The Honorable Mary F. Walrath

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 24 page decision released April 13, 2017, Judge Walrath of the Delaware Bankruptcy Court denied a motion for summary judgment in a preference action brought by Charles Stanziale as the chapter 7 Trustee of Powerwave Technologies against Superior Technical Resources – Adversary Proceeding Case No. 15-50085.  Judge Walrath’s opinion is available here (the “Opinion”).  Judge Walrath held that “genuine factual disputes precluding summary judgment”.  Opinion at *6.  While we have summarized a large number of opinions on preference actions, this is one of the most informative opinions released by the Delaware Bankruptcy Court in recent memory.

The Opinion provides an in depth analysis of the most common defense to preference actions – the Ordinary Course of Business defense.  Judge Walrath discusses the Subjective test in detail and a quick overview of the Objective test, quickly passing over the New Value defense as “the Court must deny the Defendant’s Motion for Summary Judgment as to the new value defense until the ordinary course of business defense is determined.”  Opinion at *23.

Judge Walrath analyzes how a number of different factors contribute to a determination of whether a transaction was made in the ordinary course of business under the Subjective Test.  As she says, “[W]hether a given transaction was within the subjective ordinary course of business that had developed between the parties is a broad, fact-based inquiry requiring historic examination of the parties’ pre-preference period relations.”  Opinion at *10 (quoting Moltech Power Sys., Inc. v. Tooh Dineh Indus., Inc. (In re Moltech Power Sys., Inc.), 327 B.R. 675, 680 (Bankr. N.D. Fla. 2005)).  The factors she considers are:

  1. The Historical Period: “It is well-established that the historical period should encompass ‘the time period when the debtor was financially healthy.’” Opinion st *9 (citing Davis v. R.A. Brooks Trucking Co. (In re Quebecor World (USA), Inc.), 491 B.R. 379, 387 (Bankr. S.D.N.Y. 2013)).
  2. Ordinariness of the Transfers  “Payments made during the preference period do not have to ‘possess a rigid similarity to each past transaction’; however, there must be ‘some consistency.’” Opinion at *10-11 (quoting Menotte v. Oxyde Chem., Inc. (JLS Chem. Corp.), 424 B.R. 573, 581 (Bankr. S.D. Fla. 2010)).  Judge Walrath addresses five different methods for comparing transacitons within the preference period against those made prior to the preference period.
    1. Range Method: Judge Walrath opined that “there is a material issue of fact as to the proper baseline and the range method’s applicability.”  Opinion at *12.  Judge Walrath compared a number of different cases in which the Range Method was discussed.  In some, it was applied (see, e.g., Am. Home Mortg., 476 B.R. 124, 138 (Bankr. D. Del. 2012)), in others, it was determined to be too broad (see, e.g. Quebecor, 491 B.R. at 387).  Judge Walrath held that “there are genuine disputes of material fact regarding the range method’s appropriateness, which preclude summary judgment in this case.”  Opinion at *14.
    2. Batch Method: When multiple invoices are paid with each payment, a party can calculate the average age of invoices paid in each batch and, from these, derive a standard deviation range, which can then be compared to the payments made in the preference period.
    3. Days Sales Outstanding Method: The DSO Method involves multiplying the total amount of an invoice by the number of days that it took to be paid. That number is then divided by the total amount of the invoices in that batch.
    4. Inter-quartile Range Method: This method involves calculating the range and excluding the fastest and slowest paid quartiles (25%), and considering only the range that includes 50% of pre-preference payments.  There is no precedent in Delaware for the use of this methodology.
    5. Standard Deviation Method: This method involves calculating the average days between invoice and payment, and calculating the standard deviation of the average days to payment.  The argument is that all payments made within one standard deviation of the average are ordinary, and the remainder are not.
  3. Unusual collection activity: “Subsection 547(c)(2) protects those payments that do not result from unusual or extraordinary debt collection practices.” Opinion at *17 (citing McCarthy v. Navistar Fin. Corp. (In re Vogel Van & Storage, Inc.), 210 B.R. 27, 36 (N.D.N.Y. 1997)).  This includes a change in credit terms and defendant’s collection activities.

