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Stern v. Marshall Does Not Bar Ruling on Motion to DismissFraudulent Conveyance

Kirschner v. Agoglia, et al. (In re Refco Inc., et al.), 2011 Bankr. LEXIS

4496 (Bankr. S.D.N.Y. Nov. 30, 2011)

In In re Refco Inc., the trustee for the litigation trust established pursuantto the confirmed chapter 11 plan of Refco, Inc. and its affiliated debtorscommenced an adversary proceeding to, among other things, avoid and recoveralleged fraudulent transfers to Memphis Holdings LLC (MH). The trustee allegedthat the transfer to MH was made when the debtors were insolvent and the debtorsdid not receive fair consideration for the transfer. The trustee sought to avoidthe transfer as a constructive fraudulent transfer pursuant to section 544(b) of theBankruptcy Code, which incorporates state fraudulent conveyance law (in thiscase, New York Debtor-Creditor Law). MH moved to dismiss the claimspursuant to Rule 7012 of the Federal Rules of Bankruptcy Procedure for failureto state a claim under which relief may be granted.

Prior to addressing the substantive claims at issue, the court analyzed theimpact of the Supreme Court’s decision in Stern v. Marshall, 131 S. Ct. 2594(2011) on its authority to rule on the case. In Stern, the Supreme Court ruledthat the bankruptcy court could not issue a final judgment with respect to acounterclaim to a proof of claim based upon state law tortious interference. TheRefco court observed that the Stern decision created a two-part inquiry todetermine whether the bankruptcy court could decide the current controversy:(i) whether the “core” fraudulent transfer claim “so resembles the state lawtortious interference counterclaim . . . at issue in Stern, as to preclude [the] Court’sability to issue a final judgment” and (ii) “if the Court lacks the constitutionalpower to issue a final judgment in this proceeding, does it have statutory or otherauthority to submit proposed findings of fact and conclusions of law to the districtcourt?”

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With respect to the first question, the courtanalyzed the bankruptcy court’s authority overfraudulent transfer claims from the 18th centurythrough the Stern decision. The court concluded thatadjudication of fraudulent transfer actions was“repeated[ly] and emphatic[ally]” found to fall withinthe authority of the bankruptcy court to ensure a“coordinated response overseen by one judge on behalfof a host of creditor-victims.”

With respect to the second question, the courtheld that even if it lacked authority to enter a finaljudgment, both Stern and applicable case law suggestthat where a bankruptcy court lacks authority to issuefinal judgment on a matter, such matter becomes “non-core” and the bankruptcy court may issue a report andrecommendation to the district court. In such event, abankruptcy court’s final order should be subsequentlydeemed a report and recommendation to the districtcourt.

In the end, the court dismissed the trustee’sclaims because it found that MH provided fairconsideration in respect of the transfer.

Commentary

While at least one court held that bankruptcycourts still have jurisdiction over fraudulentconveyance claims, practitioners should be preparedto address jurisdictional questions reverberating fromStern v. Marshall until the Supreme Court providesfurther clarification.

Tracing Required to Prove Funds Were Not“Property of the Estate” Subject to

AvoidanceStoebener v. Consumers Energy Company, et al. (Inre LGI Energy Solutions, Inc., et al.), 2011 Bankr.

LEXIS 4728 (Dec. 8, 2011)

In In re LGI Energy Solutions, Inc., the chapter7 bankruptcy trustee for LGI Energy, a provider ofutility-management and billing services to restaurantsand other customers, sought to avoid payments made

to several utility companies on the grounds that theywere preferential or fraudulent transfers. Undersections 547 and 548 of the Bankruptcy Code, a trusteemay recover a transfer of the debtor’s property aseither a preference or a fraudulent conveyance ifcertain conditions are met.

The utility companies argued that because thedebtor held its customers’ money in trust for thespecific purpose of paying the utility companies on thecustomers’ behalf, the funds in question were not“property of the estate.” Thus, the defendants arguedthat the transfers could not be avoided as eitherpreferential or fraudulent transfers.

The bankruptcy court entered summaryjudgment in favor of the utility companies, finding thatthe funds at issue were not property of the debtor’sestate. The trustee appealed.

