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.

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..

D.C. Bankruptcy Court Finds Pillowtex Analysis Not Required for Retaining Section 327(e) Professional

By Evan T. Miller, Esq.

In a helpful reminder for professionals regarding the nuances of 11 U.S.C. § 327 and its intersection with preference law, the Bankruptcy Court for the District of Columbia recently overruled a creditor’s objection to a debtor’s application (the “Application”) to retain special counsel under section 327(e).  The objection, filed in In re Core Communications, Inc., Case No. 17-00258, was based in part upon the fact that the debtor and proposed counsel (the “Professional”) had not provided a “Pillowtex Analysis” in support of the Application – i.e., an analysis disclosing any debtor payments made to the Professional in the 90 days prior to the Petition Date (the “Preference Period”).  The creditor maintained this assertion, notwithstanding the fact that the Professional had waived any claims it had against the estate.

The Court rejected the creditor’s argument.  Judge S. Martin Teel began with a recitation of professional retention guidelines and jurisprudence, noting that “[a] court authorizing the retention of professionals under 11 U.S.C. § 327(a) must determine whether the professional is disinterested, including whether the professional is the recipient of a preferential transfer.” In re Core Commc’ns, Inc., 2017 WL 5151674, at *3 (Bankr. D.D.C. Nov. 5, 2017) (citing In re Pillowtex, Inc., 304 F.3d 246 (3d Cir. 2002)).  While the Application did not disclose whether the debtor made any payments to the Professional during the Preference Period, the Court found the Application was made pursuant to 11 U.S.C. § 327(e), and as such, “adverse interests that would disqualify an attorney from being retained under § 327(a) are distinguishable from adverse interests that would disqualify an attorney from being retained under § 327(e).” Id. (quoting Giuliano v. Young (In re RIH Acquisitions NJ, LLC), 551 B.R. 563, 569 (Bankr. D. N.J. 2016).  Under section 327(e), “the attorney being retained only needs to be disinterested with respect to the matter on which such attorney is to be employed.” Id. (internal quotations omitted).  As a result, there was no need to “disclose the existence of any preferences incident to the Application.Id.

A copy of the Opinion can be found here.

 

 

 

Are Customer Funds Held by Debtor Logistics Company Property of the Debtor’s Estate? Chief Judge Ferguson (D.N.J.) Addresses Multiple Avoidance Issues in TransVantage Solutions

  Chief Judge Ferguson (Bankr. D.N.J.) recently tackled some of these issues at the motion to dismiss stage in her opinion for Giuliano v. Delta Air Lines, Inc. (In re TransVantage Solutions, Inc.), Adv. No. 15-1882, 2016 WL 5854197 (Bankr. D.N.J. Oct. 6, 2016).  In denying the motion to dismiss (hereafter, the “Motion”), the Court provides a detailed analysis of the 547(b) preference elements that may prove influential as these cases arise in the future, notwithstanding the non-binding nature of the opinion.

Background

The TransVantage cases were initiated under Chapter 7 of the Bankruptcy Code on May 3, 2013 (“Petition Date”), following which Alfred Giuliano was appointed Chapter 7 Trustee (“Trustee”).  In April 2015, the Trustee filed hundreds of preference and fraudulent transfer complaints against various defendants.  Per one of the complaints (which may differ from defendant to defendant), the Debtors were

in the business of providing freight audit and payment services on behalf of its customers (the “Customers”) to help ensure that the auditing and payment of freight invoices were done accurately and timely. TransVantage Solutions would receive freight invoices from the Customers’ common carriers/shippers . . . and then audit and determine whether those invoices were accurate and in compliance with the Customers’ agreements with the carriers/shippers, tariffs and/or regulations.  TransVantage Solutions would then remit the funds received from the Customers to the applicable carriers/shippers. The transfers that are the subject of this Complaint are the transfers described in the preceding sentence that were received by the [Carrier].

Many defendants in the case settled, but ten did not (those ten hereafter referred to as the “Defendants”) and sought to go forward with the Motion.

