IN RE DERIVIUM CAPITAL, LLC (Bankr.D.S.C. 9-14-2010)

e transfers sufficient to render the Defendants the initial transferees of the Customer Transfers under § 550 at the same moment that those securities became property of Debtor, which is tantamount to a transfer by Debtor to Wachovia. As support for the argument that the Customer Transfers qualify as recoverable transfers under §§ 544 and 548, Plaintiff primarily relies upon In re Manhattan Inv. Fund Ltd., 397 B.R. 1 (S.D.N.Y. 2007) (" Manhattan Investment"), in which a district court affirmed a bankruptcy court's holding that a trustee could recover transfers made by the debtor into its margin account maintained by a brokerage firm because the brokerage firm had sufficient dominion and control over the account to be an "initial transferee" under 11 U.S.C. § 550 by virtue of its "prime broker" margin arrangement.

In this case, the Stock Loan Borrowers directly transferred the stock into Debtor's brokerage accounts at Wachovia. Therefore, the transfers in this case are distinguishable from the transfers by the debtor to the margin account in Manhattan Investment, because the transfers inManhattan Investment came from the debtor itself and not directly from customers. See 397 B.R. at 5 ("To support its trading activity [the debtor] was required to keep a separate "margin account" at Bear Stearns. . . . During the year preceding [the debtor's] bankruptcy, [the debtor] transferred $141.4 million into this account. . . ."). TheManhattan Investment court expressly recognized that "before each transfer, the . . . funds were completely controlled by the [debtor] and therefore, prior to the transfer, the money could have been available to creditors had a bankruptcy been declared at that moment." Id. at 9. As to the transfers alleged within this category, Plaintiff has not demonstrated that there were subsequent transfers from Debtor to Defendants with respect to this property, other than the transfers of commissions, margin interest payments, and other fees, which are discussed below. Therefore, the Court is unable to conclude that the Customer Transfers can serve as the basis of a fraudulent transfer claim under § 544 or § 548. To hold otherwise would be an unwarranted extension of Manhattan Investment.

Plaintiff has conceded that it does not seek to recover transfers from one At-Issue Account to another At-Issue Account.

Section 548 allows a trustee to avoid any transfer of property that would have been "property of the estate" had it not been transferred. In re French, 440 F.3d 145, 151 (4th Cir. 2006). The purpose of the avoidance provisions is to prevent a debtor from diminishing, to the detriment of creditors, funds that are generally available for distribution to creditors. Id.; Nordberg v. Sanchez (In re Chase Sanborn Corp.), 813 F.2d 1177, 1181 (11th Cir. 1987). This purpose is not served by the avoidance of the Customer Transfers. In this case, had Debtor declared bankruptcy prior to the funds being transferred by the Stock Loan Borrowers into the At-Issue Accounts, these funds would not have been available to Debtor's creditors because they would not have been property of the estate.

In the alternative, Plaintiff argues that certain of the Customer Transfers made within one year of Debtor's bankruptcy filing are recoverable under § 548(a)(1)(A) because they were "margin payments" or "settlement payments" under § 546(e). The Court agrees that the stockbroker defense set forth in § 546(e) does not protect margin payments or settlement payments from recovery under § 548(a)(1)(A), to the extent that the margin payments or settlement payments were transfers of an interest of Debtor in property. See § 546(e) (providing that the trustee may not avoid a transfer that is a margin payment . . . or settlement payment . . . except under section 548(a)(1)(A)). However, § 546(e) does not provide the trustee with the right to recover transfers of non-debtor property. Section 546(e) operates only as a defense to the avoidance of transfers that would otherwise be avoidable under §§ 544, 545, 547, 548(a)(1)(B) and 548(b). Since the Customer Transfers were not transfers of an interest of Debtor in property, they are not avoidable under these sections. Accordingly, Defendants' Renewed Motion is granted with respect to the Customer Transfers.