With all of these issues involving disputes of material fact, Judge Walrath opined that she was unable to issue summary judgment as to whether the subjective test protects any of the allegedly preferential payments from recovery.

Judge Walrath quickly moves through the objective test, holding that (1) a sufficiently detailed basis is needed to establish the relevant industry, (2) expert testimony is not required, and (3) there should be sufficient statistical data or supporting basis for the evidence related to the objective standard.  As the parties disagreed about the relevant industry or NAICS classification, summary judgment could not be entered on this issue either.

While this Opinion doesn’t create precedent that can be used to obtain a final resolution for defendants, it does define the issues that the Court will consider in ruling on a motion for summary judgment.  If you are a bankruptcy practitioner, or the defendant of a preference action, this Opinion should be considered required reading.

On August 24, 2016, Judge Mary F. Walrath of the Delaware Bankruptcy Court overruling an objection to claim for reclamation.   The decision was issued in the Reichold Holdings US, Inc. Bankruptcy (Case No. 14-12237) in the Delaware Bankruptcy Court.  A copy of the Opinion is available here.

While the background to this dispute is laid out in detail in the Opinion, it can be easily summarized.  A prepetition lender had a lien on substantially all the Debtor’s assets, including inventory.  Covestro LLC (the “Claimant”) supplied goods to the Debtor within the 45-day reclamation period.  Claimant issued a reclamation demand to the Debtor within days of the Debtor’s bankruptcy filing and later filed a proof of claim for all goods provided within the reclamation period.  As part of the DIP financing, the prepetition loan was paid in full and the DIP lender obtained a first priority lien on all prepetition and postpetition property of the Debtor’s estate, including inventory.  The DIP loan was repaid from the sale of the Debtor’s assets and a plan of liquidation was confirmed.  Opinion *1-3.

The Liquidation Trustee objected to Covestro’s claim, arguing that its security interest was rendered valueless when the Prepetition Loan was repaid.  Opinion at *3.  However, Judge Walrath disagreed, holding that once the prepetition lien was repaid, the reclamation lien became the first priority lien.  “The function of a lien is to secure a debt; once that debt is repaid, the lien and the rights of the lien-holder terminate.”  Opinion at *8.  The DIP lien was expressly subject to reclamation rights.  Id.  Judge Walrath held that if the prepetition lien holder had foreclosed on the inventory, the analysis would be different.  However, “Covestro’s goods were not sold and their proceeds were not paid to the Prepetition Lender.”  Opinion at *9 (emphasis in original).

Judge Walrath concluded by opining that “Because Covestro’s rights arose before the DIP Lenders had any rights in the goods, the Court concludes that the DIP Lenders do not have prior rights in the goods.”  Id.  The Court thus overruled the Liquidating Trustee’s objection to the claim.

Introduction

From May 11 through May 17, Alfred Giuliano, the Chapter 7 Trustee (the “Trustee”) for the bankruptcy estate of Leading Edge Logistics, LLC (the “Debtor”), filed approximately 86 complaints in preference action 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 of the United States Bankruptcy Code. This post will briefly cover the Debtor’s bankruptcy proceedings.  The Trustee is represented by the law firm Subranni Zauber LLC.

Background

The Debtor was a privately-held global logistics management company that provided truckload transportation, specialized heavy haul transportation, freight forwarding, international shipping, intermodal, air/ocean, contract carriage, and warehousing.  At the time of the bankruptcy filing, one of the principal assets of the Debtor was its accounts receivable, which it valued at approximately $14 million.

The Trustee obtained Court authority to run the Debtor’s business for a short time while he liquidated the accounts receivable in an effort to maximize the recovery for the creditors of the Debtor.  Having handled the liquidation of all the remaining assets of the Debtor, the Trustee is also 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 Mary F. Walrath.

