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.


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.

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.


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.


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

  In so deciding, the Court rejected the plaintiff’s arguments that such a position (i) is inapposite to the Third Circuit’s prohibition against utilizing postpetition goods or services as subsequent new value or (ii) violates Bankruptcy Code section 502(d). To the former, the Court found that the defendant’s setoff claim was distinct and could not be considered subsequent new value under 11 U.S.C. § 547(c)(4), as that defense is concerned entirely with prepetition activity; by contrast, the defendant asserted a valid setoff claim since the opposing obligations (i.e., the preference claim against the administrative claim) both arose on the same side of the bankruptcy petition date.  With respect to the plaintiff’s second argument, the Court found that administrative expense claims are accorded special treatment under the Bankruptcy Code and are not subject to section 502(d).

The Preferential Transfers and Administrative Expense Claim

Quantum Foods, LLC, et al. (the “Debtors”) initiated these bankruptcy cases on February 18, 2014 (the “Petition Date”).  In the ninety days prior to the Petition Date, Tyson Fresh Meats, Inc and Tyson Foods, Inc. (collectively, “Defendant”) received approximately $14 million in transfers (the “Transfers”) from the Debtors.  Postpetition, Defendant provided the Debtors with approximately $2.6 million in products, an amount which was accorded administrative status by the Court (the “Admin Claim”) but was never paid by the Debtors.

On March 25, 2015, the official committee of unsecured creditors (the “Committee”) appointed in these cases commenced the instant avoidance action seeking to avoid and recover the Transfers under Bankruptcy Code sections 547, 548, and 550, and to disallow any of Defendant’s claims until the voided Transfers were returned.  Defendant answered and asserted counterclaims and third-party claims against the Debtors. The Committee filed a FRCP 12(c) Motion for Judgment on the Pleadings with respect to Count I of the counterclaims and third-party complaint.  Oral argument among the Committee, the Debtors, and Defendant took place on February 3, 2016.

The Arguments

Defendant contended that the Committee’s claims to recover avoidable preferential transfers are post-petition causes of action and that Defendant is entitled to set off any recovery claims by the amount of its allowed postpetition Admin Claim.  Defendant argued that its Admin Claim is an extrinsic setoff claim, wholly unrelated to the concept of any new value defense or to the section 547 preference analysis generally.

In response, the Committee and the Debtors argued that Defendant’s setoff claim is really a “disguised” or “renamed” postpetition new value defense because, like a new value defense, it would have the effect of reducing the total amount of preferential transfers restored to the estate. According to the Committee and the Debtors, such a result would also violate section 502(d), which prohibits courts from allowing claims by preference defendants until after they have paid the amount for which they are liable.  The Committee and Debtors further argued that Defendant’s position is forbidden by the Third Circuit’s seminal Friedman’s Liquidating Tr. v. Roth Staffing Co. (In the Friedman’s, Inc.), 738 F.3d 547 (3d. Cir. 2013).*

*For a contemporary article by the author about the importance of the Friedman’s decision, click here

The Court’s Ruling on an Issue of First Impression

The Court began by recognizing that the question presented was one of first impression: Whether an allowed post-petition administrative expense claim can be used to set off preference liability?  The Court noted that there is no provision in the Bankruptcy Code that deals expressly with postpetition setoff.

Setoff or Disguised New Value?

The Court first found that Defendant’s setoff claim was not a “disguised subsequent new value” defense.  The Friedman’s decision makes clear that the preference calculation should be cut off at the petition date, which limits the utility or applicability of “new value” to the preference period.  Ergo, the Court found that it made no sense to refer to any claim arising outside of the preference period as a new value defense.  The Admin Claim is “comprised exclusively of post-petition activity; a section 547(c)(4) new value defense is limited to pre-petition activity.”  Judge Carey further held that Defendant’s claim fit squarely into the definition of “setoff”, as it is a “counterclaim demand which defendant holds against plaintiff, arising out of a transaction that is extrinsic of plaintiff’s cause of action.”  As such, the setoff claim does not affect the calculation of the preference, “only the amount paid to the estate.”

