The Honorable Christopher S. Sontchi

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 29, 2017, The Wet Seal, LLC filed preference actions against 67 defendants.  The lead Wet Seal bankruptcy case is Case No. 17-10229 in the Bankruptcy Court for the District of Delaware.  Wet Seal is represented by A.M. Saccullo Legal, LLC and ASK, LLC.

According to the complaints, the Debtors were a national multichannel specialty retailer selling fashion apparel and accessory items designed for female customers aged 18 to 24 years old. The Debtors were comprised of two primary business units; the retail store business and an e-commerce business. Through their retail store business, the Debtors operated approximately 142 retail locations in 37 states, principally in leased-based mall locations. Through their e-commerce business, the Debtors operated an e-commerce site at  and had over 2 million followers on their Facebook page.  As retailers, they had a significant supply chain, comprised of a significant number of suppliers.  The defendants in these preference actions were entities who were alleged to have received payments within the 90-day period immediately preceding Wet Seal’s February 2, 2017 bankruptcy filing.

 

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.”

In a 33 page decision released March 29, 2017, Judge Sontchi of the Delaware Bankruptcy Court ruled on competing motions to dismiss the remaining claims and counterclaims in an adversary proceeding in the Affirmative Insurance bankruptcy – Adversary Proceeding Case No. 16-50425.  Judge Sontchi’s opinion is available here (the “Opinion”).  As Judge Sontchi stated in the Opinion, the issue was a simple one, Opinion at *3, there is a dispute of a material fact between the parties, and dismissal is therefor inappropriate.  Opinion at *4.

The issue arises as the result of the allocation of sales proceeds between parties with a claim on the debtor’s assets.  The plan appointed liquidator (the “AIC Liquidator”) asserts that the funds from the sale should be in its control pursuant to the plan, and held in trust to pay the estate’s tax liability.  Opinion at *12.  JCF AFFM Debt Holdings, L.P. (“JCF”) is the other party in interest in the Opinion.  JCF was a major lender to the debtor, and claimed to hold a validly perfected security interest in the account into which the sales proceeds were eventually deposited.

JCF had filed the complaint that initiated the adversary proceeding.  The AIC Liquidator filed its counterclaims and also moved to dismiss for lack of subject matter jurisdiction, arguing that this was a conflict between two creditors with no impact on the Debtor.

Judge Sontchi first addressed the argument of subject matter jurisdiction, determining that “the threshold question here is whether the funds [at issue] are property of the estate or not.”  Opinion at *21.  As Judge Sontchi ruled, the account at issue is in the name of the Debtor, and accordingly, “its funds are presumably property of the estate under section 541(a) of the Bankruptcy Code.” Opinion at *26. Citing In re BankUnited Financial, Judge Sontchi instructed that “what is or is not property of a bankruptcy estate is an issue that stems from the bankruptcy itself, one that can only arise in a bankruptcy proceeding…”  Opinion at *28.

On pages 31 and 32 Judge Sontchi examines the counterclaims and whether they should be dismissed.  It is interesting to note that a key aspect of his analysis, as I read the Opinion, is the remedy sought in the counterclaims – establishment of a constructive trust.  Judge Sontchi states: “The imposition of a constructive trust may be an appropriate remedy for any of the causes of action asserted.  Thus, if the AIC Liquidator prevails on any of the counterclaims it would be determinative of the ultimate issue of whether the funds are property of the estate. The Court finds that the Counterclaims contain specific factual allegations, taken they are true, to suggest that the AIC Liquidator is entitled to the funds in the …Account.. As such, it is apparent that there is a dispute of a material fact.”  I can’t help but wonder, if the counterclaims had sought relief of a different sort, such as damages, would the outcome have been the same?

At the end of the day, it’s hard to argue that a bankruptcy court doesn’t have jurisdiction over a matter that can, by definition, only arise in a bankruptcy – including determining what constitutes a debtor’s estate.  The determination of what is property of a debtor’s estate is a highly fact sensitive issue, and if there are facts in dispute, it is unlikely that a motion for summary judgment or a motion to dismiss will be granted.  We will, no doubt, continue to see them filed as they play an important role in narrowing the scope of a conflict, but in my experience and observation of the bankruptcy court, they are denied far more frequently than they are granted.

