On February 13, 2018, Judge Silverstein of the Delaware Bankruptcy Court granted a motion to dismiss the Rent-A-Wreck of America bankruptcy case (Bankr. D. Del. case 17-11592). Judge Silverstein’s opinion is available here (the “Opinion”).

In summarizing her holding, Judge Silverstein provides: These privately-owned debtors are not in financial distress (or at least they have not proven they are), and they seek to use 11 U.S.C. § 365 to redistribute value from a long-time adversary to enrich their ultimate shareholder.  The one entity that may be adversely affected by the Debtors’ bankruptcy filing is the Movant, David Schwartz.  Mr. Schwartz was held by the Maryland District Court, and affirmed by the Fourth Circuit, to be the the holder of an implied-in-fact royalty and fee-free franchise in West Los Angeles.  Opinion at *7.  He argues that the Debtors filed bankruptcy for the sole purpose of rejecting his franchise, and are not filed in good faith, but are instead a continuation of the Maryland District Court litigation.  Opinion at *12

The Debtors argued that they filed for bankruptcy protection to maximize the value of the Rent-A-Wreck trademark, to reject burdensome franchise agreements, and to relieve Debtors’ balance sheet of significant debt, all of which Debtors posit constitute valid reorganizational purposes. Opinion at *12.

Judge Silverstein began her analysis of this case by reviewing the inquiry of the Debtors’ good faith as directed by  precedential holdings of the Third Circuit.  Opinion at *14.  The Third Circuit considers two primary factors to determine good faith – first, whether the petition serves a valid bankruptcy purpose, second, whether the petition was filed to gain a tactical advantage.  Id.  The main precedential opinion cited by Judge Silverstein is In re Integrated Telecom Express, Inc., 384 F.3d 108 (3d Cir. 2004).

According to the Opinion, good faith is a predicate to a debtor’s ability to use provisions of the Bankruptcy Code, and financial distress is a part of if not itself a predicate to—a good faith analysis.  Opinion at *15.  Judge Silverstein continues: The ability to use the redistributive
provisions of the Bankruptcy Code assumes the existence of a valid bankruptcy, which, in turn, assumes a debtor in financial distress.  Id.  In this case, the Debtors never represented that they were insolvent, and Judge Silverstein, accordingly, determined that they were solvent.  Opinion at *18.  Neither did the Debtors provide evidence indicating that they were unable to pay their debts as they came due.  Opinion at *19.  Judge Silverstein determined that, in sum, the lack of credible facts demonstrating financial distress supports a finding that these cases were not filed in good faith.  Opinion at *26.

Pursuant to the Opinion, Judge Silverstein understood the Debtors’ argument that their filing was in good faith as follows: the rejection of the Schwartz franchise agreement maximizes Debtors’ assets thus permitting them to stay in business, satisfying both prongs of the bankruptcy purpose.  Opinion at *28.  Judge Silverstein disagreed, quoting Integrated Telecom:

To be filed in good faith, a petition must do more than merely invoke some distributional mechanism in the Bankruptcy Code. It must seek to create or preserve some value that would otherwise be lost—not merely distributed to a different stakeholder—outside of bankruptcy.

Opinion at *28 (quoting Integrated Telecom, 384 F.3d at 128-29) (emphasis in Opinion).  Judge Silverstein concludes my opining that the Debtors bankruptcy filing was made for the purpose of redistributing the value of the Rent-A-Wreck trademark in the Los Angeles territory from Mr. Schwartz to Bundy.  Opinion at *29.   Accordingly, the primary, if not sole, beneficiaries of that value would be the Debtors’ equity holders, not its creditors.  Judge Silverstein states that she has “no doubt these petitions were just another chapter in the attempt to terminate Mr. Schwartz’s franchise and obtain the benefits for JJFMS.”  Opinion at *36.

Judge Silverstein provides in the Opinion, that a financially distressed debtor’s recognition of the outcome of litigation and/or a desire to avoid future litigation may serve as a legitimate basis for the filing of a bankruptcy case. Opinion at *36.  I note, however, that the thread running throughout the Opinion is the requirement that a debtor be financially distressed in order to take advantage of the relief provided by the Bankruptcy Code.  Financial distress is a broad term, that can be applied to entities ranging from those suffering a liquidity crisis with substantial equity – to those suffering from over-leverage or long-term non-profitability.  In these situations, and countless others, the Bankruptcy Code can provide relief.  It is important, however, to ensure that your company can satisfy the Court’s scrutiny of whether a petition was filed in good faith – recognizing that the burden of proof is on the debtor.

