Michael Temin writes:

Fiber optical network cableWhen deciding a motion to dismiss a complaint pursuant to Federal R. Bankr. 7008, which incorporates Rule 12(b)(6), a court must accept all factual allegations in the complaint as true and construe all inferences from those allegations in favor of a plaintiff.  It was, therefore, unusual when a Michigan bankruptcy court dismissed a complaint alleging breach of fiduciary duty against a director based upon an affirmative defense.  The case is In re Great Lakes Comnet, Inc., 586 B.R. 718 (Bankr. W.D. Mich. 2018).

The debtor provided fiber optic telecommunication services to third party carriers.  The officers of the debtor schemed to charge national exchange carriers with illegal tariffs.  Six years after the scheme began the debtor filed for bankruptcy under chapter 11.  The liquidation trust formed pursuant to the plan of liquidation sued the officers and directors for breach of their fiduciary duties to the debtor.

One director moved to dismiss the breach of fiduciary duty claim as to him, arguing, inter alia, that the officers’ conduct as alleged in the complaint and supplemented by certain board meeting minutes, provided a defense to the claim.  The director attached to his motion, and relied on, minutes from board meetings and an annual shareholder meeting.  The bankruptcy court took the substance of the minutes under consideration, explaining:

The Complaint specifically refers to board meeting minutes and information provided by the officers to the board during those meetings.  All of the meeting minutes directly relate to the cause of action against [the director] for breach of fiduciary duty and are integral to the allegations in the Complaint.  Given the lack of objection and both parties’ reliance on these documents at the hearing, the court shall consider them in connection with the Motion.

The bankruptcy court further acknowledged:

Because a defendant has the burden of proof of demonstrating an affirmative defense, it is generally more appropriately considered after the pleadings stage. [citations omitted]. However, the Sixth Circuit has explained that a motion to dismiss may be granted on the basis of a meritorious affirmative defense if the facts in the complaint conclusively establish the existence of the defense as a matter of law.

The court held that the Trustee’s allegations in the complaint, as supplemented by the meeting minutes, demonstrate the affirmative defense of reasonable reliance under Michigan law.  Based upon the foregoing, the bankruptcy court granted the motion to dismiss as to the moving defendant.

Read the full opinion here.


Michael L. Temin is senior counsel in Fox’s Financial Restructuring & Bankruptcy Department, based in its Philadelphia office.

Michael Temin writes:

Litigation DamagesOne of the commonly asserted defenses to preference avoidance actions is the “new value” defense set forth in 11 U.S.C. § 547(c)(4).  One issue considered by courts is whether the “new value” must remain unpaid.  In a recent opinion, the Eleventh Circuit joined the Fourth, Fifth, Eighth and Ninth Circuits in holding that it does not.

In Kaye v. Blue Bell Creameries, Inc., (In re BFW Liquidation, LLC), No. 17-13588, (11th Cir. Aug. 14, 2018), the Eleventh Circuit determined that section 547(c)(4) was unambiguous and that the statutory history of the section supports the conclusion that new value need not remain unpaid.

The Court acknowledged that one of the policy objectives underlying the preference provisions of the Bankruptcy Code is to encourage creditors to continue extending credit to financially troubled entities.  According to the Court, requiring new value to remain unpaid would hinder this policy objective.

To support its conclusion, the Court provided a simple illustration of why its interpretation of section 547(c)(4) encourages creditors to continue to extend credit to financially troubled entities:

A chart can perhaps best illustrate the above concepts. The following chart illustrates a scenario where the vendor-creditor ships $1,000 worth of goods to the debtor every other week, and the debtor pays for those goods one week after delivery.

Transfer from creditor to debtor Transfer from debtor to creditor
Transfer 1 $1,000 in goods
Transfer 2 $1,000 in cash
Transfer 3 $1,000 in goods
Transfer 4 $1,000 in cash
Transfer 5 $1,000 in goods
Transfer 6 $1,000 in cash
Transfer 7 $1,000 in goods
Transfer 8 $1,000 in cash
Transfer 9 $1,000 in goods
Transfer 10 $1,000 in cash

Even-numbered transfers—Numbers 2, 4, 6, 8, and 10—show five payments, in the amount of $1,000 each, by the debtor to the vendor-creditor within the 90-day preference period, meaning that each such payment is potentially avoidable by a trustee. Transfers 3, 5, 7, and 9, which show the shipment of goods by the vendor, constitute equivalent new value in the total amount of $4,000 provided by the vendor subsequent to payments 2, 4, 6, and 8, respectively. 

