Delaware preference action

On September 9, 2013, Furniture Brands International (“Furniture Brands”) and various related entities filed chapter 11 petitions for bankruptcy in the United States Bankruptcy Court for the District of Delaware.  We initially published a blog post about the filing here: Furniture Brands Files for Bankruptcy in Delaware Seeking to Sell Assets

On August 1, 2014, the Debtors’ confirmed chapter 11 plan became effective, thereby creating the FBI Wind Down, Inc. Liquidating Trust (the “Trust”) and appointing Alan D. Halperin as the Trustee.  We recently were informed that the Trustee has begun sending out preference demand letters, informing recipients that if they do not settle their liability, he will bring a preference lawsuit.  The Trustee will argue that the transfers, or payments, received by various defendants are avoidable and subject to recovery under 11 U.S.C. § 547 and 548 of the United States Bankruptcy Code.

Defenses to a Preference Action

Preference actions are a form of litigation specifically provided for by the Bankruptcy Code which are intended to recover payments made by the Debtor within the 90 days prior to declaring bankruptcy.  The presumption is that the Debtor knew it was going to file bankruptcy, so any payments it made during this 90-day window went to friends and people it wanted to keep happy, and stiffed those the Debtor’s management didn’t like.   Recognizing that these payments aren’t always made for inappropriate reasons, the Bankruptcy Code provides creditors with many defenses to preference actions. Included among these are the “ordinary course of business defense” and the “new value defense.” For reader’s looking for more information concerning claims and defenses in preference litigation, attached is a booklet I prepared on the subject: “A Preference Reference: Common Issues that Arise in Delaware Preference Litigation.”

If you have received one of these demand letters and would like to discuss your options, feel free to give us a call.  Note that until we are retained, however, we can only provide general advice as our conversation will not be protected by the attorney client privilege.

John Bird is a bankruptcy attorney with the law firm of Fox Rothschild LLP.  John is admitted in Delaware and regularly practices before the United States Bankruptcy Court for the District of Delaware. You can reach John at (302) 622-4263 or at jbird@foxrothschild.com.

In 6 pages of Findings of Fact and Conclusions of Law released December 19, 2014 in the Liberty Brands bankruptcy (Bank. D. Del. 09-50965), Judge Walrath’s ruling referenced Stern v. Marshall, 131 S.Ct. 2594 (2011).  Judge Walrath’s Findings of Fact and Conclusions of Law are available here (the “Opinion”).  Because of the continuing discussions caused by the Stern opinion, we wanted to touch briefly on the (very short) part of the opinion referencing Stern.  The Stern case was previously discussed in numerous posts on this site, including the following:

Judge Walsh Provides Analysis of Stern v. Marshall in DBSI Opinion

Stern v. Marshall: Effects on Delaware

Background

The Opinion ruled on the Motion of the Trustee for New Trial to Amend or Make New Findings of Fact and Conclusions of Law with respect to certain allegedly preferential transfers.  The motion sought reconsideration of the Court’s Proposed Findings of Fact and Conclusions of Law issued on September 25, 2014, arguing that certain transactions should be ruled preferences, despite the Trustee having failed to adequately argued that point.

The Opinion

Judge Walrath’s first analysis in the Opinion is contained in paragraph 6 in which she states “[t]he Bankruptcy Court does not have the constitutional authority to enter a final order on the preference action because DTW never filed a claim in this bankruptcy case.”  She then cited to the Stern holding that “a preferential transfer claim can be heard in bankruptcy when the allegedly favored creditor has filed a claim . . . . If, in contrast, the creditor has not filed a proof of claim, the trustee’s preference action does not ‘become[] part of the claims-allowance process’ subject to resolution by the bankruptcy court.” 131 S. Ct. 2594, 2617 (2011).

This is one of few recent opinions on how the Stern holding will affect preference litigation in Delaware.  It should be remembered, however, that while the Bankruptcy Court only has the power to issue Findings of Fact and Conclusions of Law, there has yet to be a Delaware District Court opinion ruling contrary to the Bankruptcy Court’s recommendations regarding preference litigation (in this post-Stern era).  This is just one more nuance to the defense (or prosecution) of preference actions that any lawyer in this practice area needs to be aware of.

John Bird is a bankruptcy attorney with the law firm of Fox Rothschild LLP.  John is admitted in Delaware and regularly practices before the United States Bankruptcy Court for the District of Delaware. You can reach John at (302) 622-4263 or at jbird@foxrothschild.com.

