McHaffie testified that he set up yet another LLC - Urban Coast, LLC Nevada - to exercise the option and hold the membership interests. The Tropicana Partners, LLC membership interests and the Las Vegas real property (together "Tropicana") never graced Debtors' balance sheet.

Trial Tr. vol. 2, 165:9-12, Dec. 5, 2013, ECF No. 442. Minutes later, McHaffie recanted, stating, "It might have been Urban Coast California." Trial Tr. vol. 2, 178:22, ECF No. 442. Regardless, he made clear it was not UC Lofts on 4th, LLC or UC Lofts on 5th, LLC.

McHaffie planned to resell Tropicana at a substantial profit. He would then redirect the funds to finance the Atmosphere Project. But that did not happen. Instead, McHaffie failed to make any significant progress toward selling the Las Vegas property. When Schaefer threatened to foreclose, the parties negotiated a compromise. McHaffie would assign Tropicana to Frank Schaefer in full satisfaction of the April 2, 2004 Loan, which had an unpaid balance of $1,500,000. The parties finalized the settlement in December 2004, but only after Schaefer had recorded a notice of sale on the UC Lofts Real Property.

Schaefer estimated the Las Vegas property to be worth $5,000,000 to $6,000,000 around the time of the transfer. But it had an existing $2,000,000 to $2,600,000 first mortgage on it, which he assumed. The property also had many vacancies and required substantial repairs. Lemire paid Schaefer $70,000 for an option to buy the property for the $1,500,000 he "had in it plus some carrying costs," which increased daily. She also borrowed against the property to fund improvements. Schaefer attested that Lemire successfully filled vacancies through her efforts. About a year later, Lemire sold the property for $5,750,000 and paid off the $2,100,000 owed to Schaefer. She testified that she realized between $200,000 and $400,000 net from the sale. But she was not certain if she actually received any of the proceeds because she had to pay off a loan at closing. Plaintiff presented no direct evidence on this point other than Lemire's own testimony.

Trial Tr. vol. 6, 15:13-21, Dec. 18, 2013, ECF No. 462; Trial Tr. vol. 8, 12:24-25, Dec. 19, 2013, ECF No. 473.

Trial Tr. vol. 8, 54:22-55:15, ECF No. 473.

Trial Tr. vol. 8, 80-81, ECF No. 473.

Meanwhile, the Debtors had transferred several hundred thousand dollars from the First Fund Control in relation to the acquisition of Tropicana, which the Trustee also alleges benefitted the Schaefer Entities. In addition to the April 2, 2004 Loan proceeds, the Debtors made the following payments to acquire Tropicana:

• $100,000 on May 20, 2004 to Santoro, Driggs for legal fees related to the Las Vegas property;
• $1,000 on May 24, 2004 to Lawyer's Title for title fees related to the Las Vegas property;
• $50,000 on May 26, 2004 to Fred Young for "Deposit, per borrower" related to the Las Vegas property;
• $5,010 on June 17, 2004 to Santoro, Driggs for legal fees related to the Las Vegas property;
• $10,000 on July 21, 2004 to Santoro, Driggs for legal fees related to the Las Vegas property;
• $300,000 on July 21, 2004 to Joy Turner for "Deposit, per borrower" related to the Las Vegas property; and
• $60,000 on July 21, 2004 to Santoro, Driggs for legal fees related to the Las Vegas property.

Pl.'s Trial Br., ECF No. 429, p. 9; Pl.'s Ex. 14.

During this time period, the Debtors also made the following transfers from the First Fund Control that were unrelated to the Tropicana acquisition or the Atmosphere Project:

• $10,000 on May 14, 2004 to James Warner for legal fees;
• $46,666.67 on July 8, 2004 to Pacific Horizon Financial for "Interest payment, 1st TD;"
• $20,416.67 on July 8, 2004 to Action Loan Servicing for "Interest payment; 2nd TD."

Pl.'s Ex. 14.

The Trustee established that the last two transfers went to pay down interest on McHaffie's personal residence. On August 17, 2004, the Debtors also made a $36,000 interest payment toward the April 2, 2004 Loan.

Pl.'s Ex. 14.

3. The Second Loan Transaction in September 2004

By the end of September 2004, less than $100,000 remained in the First Fund Control. Schaefer testified that the Debtors had insufficient money to pay the architects, Hawkins & Hawkins, and needed a quick capital infusion to pay this invoice. Thus, on September 24, 2004, the Schaefer Entities lent the Debtors another $2,500,000 (the "Second Loan"), which was purportedly secured by an assignment of a deed of trust.

Pl.'s Ex. 14.

On direct, McHaffie indicated that this was in fact the phantom $3,400,000 UC DOT.

The Schaefer Entities initially funded the loan with $500,000 and charged $35,312 as a loan origination fee. The Debtors directed $100,000 of the Second Loan proceeds to pay Hawkins & Hawkins and deposited the remaining $365,688 into a second fund control account (the "Second Fund Control")

Pl.'s Ex. 34.

Pl.'s Ex. 34, 44.

After receiving the Second Loan Proceeds, the Debtors promptly depleted the First Fund Control with the following transfers:

• $37,000 on October 8, 2004 to Charlemagne Ed. Trust for "Funds to Borrower;"
• $35,000 on October 8, 2004 to WS-TH for "Funds to Borrower;" and
• $10,000 on October 8, 2004 to Charlemagne McHaffie Trust for "Funds to Borrower."
• $4,097.83 on October 15, 2004 to the City of San Diego to fund a bond.

After these transfers, the First Fund Control was overdrawn by $2,179.50.

WS-TH apparently was a construction project on real property in Murrieta, California in which McHaffie and Warner were involved.

Pl.'s Ex. 14.

WS-TH apparently was a construction project on real property in Murrieta, California in which McHaffie and Warner were involved.

Pl.'s Ex. 14.

4. The Third Loan Transaction and Halifax Settlement in November 2004

By mid-November 2004, the First Fund Control displayed a negative balance, the Schaefer Entities' notice of default remained on the UC Lofts Real Property, and the Debtors had no other sources of capital. At the time Schaefer and McHaffie were negotiating the Tropicana transfer to satisfy the April 2, 2004 Loan, they also discussed a possible new loan. The two transactions were separate but related - Schaefer continued the foreclosure process to pressure McHaffie to negotiate. In fact, the contemplated Tropicana transfer appears as a line item on a term sheet for the new loan in November 2004.

Defs.' Ex. C-H

Meanwhile, Scafani and Halifax had filed a lawsuit in June 2004 against McHaffie and Urban Coast for breach of the Halifax Sale Agreement and recorded a lis pendens on the UC Lofts Real Property. Scafani testified that both McHaffie and Schaefer negotiated with him in November 2004, although the only settlement offer came from Schaefer. Initially, Schaefer took the position that he could simply foreclose on his senior lien to extinguish the lis pendens. Further, James Warner, Esq., who simultaneously represented McHaffie, Urban Coast and the Debtors at that time, observed that he believed Scafani had probably recorded the lis pendens improperly. He opined that an improperly recorded lis pendens could typically be expunged by ex parte or noticed motion for less than $10,000.

Trial Tr. vol. 2, 122:11-22, ECF No. 442.

Trial Tr. vol. 2, 108:7-11, 122:11-22, ECF No. 442.

Nevertheless, by early November 2004 Scafani, McHaffie and Schaefer had reached an agreement to resolve the dispute without litigation or foreclosure. The settlement called for a $1,100,000 payment to Halifax as consideration for Halifax's releasing its $1,600,000 note and lis pendens, and for Scafani's releasing his exclusive brokerage rights and purchase options (the "Halifax Settlement"). Although the underlying Halifax Sale Agreement only lists Urban Coast, McHaffie, Scafani and Halifax as signatories, the exact Halifax Settlement language provides: "SHAFFER [sic] to pay to HALIFAX." The Trustee contends that this provision shifts the obligations owed by Urban Coast and McHaffie under the Halifax Sale Agreement onto Schaefer. The court disagrees. None of the Schaefer Entities was a party to either the Halifax Sale Agreement or the lawsuit filed by Scafani and Halifax. Rather than imposing a legal obligation on the Schaefer Entities, the court interprets this provision - which, like the rest of the document, was quite loosely drafted - as merely recognizing the source of payment.

Defs.' Ex. F-1.

For instance, it erroneously refers to the Debtors as "Lofts on 4th, LLC" and "Lofts on 5th, LLC," and incorrectly spells Defendants Schaefer and Lemire's names.

These events converged to precipitate an immediate need for capital. On November 19, 2004, the Schaefer Entities lent Debtors an additional $4,000,000 (the "Third Loan"), which was secured by the UC Lofts Real Property. The Schaefer Entities initially advanced $1,165,000 under the Third Loan. The escrow instructions routed $1,100,000 of the Third Loan proceeds directly to Halifax, charged a $210,500 loan origination fee and charged $52,500 as an extension fee for the First Loan.

Pl.'s Ex. 40, 41.

The Third Loan also extinguished the hastily made Second Loan. The Debtors transferred $206,552.65 from the Second Fund Control and $299,447.35 from the Third Loan proceeds to pay off the $500,000 funded under the Second Loan. This transfer left the Second Fund Control with a zero balance. Schaefer had to advance another $111,600 under the Third Loan on November 22, 2004 to replenish the deficiency. This left a $6,413.69 balance in the Second Fund Control.

Pl.'s Ex. 44.

