Summary

In an opinion issued January 4, 2012, Judge Sontchi of the Delaware Bankruptcy Court provided an easy to follow primer in preference law in the course of granting in part and denying in part a preference defendant’s motion for summary judgment. Judge Sontchi’s opinion is available here (the “Opinion”).  The Opinion provides an excellent framework for all preference defendants to understand why preference laws are in place and the reasoning behind their existence. The first half of the Opinion would make a fantastic introduction to any discussion of two of the most common preference defenses, the “ordinary course of business” and “new value” defenses. Please bear in mind, however, that the Opinion was issued in response to a motion for summary judgment, which applies different standards than an opinion written following a complete trial. The below blog posts address other opinions written in response to motions for summary judgment:

SemCrude Decision Delineates the Process for Analyzing Motions for Continuance vs. Motions for Summary Judgment

Decision in DBSI Delays Motion for Summary Judgment

Decision in New Century TRS Holdings, Inc. Holds That Publication in 2 Newspapers is Insufficient to Grant a Motion for Summary Judgment

Background

In 2008, Sierra Concrete Design, Inc. and Trevi Architectural, Inc. (the “Debtors”) filed for bankruptcy in the District of Delaware. As a part of their bankruptcy proceedings, the Trustee who was appointed to handle their bankruptcy proceedings, Jeoffrey L. Burtch, filed a number of preference actions against entities which had been paid by the Debtors within the ninety-day period prior to the Debtors’ bankruptcy filings. In one of these preference cases, Revchem Composites, Inc. was a named defendant. Revchem eventually filed a motion for summary judgment, arguing that the payments made to it were protected from recovery by exceptions built into the Bankruptcy Code – the “ordinary course of business” and “subsequent new value” defenses. Opinion at *4.

Judge Sontchi’s Opinion

Judge Sontchi begins the Opinion by asking, “Why is there a preference law?” Opinion at *1. He then spends the next several pages explaining what would happen in the absence of preference laws and how the ensuing strong-arm tactics and efforts by creditors to collect payment would harm businesses in general.

The two preference defenses discussed in the Opinion are (1) the ordinary course of business defense and (2) the subsequent new value defense. The ordinary course of business defense has two ways in which in can be applied. First, did you treat the Debtor the same way you always did, and did the Debtor pay you the same way they always did? If you can answer this two-part question yes, and you have a history of working with this company, you are likely protected. In this case, Judge Sontchi opines that “17 checks covering approximately 68 invoices over an 11 month period” is “insufficient evidence….” Opinion at *7. The second way in which the ordinary course of business defense can apply, is if your interactions with the Debtor were ordinary for your industry. This requires a defendant to present evidence relating to standard industry practice. This evidence will normally be provided by an expert witness who has studied the preference defendant’s industry and who testifies in court, under oath, that the interactions were ordinary. Take note, however, that “a one-paragraph, conclusory allegation” is insufficient evidence to uphold the ordinary course of business defense. Opinion at *7.

The new value defense allows a creditor to limit their preference exposure before a bankruptcy occurs. If, for example, a debtor has a line of credit for $1,000 that it maxes out and repays four times in the ninety-day period before declaring bankruptcy, it would make no sense for the creditor to be liable for $4,000 of preferences. On page 9 of the Opinion, Judge Sontchi provides an example of how the new value defense is applied, and I have recreated the chart here:

Date Preference Payment New Value Preference Exposure
1/1/2010 $1,000 $1,000
1/5/2010 $1,000 $0
1/10/2010 $1,000 $1,000
1/15/2010 $2,000 $0 (not -$1,000)
1/30/2010 $3,000 $3,000
2/5/2010 $1,000 $2,000
2/10/2010 $1,500 $3,500
Net Result $3,500

As illustrated by the chart, any value provided after a payment will reduce (or eliminate) the preference exposure. However, this defense only tracks new value, so any new value provided will not be applied to later payments. Applying the new value analysis is an exercise based entirely on the record of payments to the preference defendant and the record of goods/services provided to the debtor by the preference defendant. In the Opinion, Judge Sontchi applied this analysis to limit the maximum preference liability of the defendant. Opinion at *10. Thus, this motion for summary judgment was allowed in part and denied in part.