The Preference Counts

The Defendants based their Motion upon, inter alia, an assertion that the Trustee failed to sufficiently plead the predicate elements of section 547(b) of the Bankruptcy Code.  These points are summarized as follows:

  1. “Interest of the debtor in property”

The Defendants first contended that because the Trustee referred to the funds advanced to the Debtors by the Customers as being held in trust, there could be no property of the estate involved.  The Court, however, would not dismiss the Complaint solely because of the Trustee’s use of the word “trust”; to contrary, the Court found the usage to be conclusory at best, as “[d]etermining whether something is a true trust for bankruptcy purposes is a legal determination for the court to make, it should not be done on a motion to dismiss.” The Court found this especially true considering the early stage of the proceedings, which warrants freely permitting amendment to cure pleading deficiencies.

Having dismissed the Defendants’ “trust” language argument, the Court found that the Debtors at least had a possessory interest in the funds in its own account, which account received the transferred funds from its Customers.

  1. “To or for the benefit of a creditor”

The Court next determined that payments made to the Carriers were for the benefit of the Customers who owed the freight bills.  Customers, in the Court’s view, met the definition of “creditors” under the Bankruptcy Code, as they would have had a claim against the Debtors by virtue of the Customers advancing funds to the Debtors for payment to the Carriers.

  1. “For or on account of an antecedent debt owed by the debtor”

One of the Defendants argued that the Trustee’s failure to allege an antecedent debt owed by the Debtors to the Defendant was dispositive because its business relationship was with the Debtors’ Customers, not the Debtors.  Nevertheless, the Court found that section 547(b)(2) “does not state that the antecedent debt must be owed by the debtor to the defendant, it merely states that it must be ‘owed by the debtor’”; as such, a payment to the Defendant would have been for the benefit of a Customer (a creditor).

  1. “Made while the debtor was insolvent”

The Court found this element met by virtue of the presumption of insolvency under section 547(f) as well as the allegation of a $40 million shortfall as of the Petition Date.

  1. “Made on or within 90 days before the date of the filing of the petition”

The Court found the Complaint clearly pled that pertinent transfers were made within 90 days of the Petition Date.

  1. “Transfer enabled the creditor to receive more than it would have in a Chapter 7 but for the transfer”

The Trustee argued that the Debtors’ liabilities exceeded their assets such that all of the Debtors’ unsecured creditors would not receive full payment – i.e., the Customers whose freight carriers received either full or partial payment made out much better than those Customers whose Carriers received no payment.  The Court appeared to find this allegation sufficient.

In light of the foregoing, the Court concluded the predicate preference elements were sufficiently pled to survive dismissal.  Interestingly, one of the Defendants also raised an ordinary course of business defense under section 547(c)(2), which the Court questioned both on procedural and substantive grounds.  To the latter, “[t]aking the factual allegations in the complaint as true . . . the payments were neither made in the ordinary course of business nor made according to ordinary business terms.”  Further, “the method of payment deviated from the ordinary course of business which was supposed to have been that the funds paid by the Customers were held specifically to pay the freight bills of that Customer and only that Customer.”

The Fraudulent Transfer Counts Under State and Federal Law

The Complaint also contains fraudulent transfer allegations under sections 544 (using New Jersey law) and 548.  The Defendants attacked these counts on multiple fronts, arguing that the Trustee failed to identify “an actual creditor holding an allowed unsecured claim who could avoid the challenged transfers.”  Nevertheless, the Court found that “[w]hen analyzing the sufficiency of a complaint for purposes of Rule 12(b)(6), courts do not generally require a trustee to plead the existence of an unsecured creditor by name, although the trustee must ultimately prove such a creditor exists.”

The Court next rejected the Defendants’ argument that the Complaint is deficient with respect to Federal Rule of Civil Procedure 9(b); the Defendants asserted that the Debtors’ intent to hinder, delay or defraud creditors did not meet the rule’s heightened pleading standards. The Court, however, found that Rule 9(b) permits fraudulent intent to be alleged generally.  As such, the Court found sufficient the Complaint’s allegations that the Debtors’ insiders “were not segregating the funds in the Freight Payment Plan Account, but instead using them to pay personal and business expenses, the complaint adequately pleads actual intent to hinder, delay or defraud.”

