Attachment B

In re First Independence Capital Corp.
This case was not selected for publication in the

Federal Reporter.

Not for Publication in West's Federal Reporter See

Fed. Rule of Appellate Procedure 32.1 generally

governing citation of judicial decisions issued on or

after Jan. 1, 2007. See also Sixth Circuit Rule 28.

(Find CTA6 Rule 28)

United States Court of Appeals,

Sixth Circuit.

In re: FIRST INDEPENDENCE CAPITAL CORPORATION, Debtor.

First Independence Capital Corporation, PlaintiffAppellant,

v.

Merrill Lynch Business Financial Services Incorporated; Merrill, Lynch, Pierce, Fenner and Smith,

Incorporated, Defendants-Appellees.

No. 05-1618.

May 16, 2006.

Background: Debtor-in-possession under Chapter

11 of the Bankruptcy Code brought action against

bank, seeking to recover for various allegedly

fraudulent transfers. After a trial, the Bankruptcy

Court entered judgment in favor of bank, and the

United States District Court for the Eastern District

of Michigan affirmed. Debtor appealed.

Holdings: The Court of Appeals, Cook, Circuit

Judge, held that:

(1) Uniform Commercial Code (UCC) sections

which defined who may qualify as a holder in due

course did not provide rescission cause of action;

(2) bank acted in good faith, for purposes of Bankruptcy Code section enabling recovery of avoidable

transfers from initial transferees; and

(3) bank did not possess knowledge of voidability

of allegedly fraudulent transfers, as required for recovery of avoidable transfers.

Affirmed.

West Headnotes

[1] Bankruptcy 51 2703

51 Bankruptcy

51V The Estate

51V(H) Avoidance Rights

51V(H)1 In General

51k2702 Rights of Debtor or Injured

Creditors

51k2703 k. Debtor in Possession.

Most Cited Cases

Bills and Notes 56 327

56 Bills and Notes

56VIII Rights and Liabilities on Indorsement or

Transfer

56VIII(D) Holders in Due Course

56k327 k. Nature and Grounds of Protection. Most Cited Cases

Uniform Commercial Code (UCC) sections, as

adopted under Michigan law, which defined who

may qualify as a holder in due course, did not

provide rescission cause of action on behalf of

debtor-in-possession under Chapter 11 of the Bankruptcy Code, in action against bank seeking to recover for various allegedly fraudulent transfers;

rather, UCC sections at issue served only to invalidate a potential holder-in-due-course defense.

M.C.L.A. §§ 440.3306, 440.3307.

[2] Bankruptcy 51 2701

51 Bankruptcy

51V The Estate

51V(H) Avoidance Rights

51V(H)1 In General

51k2701 k. Avoidance Rights and

Limits Thereon, in General. Most Cited Cases

Bank, which allegedly deposited debtor's funds

into personal brokerage account of debtor's principals, acted in good faith, for purposes of Bankruptcy Code section enabling recovery of avoidable

transfers from initial transferees, although bank alPage 1

181 Fed.Appx. 524, 2006 WL 1342789 (C.A.6 (Mich.)), 2006 Fed.App. 0348N

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legedly accepted the checks in violation of its own

policy, and knew that principals used corporate

checks to fund their personal margin trading, where

there was no proof that bank had actual knowledge

of the transfers' voidability, or that it acted with

anything other than proper intentions. 11 U.S.C.A.

§ 550(b)(1).

[3] Bankruptcy 51 2701

51 Bankruptcy

51V The Estate

51V(H) Avoidance Rights

51V(H)1 In General

51k2701 k. Avoidance Rights and

Limits Thereon, in General. Most Cited Cases

Bank, which allegedly deposited debtor's funds

into personal brokerage account of debtor's principals, did not possess requisite knowledge of voidability of allegedly fraudulent transfers, for purposes of Bankruptcy Code section enabling recovery of avoidable transfers from initial transferees,

where nothing would have alerted a reasonable person to the transfers' recoverability. 11 U.S.C.A. §

550(b)(1).

*525 On Appeal from the United States District

Court for the Eastern District of Michigan.John D.

Hertzberg, Bingham Farms, MI, Ralph R. Safford,

Mary Ann Hart, Safford & Baker, Bloomfield Hills,

MI, for Plaintiff-Appellant.

Donald J. Hutchinson, Miller, Canfield, Paddock &

Stone, Detroit, MI, for Defendants-Appellees.

Before: GIBBONS and COOK, Circuit Judges;

SCHWARZER, Senior District Judge.FN*

FN* The Honorable William W Schwarzer, Senior United States District Judge for

the Northern District of California, sitting

by designation.