5. The Global Settlement in April 2005 and Subsequent Foreclosure

After the Third Loan, the Schaefer Entities made no new loans to the Debtors. But in April 2005, the Schaefer Entities and the Debtors negotiated a Global Workout Agreement that provided $1,130,000 in additional funding under the $4,000,000 Third Loan. It reinstated and extended the First Loans, extended the Third Loan's maturity date and paid delinquent real property taxes. Further, it required Debtors to reconvey all deeds of trust junior to the Third Loan, which included the UC DOT, SD Lofts DOT and the April 2, 2004 Loan trust deed that Schaefer had assigned to Lemire. Schaefer represented that these loan fees and extension fees deducted from the funding disbursements were never collected. Instead, Schaefer added these amounts to the Third Loan's balance. The only advances the Schaefer Entities made after April 15, 2004 under the Third Loan went to pay off the initial $1,750,000 Schaefer loan.

The Debtors did not obtain additional financing thereafter from any party. McHaffie, however, persuaded Mark Whillock, his wife and his company into lending over $1,000,000 to fund projects only tangentially related to the Atmosphere Project but secured by the UC Lofts Real Property nonetheless.

Defs.' Ex. B-E.

Schaefer had purchased the Barth Note by then to reduce his carrying costs. He thereafter assigned it to First National Bank.

Trial Tr. vol. 7, 64:24-66:9, Dec. 19, 2013, ECF No. 468.

Trial Tr. vol. 9, 66:15-21, Dec. 20, 2013, ECF No. 469.

As of January 11, 2006, the Third Loan had an outstanding balance of $5,678,351.50. During the Debtors' bankruptcy cases, the Schaefer Entities paid upward of $20,000 per month as a holding cost to keep the Barth Note current. The Schaefer Entities foreclosed on the Third Loan trust deed and credit bid $1,500,000 at a foreclosure sale in September 2006.

The Schaefer Entities then sold the UC Lofts Real Property through an LLC to Alpha and Omega Development, LLC for $6,000,000, and paid $5,312,330.37 out of escrow to First National Bank, the successor beneficiary to the Barth Note. Frank Schaefer Construction Pension Plan also made an additional $1,250,000 hard money loan to Alpha and Omega Development, LLC behind a first deed of trust purchase money loan to Dunham & Associates of $3,700,000. Ultimately, the holder of this new first trust deed foreclosed out the Schaefer Entities' interest.

D. Schaefer's Interactions with Debtors and Their Creditors

Much of the Trustee's case depends upon a finding that the Schaefer Entities were insiders of the Debtors. The court makes the following factual findings with respect to the Schaefer Entities' interactions with the Debtors and their creditors.

Schaefer had to authorize all disbursements from the fund controls before Debtors had access to the funds. The Schaefer Entities and Urban Coast entered into an agreement to govern disbursements out of the fund control accounts (the "Fund Control Agreement"). The Fund Control Agreement only permitted "payment of items relating to the job which are then due and payable." The agreement also allowed:

Defs.' Ex. A-X.

Control [Schaefer] shall conclusively presume that any written order of an authorized person is (1)-given for the purposes stated in the order; and (2) authorized by the Owner and Contractor.

Defs.' Ex. A-X.

The Schaefer Entities issued disbursements through checks listing the drawer alternatively as:

FRANK SCHAEFER CONSTRUCTION INC.
FBO UC LOFTS ON 4TH, LLC
FBO UC LOFTS ON 5TH, LLC; and
UC LOFTS.

In some instances, the checks did not identify the drawer. Frank Schaefer signed many of the checks and addressed them to the intended payee per McHaffie's request. He also engaged Burton Harris of Real Estate Services, Inc. to handle disbursements from the fund controls. But Mr. Harris lacked independent authority to authorize disbursements. Schaefer credibly testified that he never rejected a funding request from Mchaffie.

Pl.s' Ex. 14, 44.

Trial Tr. vol. 5, 39:11-40:1, ECF No. 450.

Whillock testified that McHaffie introduced Schaefer "as the money partner that was paying for the project" while all three were together at the UC Lofts Real Property. He asserted that Schaefer did not deny this characterization. Moreover, the Debtors paid Whillock's invoices through the Schaefer Entities. In fact, Schaefer's office sent a letter to Whillock Contracting requesting that Whillock direct its invoices to Frank Schaefer Construction.

Trial Tr. vol. 6, 52:24-25, ECF No. 462.

Pl.'s Ex. 47.

According to Schaefer, McHaffie "liked to call people his partner." To Schaefer's recollection, McHaffie only did so in his presence on one occasion, which he promptly corrected. Schaefer stated that McHaffie repeatedly attempted to persuade him to convert his loans to equity. He was not interested, however. Further, Warner testified that McHaffie did not tell him Schaefer was a partner in the Atmosphere Project. But McHaffie did inform Warner that he had a partnership agreement with Whillock.

Trial Tr. vol. 6, 30:24, ECF No. 462.

Trial Tr. vol. 6, 30:21-31:13, ECF No. 462.

Trial Tr. vol. 5, 94, ECF No. 450.

Schaefer did express interest in forming an LLC with McHaffie to obtain construction financing to complete the Atmosphere Project. He and McHaffie eventually met with John Terwilleger of IndyMac Bank's Homebuilder Division to discuss construction financing for an "LLC to be determined." Schaefer provided a financial statement to IndyMac. This meeting resulted in an application letter dated September 9, 2004 with certain preliminary terms and conditions. Schaefer stated that by the time he received the September 9, 2004 letter he no longer had any interest in pursuing the LLC formation with McHaffie.

Pl.'s Ex. 33.

Trial Tr. vol. 5, 86:14-19, ECF No. 450.

McHaffie continued to engage IndyMac without Schaefer, however, as is evident by the email sent from Mr. Terwilliger to McHaffie on February 1, 2005. By this stage, the bank required McHaffie to gather sufficient "cash to pay off Frank, put $5,000,000 in the bank and to get the project built."

Pl.'s Ex. 23.

Additionally, Plaintiff introduced an unexecuted agreement that would have effectively established a joint venture between the Schaefer Entities and McHaffie, among others. It called for the creation of an LLC - Lofts LLC - presumably to build the Atmosphere Project. Schaefer denied having seen this document before this litigation with the Chapter 7 Trustee, and it was never executed. Moreover, Warner testified ' that this document came through his office, as he was accepting facsimile transmissions for McHaffie at the time. He believed it originated from a Texas transactional attorney, Robert Graham, and was simply a proposal as part of the "back and forth" between the parties.

Pl.'s Ex. 35.

E. The Value of the UC Lofts Property

The parties offer conflicting expert opinions on the UC Lofts Real Property's fair market value between February 13, 2004 and November 24, 2004 (the "Relevant Period"). It is therefore necessary to reconcile these contrasting figures for the court to determine if the Debtors were insolvent or had unreasonably small assets during the Relevant Period.

"The fair market value is the price which a willing seller under no compulsion to sell and a willing buyer under no compulsion to buy would agree upon after the property has been exposed to the market for a reasonable time." Taffi v. United States (In re Taffi), 96 F.3d 1190, 1192 (9th Cir. 1996).

"When two appraisal reports conflict, a court 'must determine the value based on the credibility of the appraisers, the logic of their analys[es], and the persuasiveness of their subjective reasoning."' In re Atlanta S. Bus. Park, Ltd., 173 B.R. 444, 450 (Bankr. N.D. Ga. 1994) (citing In re Park Ave. Partners, 95 B.R. 605, 610 (Bankr. E.D. Wis. 1988).

1. The Parties' Divergent Appraisals

It is undisputed that by November 24, 2004, the Centre City Development Corporation ("CCDC") and the city of San Diego had issued building permits for construction of the Atmosphere Project on the UC Lofts Property. Defendants' expert, Thomas Heath, used the cost approach to opine that the Subject Property had a $13,287,500 value. By contrast, Plaintiffs expert, Matthew Shake, employed the comparable sales approach. He testified that the Subject Property's value was at most $7,650,000 between April 2004 and November 24, 2004.

The differing assumptions made by the two experts explains the primary differences between their valuations. Mr. Heath utilized a cost approach to derive a site value, a component of which involved a sales comparison analysis. He assigned a "raw land" value of $5,287,500 to the Subject Property that did not include adjustments for permitting. He did so by analyzing comparable sales of properties without any level of building permits.

Defs.' Ex C-T, at 37-43.

Defs.' Ex. C-T, at 43.

Although Mr. Heath looked to comparable sales to ascertain a "raw land" value, he explained that this constituted a component within the cost approach. Trial Tr. vol. 4, 186:14, Dec. 12, 2013, ECF No. 449.

Mr. Heath adjusted his "raw land" value upward by $8,000,000 to account for permitting, site improvements and entrepreneurial profit. He asserted that the original developer of the UC Lofts Real Property provided this figure in 2003, which estimated the cost to entitle the land and develop it into a "finished mixed-use site." His definition of a "finished mixed-use site" "assumes the subject lots have a final recorded track map, appropriate site development fees paid except school fees and building permits, land permits, and finished land improvements, including paved streets, utility extensions, street and curb improvements, streetlights, and other traffic improvements."

Trial Tr. vol. 4, 119:10, ECF No. 449.

Trial Tr. vol. 4, 123:8-13, ECF No. 449.

It is clear, however, that the UC Lofts Real Property never became a "finished mixed-use site" under Mr. Heath's definition at any time during the Relevant Period. In fact, the parties disagree on whether excavation had even started by November 24, 2004. Further, Mr. Heath's report does not distill the $8,000,000 cost to reach a "finished mixed-use site" down into its individual components. On the stand, he indicated that it included the cost to obtain permits, asphalt removal, excavation, caisson construction, shoring and entrepreneurial profit. And he resisted breaking this figure into separate values for entrepreneurial profit and site improvements. Moreover, it is grossly disproportionate to the $1,222,400 originally budgeted under the Fund Control Agreement for virtually the same improvements. Ultimately, Mr. Heath's only defense of the $8,000,000 figure was that it seemed "logical" once he compared it to his sales comparison value for the finished Atmosphere Project. Thus, his opinion of value as of November 24, 2014 was actually $13,287,500 "minus demolition, excavation, caissons, and shoring."