Introduction

In July of 2011, the Chapter 7 Trustee (the “Trustee”) in the Ultimate Acquisition Partners (formerly “Ultimate Electronics”) bankruptcy began filing complaints to avoid and recover payments which the Trustee alleged were avoidable transfers under section 547 of the United States Bankruptcy Code.  Earlier this month, the Trustee filed another round of preference complaints seeking to recover what he contends are preferential transfers.  This post will look briefly at the Ultimate’s business, why the company filed for bankruptcy and provide some general information regarding defenses to a preference action.

Reasons Ultimate Electronics Filed for Bankruptcy

Prior to going in to bankruptcy, Ultimate Electronics sold high-end home entertainment and consumer electronics throughout the western and mid-western United States.  Based in Thornton, Colorado, Ultimate Electronics employed approximately 1,500 employees before it filed for bankruptcy.  According to pleadings filed with the Delaware Bankruptcy Court, Ultimate attributed its bankruptcy filing to a “significant downturn in business at certain of the Debtors’ locations, coupled with refusal by certain of Debtors’ vendors to ship goods to the Debtors on open credit.”  By filing for bankruptcy, Ultimate was hoping to close under performing stores, re-negotiate its leases and improve its profitability.

Conversion from Chapter 11 to Chapter 7

Plans quickly changed for Ultimate after the company filed for bankruptcy.  Nine days after filing for bankruptcy, on February 4, 2011, the company filed a motion with the Bankruptcy Court seeking approval of going out of business sales.  Within two months of filing the going out of business motions, Ultimate had sold substantially all of its assets.

On April 25, 2011, Ultimate Electronic’s DIP lender issued a “Termination Event” under Ultimate’s Final Cash Collateral Order (the “DIP Order”).  Under the DIP Order, if the lenders’ termination notice is not contested within five business days, the automatic stay is lifted in favor of Ultimate’s DIP lender.  Ultimate filed its Motion to Convert to Chapter 7 one day after receiving the Termination Event.  The Bankruptcy Court converted Ultimate’s bankruptcy to a Chapter 7 liquidation on May 3, 2011.  The following day, Alfred T. Giuliano was appointed the Chapter 7 Trustee for Ultimate Electronic’s bankruptcy proceeding.

The Preference Actions

The Trustee in the Ultimate Electronics bankruptcy is represented by the law firm Pachulski Stang Ziehl & Jones LLP.  The bankruptcy proceeding, along with the preference actions filed by the Trustee, are before the Honorable Mary F. Walrath.  Judge Walrath is a former Chief Judge of the Delaware Bankruptcy Court.

For reader’s looking for more information concerning preference litigation, attached is a booklet I prepared on the subject:  “A Preference Reference:  Common Issues that Arise in Delaware Preference Litigation.”

Introduction

In January, Jeoffrey L. Burtch, the Chapter 7 Trustee (the “Trustee”) in the ManagedStorage bankruptcy proceeding, commenced adversary proceedings in the Delaware Bankruptcy Court against various defendants.  As alleged in the complaints, the Trustee claims that the defendants received “preferential” payments from ManagedStorage (dba “Incentrix Solutions” or “Incentrix”) and that the payments are subject to avoidance and recovery under the United States Bankruptcy Code (the “Bankruptcy Code”).  This post will look at the Incentrix bankruptcy, why the company filed for bankruptcy as well as some of the issues that arise in preference litigation.

The Bankruptcy Proceeding

Incentrix filed Chapter 11 petitions for bankruptcy in February of 2009.  At the time the company filed for bankruptcy, it was based in Denver, Colorado and operated offices in Illinois, Washington, California, New Jersey, Pennsylvania, New York, Oregon, Texas, Colorado and the United Kingdom. According to a Declaration of Incentrix’s Chief Financial Officer (the “Declaration” or “Decl.”), the company’s business consisted primarily of the resale of technology hardware and software products, as well as maintenance contracts.  Decl. at *3.  Aside from its resale business, the company also provided managed IT services.  Decl. at *3.

Events Leading to Bankruptcy

Approximately two years prior to filing for bankruptcy, Incentrix entered into a secured revolving loan agreement (the “Revolver”) with certain of its lenders.  Under the Revolver, Incentrix could borrow up to $20 million.  In 2008, following the recession in the U.S. and Europe, Incentrix’s customers began delaying the purchase of IT hardware and software.  As a result of the drop in sales, Incentrix was unable to generate sufficient “trade receivables collateral” under the Revolver.  Without funding under the Revolver, Incentrix could not pay its trade creditors in a timely manner.  Decl. at *17. This, in turn, led to Incentrix’s vendors placing the company on a “credit hold,” further reducing the company’s ability to generate trade receivables collateral.  Decl. at *18.