On January 22, 2018, in an adversary proceeding arising within the Haggen bankruptcy (Adv. No. 16-51204), Judge Gross of the Delaware Bankruptcy Court issued a ruling against the Plaintiff, denying the relief requested in the complaint and dismissing the adversary proceeding. Judge Gross’s opinion is available here (the “Opinion”).

The Committee filed an adversary proceeding with a 78 count, 145 page Complaint making numerous allegations including, but not limited to, fraudulent transfers, breach of fiduciary duties, and unjust enrichment.  The Defendants’ answer spanned 184 pages, denying the numerous allegations and laying out the groundwork for the intense legal battle that followed.  Accordingly, it came as no surprise that the trial lasted five days and Judge Gross’s Opinion was 162 pages.

This Opinion follows on the heels of motions for summary judgment, which were previously discussed in this blog post:  In Fact Intensive Issues, You Need a Trial to Provide the Court With the Facts.

As one could presume based on Judge Gross’s affable nature, both in the courtroom, in the public sphere, and in his rulings, Judge Gross has crafted this Opinion in a manner that clearly guides the reader through each issue and includes an easily understood summary.  Judge Gross held that the Defendants were not so cavalier in planning and effecting the Project that they were grossly negligent nor that there was anything inherently wrong with the OpCo-PropCo structure.

“The Project failed but not because the Defendants did not care if it succeeded. Moreover, it is not uncommon for parties who are planning a transaction to make certain that they are protected in the event the transaction fails. Such protection from adverse results is one of the reasons for forming a corporation or other entity – to limit personal liability.

It is unnerving that the Project failed in a matter of months and certainly the Court had questions about how it happened. It turns out that the people in charge, the Individual Defendants, to some degree were not prepared. They were not, however, grossly negligent and they certainly meant for Haggen, Holdings and the OpCo to succeed. The Committee made a strong case but, at the end of the day failed to establish gross negligence or self-dealing or the existence of any fraudulent transfers. The Committee did establish that the leases between Spirit and GIG, and the OpCo’s, were above the market rate, but there is no liability. The Committee failed however, to establish the remaining counts of the Complaint.”

Opinion at *3.  Judge Gross then cites to the Delaware Chancery Court for the proposition that “to allege that a corporation has suffered a loss as a result of a lawful transaction, within the corporation’s powers, authorized by a corporate fiduciary acting in a good faith pursuit of corporate purposes, does not state a claim for relief against that fiduciary no matter how foolish the investment may appear in retrospect.”  Opinion at *4 (quoting Gagliardi v. TriFoods Int’l, Inc., 683 A. 2d 1049, 1052 (Del. Ch. 1996)).

This case arose from a buyout that was structured with separate entities having separate roles.  The property owning entities have been successful – real estate is, after all, booming.  The operating entities, however, have struggled like a large number of other retailers.  Retail bankruptcy cases are at an all-time high and rents are higher than ever.  As Judge Gross recognized in the Opinion, the corporate structure is meant to provide down-side protection to equity holders.  In this instance (pending any possible appeals), the corporate form appears to have operated precisely as intended.

In a 32 page opinion entered December 5, 2017 Judge Gross of the Delaware Bankruptcy Court ruled on cross motions for summary judgment concerning an avoidance action in the Simplexity bankruptcy. Judge Gross’s opinion is available here (the “Opinion”).  This Opinion arises from a complaint brought by Charles A. Stanziale, Jr., as the Chapter 7 Trustee of Simplexity, LLC against the Sprint Corporation alleging that payments made by the debtor to Sprint of $3,842,951.86 were avoidable transfers.  Two issues were the subject of the joint motions for summary judgment,  (1) did the Trustee satisfy his burden of demonstrating that Sprint received more by the Transfers than it was entitled to under Chapter 7, and (2) is Sprint entitled to a new value defense for two transfers (of $505,151.53 and $125,000.00 respectively) made to Simplexity?

First, the analysis of Sprint’s recovery.  The primary issue of contention is whether the Trustee’s use of the “Add-Back” method was appropriate.