The Defendants also argued that the Complaint fails to allege a cause of action for constructive fraud under section 548(a)(1)(B) and N.J.S.A. 25:2-27 because the Debtors received reasonably equivalent value in exchange for each alleged transfer.  In other words, each transfer “was a ‘wash’ because each payment made to the Carriers reduced a corresponding liability owed to them by [the Debtors] (on behalf of the Customers) on a dollar for dollar basis.”  While not rejecting this contention, the Court found that it was inappropriate to find as much at the motion to dismiss stage, noting how highly fact-sensitive such a determination would be.

The Court likewise found that, despite the Defendants’ assertions to the contrary, the Complaint did sufficiently allege insolvency based upon statements that the Debtors’ debts were greater than their assets and that they could operate only in reliance upon new Customer funds.

Is the Bankruptcy Code Preempted by the Federal Aviation Administration Authorization Act?

The Defendants’ last argument relied upon the Federal Aviation Administration Authorization Act, which they averred should limit any remaining fraudulent transfer claims to 18 months prior to the bankruptcy filing.  The FAAAA is designed to preempt any law “related to a price, route or service of any motor carrier, … broker, or freight forwarder with respect to the transportation of property.”  Nevertheless, the Court rejected this argument for multiple reasons: (1) the Defendants cite no supporting case law in which the Bankruptcy Code or New Jersey’s fraudulent transfer statutes were preempted by the FAAAA; (2) the state law claims are derivative of the Trustee’s federal powers in any event, making it not a purely state law issue; and (3) two federal statutes should be harmonized instead of preempting one in favor of another.  To the last point, the Court found that the statutes could be so harmonized, as “the Bankruptcy Code’s goal of equality of distribution through allowing avoidance actions in no meaningful way interferes with the goal of increased competition in interstate transportation.”  Even if it did, however, the Court found that the FAAAA should yield to Bankruptcy Code, citing to a 1994 bankruptcy decision from the Northern District of California (In re Medicar Ambulance Co.).

Conclusion

It bears repeating that the Court has designated the instant opinion as “Not for Publication”.  Nevertheless, given the relative dearth of opinions in the logistics debtors space, parties representing any party in the affected trifecta (customer, debtor/trustee, carrier) should take note of this opinion.  The issues and questions in such cases are invariably quite similar – chief among them being the determination of the trifecta’s rights as to any alleged asset of the estate.

Moreover, it obviously remains to be seen what the final outcome will be in these cases once the parties have had an opportunity to flesh their arguments out with discovery.  Until then, this will be a docket to keep an eye on, barring settlement.

A copy of the Opinion can be found here.

Third Circuit Addresses Issue of First Impression in Finding the Payee Irrelevant for Purposes of Applying Section 547(c)(9)’s Aggregate Value Threshold in In re Net Pay Solutions, Inc.

  The Court rejected the Trustee’s argument as one that would render 11 U.S.C. § 547(c)(9) superfluous and ineffective.  The Court also rejected the Trustee’s argument with respect to the one remaining transfer that surpassed the Bankruptcy Code’s $5,850 preference action threshold*, finding the payment qualified as a “trust fund tax” that was not an interest of the debtor in property.  In the context of the latter ruling, the Court provides a detailed analysis of the Supreme Court’s Begier v. Commissioner, 496 U.S. 53 (1990) decision.

*since the time the adversary proceeding was initiated, the threshold has been increased to $6,225

The Bankruptcy and District Court Cases

Debtor’s business involved managing its clients’ (the “Clients”) payrolls and employment taxes. The arrangement authorized Debtor to transfer funds from Client bank accounts into Debtor’s account and to remit those funds to the Clients’ employees, the IRS, and other taxing authorities.  At issue in this case were five transfers (the “Transfers”) Debtor made to the IRS on behalf of the Clients in the ninety days leading up to August 2, 2011 (the “Petition Date”) – four of which were less than the $5,850 preference action threshold established by 11 U.S.C. § 547(c)(9).  The fifth transfer was for $32,297 (the “Remaining Transfer”).