On February 28, 2017, Judge Sontchi of the Delaware Bankruptcy Court issued an opinion (the “Opinion”) in the Money Center of America  bankruptcy – Bankr. D. Del., Case 14-10603.  The Opinion is available here.  This Opinion decided two separate, but similar, motions to dismiss filed by 2 entities owned by federally recognized Indian Tribes and sovereign nations (the “Tribes”).  Each of these Tribes owned a casino (through wholly owned entities) in which the Debtor placed ATMs and other cash advance services, in order to allow casino patrons ready access to funds.  The process that was followed in each case is that the Debtor would provide the ATM or service, the casino would advance the funds by providing payments and stocking the ATMs, and the Debtor would reimburse the casinos from the funds transferred by the patrons’ banks.  In this process, the Debtor would also charge the patrons a fee, funding its operations.

This was a process in which large sums of money flowed, but with little direct benefit to the casinos or the Debtor, as the majority of funds came from a patron’s bank and was paid to the patron.  Of course, I make no judgment as to how much additional profit this allowed the casinos to recognize, as the direct and initial transfers involved were to the patrons, through the casinos and Debtor.  Naturally, the Debtor was required to make frequent payments to the casinos as reimbursement for funds advanced and, following the Debtor’s bankruptcy filing and the appointment of the Trustee in this bankruptcy, significant preference and fraudulent conveyance lawsuits were initiated.

The Opinion

Judge Sontchi carefully weighs several issues in this Opinion, ultimately holding that (1) the Tribes sovereign immunity arguments are to be considered as Rule 12 motions, not as affirmative defenses [Opinion at *15], (2) the casinos enjoy the sovereign immunity of the Tribes [Opinion at *22], (3) the Bankruptcy Code does no abrogate the sovereign immunity [Opinion at *27], and (4) the filing of a claim by one of the Tribes will allow the Trustee’s action to proceed solely to determine if the preference action can recoup the amount of the claim [Opinion at *36].

This is a lengthy opinion, containing a large number of citations to controlling authority.  At no point did Judge Sontchi gloss over any of the case law supporting his holdings.  Accordingly, I consider this Opinion to be important reading material for any attorneys involved in preference litigation against foreign sovereigns.  It also makes me regret not having taken the class on “Native American Law” when in school – the issues involved are very interesting.

We have published a number of posts about preference actions on this blog.  The key issue of note here, is that many trustee’s merely look at a debtor’s check register and sue each and every recipient of transfers in the 90-day time period immediately preceding the debtor’s bankruptcy filing.  As this is what is allowed under the Bankruptcy Code, this is the procedure most frequently used by trustees.  Most of the time, the trustee involved has an informational problem and the only way to start talking with opposing parties in is to file suit.  I haven’t ever had a conversation go well when it starts, “you might owe me money and I’d like to talk to you about whether you do.”  But this is exactly the situation trustees often find themselves in.

If you are a named defendant in a preference action, the first step is to make sure you understand the law surrounding preference litigation.  Educate yourself, then have your lawyer start a dialogue with the Trustee’s lawyer.  The vast majority of preference actions settle or are dismissed once the parties understand whether there were actual preference payments or not.  If you are in the lucky position to have not yet had a client or customer go through bankruptcy, (1) count yourself lucky and (2) start making plans to protect yourself for when one of them does go under.  It isn’t pretty, but since most of us aren’t foreign sovereigns, we need to plan carefully toy reduce our preference exposure.

In a lengthy opinion published November 7, 2016, Judge Sontchi of the Delaware Bankruptcy Court provided a thorough analysis of the interaction between the Stored Communications Act (“SCA”) and the Bankruptcy Code.  Judge Sontchi’s opinion is available here (the “Opinion”).  The Opinion was issued in the Chapter 15 case In re Irish Bank Resolution Corporation Limited, Case No. 13-12159.  In this case, the Chapter 15 foreign representative of Irish Bank Resolution Corporation Limited (the “Debtor”) sought entry of an order directing Yahoo! Inc. (“Yahoo”) to turn over all electronically stored information (“ESI”) in a specific email account belonging to an individual who had evaded the proceeding and failed to comply with discovery orders.