The Trustee performed a liquidation analysis using the add-back of analyzing a defendant’s position on the petition date given a hypothetical liquidating by 1) accounting for the debt that was still owed by the Debtors to the defendant on the petition date; 2) adding back in the transfers paid in the preference period to the outstanding debt (i.e., complying with Section 547(b)(5)(B)’s requirement of analyzing the situation as if ‘the transfer had not been made’); and 3) comparing that debt to the collateral [as] of petition date.

Opinion at *22.  Judge Gross held that the Trustee’s methods were appropriate, and that it was able to trace what Sprint’s recovery would have been in the chapter 7 bankruptcy both with, and without these payments as a result of Sprint’s liens.  Accordingly, he granted the Trustee’s summary judgment motion on this point.  He did, however, differentiate a few cases, so if you are in a similar situation, please read the entirety of this portion of the Opinion.  It’s a quality lesson in distinguishing case law.

Second, Sprint’s New Value.

In this portion of the Opinion, Judge Gross looks to the spirit of the new value defense provided by 11 U.S.C. 547, describing “the overarching principle of Section 547(c)(4)” as the provision by a creditor of “a beacon of light in a dark time.”  Opinion at *29.  Sprint made a mid-month payment (the $505,151.53 payment), which was not contractually required.  The Court determined that because this payment was not contractually required, it constituted new value, and was not a payment made on account of amounts due and owing by Sprint.  Opinion at *28.

The second allegedly new value payment, however, was related to a “Loyalty Trial Program”.  Opinion at *30.  Since neither party provided any evidence as to the Loyalty Trial Program and whether Simplexity was entitled to the $125,000 payment, Judge Gross denied both motions for summary judgment as to this payment.

This is a compelling Opinion if you are on either side of a new value defense.  This Opinion analyzes both the receipt of more than a creditor is entitled to under chapter 7, and how new value is treated in a situation when a creditor is also obligated to make a payment to the debtor.

In a short opinion entered November 14, 2017 Judge Gross of the Delaware Bankruptcy Court denied a motion of an interested party to “Attend and Participate in the Rule 2004 Examinations to be Conducted by the Trustee”. Judge Gross’s opinion is available here (the “Opinion”).

This is a very short Opinion and resolves a very straight-forward issue.  Can a party in separate litigation take advantage of Bankruptcy Rule 2004 to obtain discovery from the opposing party?

The answer: No.

Citing multiple cases, Judge Gross explains that the “pending proceeding rule” provides that once an adversary proceeding or contested matter has been commenced, discovery must proceed under the federal discovery rules.  The cited opinions were: In re SunEdison, Inc., 572 B.R. 482 (Bankr. S.D.N.Y. 2017);  In re Wash. Mut., Inc., 408 B.R. 45 (Bankr. D. Del. 2009); In re Enron Corp., 281 B.R. 836 (Bankr. S.D.N.Y. 2002); 2435 Plainsfield Ave. v. Township of Scotch Plains (In re 2435 Plainsfield Ave.), 223 B.R. 440 (Bankr. D.N.J. 1998); In re Coffee Cupboard, Inc., 128 B.R. 509 (Bankr. E.D.N.Y. 1991).

As discussed in a previous post on this blog, 2004 discovery is most akin to fishing expeditions meant to determine whether or not litigation should be commenced.  You can read that post here: What are the Scope and Limitations of a Rule 2004 Examination?

In a 10-page decision signed November 6, 2017 in an adversary proceeding arising within the Physiotherapy Holdings bankruptcy (PAH Litigation Trust, case 15-51238), Judge Gross of the Delaware Bankruptcy Court denied a motion of the Litigation Trust (the “Trust”) to file an amended complaint, providing guidance on a number of different issues. Judge Gross’s opinion is available here (the “Opinion”).

The Defendants opposing the motion to amend had an uphill battle in this issue.  Judge Gross begins his discussion by stating, “Motions for leave to amend the complaint are granted liberally.”  Opinion at *2.  Judge Gross then provided a foreshadowing of the Defendants’ way out, stating, “The Court may, however, deny leave to amend if the proposed amendment is futile or untimely.”  Id.

The Court had established a deadline of September 30, 2016 for the amending of the complaint.  The Trust filed its motion approximately ten months after that deadline.  The Trust was thus required to satisfy the ‘good cause’ standard of FRCP 16(b)(4) in order to obtain approval of its motion.  Opinion at *2.