Analyzing the Setoff

Having found that Defendant’s claim is an assertion of setoff rights and not new value, the Court provided further analysis of the setoff claim.  Noting that “setoff is only available in bankruptcy when the opposing obligations arise on the same side of the… bankruptcy petition date,” the Court found that the Admin Claim is “clearly a post-petition obligation of Debtor” and  that a “preference claim can be asserted only after the filing of a bankruptcy petition.”  As such, setoff is permissible in this case since the opposing obligations arose postpetition.

Prohibited by Section 502(d)?

Finally, the Court addressed whether Bankruptcy Code section 502(d) – which “states broadly that “the court shall disallow any claim of any entity… that is a transferee of a transfer avoidable under… [§ 547]… unless such entity or transferee has paid the amount… for which such entity or transferee is liable” – prohibited setoff of Defendant’s Admin Claim against any preference liability.  In short, the Court found that it did not.  Observing that courts routinely recognize that “administrative expense claims are accorded special treatment under the Bankruptcy Code and are not subject to section 502(d)”, Judge Carey found no support in the Code for disallowing administrative claims if the administrative claimant fails to satisfy a preference liability.  In rejecting the Committee and the Debtors’ emphasis on the equality of distribution, the Court found that Judge Walrath had rejected a similar argument in In re Communication Dynamics, Inc. because “[e]quity does not mandate that one creditor lose rights it has under state law and the Bankruptcy Code simply because other creditors will benefit by that loss.”  Moreover, Friedman’s recognized that “[if] it is a rule in bankruptcy that all creditors must be treated equally, surely the exceptions swallow the rule.”

Therefore, the Motion was denied.


This is at least the second important 2016 preference opinion issued by Judge Carey which cuts in favor of defendants. See also Forman v. Moran Towing Corp. (In re AES Thames, LLC, et al.), summarized hereFor vendors maintaining a high level of postpetition business with a debtor, the ruling takes on added importance.

Notwithstanding, it is interesting to question how certain tweaks to the fact pattern would have affected the Court’s analysis, if at all – i.e. what if the Debtors had paid Defendant’s Admin Claim earlier in the case (which, in a sense, is indirectly addressed in this opinion)?  What if, at the time the avoidance action was brought, no order had been entered granting the administrative expense?

A copy of the Opinion can be found here.

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.

  The opinion also addresses the question of whether a substantive consolidation order can be applied nunc pro tunc to the petition date without violating Owens Corning’s prohibition against “offensive” use of the substantive consolidation doctrine.  The timing of the substantive consolidation order in this case – which provisionally carved out the defendant-bank from its application – is critical to one of the plaintiff-trustee’s avoidance causes of action.

Ultimately, the Court found that the defendant-bank’s actions were essentially administrative in nature and did not rise to the level of dominion or control over funds necessary to satisfy the statute and judicially created tests.  The Court did, however, find that in the circumstances here, applying substantive consolidation nunc pro tunc to the petition date would not be impermissibly offensive vis-à-vis the defendant, as the “carve-out” negotiated with the defendant was meant to be transitory, leaving the chapter 7 trustee free to seek application of the doctrine at a later date.


The facts of this case are extensive and warrant a full review by the reader, but pertinent to this post, they are as follows: the Debtor, Universal Marketing, Inc. (“UMI”), commenced its Chapter 11 case on July 23, 2009 (the “Petition Date”), but was quickly converted to a case under Chapter 7.  Prior to the Petition Date, Universal Delaware, Inc. (“UDI”) acted as the management company for UMI.  Operationally, UMI and UDI had separate banking relationships, the former with TD Bank and the latter with Wilmington Savings Fund Society (“WSFS”), although the cash needs of the various entities were met by numerous intercompany transfers on a daily basis.  In March 2009, UDI and WSFS entered into a line of credit loan transaction (the “Loan”), obligating WSFS to make available a $5 million line of credit.  By July 2009, however, the banking relationships with both UMI and UDI had soured, and within a few days of each other, TD Bank locked down UMI’s accounts and WSFS took similar action.  Specifically as to WSFS, the bank placed a “post no debits” (“PND”) restriction on the UDI accounts effective July 16, 2009, which had the effect of stopping automated debiting and allowing WSFS to review UDI’s account and ensure there were sufficient funds for outgoing transfers.  While the PND was in effect, UDI received over $11.6 million in transfers from UMI and a related entity (the “UMI Transfers”).  On July 20, following discussions among UDI and WSFS, WSFS removed the PND restriction, but offset $5 million to formally repay the Loan (the “Setoff”).  Three days later, UMI filed its bankruptcy petition.