The Preference Actions

On November 3, 2010, the Bankruptcy Court entered an order converting Incentrix’s bankruptcy proceeding from a chapter 11 reorganization to a chapter 7 liquidation.  The Trustee was appointed as Chapter 7 Trustee one day later, on November 4, 2010.  As alleged in the complaints, the Trustee seeks the avoidance and recovery of transfers pursuant to sections 547 and 550 of the Bankruptcy Code.

The Incentrix bankruptcy, as well as the preference actions commenced by the Trustee, are before the Honorable Mary F. Walrath.  Judge Walrath previously served as Chief Judge of the Delaware Bankruptcy Court.  The Trustee in Incentrix is represented by the law firm Cooch and Taylor, P.A..

On August 7,  2009, Meridian Automotive Systems (“Meridian”) filed a voluntary petition for relief under chapter 7 of the United States Bankruptcy Code.  Soon after Meridian filed its petition for bankruptcy, the Office of the United States Trustee appointed George L. Miller to serve as the chapter 7 trustee (the “Trustee”) for the Meridian bankruptcy estates.  Approximately one month before Meridian filed for bankruptcy, on July 6, 2009, Meridian entered in to an agreement to sell substantially all of its assets (the “Asset Purchase Agreement” or “APA”) to Ventra Greenwich Holdings, Corp. (“Ventra”), and its related entities.

A “typical” preference action includes allegations that in the ninety days prior to the debtor’s petition date, the debtor made one or more transfers to a creditor and such transfers constitute avoidable preferences.  The allegations in the Meridian preference complaints, however, take a different approach.  As alleged by the Trustee in the complaints,  under the Asset Purchase Agreement, Ventra assumed Meridian’s liabilities for certain account payables to trade creditors of Meridian.  See Trustee’s Complaint at *4.  The Trustee argues that the assumed liabilities under the APA include the antecedent debt that was owed by Meridian to various creditors.  Compl. at *4.

The Trustee further argues that the liabilities assumed under the APA constituted a “transfer” as defined under the Bankruptcy Code, as the assumed liability:

… was an indirect mode of transferring property or an interest in property.  Specifically,  the Selling Debtors by the Indirect Transfers effectively transferred to the Defendant on the Closing Date its right to receive a portion of the sale price equal to the amount of the debt.  In addition the Indirect Transfers were transfers to or for the benefit of the creditor, in that the APA required that Ventra ‘pay discharge or perform when due’ the Defendant’s Assumed Liabilities.

Compl. at. *4.

Within the preference complaint, the Trustee cites a Seventh Circuit decision, Warsco v. Preferred Technical Group, 258 F.3d 557 (7th Cir. 2001), for the proposition that an avoidable transfer does not need to come directly from a debtor to a creditor.  Instead, transfers by a third party to a creditor on the debtor’s behalf may also be avoidable under the Bankruptcy Code.  Compl. at *4-5, citing Warsco 258 F.3d at 564.  Absent from the Trustee’s complaints are citations to case law from either the Third Circuit or District of Delaware on the voidability of transfers from a non-debtor third party to a creditor.

The Meridian bankruptcy, as well as the adversary proceedings commenced by the Trustee, are before the Honorable Mary F. Walrath.  Judge Walrath previously served as Chief Judge of the Delaware Bankruptcy Court.  The Trustee for the Meridian bankruptcy estate is represented by the law firm Cozen O’Connor.

Last month, Jeoffrey Burtch, the Chapter 7 Trustee (the “Trustee”) in the Opus East bankruptcy filed approximately 90 preference actions against various defendants.  As stated in his complaints, the Trustee “seeks to avoid and recover … all preferential transfers of property made for or on account of an antecedent debt made to or for the benefit of the Defendant by the Debtor during the ninety-day period prior to the filing of the Debtor’s bankruptcy petition under 11 U.S.C. sec. 547 and 550.”  This post will look briefly at the Opus East bankruptcy proceeding, as well as provide some general information concerning defenses to preference litigation.

Opus East, LLC (“Opus East”) filed a voluntary petition for relief under the Bankruptcy Code on July 1, 2009.  Instead of filing a chapter 11 petition for reorganization, Opus East filed a chapter 7 petition for liquidation.  On July 2, 2009, the Office of the United States Trustee appointed Jeoffrey Burtch as Trustee.  Prior to filing for bankruptcy, Opus East developed residential and commercial properties.  According to court papers filed by one of Opus East’s lenders, Opus East originally intended to reorganize under chapter 11 and surrender various assets to the bank.  Once the company determined that it was unable to reach an agreement with its lenders, Opus East sought to liquidate under the Bankruptcy Code.