The  Trust argued that it satisfied the good cause requirement because the proposed defendants had “deeper pockets”.  Opinion at *3.  The Trust expressed concern that the current defendants have made distributions to their limited partners, the proposed defendants.  The Court held that “the Litigation Trust has not satisfied the ‘good cause’ requirement…  The fact that Defendants may not have sufficient assets to satisfy any judgments is not good cause to add the Proposed Defendants.”  Opinion at *4-5.

Judge Gross then turned to the motion’s request to amend the complaint to seek punitive damages.  There was an initial dispute as to whether the defendant should have raised choice of law arguments in their motion to dismiss.  Judge Gross opined that “there must be an actual conflict between the laws of different jurisdictions to engage in a choice of law determination.”  Opinion at *6 (quoting Rice v. Dow Chem. Co., 875 P. 2d 1213, 1216 (1994)).  Judge Gross held that the answer to which law controls depends on which state has the most significant relationship to the claim and the parties.  Opinion at *6-7 (following the precedent of Emerald Capital Advisors Corp. v. Bayerische Motoren Aktiengesellschaft (In re FAH Liquidating Corp.), 2017 WL 2559892, at *9 (Bankr. D. Del. June 13, 2017)).  Finding that Delaware law controls, and Delaware courts of equity do not allow for punitive damages to be awarded.  Opinion at *9 (“under Delaware law punitive damages are not available under principles of equity which Delaware courts apply.”)

And with that, Judge Gross denies the motion to amend the complaint.  The primary takeaway – if the Court sets a deadline to amend the complaint, make sure you hit the deadline.  Because the Court grants motions to amend “liberally”, had this motion been timely I imagine the result would have been very different.

In a decision signed October 25, 2017, Judge Shannon of the Delaware Bankruptcy Court issued an opinion requiring a professional to disgorge fees, pay a sanction of $25,000, and enjoined him from taking various actions in bankruptcy court. Judge Shannon’s opinion is available here (the “Opinion”).

The United States Trustee filed a Complaint for Injunctive relief, Fines and Civil Contempt against Robert F. Martin.  Mr. Martin has twice before been the subject of inquiry and action by the United States Trustee. First in 2011, the United States Trustee alleged that Mr. Martin was acting as a petition preparer in violation of 11 U.S.C. § 110. A Consent Order resolving that litigation was entered by the Court on March 28, 2012 (the “First Consent Order”) by which Mr. Martin agreed to disgorge fees and refrain from acting as a petition preparer in the future.

Two years later, the United States Trustee filed a new complaint against Mr. Martin, alleging that he had acted as a petition preparer in at least 19 cases in violation of the terms of the First Consent Order.  Mr. Martin again agreed to disgorge fees and to refrain from acting as a petition preparer in the future.

The United States Trustee alleged that Mr. Martin returned to his prior practice of encouraging homeowners to file for relief under Chapter 13, and assisting them in the process of filing bankruptcy in violation of § 110 of the Bankruptcy Code. Mr. Martin’s debtor clients were not adequately instructed  by Mr. Martin regarding the Chapter 13 filing and its potential consequences, and that his efforts constituted a violation of the provisions of Bankruptcy Code § 110 and the First and Second Consent Orders.

The Court held that “Mr. Martin’s business model is based upon practices that violate federal law and orders of this Court.”  Opinion at *14.  It then levied the above fines and directed that Mr. Martin was to refrain from taking any further actions in violation of Bankruptcy Code § 110.

While this is not the type of case normally discussed on this blog, it illustrates an important principle that I have seen play out several times in the Delaware Bankruptcy Court – each time you are penalized for the same bad act, the consequences get more severe.

In a decision signed October 4, 2017 in an adversary proceeding arising within the Haggens bankruptcy (HH Liquidation, LLC, et al., case 16-51204), Judge Gross of the Delaware Bankruptcy Court denied a motion for summary judgment, holding that he Court and needs to see evidence at trial of why and how the Debtor failed while a related entity was flush with cash. Judge Gross’s opinion is available here (the “Opinion”).