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.”

Summary

In yet another straight-forward 15 page decision signed April 18, 2016, Judge Walrath of the Delaware Bankruptcy Court granted a defendant’s motion to dismiss a preference complaint, but granted the plaintiff leave to amend. Judge Walrath’s opinion is available here (the “Opinion”).  Numerous posts on this blog discuss other opinions issued by the Delaware Bankruptcy Court dealing with preference payments, as can be seen here. PREFERENCE OPINION POSTS

Background

My colleague, Carl Neff, published a blog post when THQ first started filing preference actions.  You can read it here: THQ Inc. Preference Actions Filed

THQ was a publisher of video games, including such franchises as Saints Row and Darksiders.  Unfortunately for fans of those series, however, THQ was unable to keep pace with its secured debt.  After it failed to make a loan payment, it filed for bankruptcy.  Prior to bankruptcy, THQ had engaged the Starcom defendants to provide media and marketing services.  On December 19, 2014, THQ, Inc., the Plaintiff, filed its Complaint seeking recovery of certain transfers as preference and/or fraudulent transfers from the Starcom Defendants.  The Defendant filed its Motion to Dismiss and after a complete briefing, the Court issued the Opinion.  Opinion at *3.

The Opinion

The motion to dismiss was made pursuant to Rule 12(b)(6).  In Delaware the primary precedents for motions to dismiss are Iqbal, 129 S. Ct. 1937 (2009)  and Twombly, 550 U.S. 544 (2007), both of which are cited by the Opinion at *4.  The Third Circuit has expanded on these precedents in its opinion Fowler v. UPMC Shadyside, 578 F.3d 203 (3d Cir. 2009).  The Third Circuit has articulated a two-part analysis to be applied in evaluating a complaint.  First, the court “must accept all of the complaint’s well-pleaded facts as true, but may disregard any legal conclusions.”  Second, the court must determine “whether the facts alleged in the complaint are sufficient to show that the plaintiff has a ‘plausible claim for relief.’” Opinion at *5 (quoting Fowler at 210-211).

The motion to dismiss argues that the Trustee failed to make any of the factual allegations required.  Judge Walrath  agreed “with the Movants that the Complaint does not adequately identify the transferors and the transferees, the nature of the antecedent debt, and the dates of the alleged transfers to the Additional Defendants. There are no specific allegations of what transfers were actually made to the Additional Defendants and by whom.”  Opinion at *8.

Judge Walrath then quickly granted the Motion to Dismiss and held that “the Plaintiff is not allowed to engage in discovery until it has properly pled its Complaint.”  Opinion at * 9.

My $.02

As was the case in prior opinions granting a motion to dismiss a preference complaint, the plaintiff’s request to allow an amended complaint to be filed was granted.  Considering that most of the plaintiffs handling preference litigation have filed hundreds of prior preference cases, I wonder if a time will come when the Court will begin to require mass-filing preference plaintiffs to pay the litigation costs of the defendants.

While this motion to dismiss may have only delayed the process, it succeeded in denying the Plaintiff an opportunity to go on a fishing expedition of discovery.  I don’t know whether this case will continue through to a trial or will be finalized through a settlement.  But I can say with certainty that for most preference litigants, most of the time, it makes financial sense to settle before incurring significant legal costs.  For a quick primer on preference litigation, please take a look at the Preference Reference which I co-authored.

In an 11 page decision signed March 29, 2016, Judge Walrath of the Delaware Bankruptcy Court revised a calculation of new value pursuant to an order from the District Court remanding the case. Judge Walrath’s opinion is available here (the “Opinion”).  Numerous posts on this blog discuss other opinions issued by the Delaware Bankruptcy Court dealing with preference payments, as can be seen here.  PREFERENCE OPINION POSTS.

This matter was remanded from the District Court on the appeal of the Bankruptcy Court’s decision dated July 17, 2013.  In that opinion, Judge Walrath had ruled that (i) $781,702.61 of pre-petition transfers to Prudential (the Defendant) were preferential; (ii) Prudential had a new value defense totaling $128,379.40; and (iii) the Trustee was not entitled to prejudgment interest.

