Tag Archives: Bankruptcy Court for the District of Delaware

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.

Advertisements

Judge Walrath (Bankr. D. Del.) Denies Motion to Transfer Venue of Preference Action Notwithstanding Defendant’s Forum Selection Clause

In Judge Walrath’s RCS Creditor Trust v. Schulte Roth & Zabel LLP (In re RCS Capital Corp.) opinion, the Court found that the presence of a forum selection clause (“FSC”) was not enough to trump the bankruptcy court’s ability to maintain venue for an avoidance action.  In so finding, the judge agreed with the Trustee-Plaintiff’s argument that the Debtors’ creditors were the ultimate parties-in-interest in the action, and thus were not bound by any FSC between the Debtors and Defendant (the Debtors and Defendant hereafter the “Parties”).  On that and other bases, the Court denied Defendant’s motion to transfer venue (the “Motion”) to the Southern District of New York (“SDNY,” the venue required by the FSC) under 28 U.S.C. § 1412 and Fed. R. Bankr. P. 7087.

Background and the Twelve Factor Jumara Test

Plaintiff sought to recover approximately $580,000 pursuant to 11 U.S.C. §§ 547 and 548(a)(1)(B).  Defendant, a law firm, responded by filing the Motion.

Courts in the Third Circuit consider a variety of factors in deciding whether to grant a motion to transfer venue, including:

(1) plaintiff’s choice of forum,

(2) defendant’s forum preference;

(3) whether the claim arose elsewhere,

(4) location of books and records,

(5) convenience of the parties based upon their relative physical and financial condition,

(6) convenience of the witnesses

(7) enforceability of the judgment,

(8) practical considerations that would make the trial easy, expeditious, or inexpensive,

(9) congestion of the courts’ dockets,

(10) public policies of the fora,

(11) familiarity of the judge with the applicable state law, and

(12) local interest in deciding local controversies at home.

 

See Jumara v. State Farm Ins. Co., 55 F.3d 873 (3d Cir. 1995) (the “Jumara Factors”).  The Court found only three Jumara Factors (2, 3, and 6) weighed in Defendant’s favor here, as briefly summarized in the chart below.

 

Factor Arguments Ruling
1

(P)

D: deference to a plaintiff’s choice of forum is lessened when suing in a representative capacity. The rationale for less deference to a representative plaintiff is inapplicable to a bankruptcy trustee.
2

(D)

D: prefers SDNY. True, but D’s preference given less weight than P’s.
3

(D/P)

D: all facts occurred in the SDNY.  Also, the Parties’ engagement letter (the “Agreement”) included the FSC, requiring resolution in the SDNY.

 

P: avoidance actions arise by statute and are separate from an underlying contract. Also, the Debtors’ creditors are the parties-in-interest in an avoidance action, and thus are not bound by the Parties’ FSC.

Performance of the legal services is not at issue, although payments made in SDNY militates towards transfer.

 

Regarding the FSC, the Court agreed with Plaintiff’s argument (derived from AstroPower Liquidating Trust v. Xantrex Tech. Inc. (In re AstroPower Liquidating Trust), 335 B.R. 309 (Bankr. D. Del. 2005) and Charys Liquidating Trust v. McMahan Sec. Co., L.P., (Charys Holding Co., Inc.), 443 B.R. 628 (Bankr. D. Del. 2010)).

4

(N)

D: Books and records are all in SDNY. Discovery in this case will be largely electronic.
5

(P)

D: D is based in NYC, plus P’s counsel has a NYC office as well.

 

P: D often travels to Delaware for other cases.

While transfer would be more convenient for D, pursuing actions in multiple fora creates temporal and financial burdens on P.  Also, Delaware is nearby, D often appears in Delaware, and Delaware counsel has already been retained by P.
6

(P)

D: all witnesses are in the SDNY, beyond the Court’s subpoena power.

 

P: avoidance actions rarely go to trial, are typically short.

No indication that any witness won’t voluntarily appear.
7

(N)

Judgments in either court are entitled to full faith and credit.
8

(P)

P: keeping the avoidance action in the same venue as the main case is more economical due to the Court’s familiarity with the case and the other, similar actions taking place. Agreed with P.
9

(P)

This case does not overburden the Court.
10

(P)

P: transferring this case creates a slippery slope. Agreed with P, as P is pursuing multiple avoidance actions, and transfer of one could result in transferring hundreds of others.
11

(N)

No state law issues.
12

(P)

Purely federal bankruptcy issues predominate here, offsetting any potential interest the SDNY may have.

 

In sum, the Court found Defendant had not carried its burden to show that transfer was appropriate by a preponderance of the evidence.

Conclusion

The presence of the FSC in this case provides an interesting wrinkle, especially since the Jumara case itself instructs a court to “place considerable weight on the parties’ original choice of forum, as expressed in a contractual forum selection clause.” Jumara, 55 F.3d at 882.  The Jumara case, however, was a non-bankruptcy case brought under state law by insureds against an insurer.  Given that the instant case was (i) rooted in federal bankruptcy law, not the performance of the Agreement, and (ii) brought for the benefit of parties-in-interest who were not parties to the Agreement, the Court distinguished the FSC’s relevance here.  The extent to which this rationale could be used in the context of other types of clauses or agreements remains to be seen.  In addition, one wonders if the Court would find the “slippery slope” concerns of Factor 10 to be mitigated were the instant case the only one filed, and not one of “multiple actions” filed instead.

A copy of the Opinion can be found here.

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..

Defining Ordinary: Judge Walrath (Bankr. D. Del.) Surveys Ordinary Course of Business Methodologies in In re Powerwave Technologies

By Evan T. Miller, Esq.

Determining the proper bookends when establishing a Historical Period for an ordinary course of business defense (“OCOB”) can be highly contentious in preference litigation.  The same can be said for determining which methodology is most appropriate for analyzing preference period transfers and even when to apply a given defense. Continue reading

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

Seventh Circuit Reverses Bankruptcy and District Courts in Delineating the Ordinary Course of Business’s Baseline of Dealings Requirement  in In re Sparrer Sausage Co.

By Evan T. Miller, Esq.

The United States Court of Appeals for the Seventh Circuit (the “Seventh Circuit”) recently reversed a Bankruptcy Court ruling and District Court affirmation (both in the Northern District of Illinois, and collectively, the “Lower Courts”) that had given only partial credit to a preference defendant’s section 547(c)(2)(A) ordinary course of business defense. Continue reading

Revised on Remand: Judge Walrath Reduces Defendant’s New Value Defense and Awards the Trustee Prejudgment Interest in Remanded Proceeding

By Gregory J. Flasser, Esq.

On March 29, 2016, Judge Mary F. Walrath of the United States Bankruptcy Court for the District of Delaware (the “Court”) issued an opinion reducing the new value defense of Prudential Real Estate and Relocation Services, Inc., and Prudential Relocation, Inc. (collectively, “Prudential”) and awarding the chapter 7 trustee (the “Trustee”) prejudgment interest in Prudential Real Estate v. Burtch (In re AE Liquidation, Inc.), Adv. Proc. No. 10-55543 (MFW), 2016 WL 1238848 (Bankr. D. Del. Mar. 29, 2016). Continue reading