B. Transfers of cash by the Stock Loan Entities into the At-Issue Accounts

Plaintiff also seeks to recover cash transfers of approximately $828,500 that Debtor and Bancroft directly transferred to Defendants through deposits into their brokerage accounts in the year prior to Debtor's bankruptcy filing pursuant to § 548. To recover these transfers under § 548, Plaintiff must establish that Wachovia was the initial transferee of those transfers under § 550. The term "initial transferee" is not defined by the Bankruptcy Code, but the Seventh Circuit stated in Bonded Fin. Servs., Inc. v. European Am. Bank, 838 F.2d 890, 891 (7th Cir. 1988) that "the minimum requirement of status as a `transferee' is dominion over the money or other asset, the right to put the money to one's own purposes." The Fourth Circuit has expressly adopted this definition and added the requirement that the person or entity must have also exercised legal dominion and control over the property. Bowers v. Atlanta Motor Speedway, Inc. (In re Southeast Hotel Properties, 99 F.3d 151, 156 (4th Cir. 1996). Thus, to hold Wachovia liable as the "initial transferee," Plaintiff must prove both that Wachovia had the right to exercise dominion and control over the property at issue and that it actually exercised such dominion and control. However, a demonstration of complete unfettered control is not required — a party can be an initial transferee even if it cannot use the funds it receives for purposes unrelated to the underlying transaction. Lowry v. Security Pac. Bus. Credit, Inc. (In re Columbia Data Products, Inc., 892 F.2d 26, 29 (4th Cir. 1989).

Plaintiff has conceded that these cash transfers are "settlement payments" or "margin payments" pursuant to 11 U.S.C. § 546(e) and are thus not recoverable under 11 U.S.C. § 544.

Wachovia argues that it is not liable to Plaintiff for any transfers into the At-Issue Accounts, irrespective of their source, because it is not the initial transferee of those transfers. Relying on Manhattan Investment, Plaintiff contends that Wachovia was the initial transferee of these transfers into those accounts because the accounts were governed by margin agreements which empowered Wachovia with complete dominion and control over the property within the accounts. Wachovia argues thatManhattan Investment involved unique facts that are distinguishable from the facts presented here.

The Manhattan Investment case involved a hedge fund that entered into a prime brokerage relationship with Bear Stearns in order to facilitate its trading activity, which involved the short selling of technology stocks. 397 B.R. at 5. Bear Stearns required the hedge fund to keep a separate margin account in addition to its trading account. In addition to amounts required to be deposited into the margin account pursuant to federal regulations, Bear Stearns required the hedge fund to maintain an amount equal to 35% of the value of its open short positions on deposit in the margin account at all times. The margin account agreement between Bear Stearns and the hedge fund contained certain provisions which were designed for the protection of Bear Stearns. Specifically, Bear Stearns was allowed to set any level of maintenance margin for the account, it had a security interest in the account's contents, it could prevent the hedge fund from withdrawing money from its account while there were open short positions supported by the account, and it could use the funds in the account to liquidate the hedge fund's open short positions, with or without the hedge fund's consent. Id. The Manhattan Investment court found that the powers vested in Bear Stearns through the account agreement clearly demonstrated that the hedge fund did not have access to its deposits once it placed them in the Bear Stearns account. Furthermore, the court made findings that Bear Stearns actually prohibited the debtor from withdrawing cash from its account when short positions were open, actually used transfers from the debtor to purchase securities to cover the debtor's open trading positions (positions for which Bear Stearns would have been liable if the transfers had not been made), and made margin calls on a frequent basis by which it required the debtor to increase the flow of transfers into the margin account. Id. at 522.

A close examination of the undisputed facts in this case reveals thatManhattan Investment is distinguishable from this case. As discussed previously, in Manhattan Investment, the account at issue was an entirely separate account from the hedge fund's trading account, which was established for purpose of providing protection to Bear Stearns. In this case, the At-Issue Accounts were the trading accounts used by Debtor and the Stock Loan Entities to conduct their business. No similar separate account was established for the protection of Wachovia. While it does appear that Wachovia possessed similar rights with respect to the At-Issue Accounts under the margin agreements that Bear Stearns had in Manhattan Investments, no facts have been presented which demonstrate that Wachovia actually exercised any dominion and control over the At-Issue Accounts. In particular, no showing has been made that Wachovia liquidated securities on its own accord or took any other action with respect to the assets in the accounts for its own use or benefit. Rather, the facts presented demonstrate that Debtor and the Stock Loan Entities exclusively controlled the flow of funds and securities into and out of the At-Issue Accounts.

Specifically, under the margin agreements governing the At-Issue Accounts, Wachovia had the right to liquidate positions in the At-Issue Accounts in any circumstance which in its opinion warrants such action, Wachovia could require Debtor or the Stock Loan Entities to maintain positions as deemed necessary or advisable by Wachovia, Wachovia could prevent Debtor or the Stock Loan Entities from closing the At-Issue Accounts if there were open short positions and outstanding debts to Wachovia, Wachovia could sell any or all assets in the At-Issue Accounts without demand for margin or additional margin or other notice, and Wachovia retained a security interest in all securities and/or other property held in any Account. It appears that these margin agreements are relatively standard, boilerplate margin agreements.