The preference discussion in the Opinion is comparatively easy to follow, and I highly recommend anyone with an interest in preference actions review this decision. Not only is it an explanation suited to attorneys, but its marked lack of technical jargon makes this an opinion accessible to those who would consider themselves legal novices. Ultimately, it comes down to this – If you do business and get paid the same way you always have, you may not have to repay the preference. Or, if you provide the Debtor with some value after you get paid, you may not have to repay all of the preference. Just remember, every situation is different, and getting a professional’s help early in a preference case may save you money in the end.

Summary

In an 11 page decision signed June 30, 2011, Judge Walrath of the Delaware Bankruptcy Court granted a motion to dismiss, holding that a preference complaint must clearly identify the alleged preference transferee. Judge Walrath’s opinion is available here (the “Opinion”).  A number of decisions on motions to dismiss under Federal Rule of Civil Procedure 12(b)(6) have been released recently. If you’d like to review some of these rulings, the following blog posts provide a solid start:

Decision in Tweeter Opco Once Again Reminds Trustees of the Specificity Requirement in Pleading Preference Actions

Decision in Crucible Materials Requires Preference Claims to Contain More Than Just Recitations of the Code

Decision in DBSI Inc., Holds that the “Particularity” Requirement of F.R.C.P. 12(b)(6) and 9(b) was Satisfied, Notwithstanding the Number of Alleged Fraudulent Transfers

Background

Everything But Water, LLC (the “Debtor”) and certain of its affiliates filed for bankruptcy under chapter 11 on February 25, 2009. The case was converted to chapter 7 and Montague Claybrook was appointed as the trustee (the “Trustee”) on July 30, 2009. The Trustee filed a complaint against JDH Management (“JDH”) and various affiliates of Bear Stearns in which he asserted claims for preferential and fraudulent transfers. In response, JDH filed a motion to dismiss for failure to state a claim under FRCP 12(b)(6), arguing both that JDH did not have a relationship with the Bear Stearns entities that would create a liability and that the Trustee failed to adequately state a claim. The Opinion was written in response to JDH’s motion.

Judge Walrath’s Opinion

Judge Walrath’s legal analysis begins with a discussion of the standard for ruling on motions under FRCP 12(b)(6). She cites the usual suspects, including Ashcroft v. Iqbal, 129 S. Ct. 1937 (2009); Bell Atl. Corp. v. Twombly, 550 U.S. 544, 570 (2007); Fowler v. UPMC Shadyside, 578 F.3d 203 (3d Cir. 2009); and Kost v. Kozakiewicz, 1 F.3d 176 (3d Cir. 1993). Opinion at *4-5. Judge Walrath then turns to JDH’s assertion that it has no affiliation with the Bear Stearns entities in question. Because the Court must accept the non-moving party’s factual allegations as true in considering a motion to dismiss, Judge Walrath had to accept the Trustee’s allegations that JDH was affiliated with the Bear Stearns entities in question. Opinion at *6.

Judge Walrath then moved to an analysis of the preferential and fraudulent transfer claims. She cited In re Valley Media, Inc., 288 B.R. 189, 192 (Bankr. D. Del. 2003) in opining that “to survive a motion to dismiss a claim for avoidance of a preferential transfer, the Plaintiff must plead the following: (a) an identification of the nature and amount of each antecedent debt and (b) an identification of each alleged preference transfer by (i) date, (ii) name of debtor/transferor, (iii) name of transferee and (iv) the amount of the transfer.” Opinion at *6. Judge Walrath held that “the Trustee’s Complaint is deficient because it contains no information regarding who received any of the transfers.” Thus, the “Trustee does not meet the pleading requirements for preferential transfers.” Opinion at *8. Judge Walrath also states that the “Trustee’s Complaint fails to plead properly a claim for avoidance of fraudulent transfers for the same reason….” Opinion at *9. Because of the deficiencies in the complaint, Judge Walrath grants the motion to dismiss, but in an effort to preserve fairness given the technicality of the reason for dismissal, she explicitly allows the Trustee to file an amended complaint. Opinion at *11.