Trial Tr. vol. 4, 201:13-202:15, ECF No. 449.

See Pl.'s Ex. 98, 102.

Trial Tr. vol. 4, 136:3, 202:13, ECF No. 449.

Trial Tr. vol. 4, 155:17-18, ECF No. 449.

By contrast, Mr. Shake looked to comparable properties with CCDC, but not city, permits to arrive at a $6,525,000 value for the land. Because he used a comparable sales analysis, he did not separately classify a "raw" or "vacant" land value line item. Mr. Shake's report assumed 20 percent annual appreciation for 2004, and he adjusted his comparable sales figures accordingly.

Pl.'s Ex. 106, at 56.

Mr. Shake properly recognized that fully entitling the UC Lofts Real Property beyond the CCDC permits added significant contributory value, as well as reflected the existing state of the property during the Relevant Period. He spoke with the developers of two of his comparable parcels to calculate the cost to obtain city building permits. Based on these conversations, Mr. Shake estimated that the cost to fully permit the UC Lofts Property was $50 per square foot, which equates to $1,125,000 for the entire project. He then added this cost to the $6,525,000 figure to reach a total value of $7,650,000.

Pl.'s Ex. 106, at 58.

2. The Court Adopts Mr. Shake's Appraisal but Finds that Adjustments Are Necessary

The greatest variation in the parties' valuations results from their disagreement over whether the court should include entrepreneurial profit in the "as is" value. The court accepts Mr. Shake's assessment that a developer would not realize any appreciable entrepreneurial profit from a sale at such an early stage in the project. And the court does not find Mr. Heath's value opinions to be reliable, particularly because he employed unrealistic assumptions and failed to articulate any principled basis for calculating entrepreneurial benefit. The court thus substantially adopts Mr. Shake's appraisal as the UC Lofts Property's value during the Relevant Period.

Even so, certain upward adjustments to Mr. Shake's valuation are necessary to account for site improvements performed during the Relevant Period and the actual cost to permit the UC Lofts Real Property. For instance, Mr. Shake acknowledged that the cost of site improvements in the early stages of a project would likely add dollar for dollar value to the property. But he did not build any site improvement costs into his valuation because he had not been presented with evidence that any had been incurred during the Relevant Period.

The evidence submitted, however, shows that Whillock Construction began asphalt removal and excavation on October 8, 2004 and that the estimated total cost would be $221,000. Further, Debtor made disbursements of $21,000 to Whillock on November 9, 2004 and $99,000 to Western Foundation and Shoring on November 19, 2004 and $89,000 on January 25, 2005 for excavation and shoring work, presumably performed during the Relevant Period. The court adds this $209,000 in contributory value to Mr. Shake's overall estimate.

Trial Tr. vol. 8, 70, ECF No. 469; Defs.' Ex. C-R.

Whillock testified that he performed less than $100,000 worth of work during Relevant Period. Trial Tr. vol. 6, 59:22-23, ECF No. 462. His invoices, which he credibly asserted were accurate almost to the day, show that he billed $73,000 between October 8, 2004 and December 15, 2004. Trial Tr. vol. 6, 57, ECF No. 462; Pl.'s Ex. 77. It is unclear, however, exactly how much work his firm completed through November 24, 2004. For this reason, the court adopts the figure actually paid to Whillock as the contributory value amount.

Trial Tr. vol. 8, 70, ECF No. 469; Pl.'s Ex. 44.

Additionally, the evidence established that the Debtors incurred higher costs to maintain their CCDC and city building permits than the $1,125,000 Mr. Shake estimated. At the time McHaffie purchased the membership interests in Urban Coast, LLC, the UC Lofts Real Property already had CCDC and city permits for construction of the Atmosphere Project. But they were in danger of expiring because of an impending change to the city of San Diego's building permitting process that would have caused the Atmosphere Project to fall out of compliance. Thus, the project architects had to quickly redraw the building plans, particularly for the subterranean structures, before "a drop-dead date from the city."

Defs.' Ex. A-A.

Trial Tr. vol. 1, 92:16, Dec. 4, 2013, ECF No. 456.

Debtors engaged Hawkins & Hawkins Architects, Inc. to maintain the necessary building permits from the CCDC and city. Hawkins & Hawkins acknowledged receiving $1,858,968 in compensation to shepherd the Debtors through this process on an expedited basis. Plaintiff offered no testimony to rebut this figure's reasonableness. But the court notes that the exigency to change the building plans likely generated inefficiencies that a hypothetical buyer would not be willing to pay for. The court therefore reduces this number by half the difference between Mr. Shake's estimate and the Debtors' actual expenditures, or $366,984. Thus, the total adjustment for permitting the UC Lofts Real Property should be $1,491,984. Accordingly, the court finds that the UC Lofts Real Property was worth $7,366,306 as of April 2004, and $8,225,954 as of November 24, 2004.

Defs.' Ex. A-V.

The difference results from adjusting for annual market appreciation using Mr. Shake's 20 percent figure.

IV. THE SCHAEFER ENTITIES WERE NOT INSIDERS OF THE DEBTORS

Among the Trustee's claims against the Schaefer Entities is the allegation that they were insiders of the Debtors. Under the Code, an "insider" includes:

(B) if the debtor is a corporation--

(i) director of the debtor;
(ii) officer of the debtor;
(iii) person in control of the debtor;
(iv) partnership in which the debtor is a general partner;
(v) general partner of the debtor; or
(vi) relative of a general partner, director, officer, or person in control of the debtor;

. . . .

(E) affiliate, or insider of an affiliate as if such affiliate were the debtor; and
(F) managing agent of the debtor.

11 U.S.C. § 101(31). Specifically, the Trustee alleges that the Schaefer Entities were partners in the Atmosphere project, had control over Debtors or that they allowed McHaffie to act as their agent to third parties.

In California, a "partnership is defined by statute, as it was at common law, as an association of two or more persons to carry on as co-owners a business for profit (Corp. Code, § 16202, subd. (a))." Persson v. Smart Inventions, Inc., 125 Cal. App. 4th 1141, 1157 (2005). "[P]artnership is evidenced by the right of the respective parties to participate in the profits and losses of the business, the contribution by the partners of either money, property or services and some degree of participation by the partners in the management and control of the business." In re Lona, 393 B.R. 1, 14 (Bankr. N.D. Cal. 2008). Further, the fact that "that profits and losses are not shared equally does not necessarily compel a conclusion that no partnership existed." Id. Moreover, the Corporations Code provides that a partnership may form "whether or not the persons intend to form a partnership." Cal. Corp. Code § 16202(a) (emphasis added). The party alleging a partnership bears the burden to prove its existence by a preponderance of the evidence. See In re Lona, 393 B.R. at 11; Weiner v. Fleischman, 54 Cal. 3d 476, 490 (1991); Mercado v. Hoefler, 11 Cal. Rptr. 787, 790 (1961).

Additionally, a partnership by estoppel may arise:

If a person, by words or conduct, purports to be a partner, or consents to being represented by another as a partner, in a partnership or with one or more persons not partners, the purported partner is liable to a person to whom the representation is made, if that person, relying on the representation, enters into a transaction with the actual or purported partnership. If the representation, either by the purported partner or by a person with the purported partner's consent, is made in a public manner, the purported partner is liable to a person who relies upon the purported partnership even if the purported partner is not aware of being held out as a partner to the claimant. If partnership liability results, the purported partner is liable with respect to that liability as if the purported partner were a partner. If no partnership liability results, the purported partner is liable with respect to that liability jointly and severally with any other person consenting to the representation.

Cal. Corp. Code § 16308(a). But the Trustee has not cited any authority for the proposition that partnership by estoppel - primarily utilized to hold a party liable to a particular creditor - has any application in the insider analysis under the Bankruptcy Code. See, e.g., Williams v. Cal. 1st Bank, 859 F.2d 664 (9th Cir. 1988) (recognizing a general prohibition on the trustee asserting claims belonging only to specific creditors).

The court accepts Schaefer's testimony as credible in all respects and finds that neither he nor Frank Schaefer Construction, Inc. nor Frank Schaefer Construction, Inc. Pension Plan was an insider of the Debtors. The Schaefer Entities exerted considerable control over Debtors and McHaffie. But this control never extended beyond that of a secured lender-to-borrower relationship.

Significantly, the court notes that Schaefer faithfully acted according to the terms of the various promissory notes and deeds of trust. He also never refused a disbursement request from McHaffie. And with the exception of the Halifax payment, Schaefer did not advocate that the Debtors pay certain creditors or forego payments to others. Ultimately, the evidence did not establish that Schaefer was ever able to pressure Debtors in such a way as to substitute his own decision making power for McHaffie's.

V. FRAUDULENT TRANSFERS

The Trustee moves under § 544(b) through her standing as a present and future unsecured creditor under California's adaptation of the Uniform Fraudulent Transfer Act ("UFTA"), Cal. Civ. Code sections 3439 et seq., to avoid certain transfers of interests in the Debtors to or for the Defendants' benefit. The UFTA authorizes a creditor to avoid a transfer "[i]f the debtor made the transfer or incurred the obligation . . . [w]ith actual intent to hinder, delay, or defraud any creditor of the debtor." Cal. Civ. Code § 3439.04(a)(1). The court may consider:

(1) Whether the transfer or obligation was to an insider.
(2) Whether the debtor retained possession or control of the property transferred after the transfer.
(3) Whether the transfer or obligation was disclosed or concealed.
(4) Whether before the transfer was made or obligation was incurred, the debtor had been sued or threatened with suit.
(5) Whether the transfer was of substantially all the debtor's assets.
(6) Whether the debtor absconded.
(7) Whether the debtor removed or concealed assets.
(8) Whether the value of the consideration received by the debtor was reasonably equivalent to the value of the asset transferred or the amount of the obligation incurred.
(9) Whether the debtor was insolvent or became insolvent shortly after the transfer was made or the obligation was incurred.
(10) Whether the transfer occurred shortly before or shortly after a substantial debt was incurred.
(11) Whether the debtor transferred the essential assets of the business to a lienholder who transferred the assets to an insider of the debtor.