The Trustee sought to avoid the Transfers on the basis that, in the aggregate, the Transfers exceeded $5,850, and thus, the threshold was not a barrier.  The District Court for the Middle District of Pennsylvania (“District Court”) disagreed, granting summary judgment to the IRS and finding the Transfers could only be aggregated if they are “transactionally related” to the same debt; in this case, the District Court found that the four sub-$5,850 Transfers were separate and unrelated transactions in satisfaction of independent antecedent debts to different creditors.  The Remaining Transfer was found to fall outside the bounds of “property of the estate”, as it was protected by the Internal Revenue Code (“IRC”) provision which creates a statutory trust in favor of the United States for taxes withheld from employee paychecks.  Trustee appealed.

The Trustee’s Arguments on Appeal

On appeal, the Trustee argued that the Bankruptcy Code allows the aggregation of transfers that individually fall below the threshold, as long as they were all to the same transferee, citing 11 U.S.C. § 102(7) for the concept that “the singular includes the plural” in interpreting 11 U.S.C. § 547(c)(9).  The Trustee further argued that section 547(c)(9) is internally contradictory, because the term “aggregate” implies a summation of various transfers, while the language “such transfer” implies the defense should be applied on a payment by payment basis.

As to the Remaining Transfer, the Trustee contended that Debtor was an intermediary that withheld and paid taxes on behalf of the Client, and that the “obvious meaning of the statute is that in order for a trust to be created, a person who is required to collect the tax must actually withhold the tax.”  Trustee argues that because the Clients, not Debtor itself, were required to withhold the taxes at issue, those withholdings escape the statute’s limitations.

The Third Circuit’s Opinion

The Threshold Dispute

The Court first noted that it had not yet had the opportunity to examine section 547(c)(9), which states that a “trustee may not avoid … a transfer … if, in a case filed by a debtor whose debts are not primarily consumer debts, the aggregate value of all property that constitutes or is affected by such transfer is less than $5,850*.”

*see note above regarding the revised threshold amount

As applied to the four sub-threshold Transfers, the Court found that Trustee’s argument made little sense.  It held that by Trustee’s logic, an individual creditor’s ability to invoke the minimum threshold as a defense “would depend not only upon whether the transfer from which it benefitted was less than $5,850, but also on whether the debtor had made any transfers (large or small) for the benefit of other creditors, and whether all transfers taken together exceed the statutory threshold . . . this cannot be the law.”  The Court found that the language of section 547(c)(9) requires a transfer by transfer analysis and that creditors be considered independently, meaning creditors who have received the benefit of a prepetition transfer less than the threshold may invoke the defense regardless of what other creditors have received.  The Court noted that “ostensibly distinct transfers may nevertheless be aggregated if they are, in effect, a single transfer on account of the same debt.”

As to Trustee’s reliance on the “singular includes the plural” maxim, the Court found that it “simply means that (1) a creditor may invoke the defense for multiple, independently qualifying transfers (i.e., it’s not a “one-and-done” defense) and (2) a party may defeat the defense where the challenged transfers are strategically divided yet transactionally related.”  Since each sub-threshold Transfer involved a different Client, unrelated antecedent debts, and distinct tax liabilities, they could not be aggregated to exceed the threshold.

The Property of the Estate Dispute

The Court next addressed whether the Remaining Transfer involved the transfer of an interest of the debtor in property, as required by 11 U.S.C. § 547(b).  It began this analysis by a thorough review of the Begier decision, which established the benchmark for trust fund taxes.  Importantly, that decision found that the trust was created at the moment the relevant taxes were withheld, and that “[w]ithholding … occurs at the time of payment to the employee of his net wages.”  Furthermore, no common law tracing was required in these trust fund cases, as the applicable IRC provision “creates a trust in an abstract ‘amount’—a dollar figure not tied to any particular assets—rather than in the actual dollars withheld.”  Ergo, “any voluntary prepetition payment of trust-fund taxes out of the debtor’s assets is not a transfer of the debtor’s property” and “the debtor’s act of voluntarily paying its trust-fund tax obligation … is alone sufficient to establish the required nexus between the ‘amount’ held in trust and the funds paid.”