Following conversion to Chapter 7, the Chapter 7 Trustee (the “Trustee”) sought substantive consolidation of the Debtor’s estate and extension of bankruptcy proceedings to certain non-Debtor entities, including UDI.  WSFS initially opposed substantive consolidation, but the parties later settled the issue as approved by an August 4, 2010 order (the “Order”).  This Order, while nunc pro tunc to the Petition Date, specifically provided that substantive consolidation would not impact WSFS’s rights, and that WSFS was excepted from the effects of the Order.  As to WSFS, the parties agreed that UDI would be deemed to have filed a bankruptcy as of August 4, 2010, and that the estates would be treated as jointly administered, not substantively consolidated.  Significantly, the parties agreed that the Trustee retained the right to extend the effect of the substantive consolidation to WSFS nunc pro tunc to the Petition Date, which WSFS could challenge.

On July 18, 2011, the Trustee initiated the adversary proceeding against WSFS based on a variety of legal theories, although this post will focus on the three counts brought under 11 U.S.C. §§ 544, 547, 548, 550, and/or 553.  The parties filed motions for summary judgment in May 2014, which the instant opinion addresses.

The First Counts

The first counts relevant here are based on 11 U.S.C. §§ 544 and 548, by which the Trustee asserted actual fraud allegations based on 6 Del. C. § 1304(a)(1) and 11 U.S.C. § 548(a)(1)(A), as well as constructive fraud.  The Court found no evidence in support of a claim for intentional fraud, so it limited its analysis to constructive fraud.  The pertinent transfers are the UMI Transfers and the Setoff (whereby UDI involuntarily transferred to WSFS an amount that paid off the Loan).  The Trustee argued that the UMI Transfers went directly to WSFS, and that WSFS was an initial transferee under 11 U.S.C. § 550 because it exercised dominion and control over UDI’s depository accounts by placing the PND restriction, then taking the funds for its own benefit to satisfy the Loan.  The Trustee alleged this was for no consideration to UMI, since UMI owed no money to WSFS.  Alternatively, the Trustee asserted that he could recover the Transfers from WSFS as a subsequent transferee, as UMI did not receive reasonably equivalent value for the transfers it made to UDI.  WSFS, of course, asserted that UDI was the initial transferee, and that the Transfers were made in satisfaction of UDI’s outstanding debt in good faith and without knowledge of their avoidability.

The Court noted that the most heavily litigated issue in section 548 actions is whether the debtor received reasonably equivalent value in the transaction.  In the Third Circuit, courts employ a two-step process in determining whether a debtor received reasonably equivalent value in the form of indirect economic benefits in a particular transaction: (1) whether any value is received, and (2) whether that value was reasonably equivalent to the transfer made. In re R.M.L., 92 F.3d 139, 152 (3d Cir. 1996).  I.e., what the debtor gave up and what it received that could benefit creditors, be it direct or indirect.  As to section 544, the Trustee invoked 6 Del. C. §§ 1304 and 1305 as his authority to step into the shoes of an actual creditor who existed at the beginning of the case and avoid the Transfers pursuant to state law.

Is WSFS an initial transferee?

The Court found that the Trustee’s theory hinged on the notion that WSFS was the initial transferee of the Transfers, but since that term is not defined in section 550, courts (although not the Third Circuit) have developed tests for determining whether a party is an initial transferee.  The first of these tests is referred to as the “dominion-and-control test”, as articulated in Bonded Fin. Servs. v. European Am. Bank., 838 F.2d 890 (7th Cir. 1988): “the minimum requirement of status as a “transferee” is dominion over the money or other asset, the right to put the money to one’s own purposes.” Id. at 893.  This is related to the “conduit theory” doctrine, that says if an entity receives a transfer, it may not be a transferee at all, but only a mere conduit if the transfer is for the limited purpose of allowing the entity to pass the asset through to another party.