COOK, Circuit Judge.

**1 Plaintiff First Independence Capital Corporation, having declared bankruptcy, seeks to recover under the Bankruptcy Code and Michigan

law for various fraudulent transfers. After a trial,

the bankruptcy court held that Merrill Lynch, a subsequent transferee, took the transfers for value, in

good faith, and without knowledge of the transfers'

voidability, precluding First Independence's recovery under the Bankruptcy Code. The bankruptcy

court also held that the state law provisions on

which First Independence relied did not create a

cause of action. The district court affirmed, and

First Independence appeals. Because the bankruptcy court did not clearly err in concluding that

Merrill Lynch acted in good faith and without

knowledge of the transfers' voidability, and because

the other arguments advanced by First Independence are without merit, we affirm.

*526 I

First Independence, a Michigan corporation, is

currently a debtor-in-possession under Chapter 11

of the Bankruptcy Code. Michael and Sandra

Baumhaft owned and operated First Independence

before the bankruptcy. Michael acted as the corporation's president and sat on the board of directors.

Sandra served as First Independence's only other

director and was also the vice-president and sole

shareholder.

The Baumhafts opened a personal brokerage

account with Defendant Merrill, Lynch, Pierce,

Fenner & Smith. Shortly after this, First Independence, through the Baumhafts, opened a Working

Capital Management Account with Defendant Merrill Lynch Business Financial Services.FN1 The

Working Capital Management Account provided a

line of credit to First Independence, and the Baumhafts personally guaranteed the credit line, offering

the assets of a separate account (a sub-account of

their personal brokerage account) as collateral.

FN1. We refer to the defendants collectively as “Merrill Lynch” throughout this

opinion.

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First Independence then made nine transfers to

the Baumhafts, six of which relate to this appeal. In

all six cases, the Baumhafts presented checks to

Merrill Lynch, requesting that the funds be deposited in their personal brokerage account. In three of

the transfers, the Baumhafts presented First Independence checks drawn from its line of credit and

payable to “Merrill Lynch.” In two of the transfers,

the Baumhafts presented checks drawn from First

Independence's accounts at third-party banks, made

payable to “Merrill Lynch.” And in one transfer,

the Baumhafts presented a third-party check, payable to the order of First Independence and endorsed to “Merrill Lynch” by Michael Baumhaft on

behalf of First Independence. In all six instances,

Merrill Lynch deposited the funds in the Baumhafts' brokerage account.

When First Independence declared bankruptcy,

it sought to rescind or avoid these transfers under

the Bankruptcy Code and state law. The bankruptcy

court determined each of the transfers from First Independence to the Baumhafts to be fraudulent (and,

consequently, avoidable) but concluded that First

Independence could not recover from Merrill Lynch

because Merrill Lynch, a subsequent transferee,

took the transfers in good faith, for value, and

without knowledge of their avoidability. The court

also determined that the Michigan commercial code

provisions on which First Independence relied did

not create a cause of action to rescind the transfers.

The district court affirmed in all respects, and First

Independence appeals.

II

**2 We review the bankruptcy court's decision

rather than the district court's decision. In re Am.

HomePatient, Inc., 414 F.3d 614, 617 (6th

Cir.2005). We review the bankruptcy court's findings of fact for clear error and its conclusions of

law de novo. Id.

A. Claims Under Michigan's Commercial Code

Michigan has adopted Article 3 of the Uniform

Commercial Code. Michigan Compiled Laws §

440.3202 permits a party, “[t]o the extent permitted

by other law,” to rescind negotiation of an instrument, except “against a subsequent holder in due

course or a person paying the instrument in good

faith and without knowledge of facts that are a

basis for rescission.” Sections 440.3302, 440.3306,

and 440.3307 define who may qualify as a holder

*527 in due course. First Independence maintains

that Michigan Compiled Laws § 440.3307(2),

working with the other sections, precludes Merrill

Lynch from asserting a holder-in-due-course defense to First Independence's claims. First Independence also argues that, contrary to the bankruptcy court's conclusion, these sections create an

independent cause of action for rescission, the elements of which mirror a common-law claim for rescission.

Section 440.3307(2) provides:

If (i) an instrument is taken from a fiduciary for

payment or collection or for value, (ii) the taker

has knowledge of the fiduciary status of the fiduciary, and (iii) the represented person makes a

claim to the instrument or its proceeds on the

basis that the transaction of the fiduciary is a

breach of fiduciary duty, the following rules apply:

(a) Notice of breach of fiduciary duty by the fiduciary is notice of the claim of the represented person.