Cal. Civ. Code. § 3439.04(b). The Trustee must prove fraudulent intent by a preponderance of the evidence. See Annod Corp. v. Hamilton & Samuels, 123 Cal. Rptr. 2d 924, 928-29 (2002); see also Wolkowitz v. Beverly (In re Beverly), 374 B.R. 221, 235 (B.A.P. 9th Cir. 2007). But "[r]epayments of fully secured obligations - where a transfer results in a dollar for dollar reduction in the debtor's liability - do not hinder, delay, or defraud creditors because the transfers do not put assets otherwise available in a bankruptcy distribution out of their reach." Henry v. Lehman Commercial Paper, Inc. (In re First Alliance Mortg. Co.), 471 F.3d 977, 1008 (9th Cir. 2006) (citation omitted).

Alternatively, a creditor may avoid a constructively fraudulent transfer of the debtor's property. Cal. Civ. Code §§ 3439.04(a)(2)-3439.05. A present or future creditor may do so by proving that the debtor did not receive:

[R]easonably equivalent value in exchange for the transfer or obligation, and the debtor either:

(A) Was engaged or was about to engage in a business or a transaction for which the remaining assets of the debtor were unreasonably small in relation to the business or transaction.
(B) Intended to incur, or believed or reasonably should have believed that he or she would incur, debts beyond his or her ability to pay as they became due.

Cal. Civ. Code § 3439.04(a)(2). A present creditor of a debtor may avoid a transfer, "if the debtor made the transfer or incurred the obligation without receiving a reasonably equivalent value in exchange for the transfer or obligation and the debtor was insolvent at that time or the debtor became insolvent as a result of the transfer or obligation." Cal. Civ. Code § 3439.05.

Reasonably equivalent value is a question of fact "determined from the perspective of the creditors of the estate." Pajaro Dunes Rental Agency, Inc. v. Spitters (In re Pajaro Dunes Rental Agency, Inc.), 174 B.R. 557, 578 (Bankr. N.D. Cal. 1994). Specifically, the analysis focuses on the "net effect of the transaction on the debtor's estate and the funds available to the unsecured creditors." Frontier Bank v. Brown (In re N. Merch., Inc.), 371 F.3d 1056, 1059 (9th Cir. 2004). For this reason, the estate receives reasonably equivalent value for repayment of money actually received as well as for granting a security interest to secure the debt. See Official Comm. of Unsecured Creditors v. Hancock Park Capital II, L.P. (In re Fitness Holdings Int'l, Inc.), 714 F.3d 1141, 1149 n.9 (9th Cir. 2013); In re N. Merch., Inc., 371 F.3d at 1059; see also In re First Alliance Mortg. Co., 471 F.3d at 1008. The court must therefore compare "what the debtor surrendered and what the debtor received." In re Pajaro Dunes Rental Agency, Inc., 174 B.R. at 578.

Further, although a subsidiary may benefit by satisfying a parent's obligation, the general rule presumes that such transfers provide "nominal value to that subsidiary in the absence of specific proof to the contrary." Id. at 579; see also In re N. Merch., Inc., 371 F.3d at 1058-59. To constitute reasonably equivalent value, the debtor-subsidiary must receive some "clear and tangible benefit." In re Pajaro Dunes Rental Agency, Inc., 174 B.R. at 579.

Finally, if the Trustee establishes that a transfer is avoidable, liability under the UFTA extends to:

(1) The first transferee of the asset or the person for whose benefit the transfer was made.
(2) Any subsequent transferee other than a good faith transferee who took for value or from any subsequent transferee.

Cal. Civ. Code § 3439.08(b).

A. The Subject Transfers of Interests in the Debtor Qualify as Transfers Under the UFTA

The UFTA defines "transfer" broadly as "every mode, direct or indirect, absolute or conditional, voluntary or involuntary, of disposing of or parting with an asset or an interest in an asset, and includes payment of money, release, lease, and creation of a lien or other encumbrance." Cal. Civ. Code § 3439.01(i). The Trustee asserts that the Debtors improperly transferred interests in the UC Lofts Property as well as payments directly to and on behalf of Defendants. Thus, the interests conferred and the payments received qualify as "transfers" under the UFTA.

B. Debtors' Financial Condition from February 13, 2004 to November 24, 2004

1. Balance Sheet and Equitable Insolvency

Insolvency under the UFTA has two varieties: equitable and balance sheet. Cal. Civ. Code §§ 3439.02(a), (c). A debtor is presumed to be equitably insolvent if it "is generally not paying [its] debts as they become due." Cal. Civ. Code § 3439.02(c). A debtor is balance sheet insolvent "if, at fair valuations, the sum of the debtor's debts is greater than all of the debtor's assets." Cal. Civ. Code § 3439.02(a). Notably, the UFTA definition of "asset" excludes encumbered property to the extent it is leveraged. Cal. Civ. Code § 3439.01(a). It also omits the corresponding liability as a debt in the insolvency calculation. Cal. Civ. Code § 3439.02(e).

The Bankruptcy Code's definition of insolvency is strikingly similar to the UFTA's: "financial condition such that the sum of such entity's debts is greater than all of such entity's property, at a fair valuation . . ." 11 U.S.C. § 101(32)(A).

The court has three relevant metrics for the Debtors' financial condition during the Relevant Period. The first is the court's order following its bifurcated trial on insolvency setting the value of the Debtors' property in the range of $8,000,000 and $9,500,000 as of February 12, 2004. Debtors' liabilities on that date numbered $6,154,531. Thus, the Debtors had assets of $1,845,469 to $3,345,469 within the meaning of the UFTA.

The Honorable James W. Meyers presiding. [ECF No. 303].

This figure, advocated by Plaintiff in closing arguments, included the following liabilities: (1) $4,000,000 note to the Barth Family; (2) $1,750,000 note to the Schaefer Entities; (3) $250,000 owed to Charlemagne McHaffie; and (4) $154,531 representing invoices for services performed before February 12, 2004. Trial Tr. vol. 2, 12, Feb. 27, 2012, ECF No. 300. It notably omitted the disputed $3,400,000 note in favor of Urban Coast, LLC and the $100,000 note held by SD Lofts, LLC. The court finds that neither of these purported debts was a current obligation owed by the Debtors during the Relevant Period. The court also did not hear testimony regarding the alleged debt owed to Charlemagne McHaffie, McHaffie's son. It therefore excludes them from the insolvency calculation.

Next, the court has found that the UC Lofts Real Property was worth $7,366,306 in April 2004. The court adds the $958,000 in the First Fund Control to reach an $8,324,306 valuation for the Debtors' property. In April 2004, after the April 2, 2004 loan transaction, the Debtors' liabilities were comprised of:

• Barth Note:	$4,000,000
• First Schaefer Loan:	$1,750,000
• Hawkins & Hawkins:	$154,531.52
• Christian Wheeler Engineering:	$13,854
• April 2, 2004 Loan:	$1,200,000
• Total:	$7,118,385.52

Thus, the Debtors still held assets exceeding their debts by $1,205,920.48.

The Third Loan and the $1,100,000 payment to Halifax ultimately rendered Debtors insolvent, however. The UC Lofts Real Property had significantly appreciated in value from February 2004 to $8,225,954 as of November 24, 2004. To this, the court adds the $4,234.19 remaining in the fund controls to reach a total value of $8,230,188.19. But their liabilities increased at a much more rapid pace - and many for costs unrelated to the Atmosphere Project. The Debtors had the following debts as of November 22, 2004:

• Barth Note:	$4,000,000
• First Schaefer Loan:	$1,750,000
• Hawkins & Hawkins:	$154,531.52
• Christian Wheeler Engineering:	$13,854
• April 2, 2004 Loan:	$1,500,000
• Third Loan Initial Funding:	$1,665,000
• Additional Fund Control Disbursement:	$111,600
• Total:	$9 194,985.52

Thus, they were balance sheet insolvent by at least $964,797.33.

The court is cognizant that Defendants' valuation evidence suggests the Debtors were comfortably solvent on November 24, 2004. As explained above, the major discrepancy between the experts' valuations comes from their adjustments for entrepreneurial value. But even if the court were to accept some measure of entrepreneurial profit, it would not exceed $964,797.33. Mr. Shake expressly rejected the notion that the Debtors would realize any entrepreneurial profit from a sale on November 24, 2004. And Mr. Heath failed to offer any meaningful guidance for the court to assess his estimate of entrepreneurial profit. It is also noteworthy that Mr. Heath's cost models in his opinion allot $5,000,000 for developer's profit to complete the Atmosphere Project. It is difficult to imagine that a sale of the land with permits and minimal excavation alone could net profit that is roughly one-sixth of that expected from the finished project.

2. Unreasonably Small Assets

A transfer is constructively fraudulent as to a present or future creditor if the debtor "[w]as engaged or was about to engage in a business or a transaction for which the remaining assets of the debtor were unreasonably small in relation to the business or transaction." Cal. Civ. Code § 3439.04(a)(2)(A). The UFTA does not define unreasonably small assets ("USA"). Intervest Mortg. Inv. Co. v. Skidmore, 655 F. Supp. 2d 1100, 1105 (E.D. Cal. 2009). Consequently, courts employ varying tests to determine if a transfer leaves a debtor with USA.