In some situations, minor mistakes are all that it takes to leave a filing vulnerable to a motion to dismiss under FRCP 12(b)(6). Recent opinions published by the judges in the Delaware Bankruptcy Court seem to indicate that they are becoming more strict in their interpretation of pleading requirements. Regardless of which side of a preference action you are on, knowledge of the ever changing local rules and precedents is vital to successful litigation, or settlement.

Summary

In a 12 page decision signed July 6, 2011, Judge Walrath of the Delaware Bankruptcy Court granted a motion to dismiss, holding that a complaint that sets forth only conclusory allegations parroting the statutory language of the Bankruptcy Code is insufficient. Judge Walrath’s opinion is available here (the “Opinion”).

Background

Crucible Materials Corporation (“Crucible”) produced steel products, primarily for automotive manufacturers. Following the disruption in the American auto industry, Crucible filed for bankruptcy. Judge Walrath confirmed the plan of reorganization of Crucible and certain of its affiliates (the “Debtors”) on August 26, 2010.  At the same time, Richard D. Caruso was appointed Litigation Trustee (the “Trustee”).

On November 8, 2010, the Trustee filed an adversary proceeding (the “Complaint”) against The Lenick Company (the “Defendant”) to avoid transfers pursuant to section 547 (“Count 1″), to avoid fraudulent conveyances pursuant to section 548 (“Count 2″), to recover post-petition transfers pursuant to section 549 (“Count 3″), to recover property transferred pursuant to section 550 (“Count 4″), and to disallow any claims the Defendant may have pursuant to section 502 (“Count 5″). On January 12, 2011, the Defendant moved to dismiss the complaint pursuant to Rule 12(b)(6). Counts 2 and 3 were withdrawn by the Trustee and the Defendant withdrew its motion regarding the same two counts.

In its motion to dismiss, the Defendant argued that the Trustee’s failure to include proof of the transfers and the lack of detail concerning the transfers made the complaint insufficient to provide notice of what transfers the Trustee sought to avoid. Opinion at *6. Rather, the Defendant argued that “the Trustee simply asserts the elements of section 547(b) and relies on legal conclusions rather than factual assertions.” Opinion at *7. The details that the Trustee included were: the name of the transferee, check numbers, check amounts, invoice dates, invoice numbers, and the clear dates of the transfers. Id. The Trustee argued that this was sufficient detail to put the Defendant on notice and survive the motion to dismiss.

Judge Walrath’s Opinion

Judge Walrath’s legal analysis begins with a fairly standard analysis of the requirements of a motion to dismiss under Federal Rules of Civil Procedure (“FRCP”) 12(b)(6). A pair of posts discussing opinions that detail the requirements of a motion to dismiss are below:

Decision in Tweeter Opco Once Again Reminds Trustees of the Specificity Requirement in Pleading Preference Actions

Decision in DBSI Inc., Holds that the “Particularity” Requirement of F.R.C.P. 12(b)(6) and 9(b) was Satisfied, Notwithstanding the Number of Alleged Fraudulent Transfers

Following her summary of the precedent surrounding a motion to dismiss, Judge Walrath turned to a discussion of each of the three counts remaining in the Complaint. In examining the motion to dismiss Count 1, Judge Walrath held that the Trustee must identify the transferor by name (which debtor received the transfer), and must include information detailing the nature of the antecedent debt. Without any proof of an antecedent debt or creditor/debtor relationship, the complaint fails. Opinion at *8-10. Judge Walrath continued by acknowledging that Count 4 is derivative of Count 1, and the failure of Count 1 necessarily requires Count 4 to likewise be dismissed. Opinion at *10-11. Similarly, Count 5 is derivative of Count 1, and would also be dismissed. Opinion at *11.