The Court disagrees with Plaintiff's contention that Wachovia's deduction of fees, commissions, and margin interest payments out of the At-Issue Accounts is sufficient evidence of dominion and control to subject them to liability as the initial transferee of the entirety of the cash transfers. See In re Coutee, 984 F.2d 138, 141 (5th Cir. 1993) (holding that a law firm that accepted funds in settlement of its client's case, deposited the money in trust, kept as fees only what the client agreed to, and paid the rest to the bank on behalf of the client, was not the initial transferee of the settlement funds); In re Moon, 385 B.R. 541, 553 (Bankr. S.D.N.Y. 2008) (rejecting the trustee's contention that the attorney was "initial transferee" as to the entirety of settlement proceeds received in client trust account, and holding that the attorney was only the "initial transferee" of the settlement proceeds that the attorney actually retained for his fees and expenses); In re Cassandra Group, 312 B.R. 491, 496 (Bankr. S.D.N.Y. 2004) (attorney who received funds into client trust account was not the "initial transferee" of the funds, even though he paid his own attorney's fees from the fund). The Court further rejects Plaintiff's argument that Wachovia's treatment of the At-Issue Accounts as "related" and as a "single household" is evidence that Wachovia exercised dominion and control over these accounts.

It appears that the separateness of the account and the evidence of Bear Stearns' exercise of control over the transfers at issue were critical factors in the Manhattan Investment court's conclusion that Bear Stearns was the "initial transferee." To the extent Manhattan Investment holds that a party can be liable as an initial transferee without a demonstration that the party actually exercised dominion and control, this Court declines to follow Manhattan Investment, since it is not binding precedent and the Fourth Circuit has clearly stated that a demonstration that the transferee actually exercised dominion and control is a required element to confer initial transferee liability in this Circuit. See Bowers v. Atlanta Motor Speedway, Inc. (In re Southeast Hotel Properties), 99 F.3d 151, 156 (4th Cir. 1996).

Based upon the foregoing, the Court finds that Wachovia has presented sufficient evidence demonstrating that it was not the initial transferee of the cash transfers that Debtor and Bancroft deposited into their brokerage accounts. Since Plaintiff failed to demonstrate that a genuine issue of material fact exists with respect to this element of its claim, the Court grants summary judgment in favor of Defendants as to these transfers.

C. Transfers of commissions to Defendants

Plaintiff seeks to avoid transfers of commissions from the At-Issue Accounts to Defendants in connection with the purchase and sale of securities by Debtor or the Stock Loan Entities. Defendants move for partial summary judgment with respect to these transfers on the grounds that the "stockbroker defense" bars Plaintiff's attempt to avoid these transfers under § 544. Section 546(e), which is commonly referred to as the "stockbroker defense," provides:

Defendants do not seek summary judgment with respect to Plaintiff's claims under § 548(a)(1)(A) as to these transfers.

Notwithstanding sections 544, 545, 547, 548(a)(1)(B), and 548(b) of this title, the trustee may not avoid a transfer that is a margin payment, as defined in section 101, 741, or 761 of this title, or settlement payment, as defined in section 101 or 741 of this title, made . . . to a . . . stockbroker, . . . that is made before the commencement of the case, except under section 548(a)(1)(A) of this title.

11 U.S.C. § 546(e) (2004) (emphasis added). When applicable, § 546(e) is a complete defense to a § 544 claim. See In re Stewart Fin. Co., 367 B.R. at 916 ("§ 546(e) provides a complete bar and defense to avoidance claims brought by a bankruptcy trustee for any transfer that is a margin payment or settlement payment made to a stockbroker.") "The purpose of section 546 is `to protect the nation's financial markets from the instability caused by the reversal of settled securities transactions.'" In re Enron Corp., 341 B.R. 451, 456 (Bankr. S.D.N.Y 2006) (quoting Kaiser Steel Corp. v. Charles Schwab Co., Inc. (In re Kaiser Steel Corp.), 913 F.2d 846, 848 (10th Cir. 1990)). "In enacting the section 546(e) exception to the avoidance powers, the goal was to preserve the stability of . . . settled transactions to the extent that they are not fraudulent as defined in section 548(a)(1)(A)." Enron, 341 B.R. at 456.