* * * *

(d) If an instrument is issued by the represented

person or the fiduciary as such, to the taker as

payee, the taker has notice of the breach of fiduciary duty if the instrument is ... (iii) deposited to

an account other than an account of the fiduciary,

as such, or an account of the represented person.

We assume without deciding that First Independence is correct that Merrill Lynch was a taker

of the instruments in this case and that Merrill

Lynch cannot claim the status of holder in due

course. This would deprive Merrill Lynch of a dePage 3

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fense to First Independence's claim for rescission,

but First Independence's claim can survive only

“[t]o the extent [it is] permitted by other law.”

Mich. Comp. L. § 440.3202; see also id. at cmt. 3

(“Section 3-202 gives no right that would not otherwise exist. The section is intended to mean that any

remedies afforded by other law are cut off only by a

holder in due course.”). In other words, unless First

Independence has a valid claim for rescission under

“other law,” Merrill Lynch lacks a need for the

holder-in-due-course defense.

[1] First Independence argues that §§ 440.3306

and 440.3307 provide the rescission cause of action

that it seeks. We disagree. These sections serve

only to invalidate a potential defense. See Conder v.

Union Planters Bank, N.A., 384 F.3d 397, 401-02

(7th Cir.2004) (“[A]ll that section 3-306 does is, by

lifting the holder in due course defense, to open the

way to a tort suit. It removes a defense, rather than

altering the claim....”); Mut. Serv. Cas. Ins. Co. v.

Elizabeth State Bank, 265 F.3d 601, 621 (7th

Cir.2001); Beldance v. Huntington Nat'l Bank (In re

World Metals, Inc.), 313 B.R. 720, 729

(Bankr.N.D.Ohio 2004) (“[T]he Court finds that

[Ohio's version of U.C.C. § 3-306] does not provide

an independent cause of action.”); Chouteau Auto

Mart, Inc. v. First Bank of Missouri, 148 S.W.3d

17, 22 (Mo.Ct.App.2004) (“Even when read together, the two sections contain no direct language imposing a liability, nor do they purport to set forth all

the elements of a claim against the Bank.”). The

Bankruptcy court did not err in rejecting this claim

for rescission.

B. Claims Under the Bankruptcy Code

**3 [2] The bankruptcy court concluded that

First Independence (as a debtor-in-possession)

could avoid the transfers to the Baumhafts under 11

U.S.C. § 548, but the court also found Merrill

Lynch to be a subsequent transferee of the funds-a

conclusion First Independence does not contest. As

a subsequent transferee, Merrill Lynch could defeat

First Independence's claim to recover the transfers

if Merrill Lynch took the transfers for value, in

good faith, and without knowledge of the voidability*528 of the earlier transfers. See 11 U.S.C. §

550(b)(1). The court held that Merrill Lynch fulfilled all three requirements, and First Independence takes issue with the court's holding.

1. GOOD FAITH

First Independence insists the bankruptcy court

erred when it concluded, “For purposes of § 550(b),

good faith simply requires that the transaction not

be a ‘wash.’ ” The bankruptcy court cited Eder v.

Queen City Grain, Inc. (In re Queen City Grain,

Inc.), 51 B.R. 722, 727 (Bankr.S.D.Ohio 1985), for

this proposition, and that case in turn quoted

H.R.Rep. No. 95-595, at 376 (1977), reprinted in

1978 U.S.C.C.A.N. 5963, 6332, which states:

The phrase ‘good faith’ in this paragraph is intended to prevent a transferee from whom the trustee

could recover from transfering [sic] the recoverable property to an innocent transferee, and receiving a retransfer from him, that is, ‘washing’

the transaction through an innocent third party. In

order for the transferee to be excepted from liability under this paragraph, he himself must be a

good faith transferee.

Courts and commentators have struggled to

define the term “good faith” as used in § 550(b).

Some have concluded that the term is synonymous

with “without knowledge of the voidability,” so

that the Code's use of both creates a redundancy.

See Bonded Fin. Servs., Inc. v. European Am. Bank,

838 F.2d 890, 897 (7th Cir.1988). First Independence points to IRS v. Nordic Village, Inc. (In re

Nordic Village), 915 F.2d 1049, 1056 (6th

Cir.1990), rev'd on other grounds, 503 U.S. 30, 112

S.Ct. 1011, 117 L.Ed.2d 181 (1992), which indicated that “good faith” involved a lack of “actual notice” of voidability. Id.

