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Bankruptcy Court Adopts Income Approach to Valuation of Going Concern Business to Find Debtors Were Solvent at the Time of Alleged Constructive Fraudulent Transfers

By Charlene D. Davis

On June 10, 2013, following a three-day consolidated trial on the merits, Judge Brendan L. Shannon entered judgment (and a supporting opinion) in favor of defendants C/R Energy Coinvestment II L.P. et al. (“Ritchie”) and Cottonwood Partnership, LLP et al. (“Cottonwood”, and together with Ritchie, the “Defendants”) in adversary proceedings brought by the trustee of the SemGroup Litigation Trust (the “Trustee”) seeking to recover equity distributions as fraudulent transfers under sections 544 and 548 of the Bankruptcy Code and the Oklahoma Uniform Fraudulent Transfer Act (the “UFTA”).  The equity distributions had been made by SemCrude, L.P. (“SemGroup”) to Ritchie and Cottonwood in August 2007 (the “2007 Distributions”) and February 2008 (the “2008 Distributions”).  Thereafter, on July 22, 2008, SemCrude, l.P. and certain of its affiliates (the “Debtors”) filed chapter 11 petitions in the District of Delaware Bankruptcy Court and on October 28, 2009, the Court entered an order confirming the Debtors’ chapter 11 plan (the “Plan”).  The Plan provided for a liquidating trust that was vested with the fraudulent transfer claims.

On March 29, 2010, the Trustee filed complaints against Ritchie and Cottonwood (Adv. Proc. Nos. 10-50840 and 10-51808 respectively) seeking to recover the 2007 Distributions and the 2008 Distributions as avoidable constructive fraudulent transfers.  In December 2011, the Court approved a stipulation of the parties consolidating the adversary proceedings for discovery purposes.  Following discovery, the Defendants moved for summary judgment in their favor with regard to the 2007 Distributions (the “Summary Judgment Motion”).  On April 11, 2013, the Court granted the Summary Judgment Motion and, eleven days later, began a 3 day trial on the claims as they related to the 2008 Distributions.

At trial the evidence consisted in large part of expert testimony on the issue of insolvency.  The Court easily found that the 2008 Distributions had been made within the 2 year period prior to the Petition Date.  It also found that the Debtors did not receive reasonably equivalent value for the 2008 Distributions.  What it did not find was that the Debtors were insolvent at the time of the 2008 Distributions.  As a result, the Court held that the Trustee had failed to establish the Debtors’ insolvency by a preponderance of the evidence.

The holding was based upon the Court’s assessment of competing valuation methodologies.  The Trustee’s expert employed an Asset Approach to valuation.  The defendants’ expert used both a Market and Income Approach.  The Court noted that the parties generally agreed that, in 2008, the Debtors were a going concern; that valuation of the Debtors as a going concern was appropriate and that the Income Approach was the preferred method for going concern valuations.  The Court agreed with the parties; found that the Trustee’s arguments against using the Income Approach in these proceedings were not convincing; and adopted the Income Approach.  The Court was not convinced that the Asset Approach was the best way to value the Debtors, because they were a going concern, and, in any event, questioned certain of the adjustments made by the expert to the Debtors’ balance sheet while employing the Asset Approach.  The Court held that the Trustee’s inability to establish the Debtors’ insolvency at the time of the 2008 Distributions required judgment for the Defendants on the fraudulent conveyance claims under both the Bankruptcy Code and the Oklahoma UFTA.

A copy of the opinion can be found here.

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