At present, it appears that the Trustee has filed the preference complaints with the Court, but not the summons.  Once filed, the summons will likely include an initial pretrial conference date and a certificate of service.  It is common for a plaintiff in a preference action to serve complaints by mail. Below is a prior post I have written that addresses the validity of service by mail in bankruptcy proceedings:

Decision in Custom Food Products Looks at Requirements for Service By Mail

The Opus East bankruptcy, as well as the preference actions filed by the Trustee, are before the Honorable Mary F. Walrath.  Judge Walrath is a former Chief Judge of the Delaware Bankruptcy Court.  The Trustee in these proceedings is represented by the law firm Cooch & Taylor, P.A.

In August, the Chapter 7 Trustee in the National Wholesale Liquidators (“NWL”) bankruptcy filing approximately 90 preference actions.  Just recently,  the Trustee filed over 100 more preference actions in NWL.  In November of 2008, I wrote about the commencement of NWL bankruptcy (read my prior post concerning the NWL bankruptcy here).  As indicated in the prior post, NWL filed for bankruptcy in agreement with its lenders that it would either find a buyer while in bankruptcy, or convert and liquidate under Chapter 7 of the Bankruptcy Code.  The NWL bankruptcy converted to Chapter 7 on February 26, 2009.

The Chapter 7 Trustee hired Archer and Greiner to represent him in this bankruptcy proceeding.  Pursuant to the summons filed with the most recent preference actions, the Court scheduled a pretrial conference on February 16, 2011.  These adversary actions, as well as the NWL bankruptcy proceeding, are before the Honorable Mary F. Walrath.  Judge Walrath previously served as Chief Judge of the Delaware Bankruptcy Court.

Introduction

Earlier this month, the Chapter 7 Trustee (the “Trustee”) in the Consolidated Bedding bankruptcy commenced several avoidance actions under sections 547 and 548 of the Bankruptcy Code.  Consolidated commenced this bankruptcy proceeding on May 29, 2009, when it filed petitions for bankruptcy under Chapter 7 of the Bankruptcy Code.  Consolidated manufactured and sold mattresses under the trade name “Spring Air.”  According to documents filed with the Delaware Bankruptcy Court, Consolidated ceased operations and terminated its employees prior to filing for bankruptcy.

Events Leading to Bankruptcy

On May 13, 2009 (two weeks before filing for bankruptcy), certain lenders of Consolidated sent notices of default under the company’s loan agreement.  Soon after, the lenders accelerated Consolidated’s loan obligations and demanded repayment.  Approximately two weeks after sending the notice of default, Consolidated and its lender entered into a foreclosure agreement whereby the company agreed to sell substantially all of its assets to Spring Air International LLC.  After the sale to Spring Air International, Consolidated filed for bankrupty and the Trustee was appointed.

The Avoidance Actions

As of the date of this post, the Trustee has filed over 80 avoidance actions against various defendants.  These adversary actions, as well as the main case, are before the Honorable Brendan L. Shannon.  The Trustee is represented by Archer & Greiner and ASK Financial LLP.

Introduction

On September 1, 2010, Judge Christopher S. Sontchi of the United States Bankruptcy Court for the District of Delaware issued a decision finding that the payment practices between a creditor and debtor satisfied the ordinary course of business defense.  Judge Sontchi’s decision is worth review as it provides a current look at one of the most common defenses to a preference action.  Better still, motions for summary judgment based on ordinary course of business often fail due to fact intensive nature of the defense.  It is helpful, then, to understand the reasons for the court granting summary judgment and the facts the court found significant.

Background

Archway Cookies (“Archway”) filed for chapter 11 bankruptcy protection on October 6, 2008.  Approximately three months after filing for bankruptcy, the company converted to a chapter 7 liquidation and a chapter 7 trustee (the “Trustee”) was appointed.  The Trustee commenced several avoidance actions, one of which was against Detroit Forming, Inc. (“DFI”).  DFI manufactures plastic trays which it sold to Archway for approximately two years prior to the petition date.  Pursuant to the parties agreement, DFI shipped goods to Archway on net 20 day payment terms.  Opinion at *3.

Preference Analysis

Section 547(c)(2)(A) of the Bankruptcy Code permits a recipient of an otherwise avoidable transfer to keep the transfer if it was made “in the ordinary course of business or financial affairs of the debtor and the transferee.”  11 U.S.C. Sec. 547(c)(2)(A).  The party relying on the defense carries the burden of proof by a preponderance of the evidence.  Opinion at *9.