Plaintiff contends that commission payments should be excluded from the purview of § 546(e) because they are allegedly not "necessary" and are "discretionary." However, neither the language of § 546(e), nor the case law interpreting this section, limits "settlement payments" to necessary or non-discretionary payments. See In re Enron Corp., 341 B.R. at 451 (payments made for the purchase of securities were "settlement payments," even where the price paid was above the market price and the purpose of paying an above market price was discretionary). Furthermore, Plaintiff's argument that the legislative purpose of the statute is not served by protection of stockbroker commissions from recovery under § 544 is inconclusive.

Defendants argue that the 2006 amendments to § 546(e) indicate that Congress intended to protect transfers that are beneficial to financial intermediaries in the market, which would reasonable include transfers of commissions to stockbrokers. See 11 U.S.C. § 546(e) (2006) (amending § 546(e) to expressly include a bar to recovery under § 544 for any "transfer made by or to ( or for the benefit of) a . . . stockbroker . . . in connection with a securities contract")

Defendants argue that the commissions they received for the securities purchased and sold by Debtor and the Stock Loan Entities are encompassed within the definition of "settlement payment," and therefore, the stockbroker defense clearly applies to preclude recovery of the commissions under § 544. Defendant's argument appears to be based upon the theory that commission payments are payments commonly used in the securities trade and thus fall within the definition of "settlement payment" set forth in § 741(8). See 11 U.S.C. § 741(8) (defining "settlement payment" as a "preliminary settlement payment, a partial settlement payment, an interim settlement payment, a settlement payment on account, a final settlement payment, or any other similar payment commonly used in the securities trade.") (emphasis added). The term "settlement payment" has been interpreted broadly. See Kaiser Steel Corp. v. Pearl Brewing Co. (In re Kaiser Steel), 952 F.2d 1230, 1237 (10th Cir. 1991) ("Kaiser II") (stating that the definition of settlement payment is extremely broad). Nevertheless, the term has to be interpreted as it is "plainly understood within the securities industry." Id. "[I]n the securities industry, `any transfer of cash or securities made to complete a securities transaction is considered a settlement payment.'"In re Enron Corp., 341 B.R. 451, 456 (Bankr. S.D.N.Y 2006) (quoting Walsh v. The Toledo Hosp. (In re Fin. Mgmt. Scis., Inc.), 913 F.2d 846, 848 (10th Cir. 1990)). Despite this authority, the parties did not identify nor could the court locate any prior case that immunized commission payments from such an action due to § 546(e).

It is undisputed that Wachovia is a stockbroker for purposes of the stockbroker defense. See 11 U.S.C. § 101(53A); In re Stewart Finance Co., 367 B.R. 909, 919 (Bankr. M.D. Ga. 2007) ("A stockbroker is a person that has customers and engages in the business of effecting transactions in securities.")

In its September 19 Order, this Court observed in a footnote that there are cases where commission payments to brokers have been recovered as fraudulent transfers. See In re Old Naples Securities, 343 B.R. 310 (Bankr. M.D. Fla. 2006); Bauman v. Bliese et al (In re McCarn's Allstate Finance, Inc.,), 326 B.R. 843 (Bankr. M.D. Fla. 2005); Cuthill v. Kime et al. (In re Evergreen Security, Ltd.), 319 B.R. 245 (Bankr. M.D. Fla. 2003); Terlecky v. Abels, 260 B.R. 446 (S.D. Ohio 2001); In re Randy, 189 B.R. 425 (Bankr. N.D. Ill. 1995). However, none of these cases considers the applicability of the stockbroker defense and there is no indication that the stockbroker defense was raised or considered in these cases. Moreover, none address the payment of customary commissions for securities transactions. In Terlecky, the brokers were employees of the debtors and thus were not "stockbrokers" as that term is defined by 11 U.S.C. § 101(53A). See Collier on Bankruptcy ¶ 101.53A at 101-208 (rev. 15th ed. 2008) (an employee who effects transactions in securities is not considered a stockbroker because that employee does not have a customer). In Evergreen, there were also no "stockbrokers" under 11 U.S.C. § 101(53A). See 319 B.R. at 249-51 (investment advisors received commissions from debtor for referrals of customers). The Bauman,Cuthill, and Randy cases addressed unusual commissions paid to brokers for recruiting customers to participate in the Ponzi scheme. The Old Naples Securities case addressed commission payments to a broker that were unusually large, constituting 73-109% of the transaction.