One test equates balance sheet insolvency with USA per se. In re Pajaro Dunes Rental Agency, Inc., 174 B.R. at 591. The second variation utilizes a "case-by-case approach," which requires the court to "weigh the raw financial data of the balance sheet against the nature of the entity and its need for capital over time." Id. at 591. Courts applying this second approach have heavily criticized adoption of a per se rule for USA. See, e.g., id; see also Skidmore, 655 F. Supp. 2d at 1106. These courts reason that:

[A] transfer leaves a debtor with assets that are "unreasonably small in relation to [the debtor's] business or transaction" if the assets are not reasonably likely to meet the debtors' present and future needs. This inquiry is obviously related to whether the assets exceed the total of the debtor's existing and potential liabilities. However, a debtor's assets may be reasonable in light a debtor's business even when they leave the debtor insolvent.

Skidmore, 655 F. Supp. 2d at 1106. This is because "the unreasonably small assets test roughly measures assets against debts as the debts become due." Id. at 1105. But "the insolvency test measures assets against the combined total of debts that are due and not yet due." Id. The court adopts the more nuanced approach espoused by the Pajaro Dunes and Skidmore courts.

The court must therefore reconstruct the Debtors' financial condition during the Relevant Period to assess "whether the remaining assets left [them] reasonably able to pay obligations that they should have expected to arise out of their business." Skidmore, 655 F. Supp. 2d at 1107; In re Pajaro Dunes Rental Agency. Inc., 174 B.R. at 591. It is appropriate for the court to consider availability of credit in the analysis. See Moody v. Sec. Pac. Bus. Credit. Inc., 971 F.2d 1056, 1072 (3d Cir. 1992) (citing Credit Managers Ass'n of So. Cal. v. Fed. Co., 629 F. Supp. 175 (C.D. Cal. 1985)).

The starting point for the USA analysis is the Debtors' business, which was real estate development. McHaffie indicated that his goal for the UC Lofts Real Property was to develop the Atmosphere Project or, if he could not attract construction financing, then to sell the property in a construction-ready condition. McHaffie took pains on the stand to avoid admitting he actually intended to build the Atmosphere Project rather than to sell it in a construction-ready state. But the court finds his testimony on this point to be wholly lacking credibility and contradicted by the construction budget estimates, invoices and testimony in the record. (The court nevertheless recognizes that selling the UC Lofts Real Property to a developer constituted an attractive exit strategy for McHaffie and the Schaefer Entities as the Debtors plunged deeper into debt.)

McHaffie testified that conventional lenders would not consider financing the Atmosphere Project at the time he acquired the membership interests in Urban Coast, LLC. This drove the Debtors toward hard money lenders, such as the Schaefer Entities, as a source of capital. He acknowledged that these funds were "overpriced" and therefore necessitated a relatively quick turnaround on the project. Schaefer explained that hard money lenders do not typically scrutinize a debtor's creditworthiness. Rather, their focus rests entirely on the available equity in the collateral. Schaefer required a seventy percent loan to value ratio for this particular project. Thus, the Debtors' ability to make progress on the Atmosphere Project depended on preserving the UC Lofts Real Property's value by maintaining its entitlements, continued rapid market appreciation and restricting expenditures to improvements calculated to increase the property's value. Moreover, the Debtors' only interaction with a traditional lender, IndyMac Bank, resulted in a tentative term sheet requiring payoff of the acquisition loans and 20 percent equity in the property.

Trial Tr. vol. 1, 88:5-8, ECF No. 456.

Trial Tr. vol. 5, 46:6-15, ECF No. 450.

Pl.'s Ex. 23, 33.

Next, the focus shifts to the Debtors' balance sheet. As noted above, the Debtors had significant assets above their liabilities in February 2004 and were able to attract more financing from the Schaefer entities. In fact, they maintained at least a thirteen to fifteen percent equity cushion from February 2004 to April 2004. And the parties agree that the properties were appreciating in value at 20 percent per year during this period. Further, as of April 2004, the Debtors had $958,000 in liquid funds contained in the fund control account to finance their operations. The court concludes that the April 2, 2004 loan and accompanying transfers did not leave Debtors with USA.

The court finds, however, that the Third Loan and the Halifax payment did leave the Debtors with USA. By November 24, 2004, the Debtors had slid into balance sheet insolvency. Moreover, one of the fund control accounts showed a negative balance, and the other only had $6,413.69 - leaving $4,234.19 total. The only asset the Debtors ever possessed was the equity in the property above the liens. Without any equity, there could be no more financing to fund operations. The transfers therefore left the Debtors with USA.

3. Reasonable Ability to Pay Debts as They Come Due

Even if a transfer does not leave the debtor with USA, a creditor may still avoid it if the debtor "[i]ntended to incur, or believed or reasonably should have believed that he or she would incur, debts beyond his or her ability to pay as they became due." Cal. Civ. Code § 3439.04(a)(2)(B). "This test measures whether the debtor, as a going concern, would reasonably have been seen as able to pay its debts after making the questionable transfer." In re Pajaro Dunes Rental Agency, Inc., 174 B.R. at 593. This analysis requires the court to scrutinize "cash flow projections and other forward-looking sources of evidence available to the debtor and its creditors at the time of the transfer." Id.

Courts generally understand this measure of constructive fraud to only apply to going concerns. Id. As such, this test does not readily apply to the Debtors in this case. At no point in the relevant period did the Debtors' operations generate positive income. Although the Defendants' introduced testimony that presales had occurred, there is no indication that the Debtors had ready access to these funds as a source of operational capital. The Debtors and apparently all creditors understood that the Debtors would not realize any income unless and until the Debtors either sold the property in a construction-ready posture, or completed the Atmosphere Project and sold the units.

C. The Schaefer Entities' Liability for Fraudulent Transfers

The Trustee's claims for fraudulent transfers under the UFTA against the Schaefer Entities relate to two primary transactions: (1) the Tropicana Plaza Partners, LLC and April 2, 2004 Loan transaction, including the accompanying trust deed; and (2) the Third Loan executed in November 2004 to make the $1,100,000 payment to Halifax. At the outset, the court reiterates that the Schaefer Entities were not insiders or partners of the Debtors. Thus, the transfers out of the fund controls and directly from the escrowed loan proceeds to any party other than the Schaefer Entities did not benefit them within the meaning of the UFTA.

1. Transfers Related to the Tropicana Plaza Partners, LLC and April 2, 2004 Loan Transaction

The Trustee seeks to avoid the deed of trust securing the April 2, 2004 Loan and the subsequent transfers of Tropicana to Schaefer and Lemire. With the benefit of hindsight, it is apparent that transfers related to the Tropicana transaction set in motion the events that ultimately led to the Debtors' demise. But the court has found that the Debtors were balance sheet solvent on and after the April 2, 2004 Loan and were not left with USA as a result. The Trustee has thus failed to prove an essential element of her claim against the Schaefer Entities relating to the initial April 2, 2004 Loan trust deed and transfers from fund controls to acquire Tropicana.

The Trustee moved orally at trial to amend the pretrial order to include this claim at trial. The court granted the motion.

Notably, the Tropicana LLC interests and real property never belonged to the Debtors. Moreover, the court finds that the Schaefer Entities provided reasonably equivalent value in exchange for their receipt of Tropicana in December 2004. Thus, it is not apparent that this transaction involved property of the Debtors such that it could be constructively fraudulent as to their creditors.

Further, the April 2, 2004 Loan's balance had risen to $1,500,000 by December 2004. McHaffie and Schaefer arranged for the transfer of Tropicana Partners, LLC as an accord and satisfaction of the April 2, 2004 Loan obligation. As mentioned above, the Tropicana LLC interests came with a first position mortgage on the property, and the property needed significant repairs. The Schaefer Entities ultimately realized $2,100,000 from the transaction, once Lemire sold the property. But this figure represented the accrued interest on the April 2, 2004 Loan balance and Schaefer's carrying costs to hold the property for a year. Thus, it is not clear that the Schaefer Entities received a windfall from the transaction, and the Debtors were relieved of a large liability.

Finally, the Trustee did not adduce any evidence suggesting that the Debtors made the transfers with actual intent to defraud their creditors. The court therefore finds that they were not fraudulent and that judgment should be entered in the Schaefer Defendants' favor on the Trustee's second and third causes of action for fraudulent transfers concerning the Tropicana Partners, LLC transaction.

2. Transfers Related to the Second and Third Loans and the Halifax Payment

The Schaefer Entities made the Third Loan for $4,000,000 and initially funded it with $1,665,000. In return, they received a third position deed of trust on the UC Lofts Real Property. The Debtors used the Third Loan proceeds to retire the Second Loan, pay Defendant Halifax Investments, LLC $1,100,000 to release its lis pendens and to settle the pending lawsuit. The court has found that the Halifax payment rendered the Debtors insolvent and left them with USA. But the Schaefer Entities contributed reasonably equivalent value - indeed, dollar for dollar - in exchange for taking a security interest. The $1,665,000 advanced went through an escrow, and the Debtors' manager authorized payment of the funds to Halifax.

The Trustee has therefore failed to prove essential elements of her fraudulent transfer claims against the Schaefer Entities related to the Halifax payment. First, the transfers to third parties before the Halifax payment did not benefit the Schaefer Entities and were not made while the Debtors were insolvent or had USA. And second, the Schaefer Entities contributed reasonably equivalent value in exchange for the deed of trust on the Third Loan that provided the funding necessary for the Halifax payment. The court thus finds that the Schaefer Defendants are entitled to judgment on all of the Trustee's claims against them for fraudulent transfers related to the Third Loan and Halifax payment.

D. Defendant Lemire's Liability for Fraudulent Transfers

The Trustee's remaining fraudulent transfer claim against Lemire derives from her claim against the Schaefer Entities arising out of the Tropicana transaction. Specifically, the Trustee seeks to recover whatever profit Lemire gained from her sale of the Tropicana property.

As noted above, the Tropicana LLC interests or the underlying real property never belonged to the Debtors. Further, Lemire contributed value for the property. She paid $70,000 for an option to purchase it from Schaefer. She then borrowed funds to improve the property and reduced the vacancy rate through her own labors. Lemire sold the Tropicana real property for $5,750,000. But she could not state with certainty the amount she received from the transaction after accounting for payments to Schaefer and the liens against property. And the Trustee did not offer any evidence on the amount Lemire may have personally profited from the sale.