This is one in a series of several opinions which has ruled that the SCA prohibits certain disclosures.  Opinion at *37-38 (“Other courts have come to similar conclusions regarding judicially-manufactured consent over the steadfast objection of an email user. That is, that the SCA does not provide for a mechanism in civil litigation to compel disclosure of a user’s private email contents through a subpoena or a court order directed at the service provider when none of the parties to the communication gave their consent.”)

The SCA allows only a small number of people to consent to the disclosure of the contents of an email account.  And despite no other contact information existing for the owner of this account, as their real identity is unknown, the Court found itself constrained by the limits of the SCA.  This is a particularly offensive situation as the owner of the email account shut it down for the apparent purpose of avoiding service.  As Judge Sontchi stated, “the Foreign Representatives rightly indicate that the only logical conclusion is that Rasimov (or someone on his behalf) terminated it upon receiving the 2004 Motion.”  Opinion at *16 (emphasis added).  To get a full flavor of the efforts the Foreign Representative engaged in to try and obtain this discovery, I recommend you read the 13 pages of history laid out in the Opinion.

This Opinion supports the principle that the will of Congress,  as understood by the courts, will be upheld.  See, e.g., Opinion at *44.  “[T]he Court reaches its conclusion based on clear principles laid down by Congress in the Bankruptcy Code and the SCA.”  Thus, it is my opinion that the most certain way for Congress to ensure they make the laws, rather than having judge made law, is to make it very clear what the intent of the law is as well as any limitations when creating the record of the law’s enactment.  Many may argue that the SCA’s provisions were created in an effort to prevent the government from becoming “Big Brother”, but the unfortunate result of how courts have applied it, is that those who should have their communications uncovered can shelter behind its broad protection.

Yet another company in the energy sector has filed for bankruptcy protection.  On June 17, 2016, Maxus Energy Corporation, and its affiliates (“Debtors”) filed for chapter 11 protection in the United States Bankruptcy Court for the District of Delaware.

A significant portion of this post draws upon information in the first day declaration of Javier Gonzalez [D.I. 2] (the “Declaration”).  The Debtors’ business is comprised of three principal components: (i) management of various oil and gas-related interests held by Maxus and its subsidiaries, (ii) environmental remediation management services, and (iii) management of legacy employee benefit obligations to retired former employees.

The Debtors have obtained DIP financing sufficient to carry this case for twelve months, having determined that the “Chapter 11 Cases will provide the Debtors with the opportunity to assess whether the Debtors’ existing environmental remediation operations and/or oil and gas operations can be restructured as a sustainable, stand-alone enterprise.”  Declaration at *6.  Thus, we can’t be sure if this will liquidate, like so many energy companies have in recent months, or reorganize with the hopes of tapping into an improved climate for energy companies.  The first day hearing is scheduled for today (6/20/2016) at 5:00 p.m. ET.

The case is pending before the Honorable Christopher S. Sontchi.  The Debtors are represented by the law firm of Young, Conaway, Stargatt & Taylor.  This is case number 16-11501-CSS.  The proposed claims and noticing agent in this case is Prime Clerk LLC.  Prime Clerk has established a website for this case at https://cases.primeclerk.com/maxus/.

The primary source of liabilities are the environmental remediation obligations held by the Debtors.  As I have seen in other cases, environmental liabilities can be crushing.  Luckily, my experience with environmental remediation issues came under the tutelage of Jeff Pollock, in our Princeton office (who is regularly recognized as a top environmental lawyer).

In a 21 page decision released April 15, 2016, Judge Sontchi of the Delaware Bankruptcy Court ruled on summary judgment regarding a claim submitted by attorneys related to previous litigation.  Judge Sontchi’s opinion is available here (the “Opinion”).  The Opinion was issued in Devonshire PGA Holdings LLC, Case No. 13-12460.  In this case, Potter Anderson & Corroon represented the Debtors in litigation in the Chancery Court prior to the Debtors’ bankruptcy filing.  Prior to the conclusion of the litigation, the Debtors filed for bankruptcy protection, just six days prior to the voluntary dismissal of the Chancery litigation.  Opinion at *8-9.