Even if “good faith” under § 550(b) means a

lack of actual notice or, as First Independence also

contends, a lack of illicit intent, we discern no error

in the bankruptcy court's conclusion that Merrill

Lynch acted in good faith. First Independence arPage 4

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gues that Merrill Lynch accepted the checks in violation of its own policy, and that Merrill Lynch's account manager knew that the Baumhafts used corporate checks to fund their personal margin trading.

But these facts neither prove that Merrill Lynch

possessed actual knowledge of the transfers' voidability nor show that it acted with anything other

than proper intentions. The court found that Merrill

Lynch did not have actual notice of the voidability

of the transfers or of the Baumhafts' alleged misappropriation of the funds, and it found that the case

did not involve “egregious, vindictive or intentional

misconduct.” First Independence suggests no reason for us to discard these findings as clearly erroneous.

2. KNOWLEDGE OF VOIDABILITY

**4 [3] First Independence next argues that it

should recover the transfers because Merrill Lynch

possessed the requisite knowledge of the transfers'

voidability. First Independence does not suggest

that at the time Merrill Lynch accepted the transfers

it knew the precise bases of voidability, but argues

instead that Merrill Lynch should have questioned

the propriety of the transfers. It first points to Allis

Chalmers Leasing Servs. Corp. v. Byron Center

State Bank, 129 Mich.App. 602, 341 N.W.2d 837,

840 (1983), which held that “a payee bank is put on

a duty of inquiry where a check, drawn payable to

the order of the bank, is presented by a third party

seeking to negotiate the check for his own benefit.”

FN2 First Independence also points *529 to Mich.

Comp. L. § 440.3307 (describing, as explained

above, when a taker has notice of a potential claim

of breach of fiduciary duty in order to preclude

holder-in-due-course status under the commercial

code) and to Merrill Lynch's policy on “Corporate

and Partnership Checks,” which provides that corporate checks drawn on a Working Capital Management Account presented for deposit in an individual

account should be “accompanied by written instructions signed by an appropriate officer of the corporation.” Finally, First Independence points us to

Merrill Lynch's account manager Alan Sasson's

testimony as establishing that Merrill Lynch knew

of the illegitimacy of the transfers.

FN2. To the extent that First Independence

seeks to maintain a claim under Allis

Chalmers, we note that Allis Chalmers involved an ordinary negligence action for a

bank's breach of its duty of inquiry. See Allis Chalmers, 341 N.W.2d at 839. As in

any negligence case, First Independence

bears the burden of proving causation, an

element that the bankruptcy court concluded First Independence had not shown

because any inquiry by Merrill Lynch

would have been directed to the Baumhafts. See Travelers Cas. & Surety Co. of

Am. v. Wells Fargo Bank, 374 F.3d 521,

524 (7th Cir.2004) (“[E]ven if Travelers

proved that Schwab had violated its duty

[to inquire whether the check was authorized], in order to obtain relief Travelers

would have to show that Schwab, had it

fulfilled its duty, would have discovered

that [the corporation] had not authorized

the check ..., and having discovered this

would not have let [the depositor] transfer

the money out of his Schwab account.”).

a. Merrill Lynch's Notice

First Independence contends that Allis

Chalmers and Mich. Comp. L. § 440.3307, as well

as Merrill Lynch's own check-acceptance policy,

placed Merrill Lynch on notice of the transfers' illegitimacy. According to First Independence, our decision in Nordic Village renders such notice sufficient to constitute “knowledge” for the purposes of

§ 550(b).

In Nordic Village, an employee of the bankrupt

company (Swiss Haus) drew a corporate check payable to a bank, which then issued a cashier's check

with the notation “REMITTER: SWISS HAUS,

INC.” 915 F.2d at 1050. The employee submitted

the cashier's check to the IRS with his income tax

with instructions to credit the check toward his tax

liability, and the IRS complied. Id. at 1050-51. The

court held that “[t]he requirement of ‘knowledge’ is

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satisfied if the transferee ‘knew facts that would

lead a reasonable person to believe that the property

transferred was recoverable.’ ” Id. at 1055 (citation

omitted); see Wasserman v. Bressman (In re Bressman), 327 F.3d 229, 236 (3d Cir.2003) (citing Nordic Village); Brown v. Third Nat'l Bank (In re Sherman), 67 F.3d 1348, 1357 (8th Cir.1995) (same). In

finding that the IRS had knowledge of the transfer's

voidability, the court determined that the notation

on the cashier's check would lead a reasonable person to conclude that the property transferred was

recoverable. Nordic Vill., 915 F.2d at 1056.

