Tese-Milner v. Capstone Credit, LLC (In re Level 8 Apparel, LLC)

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In re: LEVEL 8 APPAREL, LLC, Debtor.

ANGELA TESE-MILNER, as Trustee of the Estate of Level 8 Apparel, LLC, Debtor, Plaintiff, v. CAPSTONE CREDIT, LLC and CAPSTONE CAPITAL GROUP, LLC, Defendants.

No. 16-13164 (JLG)

Adv. Pro. No. 20-1208 (JLG)

United States Bankruptcy Court, S.D. New York

July 11, 2024

Not For Publication

Chapter 7

APPEARANCES:

LAW OFFICE OF WILLIAM F. MACREERY William F. Macreery -and-The Law Firm of Tese & Milner Angela Tese-Milner Counsel for the Plaintiff-Trustee KLESTADT WINTERS JURELLER SOUTHARD & STEVENS, LLP By Tracy L. Klestadt By: Andrew C. Brown Counsel for Defendants Capstone Credit, LLC and Capstone Capital Group, LLC

MEMORANDUM DECISION ON PLAINTIFF'S AND DEFENDANTS' MOTIONS FOR PARTIAL SUMMARY JUDGMENT

HONORABLE JAMES L. GARRITY, JR. UNITED STATES BANKRUPTCY JUDGE

Introduction^[1]

As of the Petition Date, Capstone Capital Group LLC ("Capstone Capital" or "Capstone") was party to a Sales Representative Agreement with Level 8 Apparel LLC (the "Debtor" or "Level 8") dated as of October 29, 2015 (the "Sales Representative Agreement" or "SRA"), and to certain agreements (defined below as the "Costco Agreements") with Costco Wholesale Group and its affiliates (collectively, "Costco") to produce outerwear for Costco. After the Petition Date, the Debtor transferred accounts receivable generated under the Costco Agreements totaling approximately $51 million (i.e., the Accounts Receivable, as defined below) to Capstone Capital.

Angela Tese-Milner is the chapter 7 trustee (the "Trustee") of the Debtor's estate in this converted chapter 11 case. On August 19, 2020, the Trustee commenced this adversary proceeding (the "2020 Adversary Proceeding"). The Trustee's complaint (the "Complaint")^[2] contains five claims to relief (each, a "Claim") against one or both of Capstone Capital and Capstone Credit, LLC ("Capstone Credit," and together with Capstone Capital, the "Capstone Defendants," and together with the Trustee, the "Parties"). Generally, the Trustee seeks to avoid the transfers of the Accounts Receivable to the Capstone Defendants, as illegal, unauthorized, and fraudulent post-petition transfers and misappropriations of estate property, and to compel the Capstone Defendants to turn over and pay to the Trustee $51 million or such amount that was collected by them on account of the Accounts Receivable. She also seeks a money judgment against the Capstone Defendants, jointly and severally, in the sum of $51 million for the conversion of the Debtor's property and for aiding and abetting the conversion of the Debtor's property.

This is the second of two adversary proceedings that the Trustee has brought against the Capstone Defendants. In the 2019 Adversary Proceeding,^[3] the Trustee sued the Capstone Defendants and others to avoid alleged fraudulent transfers of or impose constructive trusts on, property of the Debtor, and to "avoid preferential and fraudulent transfers of, and/or impose constructive trusts on, property of the Debtor, and to impose joint and several liability on some of the Defendants for all of the Debtor's obligations." 2019 Amended Complaint at 2.^[4]

The matters before the Court are competing motions for summary judgment in the 2020 Adversary Proceeding (the "Motions," and each the "Trustee's Motion" and "Capstone Defendants' Motion," respectively). The Parties requested leave to file the Motions pursuant to their joint letter to the Court (the "Joint Letter").^[5] The letter includes a single statement of the following three issues (the "Issues") they ask the Court to consider in resolving the Motions:

The "First Issue": "Was the SRA, along with the related agreements executed in connection therewith, a form a [sic] financing agreement between the Debtor and the Capstone Defendants that had to be perfected under Article 9 of the New York Uniform Commercial Code ("UCC"), or rather, did the SRA form that of a service relationship between the Debtor and the Capstone Defendants, whereby the Debtor acted on the Capstone Defendants' behalf?"

The "Second Issue": "Did the terms of the SRA and the related agreements provide the Debtor with an interest in the goods produced and accounts receivable generated under the SRA, or rather, were all goods produced and accounts receivable generated under the SRA at all times the sole property of the Capstone Defendants?"

The "Third Issue": "Alternatively, is the SRA an agreement for the absolute sale and assignment of contract rights and accounts receivable created in the future by the Debtor, subject to the provisions of Article 9 of the UCC?"