The court therefore finds that the Trustee has failed to meet her burden of showing that Lemire was a subsequent transferee of property of the Debtors or that she did not provide reasonably equivalent value. The court will enter judgment in Lemire's favor.

E. Defendants Scafani and Halifax's Liability for Fraudulent Transfers

The court finds that the payment to Halifax were constructively fraudulent and should be avoided. The Halifax payment left the Debtors with USA and rendered them insolvent. Moreover, neither Halifax nor Scafani provided reasonably equivalent value for this transfer.

As noted above, the general rule presumes that a subsidiary's payment of a parent's obligation provides "nominal value to that subsidiary in the absence of specific proof to the contrary." In re Pajaro Dunes Rental Agency, Inc., 174 B.R. at 579. In such an indirect benefit scenario, the debtor-subsidiary must receive some "clear and tangible benefit" to qualify as reasonably equivalent value. Id.; see also In re N. Merch., Inc., 371 F.3d at 1058-59. For instance, a debtor-corporation receives reasonably equivalent value for granting a security interest to secure its shareholders' loan obligation if the debtor enjoyed the benefit and unfettered use of the loan proceeds. In re N. Merch., Inc., 371 F.3d at 1059. In Northern Merchandise, the bank lent directly to a debtor-corporation's shareholders - but not to the debtor who then caused the debtor to grant a security interest in its "inventory, chattel paper, accounts, equipment, and general intangibles." Id. at 1058. The shareholders intended to use the proceeds to fund the debtor's operations, and they deposited them directly into the debtor's account. Id. at 1057. Thus, the debtor received equivalent value for the security interest. Id. at 1059.

By contrast, the Pajaro Dunes court addressed a scenario in which a parent corporation and its subsidiary jointly made a note for $1,000,000 to build an office building. 174 B.R. at 562. As consideration for the note, the subsidiary was to receive title to the building for a term of years and rights to use it during that time. Id. at 585. Unbeknownst to the lender, after the parent accepted the loan proceeds, it directed the funds to the subsidiary and immediately siphoned them back to support its own unrelated operations. Id at 579. Somehow the borrowers completed the building, but the court found the subsidiary's interest in it to be worth only $541,895.55 - roughly half of the obligation it owed jointly with the parent. Id. at 589. Despite having actually funded the full $1,000,000 to the parent, the court found that the $541,895.55 transferred to the subsidiary did not constitute reasonably equivalent value. Id. at 590. Nor did the upstream benefit to the parent sufficiently compensate the subsidiary. Id at 579. The court therefore avoided the note as a fraudulent transfer. Id at 597.

In this case, McHaffie, Urban Coast, Halifax and Scafani executed the Halifax Sale Agreement. One component of this agreement required Urban Coast or McHaffie to pay $1,600,000 to Halifax. This secured McHaffie's acquisition of Urban Coast and through it, the UC Lofts Real Property. McHaffie and Urban Coast also owed brokerage rights and purchase options to John Scafani. The Debtors were not signatories to the Halifax Sale Agreement. That the UC Lofts Real Property secured those obligations did not transform them into the Debtors' liabilities. Nor is it apparent that the change in leadership from Scafani to McHaffie provided any value to the Debtors to support granting a security interest in their property. Thus, under the indirect benefit rule stated in Northern Merchandise and Pajaro Dunes, Defendants must demonstrate that Debtor's received a direct, tangible benefit from paying Urban Coast and McHaffie's obligation.

Defendants offered substantial testimony emphasizing that Scafani agreed to relinquish his purchase options and brokerage rights and that Halifax agreed to a $500,000 reduction on its note. But the testimony from Warner and Schaefer established that they believed the lis pendens was improperly recorded and could have been expunged for a fraction of the settlement price. The court accepts this characterization. Thus, the Debtors can hardly be said to have received reasonably equivalent value by paying $1,100,000 for its removal. Moreover, the upstream benefit Urban Coast and McHaffie received by being relieved from obligations under the Halifax Sale Agreement did not provide a sufficiently tangible benefit to the Debtors to allow the court to conclude they received reasonably equivalent value.

Lastly, Defendants unpersuasively argue that they should not face liability because they engaged in good faith negotiations regarding their claim. But a transferee can only take advantage of the good faith defense if he lacks actual knowledge of the facts and circumstances suggesting to a reasonable person that the transfer is fraudulent. See Plotkin v. Pomona Valley Imps., Inc. (In re Cohen), 199 B.R. 709, 719 (B.A.P. 9th Cir. 1996). Here, Scafani and Halifax attempted to illustrate the fiction of separation between Urban Coast, UC Lofts and McHaffie. But they stopped short of fully advocating alter ego liability between these entities, and such a claim did not appear in the pretrial order. Moreover, Scafani owned the Debtors at one point in time. And the facts suggest that their structure did not change once McHaffie took the helm. Scafani therefore knew or should have known that Urban Coast - and not UC Lofts - owed the $1,600,000 debt.

The court finds that Scafani and Halifax improperly recorded the lis pendens against the UC Lofts Real Property and that Halifax's agreement to take $1,100,000 did not provide reasonably equivalent value for its release. The evidence established that the payment went to Halifax - not to Defendant Scafani. The Trustee presented no evidence to trace the funds to Scafani or otherwise demonstrate that he was a subsequent transferee or beneficiary of this payment. The court therefore concludes that Defendant Scafani is not liable for this transfer. The court awards judgment against Halifax in the amount of $1,100,000, plus interest.

VI. PREFERENTIAL TRANSFERS

The Trustee asserts that the two payments totaling $506,000 to the Schaefer Entities on the unsecured Second Loan from the Second Fund Control and Third Loan proceeds are avoidable as preferential transfers. Section 547(b) allows the trustee to avoid any transfer of an interest of the debtor in property:

(1) to or for the benefit of a creditor;
(2) for or on account of an antecedent debt owed by the debtor before such transfer was made;
(3) made while the debtor was insolvent;
(4) made--
. . . .
(B) between ninety days and one year before the date of the filing of the petition, if such creditor at the time of such transfer was an insider; and
(5) that enables such creditor to receive more than such creditor would receive if--
. . . .

(B) the transfer had not been made; and
(C) such creditor received payment of such debt to the extent provided by the provisions of this title.

11 U.S.C. § 547(b).

Because the court finds that the Schaefer Entities were not insiders, the extended preference period does not apply. The disputed transfers occurred on November 19, 2004. The Debtors involuntary petition was filed on October 24, 2005. Since these two transfers took place more than ninety days before the petition date, they are not recoverable as preferences.

VII. EQUITABLE SUBORDINATION

The court may equitably subordinate a claim under § 510(c) if it finds: "(1) that the claimant engaged in some type of inequitable conduct, (2) that the misconduct injured creditors or conferred unfair advantage on the claimant, and (3) that subordination would not be inconsistent with the Bankruptcy Code." In re First Alliance Mortg. Co., 471 F.3d at 1006 (quoting Feder v. Lazar (In re Lazar), 83 F.3d 306, 309 (9th Cir. 1996)). The three major categories of inequitable conduct are: "(1) fraud, illegality, and breach of fiduciary duties; (2) undercapitalization; or (3) claimant's use of the debtor as a mere instrumentality or alter ego." Blasbalg v. Tarro (In re Hyperion Enters.), 158 B.R. 555, 560 (D.R.I. 1993) (quoting In re Fabricators, Inc., 926 F.2d 1458, 1467 (5th Cir. 1991)).

A heightened standard applies to equitable subordination claims against non-insiders. See Firstmark Capital Corp. v. Hempel Fin. Corp., 859 F.2d 92, 93-94 (9th Cir. 1988). Ordinarily, "gross and egregious conduct will be required before a court will equitably subordinate a claim." In re First Alliance Mortg. Co., 471 F.3d at 1006. In a claim for equitable subordination against an insider, however, the burden shifts to the insider to prove the transaction's fairness once the plaintiff presents material evidence of inequitable conduct. See Stoumbos v. Kilimnik, 988 F.2d 949, 958 (9th Cir. 1993); Olympia and York Fla. Equity Corp. v. Bank of N.Y (In re Holywell Corp.), 913 F.2d 873, 880-81 (11th Cir. 1990). But the occurrence of an insider transaction alone is insufficient to invoke equitable subordination absent inequitable conduct. See In re Hyperion Enters., 158 B.R. at 560; Diasonics, Inc. v. Ingalls. 121 B.R. 626, 630 (Bankr. N.D. Fla. 1990).

On a proper showing of misconduct and prejudice to creditors, a court may equitably subordinate a secured claim. See 11 U.S.C. § 510(c)(2); Reiner v. Washington Plate Glass Co., 27 B.R. 550, 552 (D.D.C. 1982). A secured creditor generally does not act inequitably for purposes of equitable subordination by exercising its bargained-for remedies. See Smith v. Assocs. Comm. Corp. (In re Clark Pipe & Supply Co., Inc.), 893 F.2d 693, 701 (5th Cir. 1990). A secured lender "will usually possess 'control' in the sense that it can foreclose or drastically reduce the debtor's financing." Id. But "[t]he crucial distinction between what is inequitable and what a lender can reasonably and legitimately do to protect its interests is the distinction between the existence of 'control' and the exercise of that 'control' to direct the activities of the debtor." Id. The latter manifests itself in the "exercise of such total control over the debtor as to have essentially replaced its decision-making capacity with that of the lender." Id.