Defendants bear the burden of proving that § 546(e) is applicable to bar Plaintiff from avoiding these transfers. See In re Stewart Fin. Co., 267 B.R. 909, 920-21 (Bankr. M.D.Ga. 2007). The record before the Court does not adequately reflect facts regarding whether the commissions in this case are customary or reasonable and therefore, the Court denies Defendants' Renewed Motion as to this issue.

D. Transfers of Margin Interest Payments to Defendants

Defendants further contend that the stockbroker defense prevents Plaintiff from recovering margin interest payments made to Defendants. Plaintiff argues that margin interest payments are not embraced within the definitions of the term "margin payment" or "settlement payment," because a margin interest payment is merely "a payment towards interest [and] does not reduce the principal debt." A "margin payment" is defined by § 741(5) as a "payment or deposit of cash, a security, or other property, that is commonly known to the securities trade as original margin, initial margin, maintenance margin, or variation margin, or as a mark-to-market payment, or that secures an obligation of a participant in a securities clearing agency." The term "margin payment" has been interpreted broadly. In re Stewart Fin. Co., 367 B.R. at 917 ("`Margin payment' is a broadly construed term.")

The parties agree that the determination of whether a margin interest payment constitutes a "margin payment" turns on whether the payments reduced a deficiency in a margin account. See In re David, 193 B.R. 935, 940 (Bankr. C.D. Cal. 1996). While payment of margin interest does not reduce the initial principal debt in the account, payment of margin interest would appear to reduce the total deficiency in the account. When margin interest accrued in the At-Issue Accounts, the total debt owed by the Stock Loan Entities increased. When a margin interest payment was made to Defendants (or deducted from the account under the terms of the Account Agreement), the total debt, or deficiency, in the margin account decreased. For these reasons, the Court concludes that the margin interest payments at issue in this litigation are within the scope of § 546(e) and thus are not recoverable as fraudulent transfers under § 544. Accordingly, summary judgment is granted in favor of Defendants as to Plaintiff's § 544 claim with respect to the transfers that constitute margin interest payments.

E. Other Transfers

It appears that there are additional transfers embraced by the Third Amended Complaint which were not addressed by Defendants' Renewed Motion. Specifically, although settlement payments and margin payments are not recoverable under § 544 due to the stockbroker defense, transfers made during the one-year pre-petition period that constitute settlement payments or margin payments, including margin interest payments and commissions, may be recoverable under § 548(a)(1)(A). It further appears that there may be transfers of other broker fees to Defendants, including wire transfer fees and prepayment fees, which have not been addressed by the Renewed Motion. In its Third Amended Complaint, Plaintiff sought recovery of transfers to Defendants including, but not limited to, commissions, investment advisory fees, professional fees, and sales, as well as other property and property interests received by the Defendants, directly or indirectly from Debtor or the Stock Loan Entities. While Defendants' assert in their Renewed Motion that payments of commission and margin interest payments were barred by the defense afforded to stockbrokers in § 546(e), the Renewed Motion did not address transfers of other fees such as wire transfer fees and prepayment fees. Defendants assert in their Reply to Plaintiff's Objection that Plaintiff should be barred from recovering these transfers based upon the Plaintiff's agreement during discovery to provide the details of all the transfers it was seeking to recover and subsequent failure to specify these transfers. Defendant cites the transcript of the July 27, 2010 hearing on the Renewed Motion as support for this claim. A review of the transcript does not clearly indicate the terms of an agreement between the parties with respect to this issue and the Court is not aware of such an agreement being otherwise of record in this adversary proceeding. The Court finds that the issues as to these transfers are not ripe for determination at this time and that Plaintiff is therefore not estopped from recovering these transfers. Accordingly, to the extent Defendants' seek summary judgment as to these transfers, the Motion is denied.

Pursuant to § 546(e), the stockbroker defense does not apply to claims made under § 548(a)(1)(A). See 11 U.S.C. § 546(e) ("Notwithstanding sections 544, . . . 548(a)(1)(B), and 548(b) of this title, the trustee may not avoid a transfer that is a margin payment . . . or settlement payment . . . made by or to (or for the benefit of a . . . stockbroker, except under section 548(a)(1)(A)). Section 548(a)(1)(A) requires Plaintiff to prove that the transfer was made "with the actual intent to hinder, delay, or defraud any entity to which the debtor was or became, on or after the date such transfer was made or such obligation was incurred, indebted."