The court in Archway considered two time periods in deciding whether the payments made to DFI fell within the ordinary course of business safe harbor.  From October 6, 2206 to July 7, 2008, Archway paid DFI’s invoices between 21 and 177 days after invoice (the “Historical Period”).  Further, from July 8, 2008 to October 6, 2008 (the “Preference Period”), Archway paid DFI’s invoices between 33 and 64 days after invoice.  Opinion at *3-4.

Relevant Factors

There are two ways to prove the ordinary course of business defense:  the “subjective test” and the “objective test”.  The subjective test looks to whether the transfers between the parties were made in the ordinary course of business.  The objective test, on the other hand, looks to whether the transfers were made according to “ordinary business terms.”  In Archway Cookies, DFI argued that the payments it received from Archway were protected under the “subjective test” (i.e. the payments were ordinary as between Archway and DFI).

In deciding whether to apply the ordinary course of business defense using the subjective analysis, the Court looked at factors such as (1) the length of time the parties engaged in the type of dealing at issue; (2)  whether the transfers were in an amount greater than what was usually paid; (3) whether the payments at issue were made in a manner different from prior payments; (4) whether there was unusual collection activity; and (5) whether the creditor did anything to gain an advantage over the debtor.  Opinion at *11-12.

Court’s Analysis

The court first considered the length of the parties’ relationship.  This is significant because in deciding whether to apply the ordinary course of business defense, the court had to determine whether the parties’ relationship was of “recent origin” or one that is “cemented long before the onset of insolvency.”  Opinion at 12-13, citing In re Molded Acoustical Products, Inc., 18 F.3d 217, 219 (3d Cir. 1994).  Archway and DFI had a two-year relationship during which there were 117 transactions between the parties. Opinion at *13.  Based on this time period and the number of transactions, the court found that the relationship was of “sufficient length to establish an ordinary course of dealing between the parties.”

Next, the court looked at the similarity of transactions in the Historical Period and the Preference Period.  Based on the facts before it, the court found there was no evidence that the payments were inconsistent with the practices between the parties.  By this, payments during the Historical Period ran from 21 to 177 days, averaging 42.3 days.  During the Preference Period, payments ranged from 41 to 64 days, averaging 47.2 days to pay.  Opinion at *15.  This difference, the court found, was not material.  Further, the Trustee presented no evidence of differing payment practices between the parties.  Id. Based upon these findings, the court found that the practices between the parties were consistent with their historical dealings and summary judgment was appropriate.  Opinion at 17.

Conclusion

Preference actions are fact senstive proceedings that often center around the course of dealings between the parties. The Archway decision reminds readers that creditors can, in some instances, establish a solid ordinary course relationship in a relatively short amount of time – two years.  Further, Archway shows that the range of payments may vary, yet still remain within the protections of the ordinary course of business defense.  A copy of the court’s decision in Archwary is available here.

Recently, the Chapter 7 Trustee (the “Trustee”) in the HRP Myrtle Beach Holdings bankruptcy, filed several avoidance actions pursuant to sections 547, 548, and 549 of the Bankruptcy Code.  The avoidance actions, filed in the United States Bankruptcy Court for the District of Delaware, are before the Honorable Kevin J. Carey, Chief Judge of the Delaware Bankruptcy Court.  For those not familiar with the HRP bankruptcy proceeding, this post will look briefly at the nature of HRP’s business and why the case ultimately converted to a chapter 7 liquidation.

HRP Myrtle Beach Holdings, LLC (“HRP”) is the parent company of various subsidiaries and affiliates that owned and operated the Hard Rock Park theme park, located in Myrtle Beach, South Carolina.  HRP marketed the theme park as the world’s first rock n’ roll theme park that highlighted the “culture, lifestyle and legends of rock music entertainment.”  See HRP’s Declaration in Support of First-Day Pleadings (the “Declaration”) at *3.  Situated on 140 acres, HRP considered the $400 million property the largest investment to date in South Carolina tourism.  Id. at *4.

Despite its size and unique theme, HRP’s theme park suffered from low attendance following its opening in April 2008.  According to the Declaration, HRP blames poor attendance at its park on high energy and food costs, which in turn reduced overall consumer spending.  Declaration at *8.  In response to slumping sales, HRP filed for bankruptcy in September of 2008 hoping to restructure its debt and better develop its marketing and operations.  While in bankruptcy, HRP tried unsuccessfully to complete a sale of all of its assets under section 363 of the Bankruptcy Code.  Following the unsuccessful sale attempts, on January 2, 2009 HRP sought permission from the Bankruptcy Court to convert to a chapter 7 liquidation.  The Court approved the conversion to chapter 7 on January 6, 2009 and the Trustee was appointed soon after.