The following day, the Debtors and the other parties to the Chancery litigation entered into a settlement agreement.  The settlement agreement was approved by the Bankruptcy Court one month later.  The Debtors’ cases were administratively consolidated and their schedules were filed less than a week later.  In their filings, the Debtors listed Potter Anderson as a creditor holding a non-disputed claim for $225 thousand.  The Debtors’ plan was confirmed later that year, December 2013.  On March 14, 2014, the Debtors amended their schedule to list Potter’s claim as disputed.  Opinion at *9.  Potter filed a claim, to which the Debtors objected and regarding which the Debtors filed a motion for summary judgment.

The Debtors presented four alternate theories for why Potter should not recover on account of its claim.  However, Judge Sontchi takes 10 pages of the Opinion to explain why each and every theory advanced by the Debtors fails.  Ultimately, Judge Sontchi held that ELP did not show that any applicable law renders Potter’s claims unenforceable and the Court must therefor deny the request for summary judgment.  Opinion at *21.

It will be interesting to see if this issue goes to trial, and whether there will be any impact in the Debtors’ having reported these claims as allowed in their Schedules.  Regardless of how the other legal issues play out, it seems that such an admission would greatly inhibit their argument that the claims should now be disallowed.  It also makes me wonder how the treatment of Potter’s claim may have affected the voting on the Plan.

Introduction

Charles A. Stanziale, Jr., is on a roll, filing preference actions in a number of cases within the Delaware Bankruptcy Court this month.  As the Chapter 7 Trustee (the “Trustee”) for the bankruptcy estate of EP Liquidation, LLC f/k/a Equinox Payments, LLC (the “Debtor”), he filed approximately 37 complaints to recover what he contends are assets of the Debtor’s estate.  These actions are made up of preference actions, fraudulent transfer and asset turnover cases.  The Trustee filed these actions in the Delaware Bankruptcy Court and argued that the defendants hold assets belonging to the Debtor and that the 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. This post will briefly cover the Debtor’s bankruptcy proceedings.

Background

The Debtor was formed as HYI Acquisition, LLC to facilitate the purchase of the majority of assets owned by Hypercom Corporation, which was in the business of electronic payment solutions or the electronic point of sale business. The sale was considered to be a bargain purchase wherein the business was bought for less than the aggregate value of the assets.

The Debtor was a point-of-sale terminal manufacturer and in 2011, was reported to have the second largest terminal market base of installed terminals in the United States. However, the technology used by the Debtor in its products was scheduled to fall out of compliance with the Payment Card Industry Data Security Standard in 2014.

On February 6, 2014 the Debtor sold substantially all of its assets and business operations including certain equity ownership interests in SIA Equinox Payments Latvia and Netset Americos Centro Servicios, S. de R.L. de C. V, and the right to use its name to Brookfield Equinox, LLC pursuant to an Asset Purchase Agreement dated February 6, 2014. Included among the purchased Assets sold by the Debtor were all of the Debtor’s books and financial records (the “Sale”).

According to the last of the complaints filed by the Trustee, by the time the Trustee was appointed, the Debtor had run its bank accounts down to $4.06.  On February 24, 2014, the Debtor filed its chapter 7 petition for bankruptcy in the United States Bankruptcy Court for the District of Delaware.  The Trustee was appointed on February 24, 2014.  As the statute of limitations on these actions is 2 years from the appointment of the Trustee, he was cutting it close when filing the last of these actions – four were filed on February 24, 2016.

The Trustee handled the liquidation of all the remaining assets of the Debtor and is tasked with prosecuting litigation intended to increase the assets available to distribute to the company’s creditors.  This includes filing and prosecuting preference actions.  The Debtor’s bankruptcy, as well as the preference actions, are before the Honorable Christopher S. Sontchi.  The Trustee/Plaintiff prosecuting the preference actions is represented by the law firms Billion Law and Forman Holt Eliades & Youngman LLC.