III. Waiver

Defendants contend that Plaintiff is prohibited from recovering transfers from Optech and Witco in this proceeding because it waived its right to assert that those entities are alter egos of Debtor by limiting its alter ego theory to Bancroft in its response to Defendants' Second Motion to Dismiss and proposed order. Typically, waiver principles come into play when a party voluntarily or intentionally relinquishes a known right. In re Varat Enterprises, 81 F.3d 1310, 1317 (4th Cir. 1996). Defendants cite to Wojtas v. Capital Guardian Trust Co., 477 F.3d 924 (7th Cir. 2007) and Rosen v. Mystery Method, Inc., 2008 WL 723331 (N. D. Ill. 2008) as support for their claim that Plaintiff waived its right to recover transfers of Debtor's property made by Optech and WITCO as alter egos. Wojtas and Rosen hold that the failure to oppose an argument raised in a motion to dismiss operates as a waiver as to that theory. In bothWojtas and Rosen the plaintiffs entirely failed to respond to legal arguments raised by the defendants in their motions to dismiss. However, in this case, Defendants' arguments in connection with their motion to dismiss did not specifically address Optech and WITCO and therefore Plaintiff cannot be said to have intentionally failed to oppose that argument. For this reason, this case is distinguishable from Wojtas and Rosen, and the Court finds that Plaintiff has not waived its claims with respect to Optech and WITCO.

Defendants further assert that the Court, in its September 19 Order, limited Plaintiff's claims to transfers made by Debtor and Bancroft only. The Court disagrees with Defendants' contention that its September 19 Order thereafter precluded Plaintiff's claims to transfers made by the Debtor by limiting them to a discussion of Bancroft. While it is true that Plaintiff's response to Defendants' Second Motion to Dismiss focused on allegations relating to Bancroft, the issue being decided was whether property of an alter ego of a debtor may be recovered at all. In their Motion to Dismiss, Defendants had argued that Plaintiff had failed to state a claim under §§ 544 and 548, which apply only to transfers of a debtor's property, because Plaintiff seeks to recover transfers from non-debtor entities, including Bancroft. In examining the sufficiency of the Second Amended Complaint, the Court concluded that, for purposes of deciding the Rule 12(b)(6) motion, Plaintiff had sufficiently alleged facts that, if true, could permit a finding that Bancroft was an alter ego of Debtor and that property of an alter ego could be considered property of Debtor. Therefore, the Court concluded that the allegations relating to Bancroft were sufficient to overcome Defendants' motion to dismiss the §§ 544 and 548 claims on the grounds that no transfers of Debtor's property had been alleged.

In its September 19 Order, the Court stated in a footnote that "Grayson's Objection and Proposed Order appear to limit the application of the alter ego theory to Bancroft." This observation was made for the limited purpose of deciding the motion to dismiss and was not intended to narrow the substantive issues in this case. This Court further stated in the September 19 Order that "considering the large number of transfers at issue and the complicated nature of the relationships between the Derivium Owners, the Debtor, Bancroft, and these other entities, the Court is now satisfied that the details of the transfers are best addressed by the discovery process."

For the foregoing reasons, Defendants' Renewed Motion is denied to the extent that it seeks to limit Plaintiff's claims to transfers made via accounts held in the names of Debtor and Bancroft only.

IV. Alter Ego Theory

In its Alter Ego Motion, Wachovia argues that Plaintiff's claims for transfers into the At-Issue Accounts and for commissions, margin interest, and wire and pre-payment fees paid from those accounts also fail to the extent those transfers were made by the Stock Loan Entities because Plaintiff cannot meet its burden of establishing that these entities are alter-egos of Debtor. Without a showing that the Stock Loan Entities are alter-egos of the Debtor, the transfers at issue would not be transfers of Debtor's property and thus would not be recoverable.

To recover these transfers using the alter ego theory provided by South Carolina law, Plaintiff must show, by a preponderance of the evidence, total domination and control of the Stock Loan Entities by Debtor and inequitable consequences caused thereby. Colleton County Taxpayers v. School District of Colleton County, 638 S.E.2d 685, 692 (S.C. 2006). Control may be shown where the subservient entity manifests no separate interest of its own and functions solely to achieve the goals of the dominant entity. Id. "[C]ourts will look through the forms to the realities of the relation between the companies as if the corporate agency did not exist and will deal with them as the justice of the case may require." Osborn v. Univ. Med. Assoc. of the Med. Univ. of S.C., 278 F.Supp.2d 720, 727 (D.S.C. 2003) (quoting United States v. Reading Co., 253 U.S. 26, 63 (1920)). To overcome summary judgment, Plaintiff must demonstrate that a genuine issue of material fact exists regarding the total domination and control of the Stock Loan Entities by Debtor and the inequitable consequences caused thereby.