On appeal, the trustee argued that although LGIwas required to use the funds only to pay the utilitycompanies on behalf of its customers, LGI failed tosegregate the funds as required under the respectiveagreements with LGI’s customers and commingledmonies designated for the defendants with otherincome from operations. Thus, the trustee argued thatthe funds in question were indeed property of theestate.

The Bankruptcy Appellate Panel reversed thebankruptcy court’s orders granting summary judgment.The Bankruptcy Appellate Panel noted that underBankruptcy Code section 547, the trustee may onlyavoid a transfer of “an interest of the debtor inproperty.” The BAP noted that the term “interest ofthe debtor in property” is not defined in the BankruptcyCode but is understood to encompass “that propertythat would have been part of the estate had it not beentransferred before the commencement of bankruptcyproceedings.” The BAP then turned to an analysis ofthe contractual trusts at issue and distinguished thefunds held in LGI Energy’s account pursuant to thecontractual trusts from funds subject to a statutorytrust, such as trust fund taxes. The BAP found that in

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the case of a contractual trust (as opposed to a statutorytrust), the party asserting that the funds were in a trustbears the burden of tracing the funds in question. Inother words, such party must demonstrate that theoriginal funds placed in trust remain, or show exactlyhow and where the funds were allocated. The BAPnoted that the defendants did not demonstrate that thedebtor honored the trust relationship created under thecontracts with its customers because they did not traceor track the funds to the customers. Thus, the BAPruled that summary judgment was improper and thematter was remanded to the bankruptcy court forfurther proceedings.

Commentary

While transfers of money held in trust mayindeed be excluded from “property of the estate,” andtherefore immune from avoidance actions,practitioners should be aware of the heightened burdenof proving the parties adhered to a contractual trustrelationship by tracing the funds to trust funds.

Kiwi Defense Is Alive and Well in DelawareGuiliano v. Almond Inv. Co. (In re Carolina Fluid

Handling Intermediate Holding Corp.), 2012

Bankr. LEXIS 1092 (Bankr. D. Del. 2012)

In Carolina Fluid Handling, the chapter 7trustee commenced an adversary proceeding againstAlmond Products, Inc. (Almond) to recover allegedpreferential payments made by the debtors undersection 547 of the Bankruptcy Code. Almond filed amotion for summary judgment asserting that thealleged preferential transfers were not avoidablebecause they were paid pursuant to an executorycontract that was assumed and assigned by the debtorsas set forth in a list of assumed contracts attached to anasset purchase agreement for the sale of the debtors’assets.

The trustee responded that summary judgmentwas inappropriate because the contract at issue was notactually assumed. The trustee asserted that (i) the

debtors did not actually amend the notice ofassumption and assignment despite agreeing to do so,(ii) the contract at issue was merely referred to as anassumed contract in a notice that was served on the eveof the sale hearing rather than pursuant to theprocedures established by the court in connection withthe bidding process, (iii) the contract was not anexecutory contract and, therefore, it could not beassumed and assigned, and (iv) Almond fullyperformed on the non-executory contract by deliveringgoods to the debtors.

At the outset, the court examined the applicablelaw governing recovery of payments made pursuant toan executory contract which is assumed by a debtor inthe course of the bankruptcy proceeding. UnderKimmelman v. Port Authority of New York and New

Jersey (In re Kiwi International Air Lines, Inc.), 344F.3d 311 (3d Cir. 2003), if the payment was madepursuant to the terms of a contract that was assumed,the trustee cannot satisfy section 547(b)(5) of theBankruptcy Code, which requires that the defendantreceive more than it would have received in a chapter7 liquidation because a party to an assumed contractwould have received a cure payment resulting in a fullrecovery on its claim. Turning to the issue of whetherthe supply agreement between Almond and the debtorswas indeed executory and assumed and assigned, thecourt found that while Almond was not on the initiallist of contracts to be assumed, (i) it was specificallylisted in a notice, (ii) the agreement governing therelationship with Almond was specifically attached tothe sale order, and (iii) Almond was listed in the list ofcontracts to be assumed and assigned included in theamendments to the asset purchase agreement. Thecourt also noted that an initial list of contracts to beassumed and assigned always remains subject tochange until the court actually approves the sale order.In addition, the court concluded that the contract wasan executory contract because both parties wereobligated to perform under the agreement – Almondhad to supply parts to the debtors and the debtors hadto pay for the parts at a specified rate through a datecertain. Furthermore, the court found that the trusteewas estopped from arguing that the contract was not

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executory because the debtors already assumed theagreement and benefited from the court’s approval ofthe assumption.