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.”

On February 17, 2016, the Bankruptcy Court published a notification that Judge Christopher S. Sontchi is seeking feedback from the bar on his performance.  As of March 1, 2016, the notice is still available on the website for the Delaware Bankruptcy Court: http://www.deb.uscourts.gov/news/survey-judge-christopher-s-sontchi.

According to the notice, Judge Sontchi wants to assess his level of performance as part of his “on-going commitment to provide the highest level of public service possible.”  He is seeking feedback from all attorneys who have appeared before him for the last 5 years.  The notice states that “The results are exclusively for Judge Sontchi ‘s use in improving his performance; the FJC will not provide the results to anyone other than the judge and the results will not be used in the reappointment process.”

To be frank, I have not heard of a judge actively seeking feedback in such a broad manner from those whom he has provided over.  I can’t imagine a criminal judge requesting feedback from everyone who appeared before him/her in the last 5 years; That would be painful.

In this case, however, Judge Sontchi’s actions are merely another example of the efforts of the Delaware Bankruptcy Court to continue to advance its practice and maintain its position as one of the preeminent bankruptcy circuits in our nation.

Not that I could possibly be biased…

In a 16 page opinion released January 28, 2016 in the Casino Caribbean, et al. v. Money Centers of America adversary proceeding (Bank. D. Del. Adv. No. 14-50437), Judge Christopher S. Sontchi of the Delaware Bankruptcy Court granted the motion of Quapaw Casino to intervene in the adversary proceeding.  Judge Sontchi’s opinion is available here (the “Opinion”).

Plaintiffs in the adversary proceeding had obtained a court order requiring the Debtors’ to maintain a cash balance of $900,000 or more, in order to compensate the Plaintiffs if it should be determined that the Debtors were holding funds as a ‘mere conduit’ to which the Plaintiffs were entitled.  Opinion at *2.  Quapaw claimed that the Debtors were likewise holding funds to which it was entitled, and moved to intervene in the adversary proceeding, in order to obtain the same relief.  Plaintiffs opposed the motion, fearing that the set-aside funds would be insufficient to compensate them and Quapaw.  Opinion at *2.

The Debtors had entered into an agreement with Quapaw to provide ATM and other cash advance services to Quapaw’s customers, and that any funds advanced to a customer by Quapaw would be reimbursed by the Debtors.  Quapaw is listed on the Debtors’ schedules and filed a proof of claim for $502,018.  Opinion at *4.

The adversary complaint was filed on July 7, 2014.  Quapaw filed its motion to intervene on January 21, 2015.  As of that time, the Debtors had not yet filed an answer in the adversary proceeding.  Pursuant to Fed. R. Civ. P. 24(a) “A movant has an unconditional right to intervene when its motion is timely filed and either (A) a federal statute grants an unconditional right to intervene or (B) the movant claims an interest that is related to the property or transaction that is the subject of the adversary proceeding and disposing of the proceeding impairs or impedes the movant’s ability to protect its interest as a practical matter, unless the parties adequately represent that interest.”  Opinion at *7.  Ultimately, Judge Sontchi found that Quapaw satisfied this requirement.  Opinion at *8.

Judge Sontchi then examined the case under the permissive intervention standard of Fed. R. Civ. P. 24(b), finding that Quapaw also satisfied those requirements.  Opinion at *16.

As this Opinion illustrates, it is difficult to prevent another party from following the path you create and obtaining the same relief, when their claims are practically identical to your own.  In cases like this one, where a finite quantity of funds are available, it may be worth your time to investigate whether your relief would be diminished if another party received identical treatment.  If it would, then you may want to spend a bit more time investigating whether those similarly situated parties exist and take them into account in the relief you seek.

The Court held that QCA had a right to intervene under both Fed. R. Civ. P. 24(a)(1) and (a)(2), and that permissive intervention was warranted under Fed. R. Civ. P. 24(b)(1)(B).  Rule 24(a) has 4 requirements,