State law applies to determine whether the corporate form should be disregarded under an alter ego theory. See Perpetual Real Estate Serv., Inc. v. Michaelson Properties, Inc., 974 F.2d 545 (4th Cir. 1992) (finding that Virginia state law should have been applied to determine whether the corporate form should be disregarded under an alter ego or veil piercing theory).

To support its alter-ego cause of action, Plaintiff presented deposition testimony of Timothy Scrantom and F. Ron Jenkins, who directly and through their law firm, Ten State Street, LLP, helped to form, and later represented the Stock Loan Entities at the direction of the Derivium Owners, primarily Charles Cathcart. Mr. Scrantom's testimony indicated that the Stock Loan Entities were created in order to further Debtor's business purpose and Debtor controlled their assets, income and business activities. Mr. Scrantom further testified that all bills for legal services provided by Ten State Street, LLP, on behalf of the Stock Loan Entities were authorized for payment by the Derivium Owners.

A. Bancroft

Mr. Scrantom's testimony indicated that Debtor and Bancroft had agreements in place which set forth the respective rights and limitations of the parties. However, Mr. Jenkins' testimony indicated that Cathcart essentially set the terms of these agreements and there was no real negotiation of those terms. He further testified that these agreements did not function in accordance with their terms and that Bancroft's directors did not have the rights and authority in fact that was accorded to them in the agreements. Significantly, Mr. Jenkins testified that the directors at Bancroft did not have the kind of information they needed in order to act independently. It further appears that the majority of the board meetings that took place for Bancroft occurred after litigation against Bancroft was commenced in California in the fall of 2002. Seven records of minutes of Bancroft board meetings were presented — five out of the seven minutes of board meetings presented were minutes of meetings held between April 19, 2005 and May 6, 2005, the date on which the board members tendered their resignations. The minutes of board meetings also show the Board's authorization of a brokerage account to be opened to conduct business (with Yuri Debevc and his designees being authorized to use the account) and the approval of an asset acquisition that had occurred almost two months earlier. It further appears from the testimony of Mr. Jenkins and the exhibits to his deposition that he hired counsel to defend Bancroft in the California litigation without the directors' authority and that Cathcart paid the associated bills. Mr. Jenkins also testified that Debtor was the ultimate beneficial owner of Bancroft because Debtor owned all the assets and cash and that the Bancroft and Derivium "structure" was designed to protect intellectual property belonging to Cathcart.

For example, the Bancroft directors were not provided with formal financial statements for fiscal year 2001 and 2002 until after May of 2003. Minutes from meetings in April and May of 2005 reflect that the directors were not in possession of Bancroft's accounting books and financial records.

Viewing the facts in the light most favorable to the Plaintiff, the Court finds that these facts raise a genuine issue of material fact regarding whether Debtor exercised dominion and control over Bancroft. The facts presented are sufficient to support a finding that, despite its limited efforts to observe corporate formalities (the majority of which took place after litigation was commenced against it), Bancroft did not act independently and its actions and business decisions were directed by Debtor through the Derivium Owners.

Defendants argue that, under Osborn, total control cannot be found where the alleged alter ego observes corporate formalities. 278 F. Supp. 2d at 729. In Osborn, the alleged alter ego had separate facilities, a separate Board of Directors, a separate Chief Executive Officer and President, and separate employees. The District Court found that the evidence presented in Osborn did not sufficiently indicate that total control had been exercised over the alleged alter ego and thus the alleged alter ego could not be held liable for the obligations of the alleged dominant entity. However, Osborn also observes that courts must look through the forms to the realities of the relation between the companies. The observance of corporate formalities is certainly indicia of whether a corporation has a separate mind, will or existence of its own. In some circumstances, however, it may be inequitable to deny liability based on an alter ego theory merely because a corporation observed certain limited corporate formalities, particularly where the corporation is a sham entity under the complete control of another entity. In this case, the deposition testimony and documents submitted by the parties raise a genuine issue of fact regarding whether Bancroft's exercise of corporate formalities were the legitimate practices of an independent entity or merely a façade for Debtor. The evidence presented could be viewed to indicate that Bancroft's directors merely rubber stamped documents in accordance with instructions from Debtor. Viewing the evidence in the light most favorable to the Plaintiff, there is sufficient evidence to support a finding that Debtor had total dominion and control over Bancroft's business affairs.

