Judge Gross (Bankr. D. Del.) Grants Insider’s Motion to Dismiss Chapter 7 Trustee’s Claims to Avoid Prepetition Setoffs

In Judge Gross’s Miller v. D&M Holdings US Inc. (In re Digital Networks N.A. Inc.) opinion, the Court granted Defendant’s 12(b)(6) motion to dismiss Plaintiff-Trustee’s attempt to avoid prepetition setoffs which accrued to Defendant, yet denied the Motion as it pertained to other non-setoff transfers.  Notable in this case is the fact that Defendant is the Debtor’s parent company, thus rendering the transfers subject to the one-year lookback period attributable to insiders.

Background and Holding

The complaint sought avoidance of three buckets of transfers (note: little detail on the transfers is provided in the opinion): (i) Prepetition Setoffs; (ii) Payroll Transfers; and (iii) Expense Transfers.  With respect to the Prepetition Setoffs, Defendant argued that a setoff governed by section 553 is not avoidable under section 547, while Plaintiff relied upon Pardo v. Pacificare of Texas, Inc. (In re AFP Co.), 264 B.R. 344 (Bankr. D. Del. 2001) in countering that setoffs can still be avoidable if they are found to be invalid or otherwise unavailable in bankruptcy.  The Pardo court found that section 553(a) recognized setoffs where (i) the creditor holds a prepetition claim against the debtor; (ii) the creditor owes a prepetition debt to the debtor; (iii) the claim and debt are mutual; and (iv) the claim and debt are both valid and enforceable.  That opinion further noted that section 553(b) protects an otherwise preferential setoff excluding any insufficiency.

In the present case, Judge Gross found that Plaintiff, despite correctly citing the 553/547 dynamic (i.e. that a setoff can be avoided if it is invalid or otherwise impermissible), failed to actually show there was anything impermissible about the Prepetition Setoffs.  The Court found that if Plaintiff had any claim to avoid the Prepetition Setoffs, then his claim should have been brought under section 553, not section 547; yet Plaintiff asserted no counts under section 553.  As such, the count attacking the Prepetition Setoffs under section 547 was dismissed without prejudice.

The Court denied Defendant’s motion to dismiss the Payroll Transfers, which motion was grounded in the fact that the complaint provided little insight as to the Payroll Transfers’ purpose, scope, or mechanics.  Plaintiff replied, and the Court agreed, that the Debtors’ amended schedules of assets and liabilities and statement of financial affairs indicate the transfers were for “payroll,” thereby addressing the only potential deficiency the Court noted—section 547(b)(2) (transfer must be made for or on account of an antecedent debt).

Lastly, the Court found that Plaintiff adequately plead the components of avoiding the “Expense Transfer,” which purportedly was made by the Debtor to its “tax-affiliated” group in order to pay Debtor’s share of its federal corporate tax expense.  In finding that the allegations were sufficient, the Court made the finding that, with respect to Defendant’s opposition to Plaintiff’s assertion of insolvency at the time of the transfers, it had “no issue with inferring insolvency beyond 90 days on the basis of the Debtor’s financials upon the Petition Date.”  The presumption of insolvency under 547(g), of course, is only applicable to the ninety (90) days prior to the petition date.

Conclusion

The opinion provides guidance for both plaintiffs and defendants alike where prepetition setoffs are at issue in a preference complaint; quite simply, such complaints must address setoff insufficiency under 553.  The opinion likewise provides an interesting finding regarding insolvency, which Judge Gross—albeit briefly and without elaboration—held that he had “no issue” inferring insolvency beyond 90 days on the basis of the Debtor’s financials upon the Petition Date.  It will be interesting to see if this “inference of insolvency beyond 90 days” based upon the Debtor’s petition date financials will find any application beyond the facts and procedural posture of the instant case.

A copy of the Opinion can be found here.

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