Applying Begier to the instant case, the Court found that the fact that Debtor was an intermediary that withheld and paid taxes on behalf of the clients – the sole relevant distinction here from the facts of Begier – was irrelevant.  To the contrary, the applicable IRC provision “does not say that clients themselves must be the only ones involved in the withholding process in order for trust principles to be implicated.”  Nothing “suggests that an employer may avoid the fact that an amount required by law is being held in trust for the United States merely by outsourcing payroll processing to a third party.”  The Court conceded that Trustee cited one non-jurisdictional bankruptcy court decision that directly supported his argument, but found that opinion to be “devoid of analysis”, a defect that was not corrected by a subsequent opinion from the pertinent Court of Appeals.

The Court adds, in an interesting footnote, that even without the preemption of federal law in this case, Pennsylvania law (which governed Debtor’s agreements with the Clients) would mandate that the Transfers be held in a resulting trust, as the IRS produced ample evidence to show that there was no intention by the Clients to give Debtor the beneficial interest in the Transfers.

Thus, the Court affirmed the District Court’s judgment in all respects.

Conclusion

Aside from this being a matter of first impression in the Third Circuit with respect to aggregation dispute, the Court provides a detailed breakdown of the Begier decision and its continued vitality in tax-related preference issues.  Given the involvement of the IRC, the ultimate utility of this decision (as to its trust component) in other contexts remains to be seen.

A copy of the Net Pay Opinion can be found here.

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

  The matter was remanded from the United States District Court for the District of Delaware (the “District Court”) on appeal of the Court’s July 17, 2013 Order (the “Order”) granting judgment in favor of the Trustee’s Complaint to avoid and recover preferential transfers against Prudential.

On November 25, 2008, AE Liquidation, Inc., EIRB Liquidation, Inc., and Eclipse Aviation Corporation filed for voluntary relief under chapter 11 of the Bankruptcy Code.  On March 5, 2009, the case was converted to chapter 7 and the Trustee was appointed.  On November 23, 2010, the Trustee filed a Complaint against Prudential asserting that certain pre-petition transfers were preferential and avoidable under § 547(b) of the Bankruptcy Code.  On July 17, 2013, the Court entered the Order finding: (i) $781,702.61 of pre-petition transfers to Prudential were preferential; (ii) Prudential had a new value defense totaling $128,379.40; and (iii) the Trustee was not entitled to prejudgment interest.  On appeal, the District Court remanded the matter for the Court to reconsider: (i) the amount of Prudential’s new value defense; and (ii) whether the Trustee was entitled to prejudgment interest.*

*A blog post on this earlier opinion was published on December 1, 2015, available here.

 The Trustee argued that $71,808.83 of the new value defense was not eligible for new value credit because it related to post-petition services.  Prudential responded that the post-petition invoices were prepared solely to support its proof of claim and did not reflect the actual date the underlying services were performed.  Prudential also claimed the Trustee waived the argument by failing to raise it until post-trial briefing.  The Court found that the testimony of Prudential’s Director of Accounting was contrary to Prudential’s assertions and that the District Court already rejected Prudential’s waiver argument.  Accordingly, the Court reduced Prudential’s new value defense to $56,571.37, to reflect only services provided pre-petition.

With regard to prejudgment interest, the Trustee argued that the estate should be able to recover prejudgment interest beginning on the date the last preferential transfer was made.  Prudential contended that the Court reasonably exercised its discretion in denying prejudgment interest in the Order.  In granting prejudgment interest, the Court relied on the decision in Peltz v. Worldnet Corp. (In re USN Communications., Inc.), 280 B.R. 573, 602 (Bankr. D. Del. 2002), for the proposition that prejudgment interest is routinely granted in avoidance actions.  The Court disagreed, however, with the amount of prejudgment interest sought by the Trustee.  Relying again on USN Communications, the Court held that the prejudgment interest should be calculated from the date the action was commenced, not the date of the last avoidable transfer; further, the Court found that the appropriate rate for prejudgment interest is the federal judgment interest rate, for the calendar week preceding the filing date of the Complaint.  Therefore, the Court awarded the Trustee $5,186.97 in prejudgment interest.

A copy of the Court’s opinion is available here.