B. Optech and WITCO

No evidence was presented to demonstrate that Optech or WITCO held regular board meetings, prepared or maintained meeting minutes, or had an independent business purpose. The record includes evidence indicating that Optech and Witco were created solely to benefit Debtor and to further Debtor's business purpose. The record lacks any evidence that Optech and WITCO observed any corporate formalities beyond its initial formation and execution of brokerage account agreements over which the Derivium Owners had control. The testimony of Mr. Scrantom indicated that all bills for services on behalf of Optech and WITCO were authorized for payment by the Derivium Owners. The record includes an e-mail sent by Cathcart where he instructs Optech's directors regarding which individuals should have Optech business cards and stationary. The record also includes an indemnification agreement where Cathcart agreed to personally indemnify Optech's directors for any and all liability arising out of Optech's business. Additionally, Mr. Jenkins testified that the directors of Optech were mere fiduciaries, with no financial stake in the businesses other than their fees for administration and provision of directors, shareholders, and corporate services. These facts raise a genuine issue of material fact regarding whether Optech and WITCO were dominated and controlled by Debtor.

In summary, the Court finds that genuine issues of material fact exist regarding whether Debtor and the Derivium Owners exercised total domination and control of Bancroft, Optech and WITCO such that these entities manifested no separate interest of their own and functioned solely to achieve the goals of Debtor. Therefore, Defendants' Alter Ego Motion is denied.

CONCLUSION

Based on the foregoing, it is hereby

ORDERED that Defendants' Renewed Motion is granted as to the following issues:

1. Plaintiff's fraudulent transfer claims pursuant to 11 U.S.C. §§ 544 and 548 with respect to transfers of stock from the Stock Loan Borrowers into the At-Issue Accounts;

2. Plaintiff's fraudulent transfer claims pursuant to 11 U.S.C. § 544 with respect to transfers of margin interest payments; and

3. Plaintiff's fraudulent transfer claims pursuant to 11 U.S.C. § 548 with respect to the cash transfers that Debtor and Bancroft directly deposited into their brokerage accounts with Defendants in the year prior to Debtor's bankruptcy filing.

IT IS FURTHER ORDERED that Defendants Renewed Motion is denied:

1. To the extent that Defendants seek to bar Plaintiff's claims to transfers by Optech and WITCO based on waiver or prior court order; and

2. As to Plaintiff's fraudulent transfer claims pursuant to 11 U.S.C. § 544 with respect to transfers of commissions, wire transfer fees, and prepayment fees.

IT IS FURTHER ORDERED that Defendants' Alter Ego Motion is denied.

AND IT IS SO ORDERED.

Entered: 09/14/2010

Notice Recipients

District/Off: 0420-2 User: smithj Date Created: 9/14/2010 Case: 07-80119-jw Form ID: pdf01 Total: 20 Recipients of Notice of Electronic Filing: tr Kevin Campbell kcampbell@campbell-law-firm.com ust US Trustee USTPRegion04.CO.ECF@usdoj.gov aty Alisa J. Roberts roberts@graysonlaw.net aty David Brian Wheeler davidwheeler@mvalaw.com aty George Trenholm Walker gtw@wiselaw.com aty George Wayne Hillis, Jr. whillis@phrd.com aty J. Ronald Jones, Jr. rjones@clawsonandstaubes.com aty Jason A. Daigle jason@maybanklaw.com aty Joseph C. Wilson, IV joewilson@phsm.net aty Melissa Martin Burton mburton@phrd.com aty Sonaly K. Hendricks sonalyhendricks@phsm.net TOTAL: 11 Recipients submitted to the BNC (Bankruptcy Noticing Center): db Derivium Capital, LLC PO Box 754 Tuxedo Park, NY 10987 md Lawrence W. Johnson, Jr. PO Box 883 Columbia, SC 29202 intp Charles Cathcart PO Box 754 Tuxedo Park, NY 10987 aty Christian Levine Simpson 8605 Westwood Center Drive, Ste. 410 Vienna, VA 22182 aty David A. Picon Proskauer Rose LLP 185 Broadway New York, NY 10036-8299 aty Jeffrey T. Kucera Wachovia Building 20th Floor 200 South Biscayne Boulevard Miami, FL 33131 aty Matthew Triggs Proskauer Rose LLP 2255 Glades Road Ste 340W Boca Raton, FL aty Stephen L. Ratner Proskauer Rose LLP 1585 Broadway New York, NY 10036-8299 aty Victor A. Kubli Kubli and Associates PC 9081 Shady Grove Ct Gaithersburg, MD 20877 TOTAL: 9