By way of history, the Haggen family started operating a grocery in 1933, growing to operate thirty stores and a pharmacy by 2011.  In late 2014, the Safeway / Albertsons merger occurred, which required them to sell 146 stores.  In February 2015, Haggen (thanks in large part to the direction of Comvest Partners, a private equity firm who had purchased 80% of Haggen’s equity) purchased the 146 former Albertsons locations.  With a signature, Haggens grew to a size that was approximately 600% larger than it had ever been.  It is my opinion that growth at this pace either succeeds fantastically, or fails fantastically.  Unfortunately, this is a bankruptcy court opinion – so it’s clear this wasn’t a fantastic success.

Haggens split the acquisition into multiple pieces, segregating the operating and real property assets in different entities.  Those which held real property I will refer to collectively as PropCos, and those which operated stores and leased the real property for such a purpose I will refer to collectively as OpCos.  For those who have not followed the Haggens bankruptcy, it is important to recognize that OpCos were placed into bankruptcy and the PropCos were not.

The plaintiff in the adversary proceeding argued that the debtor and non-debtor related entities should be substantively consolidated and that the OpCos and PropCos were liable for fraudulent transfer.  Without consolidation or a fraudulent transfer ruling, the PropCos creditors will receive 100% of their claims while OpCos unsecured creditors will receive 0%.  If the plaintiffs are successful in their claims, the PropCos creditors and the OpCos creditors would all receive approximately 20% of their claims.  Opinion at *7.

Judge Gross was not sympathetic to the Debtors’ opining that:

Comvest created Holdings, the OpCo Entities and the PropCo Entities and formed them to hold separate assets. The OpCo Entities held operational assets and leased property from the PropCo  Entities which held the real property. Then, in a matter of a few months the OpCo Entities were bankrupt and are unable to pay unsecured creditors anything while the PropCo Entities are flush with money.  The Court and the OpCo Entities’ creditors need to see evidence at trial of why and how this happened.

Opinion at *7-8.  Of particular note, Judge Gross made repeated references to the Mervyn’s decision,  In re Mervyn’s Holdings, LLC, 426 B.R. 488 (Bankr. D. Del. 2010).  “In Mervyn’s, like here, the owner of real property (Target Corporation) sold its interest in Mervyn’s, LLC to a group of private equity firms who spun off real estate leaving the operational portion of Mervyn’s, LLC undercapitalized and paying rent to the real estate holding entity.”  Opinion at *9.  I have found that when a judge on the Bankruptcy Court makes repeated reference to another decision, particularly when it is a decision of that very judge, litigants should make every effort to differentiate, or analogize, the instant case.  The repeated reference to Mervyn’s by Judge Gross provides a clear picture of the issues he will need answered by the litigants here.  It’s his opinion, I’d expect it to be the first and last thing out of both litigants’ mouths.

In a decision signed September 21, 2017 in an adversary proceeding related to the Boomerang Systems bankruptcy (case 15-11729), Judge Walrath of the Delaware Bankruptcy Court denied a defendants FRCP 12(b)(6) motion to dismiss a preference complaint. Judge Walrath’s opinion is available here (the “Opinion”).

Judge Walrath first provided the requirements for a preference action to survive a motion to dismiss.  Quoting Stanziale v. DMJ Gas-Mktg. Consultants, LLC (In re Tri-Valley Corp.), Adv. No. 14-50446 (MFW), 2015 WL 110074, at *2 (Bankr. D. Del. Jan. 7, 2015), Judge Walrath stated that “to satisfy Rule 8, the complaint must identify each alleged preferential transfer by the date of the transfer, the name of the debtor/transferor, the name of the transferee, and the amount transferred.”  Opinion at *5.

In this case, Gavin Solmonese, LLC, the liquidating trustee of Boomerang Systems (the “Liquidating Trustee”), filed a preference action that is, in Delaware, a fairly routine pleading.  In its complaint, the Liquidating Trustee alleged the amount, date, and method of payment made by the Debtors to the Defendant.  Judge Walrath held that “this allegation is sufficient to allege a preferential transfer.”  Opinion at *6.

The Defendant asserted its affirmative defenses as grounds for dismissal of the complaint.  However, as the Court held, “these defenses are not grounds to dismiss the action under Rule 12.”  Opinion at *6.  A 12(b)(6) dismissal requires a deficiency in the plaintiff’s pleading.