The Ninth Circuit made a distinction between “dominion” and “control” in In re Incomnet, Inc., 463 F.3d 1064 (9th Cir. 2006), stating the “focus of the dominion standard is “whether an entity had legal authority over the money and the right to use the money however it wished.” Id. at 1070. The transferee has dominion if it has “the right to put the money to one’s own purposes.” Id.  In contrast, the “control” standard may involve a broader, more flexible approach, in which the courts look at the entire transaction as a whole to evaluate which party truly had control of the money”. Id.

The Trustee pushed the Court to employ the “dominion-and-control test”, and focus on the transferee’s relationship to the property; WSFS encouraged application of the “dominion test” as set forth by Incomnet, since it never exercised dominion over the UMI Transfers because it had no legal right to use those funds – the PND was just a temporary cautionary measure.  Moreover, WSFS argued that the Setoff was a subsequent transaction, performed only after UDI had taken title and dominion over the UMI Transfers.

The Court agreed with WSFS that it was only a subsequent transferee, not an initial transferee.  It found that the measures taken by WSFS at the time of the PND did not restrict all outgoing transfers from UDI’s account.  In addition, there was no evidence of any legal title change to the funds in UDI’s account, nor is there any indication that UDI was helpless and without access to funds.

As to the Trustee’s subsequent transferee argument, the Court found that the Trustee failed to prove that UMI did not receive reasonably equivalent value for the UMI Transfers.  Beyond the fact that the Trustee submitted no evidence to substantiate his supposition that UDI did not provide value to UMI, WSFS offered evidence that the Transfers were made in exchange for value in the form of receivables UMI owed to UDI and liquidity obtained through cash management services WSFS provide to UDI.

The Second Count

The Trustee also sought to avoid the Setoff under 11 U.S.C. §§ 550 and 553(b).  That section permits a trustee to avoid the amount by which a creditor improved its position by setoff during the 90 day period prior to the petition date.  In this case, 90 days before the Petition Date, there was an “insufficiency” (the amount by which a claim against a debtor exceeds a mutual debt owing to the debtor by the claimholder) of $5.75 million, and on the day of the Setoff, there was no insufficiency.  This depends, of course, on a finding that UDI’s estate was substantively consolidated with UMI’s as to WSFS, making the Petition Date July 23, 2009 – not August 4, 2010 as the Order provides.  If the latter, then the Trustee’s argument could not satisfy the 90 day requirement in section 553(b).

Can the Trustee seek substantive consolidation as to WSFS?

WSFS, relying on In re Owens Corning, 419 F.3d 195 (3d. Cir. 2005), argued that the Trustee could not wield substantive consolidation offensively, i.e., in a manner to single out and create a section 553(b) claim against WSFS.  The Trustee argued he was not singling out WSFS and that a major aspect of substantive consolidation is to allow the estate to bring actions on behalf of the consolidated estates; in his opinion, the issue was merely deferred as to WSFS, not waived.

The Court agreed with the Trustee.  Having walked through the seminal Owens Corning decision – and specifically WSFS’s favored tenet that while “substantive consolidation may be used defensively to remedy the identifiable harms caused by entangled affairs, it may not be used offensively (for example, having a primary purpose to disadvantage tactically a group of creditors in the plan process or to alter creditor rights)” Id. at 211 – the Court found that that tenet simply did not control here.  Rather, the Trustee was not seeking to isolate WSFS impermissibly, and the Order clearly stated the parties reserved their rights to seek or contest further substantive consolidation.  In effect, the Court found the agreement approved in the Order to be a “standstill agreement”, and to give effect thereto, the litigation should be treated as resuming the dispute when they declared a truce in August 2010.  The Order should not now be read to have essentially waived the parties’ rights.  As such, the Court found that the issue could be considered on its merits and refused to grant summary judgment in favor of WSFS, as neither party discussed whether the Trustee has evidence to support substantive consolidation or the elements of a setoff claim under section 553(b).

Can parties carve themselves out of a substantive consolidation order?

An interesting side note to this section of the opinion is the Chief Judge’s acknowledgement that Owens Corning left open the question whether a creditor may carve itself out of the effects of consolidation.  Nevertheless, the Court states that “right or wrong, that is what occurred in this case…”

A copy of the opinion is attached here.