Joint Letter at 2. The Parties agreed that the Motions would be filed in the 2020 Adversary Proceeding, but that the Court's decision on the Issues will be applied to the claims in the 2020 Adversary Proceeding and the 2019 Adversary Proceeding (collectively, the "Adversary Proceedings"), as follows:

(i) Claims One, Eighteen, and Twenty-Two in the 2019 Adversary Proceeding, and

(ii) Claims One through Five in the 2020 Adversary Proceeding.

See Joint Letter at 2. The Court endorsed the Parties' requests in the Joint Letter.^[6]

In filing the Motions, the Capstone Defendants and the Trustee submitted identical Joint Statements of Undisputed and Disputed Material Facts.^[7] In support of the Trustee's Motion, the Trustee filed (i) a memorandum of law (the "Trustee Memo."),^[8] the affirmation of her counsel, William Macreery (the "Macreery Affirmation"),^[9] and a reply memorandum of law in support of her motion (the "Trustee Reply Memo.").^[10] She also submitted the Expert Report of Ronald G. Quintero, CPA, CFA, CFE, CIRA, CMA, CTP, prepared by Ronald G. Quintero (the "Quintero Report").^[11] In support of the Capstone Defendants' Motion, the Capstone Defendants filed a memorandum of law in support of their motion (the "Capstone Memo."),^[12] the declaration of Joseph F. Ingrassia (the "Ingrassia Declaration" or "Ingrassia Decl."),^[13] and a memorandum of law in response to the Trustee Memo. (the "Capstone Opposition Memo.").^[14] The Court heard argument on the Motions.

There are only two sets of agreements relevant to the Motions: the Costco Agreements and the SRA. The Accounts Receivable were generated under the Costco Agreements, and those agreements unambiguously give Capstone Capital, rather than the Debtor, the right to the Accounts Receivable. The SRA does nothing to effect a transfer of those Accounts Receivable to the Debtor, but instead, confirms that those Accounts Receivable belong to Capstone Capital. The contrary premise upon which the Trustee's claims against the Capstone Defendants in the Adversary Proceedings generally rely is that the Accounts Receivable belong to the Debtor because they are property of the Debtor's estate under section 541 of the Bankruptcy Code. In the Trustee's view, under the SRA, the Capstone Defendants are general unsecured creditors of the Debtor with no interest in the Accounts Receivable.

The Trustee's argument fundamentally hinges on some theory that would allow the Court to consider the Accounts Receivable as though they belonged to the Debtor. The Trustee does not clearly explain what this theory is, but alludes to the principle that a court should elevate an agreement's form beyond its substance. She argues that the Court should credit the Debtor as the owner of the Accounts Receivable because the SRA allocates to the Debtor most of the risks attendant to the relationship between Capstone Capital and the Debtor. There is support for the Trustee's characterization of the SRA. However, the authorities that she cites in support of that principle are distinguishable and have no application here.

The Trustee is attempting to recover on account of a deal that, with the benefit of hindsight, purportedly takes from the Debtor assets that it would have had under a conventional financing agreement. Though the Trustee finds herself in an unenviable position-that is the not the agreement the Debtor entered. The Court can neither rewrite the terms of the Costco Agreements nor of the SRA. For that reason, and as explained fully below, the Court finds that the Accounts Receivable are not property of the estate under section 541 of the Bankruptcy Code.

The Court awards the Capstone Defendants summary judgment dismissing Claims Two through Five, and 2019 Claim One. The Court denies the Trustee summary judgment on those claims. The Court denies the Motions to the extent they seek relief on Claim One and 2019 Claims Eighteen and Twenty-Two.

Jurisdiction

This Court has jurisdiction over the Motions pursuant to 28 U.S.C. §§ 1334(b) and 157(a) and the Amended Standing Order of Referral of Cases to Bankruptcy Judges of the United States District Court for the Southern District of New York (M-431), dated January 31, 2012 (Preska, C.J.). This is a core proceeding pursuant to 28 U.S.C. § 157(b)(2).

Procedural History

The Chapter 11 Cases

On November 14, 2016 (the "Petition Date"), the Debtor commenced a voluntary case under chapter 11 of the Bankruptcy Code (the "Chapter 11 Case"). Pursuant to sections 1107(a) and 1108 of the Bankruptcy Code, the Debtor remained in possession and control of its business and assets as the debtor and debtor-in-possession until the Conversion Date.

The Chapter 7 Case

On August 22, 2018, on the motion of the United States Trustee, the Court converted the Chapter 11 Case (the "Conversion")^[15] to a case under chapter 7 of the Bankruptcy Code (the "Chapter 7 Case"). Angela Tese-Milner was appointed as the interim trustee for the Debtor's estate the following day,^[16] and became the permanent chapter 7 trustee at the first meeting of creditors held in the Chapter 7 Case following the Conversion.

The Proofs of Claim

On...