Avoidance actions are painful for defendants – particularly when they are innocent actors.  But the innocence of a preference defendant is not a defense.  The only defenses available are those provided by statute – 11 U.S.C. § 547(c). We have provided an overview of these defenses in our short booklet A Preference Reference.

In a decision signed September 8, 2017 in an adversary proceeding related to the Money Center of America bankruptcy (case 14-10603), Judge Sontchi of the Delaware Bankruptcy Court denied a defendants FRCP 12(b)(6) motion to dismiss a complaint filed in the adversary proceeding 15-50250. Judge Sontchi’s opinion is available here (the “Opinion”).

The chapter 7 trustee of the Money Center of America bankruptcy, Maria Aprile Sawczuk (the “Trustee”) filed a complaint against Christopher Wolfington, Jason Walsh and Lauren Anderson, alleging breach of fiduciary duty, aiding and abetting breach of fiduciary duty, corporate waste, conversion, recovery of avoidable transfers, and equitable subordination.  Defendant Walsh filed a motion to dismiss, arguing that the Trustee failed to adequately plead non-dischargeability in his personal bankruptcy or fraud.  His motion to dismiss was the subject of the Opinion.

After analyzing and reciting the complaint, the Court determined that “the Trustee’s Complaint sufficiently alleged that Walsh perpetrated fraudulent transfers through conduct “of the kind” specified in sections 523(a)(2) and (a)(4) in order to withstand a motion to dismiss.”   Opinion at *6.  The Court further held that “the Trustee has sufficiently alleged facts showing that Walsh’s conduct of the kind specified under sections 523(a)(2) and (a)(4).”  Opinion at *7.

This Opinion, although short, provides a strong reminder of the requirements of the pleading standards in the Delaware Bankruptcy Court.  Complaints do not need to contain long recitations of facts supported by extensive evidence.  Rather, a complaint need only contain allegations of sufficient facts to support the claims alleged.  In a prior blog post I discussed a time when this did not occur: You Don’t Get Three Strikes when Filing a Complaint – Lessons from Tropicana.  When a complaint clears this hurdle, it will not be dismissed by the Bankruptcy Court.

On August 23, 2017, Judge Shannon of the Delaware Bankruptcy Court issued an order that is a reminder that this is a court of equity – and that at the end of the day, he will act equitably.  A copy of Judge Shannon’s opinion (the “Opinion”) is available here.  Mr. Welsh filed the complaint that led to this Opinion, seeking damages for emotional distress, and punitive damages, for alleged violations of the automatic stay.

Brian Welsh is a debtor in bankruptcy case no. 14-11503 in the Bankruptcy Court for the District of Delaware.  On April 13, 2012, despite his mortgage being in default, Bank of America (“BofA”) mistakenly recorded a satisfaction of mortgage.   On February 7, 2014, BofA
filed a complaint in the Superior Court in the State of Delaware to set aside the Satisfaction.  On June 18, 2014, prior to any disposition in the Superior Court litigation, Mr. Welsh filed his Chapter 13 petition. On November 3, 2014, in order to protect its interest, BofA filed a proof of claim on account of the mortgage.  In response to an adversary proceeding seeking to avoid BofA’s claim, the Court issued a decision on October 1, 2015, in which it held that a bona fide purchaser would not have been on notice of the Superior Court litigation as of the Petition Date, and the lien was therefore avoided pursuant to Section 544(a)(3).  At that time, Judge Shannon said that Mr. Welsh “will benefit mightily due to [Defendant’s] honest mistake”, in essence obtaining “a house for free”.

As the facts are provided by Judge Shannon in the Opinion, it appears that he would be inclined to rule that BofA did violate the automatic stay.  This is reinforced by his denial of the defendants’ motion to dismiss the complaint.  He does, however, issue a parting word of guidance to the parties that makes exceptionally clear that the Debtor should not expect to receive any amount of damages due to BofA’s violation of the automatic stay.  “Candor requires that the Court advise the parties that it is highly unlikely that, at trial, this Court would award damages to the Plaintiff beyond the free house he has already obtained.”

When I was in law school, I heard numerous times that “pigs get fat and hogs get slaughtered”.  Mr. Welsh got a rich reward due to his handling of his bankruptcy petition – a free home.  Anything more than a free home, which had a mortgage of $205,000, may be more than a judge in a court of equity could in good conscience award.