Certainly “some facts suggest ... other facts,”

and “[i]f a transferee possesses knowledge of facts

that suggest a transfer may be fraudulent, and further inquiry by the transferee would reveal facts

sufficient to alert him that the property is recoverable, he cannot sit on his heels, thereby preventing

a finding that he has knowledge.” In re Sherman,

67 F.3d at 1357. But here the facts surrounding the

Baumhafts' deposits would not lead a reasonable

person to believe that the transfers were voidable,

even though the Baumhafts' use of corporate checks

may have placed Merrill Lynch on implied notice

of the transfers' illegitimacy under Michigan law.

As the bankruptcy court stated, “[t]here was a range

of legitimate scenarios under which the Baumhafts

were entitled to funds from [First Independence] for

their own personal use, including his salary, repayment of the officer loan debt and distribution to

Sandra Baumhaft as sole shareholder.” FN3 Also,

as the bankruptcy court *530 noted, “[t]here was no

one other than the Baumhafts themselves to ask

whether these funds were paid for a legitimate purpose.” Any inquiry into the legitimacy of the transfer would have been obviously circular in this case

because the party seeking to use the funds for his

own benefit was also the only party to whom the

bank could make inquiry. See Bonded Fin., 838

F.2d at 898 (“Had the Bank ... inquire[d] about the

check, the Bank would have learned that the instrument was authorized by the appropriate corporate

officials. Since the inquiry would have turned up

nothing pertinent to voidability, the Bank's failure

to make it does not permit a court to attribute to it

the necessary knowledge [under § 550(b) ].”). On

these facts, we see nothing that would alert a reasonable person to the transfers' recoverability. See

Nordic Vill., 915 F.2d at 1055.

FN3. Generally, of course, the corporate

check would be made out to the individual,

who may then deposit it. But Merrill

Lynch's failure to require that here-where

the corporation's sole signatory authority

was also the individual presenting the

check, and the deposit was into an account

jointly owned by the corporation's only

two officers and directors-does not demonstrate its “knowledge of the voidability of

the transfer avoided.”

b. Sasson's Testimony

**5 Alan Sasson's testimony belies First Independence's assertion that Merrill Lynch knew of the

transfers' voidability. The testimony confirms that

Sasson knew the Baumhafts deposited funds from

First Independence's accounts, but the same testimony also demonstrates his ignorance of any impropriety. He testified that he considered First Independence's funds and the Baumhafts' funds to be essentially one and the same; he thus did not look

askance at their transferring funds between the

business and personal accounts.

In this case, Merrill Lynch and its agents did

not know “facts that would lead a reasonable person to believe that the property transferred was recoverable,” Nordic Vill., 915 F.2d at 1055

(quotation omitted), and any inquiry that it conducted into whether First Independence actually authorized the transfers would have been patently futile. The bankruptcy court did not clearly err in concluding that Merrill Lynch acted without knowledge of the transfers' voidability.

C. Claims Under Michigan's Fraudulent Transfer

Act

Section 544 of the Bankruptcy code permits a

debtor-in-possession to step into the shoes of cerPage 6

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tain creditors in order to avoid transfers that creditors could avoid under laws outside of the Bankruptcy Code. See 11 U.S.C. § 544. The bankruptcy

court concluded that First Independence's transfers

to the Baumhafts were fraudulent under Michigan's

version of the Uniform Fraudulent Transfer Act,

see Mich. Comp. L. § 566.34, and found that First

Independence, as the debtor-in-possession, could

avoid the transfers under § 544 of the Bankruptcy

Code. But even though voidability under § 544 may

be premised on state law, recovery of transfers

avoided under this section, like recovery of transfers avoided under § 548, hinges on § 550 of the

Bankruptcy Code rather than on state law. See 11

U.S.C. § 550(a). Thus the bankruptcy court's findings that Merrill Lynch took the transfers in good

faith, for value, and without knowledge of voidability bar recovery for the transfers avoided under §

544. Because First Independence invoked § 544 of

the Bankruptcy Code in seeking to avoid the transfers under Michigan's Fraudulent Transfer Act and

because § 550 of the Bankruptcy Code governs recovery of those avoided transfers, we find irrelevant First Independence's arguments regarding its

ability to recover under Michigan's Fraudulent

Transfer Act.

*531 III

Because the bankruptcy court did not clearly

err in determining that Merrill Lynch took the

transfers for value, in good faith, and without

knowledge of their voidability, and because First

Independence asserts no valid basis for rescission,

we affirm the judgment of the district court.

C.A.6 (Mich.),2006.

In re First Independence Capital Corp.

181 Fed.Appx. 524, 2006 WL 1342789 (C.A.6

(Mich.)), 2006 Fed.App. 0348N

END OF DOCUMENT

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