After both parties appealed, the District Court ruled that post-petition new value was not protected and that the Plaintiff was entitled to pre-judgment interest.  Both parties rested after argument and without presenting any additional All that was left for Judge Walrath to do in this Opinion was to determine the total transfers protected pursuant to the new value defense and how much interest to award the Plaintiff.

This Opinion illustrates the careful deference that the District Court and Bankruptcy Court pay to the Opinions of the Third Circuit.  In particular in this case, the Bankruptcy Court cites to Hechinger Investment v. Universal Forest Products (In re Hechinger), 489 F.3d 568, 580-81 (3d Cir. 2007).  For a quick primer on preference litigation, please take a look at the Preference Reference which I co-authored.  As expected, we have paid particular attention in the Preference Reference to the opinions of the Third Circuit.

On March 15 and 16, 2016, the Debtors in the Sports Authority bankruptcy, Case No. 16-10527, filed approximately 161 adversary complaints against consignment vendors.  The purpose of these complaints is to determine the priority and validity of the consignment vendors’ claims of title and their claim to a security interest in the consigned goods.

For any vendors who failed to file a UCC-1 security statement within 30 days of sending goods to Sports Authority, this could prove to be a painful lesson.  According to the Debtors’ argument, the consignment vendors do not have title to the goods: “The retention or reservation of title by a seller of goods notwithstanding shipment or delivery to the buyer under § 2-401 is limited in effect to a reservation of a ‘security interest.’” Del. Code Ann. tit. 6, § 1-201(35).

If Judge Walrath agrees with this argument, then consignment vendors will have only a security interest, governed by the Uniform Commercial Code as enacted in Delaware and the principles of bankruptcy law.  Pursuant to the Post-Petition Financing order entered in these bankruptcies, the Debtors have given their DIP Lenders a first-lien security interest in all assets not otherwise encumbered by a perfected lien.  This means that for any shipments that were not properly perfected (by filing a UCC-1 statement within 30 days of shipment), the consignment vendors may not have a 1st priority lien.

The Debtors have argued that any attempts at perfection after the 30-day period provided by the UCC is considered a preferential transfer (if made within the 90 days preceding bankruptcy), and should thus be avoidable.

It’s a tricky situation for any vendors who allowed their diligence to wane over the course of a long relationship with Sports Authority.  Whether you are affected directly by this bankruptcy filing or not, you should use this as an opportunity to re-commit to filing UCC-1 financing statements regardless of how good your relationship is with a contract counter-party.  It’s not a matter of whether you trust your counterparty, its a matter of how much you trust their bankers and attorneys…

In what looks like a case study in the need to diversify, Univita Health Inc. filed for Bankruptcy in the District of Delaware on August 28, 2015 – It is being administered as Case No. 15-11788.  Pursuant to the Bankruptcy Petition it filed, Univita has also filed for bankruptcy under chapter 7 for 11 affiliates.

Although no official explanation for the bankruptcy filing appears on the docket, a quick Google search leads me to believe that Univita was the sole authorizer of home services for most Medicaid plan members in Florida.  Univita broadened its business to compete in the home health-care sector, and may have stepped on some toes in the process.  Regardless of whether it was forced into bankruptcy because of low payment rates from Medicaid or the termination of its contract by the Florida Agency for Health Care Administration (the “AHCA”), it appears likely that a single aspect of its business caused its ultimate failure.  The AHCA now lists Univita as “CLOSED”.  The listing is on AHCA’s Website here.

While explanations are not readily apparent on the docket, they will likely be provided at the 341 Meeting of Creditors, which is currently scheduled for 9/25/2015 at 11:00 AM at the J. Caleb Boggs Federal Building, 844 King St., Room 2112, Wilmington, DE 19801.

