Category Archives: Setoff (11 U.S.C. § 553)

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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Delaware Bankruptcy Judge Addresses Issue of First Impression Regarding Section 547(b)(5): Must a Preference Defendant Be Secured on the Transfer Date or the Petition Date?

By Evan T. Miller, Esq.

In Stanziale v. Sprint Corp. (In re Simplexity, LLC), 578 B.R. 255 (Bankr. D. Del. 2017), Delaware Bankruptcy Judge Kevin Gross addressed an issue of first impression: which was the proper date for determining the secured status of a creditor in a preference dispute under 11 U.S.C. § 547(b)(5), the petition date or the transfer date?  Ultimately, Judge Gross decided that the petition date was most proper, at least with respect to creditors secured by a purchase money security interest (“PMSI”).  Nevertheless, this aspect of the analysis under section 547(b)(5) remains highly fact-specific.

Background

The Debtors, formerly independent online activators of mobile phones, filed for bankruptcy protection under Chapter 11 on March 16, 2014.  Prior to that time, the Debtors and Defendant were parties to an agreement that let the Debtors solicit and subscribe customers to Defendant; to that end, the Debtors could either purchase products from Defendant and resell them to customers, or sell products directly from Defendant’s inventory.  Defendant received a PMSI in products the Debtors purchased on credit and proceeds from the sale of such products.  Following conversion to Chapter 7, the Chapter 7 Trustee (the “Trustee”) initiated the instant adversary proceeding to recover these payments to Defendant; the parties’ motions for summary judgment ultimately followed, raising section 547(b)(5) and subsequent new value arguments.

Must a preference defendant be secured on the transfer date or the petition date for section 547(b)(5) purposes?

In light of the PMSI, Defendant argued that the Trustee could not satisfy his burden under section 547(b)(5)’s hypothetical liquidation test.  The Trustee first countered that the burden was not on him to do so in this instance; rather, Defendant had to prove it was truly secured given its reliance upon state law.  The Court rejected this reasoning based upon the plain language of section 547(g) (placing the burden on the Trustee to establish the elements under section 547(b)).

The Court next addressed the issue of first impression referenced above and incidentally, one that had created a split among courts which had considered it—is secured status assessed at the time of the transfer or the petition date?  Defendant argued that it was entirely secured, notwithstanding that the Debtors kept their funds in commingled accounts which were swept only a few days prepetition.  Further, Defendant argued that a Supreme Court decision which had determined the petition date to be the proper date of reference (Palmer Clay Products Co. v. Brown, 297 U.S. 227 (1936)) was misplaced in the context of a secured creditor, as that case had been dealing with an unsecured creditor.  Thus, with that in mind and in reliance upon a decision by Delaware Bankruptcy Judge Peter Walsh (Forman v. IPFS Corp. of the South (In re Alabama Aircraft Indus.), 2013 WL 6332688 (Bankr. D. Del. Dec. 5, 2013) (holding the transfer date to be the proper one for assessing preference liability of a creditor pursuant to an insurance premium financing agreement), Defendant argued that the transfer date controlled.

The Court disagreed, finding the fact-specific distinctions in Defendant’s “transfer date” cases and the instant case to be determinative; i.e., the Court distinguished between a PMSI case and cases dealing with premium financing arrangements or cases with liens of diminishing value.  This was so because a PMSI is a decidedly limited and better defined interest compared to a floating lien; moreover, the collateral at issue here (headsets and proceeds from selling the same) was unlikely to undergo stark changes in valuation.  Thus, while the Court envisioned a factual scenario that may warrant deviating from the petition date analysis, the instant case did not contain such facts.  The PMSI vs. floating lien distinction likewise underpinned the Court’s holding on the propriety of the Trustee’s tracing method—i.e., the “add-back” method, used for determining a defendant’s position on the petition date in a hypothetical liquidation.

Does an earlier-than-usual payment by a preference defendant to a debtor constitute subsequent new value?

The Court also ruled upon part of Defendant’s subsequent new value argument under section 547(c)(4).  Specifically, Defendant argued that a payment it made to the Debtors two days before the petition date qualified as subsequent new value, as it was commission money not yet owed to the Debtors under any of their agreements; ergo, it augmented the estate.  The Trustee opposed this defense on the grounds that it was a seemingly random payment made in Defendant’s capacity as a debtor, not a creditor, and that in any event, Defendant merely substituted one asset of the Debtor for another (i.e. an A/R for cash).  To the latter point, Defendant argued that the Trustee ignored the fact that Defendant would never have paid the A/R due to Defendant’s rights under various agreements and section 553 (setoff).

The Court agreed with Defendant, finding the issue centered around determining the purposes of Defendant’s payment.  To that end, Judge Gross found that the underlying agreements and the parties’ course of dealing demonstrated that Defendant’s commission payments to the Debtors were due at the end of the month, whereas the instant payment was made mid-month; as such, Defendant was not yet a debtor, nor were the Debtors creditors of Defendant.

Furthermore, the Court found that Defendant did not merely substitute Debtor’s A/R for cash.  For one thing, the commission payment was an (out of the ordinary) advance, not a regularly scheduled payment.  For another, the A/R would have been uncollectable for the reasons argued by Defendant.  At bottom, Judge Gross found Defendant’s commission payment personified section 547(c)(4)—a “beacon of light in a dark time” that decisively enhanced the Debtors’ estate.

Conclusion

The Court’s opinion in Simplexity sheds light on how the analysis under section 547(b)(5) changes where a creditor is secured.  Particularly, the Court makes clear that the type of security interest at play will likely impact the Court’s analysis.  In that sense, the Court seemingly harmonized its opinion here with earlier, seemingly conflicting decisions, including those from the same jurisdiction.  Perhaps the greater point, however, is that these analyses will remain highly contextual determinations.

The opinion also provides support for interesting subsequent new value arguments, and incidentally, strategic considerations for defendants dealing bilaterally (i.e., relationships where the defendant may be acting as both a creditor and a debtor at times) with companies on the verge of bankruptcy.  Specifically, making a payment earlier than contractually obligated can inure to Defendant’s benefit, as the advance potentially prevents the creation of an A/R—and concurrently may prevent the bankrupt company becoming a creditor of the defendant.  This argument becomes stronger if the defendant likewise maintains setoff rights, as Defendant did here.

A copy of the Opinion can be found here..

Can an Administrative Claim Be Used to Offset Preference Liability? Judge Carey (D. Del.) Addresses an Issue of First Impression in Quantum Foods

By Evan T. Miller, Esq.

Addressing an issue of first impression, Judge Kevin Carey (Bankr. D. Del.) ruled that a preference action defendant could use their allowed administrative expense claim as a setoff against any preferential transfer exposure. Continue reading

How Much Control Must a Bank Exert to be Considered an Initial Transferee Under 11 U.S.C. § 550? Can Substantive Consolidation be Applied Nunc Pro Tunc to Help ‘Create’ an Avoidance Action? Chief Judge Frank (Bankr. E.D. Pa.) Provides an Answer in In re Universal Marketing, Inc.

By Evan T. Miller, Esq.

Chief Judge Frank of the Bankruptcy Court for the Eastern District of Pennsylvania recently issued an opinion in Goldstein v. Wilmington Savings Fund Society (In re Universal Marketing, Inc.) that deals with certain issues not often seen in avoidance actions.  Specifically, the opinion touches upon the level of control or dominion that a bank must exercise over a disputed conveyance for purposes of determining whether it was an “initial transferee” under 11 U.S.C. § 550. Continue reading