Judge Walrath concluded by quoting FRCP 15(a), which states that “leave to amend shall be freely given when justice so requires.” Opinion at *12. Because the Defendant provided no reasons why leave to amend should not be granted, Judge Walrath determined that justice would best be served by granting the requested leave to amend. Id.

When arguing for a dismissal of a complaint, never forget to include argument as to why the plaintiff should not be granted leave to amend. Some attorneys may think that a mention of FRCP 15 will give their opponent the idea to argue for amendment. However, failing to argue that leave should not be granted means that any argument to the contrary by opposing counsel, almost guarantees that leave to amend will be granted.

Summary

In an 11 page decision signed June 22, 2011, Judge Walsh of the Delaware Bankruptcy Court denied a motion to dismiss, holding that the Bankruptcy Court of the District of Delaware has personal jurisdiction over an insider of a debtor when the debtor files for bankruptcy in the District of Delaware. Judge Walsh’s opinion is available here (the “Opinion”).  DBSI’s preference actions have resulted in Judge Walsh publishing a number of opinions. Here are some of our prior posts dealing with DBSI preference actions:

Decision in DBSI Delays Motion for Summary Judgment

Decision in DBSI Inc., Holds that the “Particularity” Requirement of F.R.C.P. 12(b)(6) and 9(b) was Satisfied, Notwithstanding the Number of Alleged Fraudulent Transfers

Trustee In DBSI Bankruptcy Files Adversary Actions

Background

DBSI and certain of its affiliates filed for bankruptcy on November 6, 2008. A plan of liquidation was confirmed October 26, 2010, and a Litigation Trust was formed. The Litigation Trustee was given the power to pursue the Debtors’ causes of action, including bringing lawsuits to recover preference payments and fraudulent transfers.

The Litigation Trustee brought a claim against certain DBSI insiders, including Thomas Var Reeve, alleging fraudulent transfers were made to these insiders prior to DBSI’s bankruptcy. Opinion at *2. Mr. Reeve moved to dismiss the complaint under Federal Rules of Civil Procedure 12(b)(2), arguing that he did not have any contact with Delaware, so the preference action against him should have been brought in Idaho, where his interactions with DBSI occurred. Opinion at *3-4. The Trustee raised three arguments in response to the motion to dismiss: (1) the confirmed Plan provided for Delaware to retain jurisdiction, (2) Rule 7004 provides for nationwide service of process, and (3) Reeves either has sufficient contact with Delaware or would not be severely burdened by litigating in Delaware. Opinion at *4.

Judge Walsh’s Opinion

Judge Walsh’s legal analysis begins with the quote “When the court does not hold an evidentiary hearing on the motion to dismiss, the plaintiff need only establish a prima facie case of personal jurisdiction and is entitled to have its allegations taken as true and all factual disputes drawn in its favor.” Opinion at *5, citing Charan Trading Corp. v. Uni-Marts, LLC (In re Uni-Marts, LLC), 399 B.R. 400, 406 (Bankr. D. Del. 2009). Judge Walsh then turned to a discussion of nationwide service of process, holding that because Congress allows for this wide ranging service, federal courts have equally broad jurisdiction. Opinion at *6.

Judge Walsh also examined the relative burden upon Reeve of litigating in Delaware and upon the bankruptcy estate should litigation occur in Idaho. Reeve did not argue that he was unable to afford to litigation in Delaware and he is alleged to have received over $6 million in transfers from DBSI in the four years prior to DBSI’s bankruptcy. Opinion at *9. If Reeve were allowed to remove his trial to Idaho, it is likely that the other five defendants in this preference action would have to testify in Idaho and Delaware, creating unnecessary expenses for the estate. Opinion at *9-10. Thus, Judge Walsh determined that the motion to dismiss should be denied.
Judge Walsh finished his opinion by addressing the section of the Bankruptcy Code concerning jurisdiction, 28 U.S.C. § 1409. Section 1409(b) creates a very limited exception to the presumption that the Bankruptcy Court in which the bankruptcy filing occurred is the proper venue for any preference actions. The exception provides that claims against non-insiders for less than $11,725 may only be brought in the district court for the district in which the defendant resides. In this case, however, the claim is both in excess of $11,725 and against an insider, making this limited exception inapplicable.