In Clark Pipe, the debtor and lender entered into a loan agreement for revolving credit advances secured by the debtor's inventory and accounts receivable. Id. at 695. The lender required debtor to deposit all receivables into an account so it could to determine how much to lend. Id. Under the contract's terms, the lender could reduce the credit extended at its discretion. Id. When the debtor's business suffered, the lender reduced the credit advances thereby hampering the debtor's ability to meet all but its most essential operating expenses. Id. As the debtor defaulted on its trade vendor liabilities, litigation ensued, and the debtor filed for bankruptcy. Id. at 695-96.

The court ultimately found that the lender's aggressive stance and disregard for the debtor's vendors did not rise to the level of inequitable conduct necessary to subordinate its claim. Id. at 701-2. It noted that the lender had simply exercised remedies negotiated at arm's length while the debtor was solvent. Id. at 700. Further, the lender never instructed the debtor not to pay vendors or to pay certain vendors over others. Id. at 702. And significantly, the lender adhered to its procedures set forth in the original lending arrangement. Id.

Courts draw a distinction between inequitable conduct in the acquisition of a secured claim and in its enforcement. See In re First Alliance Mortg. Co., 471 F.3d at 989; In re Clark Pipe and Supply Co., Inc., 893 F.2d at 702. To subordinate a claim, the creditor's inequitable conduct must cause the injury to creditors - not the creditor's status. See Stoumbos, 988 F.2d at 960 n.5. Thus, a junior lienholder or unsecured creditor suffers no harm from a senior lienholder's foreclosing its interest if it originally acquired a valid security interest. Id. Rather, the creditor's lesser priority or unsecured status creates the risk of nonpayment, not the senior lender's subsequent misconduct, if any. Id.

The Trustee has not met her burden to equitably subordinate the Schaefer Entities' claims. Notably, the court has found that none of the Schaefer Defendants was an insider or partner of the Debtors. Thus, the burden remains with the Trustee to prove circumstances justifying subordination.

Nor does the evidence establish that the Schaefer Entities engaged in inequitable conduct. The gravamen of the Trustee's claim is that the Schaefer Entities improperly participated in McHaffie's scheme to encumber the Debtors' only asset for purposes unrelated to the Atmosphere project and charged usurious interest rates and exorbitant fees all along. She also alleges that, despite advances on the loans for fees and interest payments, the Schaefer Entities never reduced Debtors' corresponding liability in kind. This, she contends, was aimed at padding the Schaefer Entities' claim to enhance their posture in a seemingly inevitable foreclosure.

The court is not persuaded. At the outset, Schaefer understood that his involvement in the Atmosphere Project would not extend beyond the First Loan for McHaffie to acquire Urban Coast. Presumably because of the permitting concerns, McHaffie could not find viable financing other than hard money lenders for the initial acquisition and development. Schaefer testified that he, as such a lender, generally only looks to the equity in the collateral rather than the borrower's creditworthiness. This reality, coupled with the parties' intention for Schaefer to provide short-term swing financing, in all likelihood produced the high interest rates. This was a function of market forces demanding a higher price for capital not inequitable bilking of the Debtors. In fact, had the Schaefer Entities not expressed a willingness to lend, it appears, based on McHaffie's testimony, that no lender stood behind them to offer financing.

As McHaffie's mishandling of the Debtors progressed into 2004, he approached Schaefer for more financing. Schaefer admitted that the Tropicana transaction seemed ill advised. Even so, he believed sufficient equity remained in the UC Lofts Real Property to make the April 2, 2004 Loan. The latter transaction set off a reaction culminating in Scafani's recording the lis pendens on the UC Lofts Real Property. This threatened to derail the Atmosphere Project. The parties reasonably believed the lis pendens at that stage in development directly imperiled the UC Lofts Real Property's permit status.

Schaefer expressed that both the Halifax note and the Scafani lawsuit took him by surprise. Indeed, he testified that he probably called McHaffie "screaming" once he became aware of the lis pendens. Schaefer then took the lead in negotiations with Scafani to protect his interest in the UC Lofts Real Property. At the same time, he was exerting pressure on McHaffie to make payments on the April 2, 2004 Loan or to transfer Tropicana over to him. Thus, the Schaefer Entities possessed a significant degree of control over the Debtors.

But the control Schaefer exercised, although sharp-elbowed, was not inequitable. The term sheet for the Third Loan required McHaffie to transfer Tropicana to Schaefer as an accord and satisfaction. The Schaefer Entities acted within their rights to pursue foreclosure of the April 2, 2004 Loan trust deed once the note came due. Accepting Tropicana rather than foreclosing on the UC Lofts Real Property actually preserved value for creditors.

From the Debtors' and Schaefer Entities' perspective, inducing Scafani to voluntarily relinquish his lis pendens presented the path of least resistance toward continuing the Atmosphere Project. Moreover, the Third Loan with its $4,000,000 credit line allowed the Debtors to maintain the UC Lofts Real Property with its permits in place for another fifteen months. Absent the Third Loan, the Atmosphere Project would likely have been pulled into litigation much earlier. Lastly, the court notes that the record contains no evidence that the Schaefer Entities coerced the Debtors into accepting the Third Loan and granting a security interest in the UC Lofts Real Property.

The Schaefer Entities' negotiating position left the Debtors with a difficult choice. But the court finds that this situation effectively arose from McHaffie's deception of Schaefer and through the Schaefer Entities' legitimate exercise of their remedies. For these reasons, the Trustee has failed to carry her burden on her claim to subordinate the Schaefer Entities' claims.

VIII. RECHARACTERIZING THE SCHAEFER ENTITIES' DEBT AS EQUITY

The pretrial order includes a claim to reclassify the Schaefer Entities' claims as equity interests, although the Defendants disputed its inclusion. The Ninth Circuit recently explained that allowing a bankruptcy court to recharacterize debt into equity comports generally with the Butner principle. See In re Fitness Holdings Int'l. Inc., 714 F.3d at 1146-47. As distinct from equitable subordination, which analyzes the creditor's behavior, debt recharacterization focuses on the substance of the transaction. See Daewoo Motor Am., Inc. v. Daewoo Motor Co., Ltd. (In re Daewoo Motor Am., Inc.), 471 B.R. 721, 735 (C.D. Cal. 2012) (citing Cohen v. KB Mezzanine Fund II, LP (In re SubMicron Sys. Corp.), 432 F.3d 448, 454 (3d Cir. 2006)).

State law provides the applicable framework for distinguishing between debt and equity. In re Fitness Holdings Int'l. Inc., 714 F.3d at 1148. In California, when "determining whether the transaction is a loan or a forbearance, courts look to substance rather than form." Sw. Concrete Prods. v. Gosh Construction Corp., 51 Cal. 3d 701, 710 (1990). Specifically, the court will look to the parties' intent to determine their status as equity interest holder or creditor. See Hoppe v. Rittenhouse, 279 F.2d 3, 8 (9th Cir. 1960) (citing Hughes Mfg. & Lumber Co. v. Wilcox, 13 Cal. App. 22 (1910)).

The Trustee presented only scant argument on this claim. The court finds no basis in the record to convert the Schaefer Entities' claims to equity for many of the same reasons it denies the Trustee's request to equitably subordinate these claims. The court considers the relationship between Debtors and the Schaefer Entities to have been strictly limited to that of a borrower and a lender - and that they intended it to be so. The Trustee's reclassification claim is therefore denied.

IX. BREACH OF FIDUCIARY DUTY

The Trustee contends that the Schaefer Entities breached fiduciary duties owed to the Debtors by: (1) charging usurious interest rates on the loans; and (2) participating in McHaffie's breaches of his fiduciary duty. The elements of a claim for breach of fiduciary duty under California law are: "(1) existence of a fiduciary duty; (2) breach of the fiduciary duty; and (3) damage proximately caused by the breach." Stanley v. Richmond, 35 Cal. App. 4th 1070, 1086 (1995). General partners owe fiduciary duties to one another. See Pellegrini v. Weiss, 165 Cal. App. 4th 515, 524 (2008). Generally, lenders do not owe fiduciary duties to their borrowers or other creditors. See Software Design & Application Ltd. v. Hoelter & Arnett. Inc., 56 Cal. Rptr. 2d 756, 760 (1996).

The crux of the Trustee's claim for breach of fiduciary duties is that the Schaefer Entities were partners in the Atmosphere Project. But the Trustee's claim must fail because the court has concluded that none of the Schaefer Entities was an insider or partner of the Debtors. Judgment for the Schaefer Entities on this claim is therefore appropriate.

X. AIDING AND ABETTING BREACH OF FIDUCIARY DUTY

Under California law, "[l]iability may . . . be imposed on one who aids and abets the commission of an intentional tort if the person . . . knows the other's conduct constitutes a breach of a duty and gives substantial assistance or encouragement to the other to so act.'" In re First Alliance Mortg. Co., 471 F.3d at 993 (quoting Casey v. US. Bank Nat'l Assn., 127 Cal. App. 4th 1138, 1144 (2005)); see also Fiol v. Doellstedt. 50 Cal. App. 4th 1318, 1325-26 (1996). "[A]iding and abetting liability . . . requires a finding of actual knowledge, not specific intent." In re First Alliance Mortg. Co., 471 F.3d at 993.

In First Alliance Mortgage, a jury found Lehman Brothers, Inc. and its subsidiary ("Lehman") liable for aiding and abetting the debtor's fraudulent lending practices. Id. at 983. The finding relied on Lehman's eventual relationship as the debtor's only lender, its intimate knowledge of the debtor's lending practices and its substantial assistance in furthering the scheme by continuing to lend. Id. at 986-87, 994-95. In fact, Lehman warned the debtor that if it did "not change its business practices, it [would] not survive scrutiny." Id. at 994.