As this is a Chapter 7 liquidation, topics that are discussed during a Section 341 meeting may include the following:

  • The nature and scope of a debtor’s assets and liabilities;
  • The amount of accounts receivable and accounts payable;
  • The extent that the debtor is able to repay its creditors;
  • Whether insurance remains active; and
  • The condition and location of goods received in the 20-45 days before bankruptcy.

The Debtor is represented by Young Conaway Stargatt & Taylor and Latham & Watkins LLP.  The Docket currently shows that David Carickhoff of Archer & Greiner PC will be the Trustee who will administer the bankruptcy estate.

Summary

In a straight-forward 11 page decision signed January 7, 2015, Judge Walrath of the Delaware Bankruptcy Court granted a defendant’s motion to dismiss a preference complaint, but granted the plaintiff leave to amend. Judge Walrath’s opinion is available here (the “Opinion”).  Numerous posts on this blog discuss other opinions issued by the Delaware Bankruptcy Court dealing with preference payments, as can be seen here. PREFERENCE OPINION POSTS.

Additionally, this opinion is very similar to that discussed in these prior posts:

Decision in Ultimate Acquisition Grants Motion to Dismiss, But Also Grants Leave to Amend the Preference Complaint

Decision in Everything But Water, LLC Requires Preference Claimants to Identify Transferees Specifically in Granting Motion to Dismiss.

Background

Tri-Valley Corporation and its affiliates (the “Debtors”) were crude oil and natural gas exploration, development, and production companies operating in California.  Opinion at *2.  They filed for bankruptcy relief on August 7, 2012.  On March 25, 2013, the case was converted to chapter 7 and Charles A. Stanziale, Jr. was appointed as the chapter 7 trustee (the “Trustee” or “Plaintiff”).  The Trustee filed a complaint seeking to avoid allegedly preferential transfers from the “Defendant” DMJ Gas-Marketing Consultants, LLC.  The Defendant filed its Motion to Dismiss and after a complete briefing, the Court issued the Opinion.

The Opinion

As we are now in the post-Stern v. Marshall world, the Opinion lays out the legal authority for its granting a motion to dismiss.  The main rationale is stated in the Trinsum case: In re Trinsum Grp., Inc., 467 B.R. 734, 739 (Bankr. S.D.N.Y. 2012) (“After Stern v. Marshall, the ability of bankruptcy judges to enter interlocutory orders in . . . proceedings has been reaffirmed . . . .”).

The motion to dismiss argues that the Trustee failed to state which debtor owed the antecedent debt to the Defendant and the nature of the antecedent debt. Opinion at *7.  Judge Walrath agreed.  “the Court finds that the Complaint fails to allege sufficient facts detailing the nature of the alleged antecedent debt.”  Opinion at *9.

Judge Walrath then quickly granted the Motion to Dismiss.  However, the Trustee asked for leave to amend the Complaint, and as Rule 15(a) of the F.R.C.P. provides that “leave to amend shall be freely given when justice so requires” Judge Walrath granted the Trustee 28 days to amend the Complaint.  Opinion at * 11.

My $.02

As was the case in prior opinions granting a motion to dismiss a preference complaint, the plaintiff’s request to allow an amended complaint to be filed was granted.  While I certainly believe that preference plaintiffs should be required to due the groundwork prior to filing a complaint, there is a cost in having an attorney file and prosecute a motion to dismiss.

In the Ultimate Acquisition case discussed in my prior post, the litigants ended up settling.  For those not aware, settlement is the typical resolution in preference litigation.  Was it worth the cost of prosecuting a motion to dismiss that was, effectively, just a delay tactic (given the Delaware Bankruptcy Courts interpretation of Fed. R. Civ. P. 15(a))?  Since I don’t know what the settlement stances of the litigants were, I cannot say.  I provide this information to illustrate one principle.  For most people, most of the time, it makes sense from a financial perspective to settle before incurring significant legal costs.  For a quick primer on preference litigation, please take a look at the Preference Reference which I co-authored.

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.