Thus, the court concluded that the supplyagreement was an executory contract that was assumedby the debtors and assigned to the purchasers andgranted Almond’s motion for summary judgment.

Commentary

Plaintiffs commencing preference actionsshould carefully examine whether a potentialdefendant was party to executory contracts or leaseswith the debtor, and whether such executory contractsor leases were assumed in the course of the bankruptcyproceeding. Practitioners representing counterpartiesto a contract that the debtor intends to assume shouldensure that it is clear that the contract is assumedpursuant to an order to protect the counterparty frompotential preference liability.

Bankruptcy Court Chooses Historical “Daysto Payment Range” Over “Average Days to

Payment” To Determine the Ordinary Courseof Business Range

PN Chapter 11 Estate Liquidating Trust v. InsertsEast, Inc. (In re Philadelphia Newspapers, LLC),2012 Bankr. LEXIS 1216 (Bankr. E.D. Pa. Mar.

22, 2012)

In Philadelphia Newspapers, the trustee for theliquidation trust established pursuant to the debtors’confirmed chapter 11 plan commenced an adversaryproceeding against Inserts East, Inc. (Inserts) torecover alleged preferential payments under section547 of the Bankruptcy Code. The trustee soughtsummary judgment in the amount of $65,655.26,representing the recoverable amount after accountingfor certain statutory defenses.

Bankruptcy Code section 547 allows a trusteeor debtor in possession to avoid a transfer made by adebtor while insolvent to or for the benefit of a creditoron account of an antecedent debt within 90 days (orone year in the case of an “insider”) of the petitiondate, where such transfer enables the creditor toreceive more than it would have received in a chapter7 liquidation.

Bankruptcy Code section 547(c)(2) providesthat the trustee may not avoid a transfer: to the extentthat such transfer was in payment of a debt incurredby the debtor in the ordinary course of business orfinancial affairs of the debtor and the transferee, andsuch transfer was — (A) made in the ordinary courseof business or financial affairs of the debtor and thetransferee; or (B) made according to ordinary businessterms.

The debtors and Inserts had a businessrelationship dating back to at least February, 2003.During that time, the debtors paid 93 of Inserts’invoices within 7 to 112 days after the date of theinvoice. The debtors paid approximately 80% of suchinvoices between 30 to 70 days from the invoice date.The average payment time was 50 days from invoicedate.

The trustee filed a motion for partial summaryjudgment against Inserts in the amount of $65,655.26,submitting that payments other than those madebetween 40 and 60 days from the invoice date were notprotected by the ordinary course of business defenseand therefore, are avoidable. The trustee computedthis ordinary course range by allowing a 10-dayvariance from the historical average payment time of50 days.

Inserts opposed the trustee’s summaryjudgment motion and argued that invoices paid within30 to 70 days from invoice date were paid in theordinary course of business. Inserts reasoned thathistorically, the debtors paid approximately 80% ofInserts’ invoices between 30 to 70 days from theinvoice date.

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The court ruled that the appropriate ordinarycourse of business range was 30 to 70 days, not 40 to60 days, because historically the debtors paidapproximately 80% of Inserts’ invoices within thatrange. The court stated that using the historical averagedays to payment in this instance was inappropriatebecause in the “historical period,” the debtors paidonly 33% of Inserts’ invoices between 40 to 60 daysfrom invoice date. Accordingly, the court held thatrelying solely on the historical average days topayment did not properly reflect the parties’ historicalordinary course of dealings. Thus, the court grantedthe trustee summary judgment but reduced the amount

to $37,082.37, representing payments made before 30days and after 70 days from the invoice date.

Commentary

Practitioners prosecuting or defendingpreference actions should be mindful that while somecourts rely on the average historical days to payment todetermine the ordinary course of business range, whenthe historical average only represents a smallpercentage of invoices paid in the historical period,courts will not rely on the average and will instead lookat the “days to payment range” of historical payments.

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