Here, the Schaefer Entitles, like Lehman, at some point became the Debtors' only source of financing such that they provided substantial assistance. Further, it is apparent that Schaefer at least had the opportunity to scrutinize each disbursement from the fund controls. But distinct from the situation in First Alliance, Schaefer credibly testified that his primary, if not sole, focus was the equity in the property - not the Debtors' progress on the Atmosphere Project. Moreover, the Fund Control Agreement gave him the contractual right to presume that each disbursement request was actually what the borrower requested and related to the project. Finally, the proposed budget negotiated between the Schaefer Entities and McHaffie contemplated management and contingency line items, for which they allotted over $400,000.

Thus, the court cannot conclude that the Schaefer Entities had actual knowledge of McHaffie's defalcations as they occurred. The Trustee has therefore failed to meet her burden on this claim, and judgment for the Schaefer Entities is appropriate.

XI. CONVERSION

The Trustee's final claim alleges that the Schaefer Entities converted UC Lofts' personal property. "In California, conversion has three elements: ownership or right to possession of property, wrongful disposition of the property right and damages." G.S. Rasmussen & Assocs., Inc. v. Kalitta Flying Serv., Inc., 958 F.2d 896, 906 (9th Cir. 1992).

There was no evidence presented at trial that the Schaefer Entities converted UC Lofts assets. First, the UC Lofts Real Property constituted the Debtors' only asset during the Relevant Period. And the Schaefer Entities never received payments on their loans except out of their own loan proceeds and advances. Finally, the Schaefer Entities enforced a valid lien to foreclose on the UC Lofts Real Property, in which they realized substantially less than their debt's face value. The court therefore awards judgment for the Schaefer Entities.

XII. DAMAGES AND INTEREST

"[State] law regarding prejudgment interest is applicable via 11 U.S.C. § 544(b)." Hayes v. Palm Seedlings Partners (In re Agric. Research & Tech. Group. Inc.), 916 F.2d 528, 541 (9th Cir. 1990). In "every case of oppression, fraud, or malice," an award of prejudgment interest rests in the trial court's sound discretion. See Cal. Civ. Code § 3288 ; Johnson v. Neilson (In re Slatkin), 525 F.3d 805, 820 (9th Cir. 2008). The purpose of prejudgment interest is to compensate the plaintiff for a defendant's wrongful conduct and therefore forms an element of damages. Wisper Corp. v. Cal. Comm. Bank, 57 Cal. Rptr. 2d 141, 154 (1996); Big Bear Prop. v. Gherman, 157 Cal. Rptr. 443, 446-47 (1979).

The court notes that § 3287(a) makes prejudgment interest mandatory for "[a] person who is entitled to recover damages certain, or capable of being made certain by calculation, and the right to recover which is vested in the person upon a particular day . . ." Cal. Civ. Code § 3287(a). But § 3287 "applies only in cases where the recovery is predicated on breach of contract." Pepitone v. Russo, 134 Cal. Rptr. 709, 712 (1976). In cases predicated on constructive fraud, however, § 3288 governs an award of prejudgment interest. Id.; see also Redke v. Silvertrust, 6 Cal. 3d 94, 106 (1971).
--------

In California, the prejudgment interest rate for a fraud claim is seven percent. CAL. CONST. ART. XV, § 1; Michelson v. Hamada, 36 Cal. Rptr. 2d 343, 352-53 (1994). Courts generally do not award compound interest unless the parties stipulate or a statue provides otherwise. See State v. Day, 173 P.2d 399, 409 (Cal. Ct. App. 1946); see also Michelson, 36 Cal. Rptr. 2d at 353.

Constructive fraud forms the basis for Defendant Halifax's liability. The court thus has discretion under California Civil Code § 3288 to award prejudgment interest. See Pepitone, 134 Cal. Rptr. at 712. Plaintiff waited three years after the fraudulent transfer to file her Complaint. The Trustee also conducted minimal discovery and took six years to bring this adversary proceeding fianlly to trial. The estate should not obtain a windfall from such delay in the form of an inflated prejudgment interest award.

But some measure of prejudgment interest is appropriate to compensate the estate for the lost time value of these funds. The court therefore awards prejudgment interest at the California legal rate of seven percent from April 2, 2007, the date the Trustee filed the Complaint. The court will compute prejudgment interest on a simple basis. Defendant Halifax is thus liable in the principal amount of $1,100,000, plus $537,734.25 in prejudgment interest. Interest accrues postjudgment at the federal rate.

XIII. CONCLUSION

For the foregoing reasons, the court finds that the Trustee has failed to meet her burden to hold Defendants John Scafani, Sheila Lemire, Frank Schaefer, Frank Schaefer Construction, Inc. or Frank Schaefer Construction, Inc. Pension Plan liable on any of her claims. The court finds, however, that Defendant Halifax received a fraudulent transfer, and so awards judgment against it in the amount of $1,100,000 plus $537,734.25 in prejudgment interest. Postjudgment interest accrues at the federal rate. A separate judgment shall issue.

IT IS SO ORDERED.

__________

CHRISTOPHER B. LATHAM, JUDGE

United States Bankruptcy Court
In re UC Lofts on 4^th LLC, UC Lofts on 5^th LLC, Bk. Nos. 05-15409-CL7, 05-15410-CL7

Leslie T. Gladstone, Chapter 7 Trustee v. Charles McHaffie, et al., Adv. No. 07-90139-CL

CERTIFICATE OF MAILING

The undersigned, a regularly appointed and qualified clerk in the office of the United States Bankruptcy Court for the Southern District of California, at San Diego, hereby certifies that a true copy of the attached document, to wit:

MEMORANDUM DECISION AND ORDER

GRANTING JUDGMENT AGAINST DEFENDANT HALIFAX INVESTMENTS, LLC AND

GRANTING JUDGMENT IN FAVOR OF DEFENDANTS SHEILA LEMIRE,

FRANK SCHAEFER, FRANK SCHAEFER CONSTRUCTION, INC.,

FRANK SCHAEFER CONSTRUCTION, INC. PENSION PLAN AND JOHN SCAFANI

was enclosed in a sealed envelope bearing the lawful frank of the bankruptcy judges and mailed via first class mail to the parties at their respective addresses listed below: Jeffry A. Davis, Esq.
Mintz Levin Cohn Ferris Glovsky & Popeo
3580 Carmel Mountain Road, Suite 300
San Diego CA 92130
(Attorney for Plaintiff/Chapter 7 Trustee)
James Jay Stoffel, Esq.
Beberman, Stoffel & Beberman
7676 Hazard Center Dr., Suite 500
San Diego CA 921 08
(Attorney for Schaefer Defendants)
Gregg A. Johnson, Esq.
12526 High BluffDrive, Ste 300
San Diego CA 92130

(Attorney for Defendant Halifax Investments, LLC)
Leslie T. Gladstone, Chapter 7 Trustee
401 Via Del Norte
La Jolla CA 92037
(Plaintiff)
Sheila Lemire
PO Box 675548
Rancho Santa Fe CA 92067
(Defendant in Pro Per)
Sheila Lemire
1820 Avenida Del Mundo, Unit 128
Coronado CA 921 18
(Defendant in Pro Per)
Frank Schaefer
Frank Schaefer Construction, Inc.
Frank Schaefer Construction, Inc. Pension Plan
1028 Berwicks Court
Carlsbad CA 9201 1
(Defendants)
John Scafani and Halifax Investments, LLC
5155 Waring Road
San Diego CA 92120
(Defendants)
Said envelope(s) containing such document was deposited by me in the City of San Diego, in said District on March 27, 2014.

__________

Jillmarie R. McGrew, Deputy Clerk

Gladston v. McHaffie (In re UC Lofts on 4th, LLC)

Opinion

WRITTEN DECISION - NOT FOR PUBLICATION

Chapter 7

MEMORANDUM DECISION AND ORDER

GRANTING JUDGMENT AGAINST

DEFENDANT HALIFAX INVESTMENTS,

LLC AND GRANTING JUDGMENT IN

FAVOR OF DEFENDANTS SHEILA

LEMIRE, FRANK SCHAEFER, FRANK

SCHAEFER CONSTRUCTION, INC.,

FRANK SCHAEFER CONSTRUCTION, INC.

PENSION PLAN AND JOHN SCAFANI

Judge: Christopher B. Latham

MEMORANDUM DECISION AND ORDER GRANTING JUDGMENT AGAINST

DEFENDANT HALIFAX INVESTMENTS, LLC AND GRANTING JUDGMENT IN FAVOR

OF DEFENDANTS SHEILA LEMIRE, FRANK SCHAEFER, FRANK SCHAEFER

CONSTRUCTION, INC., FRANK SCHAEFER CONSTRUCTION, INC. PENSION PLAN

AND JOHN SCAFANI

I. JURISDICTION AND VENUE

II. PROCEDURAL HISTORY

III. FACTUAL BACKGROUND AND FINDINGS

IV. THE SCHAEFER ENTITIES WERE NOT INSIDERS OF THE DEBTORS

V. FRAUDULENT TRANSFERS

VI. PREFERENTIAL TRANSFERS

VII. EQUITABLE SUBORDINATION

VIII. RECHARACTERIZING THE SCHAEFER ENTITIES' DEBT AS EQUITY

IX. BREACH OF FIDUCIARY DUTY

X. AIDING AND ABETTING BREACH OF FIDUCIARY DUTY

XI. CONVERSION

XII. DAMAGES AND INTEREST

XIII. CONCLUSION

CERTIFICATE OF MAILING

MEMORANDUM DECISION AND ORDER

GRANTING JUDGMENT AGAINST DEFENDANT HALIFAX INVESTMENTS, LLC AND

GRANTING JUDGMENT IN FAVOR OF DEFENDANTS SHEILA LEMIRE,

FRANK SCHAEFER, FRANK SCHAEFER CONSTRUCTION, INC.,

FRANK SCHAEFER CONSTRUCTION, INC. PENSION PLAN AND JOHN SCAFANI

Gladston v. McHaffie (In re UC Lofts on 4th, LLC)

Gladston v. McHaffie (In re UC Lofts on 4th, LLC)

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