Jurisdiction and Venue in a bankruptcy proceeding are difficult to challenge. As Judge Walsh stated, Congress created a very limited venue restriction in 28 U.S.C. § 1409(b) for claims brought against non-insiders for less than $11,725. Trustees who operate in Delaware are well aware of the venue restrictions, making it very difficult for defendants of preference actions to successfully remove a claim on the grounds of improper venue.

Summary

In an 11 page opinion published June 14, 2011, Judge Walrath ruled that a Chapter 7 Trustee’s lack of specificity in pleading a preference action was grounds for dismissal under FRCP 12(b)(6). Judge Walrath’s opinion is available here (the “Opinion”).

Background

Tweeter Opco, LLC and its affiliates (the “Debtors”), filed voluntary petitions for bankruptcy on November 5, 2008. On December 5, 2008, the case converted to a chapter 7 liquidation and George L. Miller was appointed as the chapter 7 trustee (the “Trustee”). On November 2, 2010, the Trustee brought an action against Mitsubishi Digital Electronics America In. (“Mitsubishi”) to recover alleged preference payments. The Opinion was given in response to Mitsubishi’s motion to dismiss the complaint under FRCP 8(a) and 12(b)(6).

Judge Walrath’s Opinion

In the Opinion, Judge Walrath cited heavily from Supreme Court opinion. In this Opinion, she made numerous citations to Bell Atl. V. Twombly, 550 U.S. 554 (2007) and Ashcroft v. Iqbal, 129 S. Ct. 1937 (2009). These cases dealt extensively with the standards necessary for a pleading to survive a motion to dismiss. Judge Walrath also quoted Valley Media Inc. v. Borders, Inc. (In re Valley Media, Inc.), 288 B.R. 189 (Bankr. D. Del. 2003), for the requirement that in addition to the statutory elements of a preference, a preference pleading must include: “(a) an identification of the nature and amount of each antecedent debt and (b) an identification of each alleged preference transfer by (i) date [of the transfer], (ii) name of debtor/transferor, (iii) name of transferee and (iv) the amount of the transfer.” Opinion at *6.

In the instate case, Mitsubishi argued that the complaint should be dismissed under FRCP 12(b)(6) as it (i) failed to identify the nature of the antecedent debt, (ii) failed to allege which Debtor made the payment, and (iii) failed to describe the relationship between the transferor and Mitsubishi. Opinion at *6. Judge Walrath agreed with Mitsubishi’s arguments and held: (i) “the Trustee must identify the transferor precisely by name,” Opinion at *9; (ii) the Trustee has not “provided Mitsubishi with sufficient detail regarding the nature of the transfer in this proceeding,” Opinion at *9; and (iii) that without “detail of any relationship between the Debtors and Mitsubishi,” “the Trustee has failed to describe sufficiently the nature of the antecedent debt,” Opinion at *10.

Judge Walrath then followed the provisions of FRCP 15(a), which provides “leave to amend shall be freely given when justice so requires.” Despite Mitsubishi’s argument that amendment should not be allowed, Opinion at *10, Judge Walrath held that there was sufficient basis to allow the addition of the lacking detail to the Complaint. So while she granted the motion to dismiss, Judge Walrath also granted leave for the Trustee to amend the Complaint. Opinion at *11.

A Motion to Dismiss is an extreme remedy, and in order to ensure justice, Courts will often allow a party whose complaint is dismissed to amend their complaint, if that could resolve the complaint’s legal inadequacies. In situations where a court lacks jurisdiction, or a complaint is filed in the wrong venue, however, amending the complaint won’t solve the problem. In those types of instances, the dismissal will not include the option to amend the complaint.