That being so, and under Blue Bell’s position, this $4,000 in new goods shipped would wash $4,000 of the previous payments made by the debtor, for purposes of avoidability. Yet, under the Trustee’s position, the vendor loses this new-value defense because, after conferring new value via the shipment of goods equivalent to the previous payment made by the debtor, the debtor later paid off the value of the shipped goods that constituted the new value. Specifically, Transfer 4 paid off Transfer 3; Transfer 6 paid off Transfer 5; Transfer 8 paid off Transfer 7; and Transfer 10 paid off Transfer 9. According to the position of the Trustee in this case, the vendor in the above scenario would be required to repay the entirety of the $5,000 paid to him by the debtor, even though new value was conferred on the debtor as to $4,000 of these payments.

Blue Bell argues that a subsequent payment by the debtor to the vendor-creditor for new value that was previously provided to the former does not negate the defense as to the particular new value in question. Adopting that position, the vendor in this scenario would be protected by the new-value defense as to debtor payments 2, 4, 6, and 8 because, subsequent to each of these payments by the debtor, the vendor provided new value to the debtor in the form of new goods shipped. It is only the last $1,000 payment by the debtor—Transfer 10—that Blue Bell concedes would be avoidable by the trustee because the vendor delivered no goods after this last payment by the debtor, meaning the vendor provided no subsequent new value. Because it would lack a new-value defense to the preference represented by this last payment, the vendor would have to repay the estate the $1,000; it would then have a corresponding unsecured claim against the estate for that same $1,000. But the vendor would be entitled to retain the remaining $4,000. See 11 U.S.C. §§ 547(b), 550(a), 502(h).

Notably, this is the same situation the vendor would have found itself in had it simply stopped doing business with the debtor after Transfer 2: it would have had to return that $1,000, and it would have had a $1,000 unsecured claim against the estate based on Transfer 2. It would have owed the estate no additional moneys as a clawback by the trustee for any preferences. Yet, the debtor (and the estate it leaves behind) would be in a worse position had the vendor decided to abandon the debtor after Transfer 2. Had that been the case, the debtor would not have received the $4,000 worth of future shipments of goods. With those additional shipments, however, the debtor had additional goods that it could sell to its customers, and thereby potentially increase the size of the estate available at the time of the later bankruptcy filing.

Consider, moreover, the strong disincentives for a vendor to continue supplying an ailing customer with goods if the Trustee’s position wins out. Under the interpretation the Trustee gives the new-value defense, the vendor would have to return all of the payments it subsequently received for the new value it provided the debtor. Were this the rule, a prudent vendor, sensing financial problems by the debtor, would be foolish to continue delivering goods to the debtor following Transfer 2. Cf. Laker v. Vallette (In re Toyota of Jefferson, Inc.), 14 F.3d 1088, 1091 (5th Cir. 1994) (noting that, without the protection of § 547(c)(4), “a creditor who continues to extend credit to the debtor, perhaps in implicit reliance on prior payments, would merely be increasing his bankruptcy loss”). Indeed, focusing on post-Transfer 2 events set out in the chart, not only would the vendor have to return the entirety of the payments it had received for goods it had delivered under the Trustee’s interpretation, but it would also be out $4,000 in the value of the goods it had provided the debtor: $4,000 worth of goods that it could have to sold to another grocery store.

In short, were the Trustee’s approach applicable, a sensible vendor should immediately cut off the debtor, which would likely hasten the latter’s financial demise and his ensuing bankruptcy. Yet, the bankruptcy estate would almost always be better off if a vendor continues to supply the debtor with goods to sell, and the new-value defense, as interpreted by Blue Bell, would encourage it to do so.

Read the full opinion here.


Michael L. Temin is senior counsel in Fox’s Financial Restructuring & Bankruptcy Department, based in its Philadelphia office.

Yesterday, the Bankruptcy Panel of the Ninth Circuit Court of Appeals issued yet another decision related to standing and rights to appeal bankruptcy court orders.  In Bray v. U.S. Bank National Association, (In re Bray), the Ninth Circuit BAP considered a chapter 7 individual debtor’s appeal from an order reopening his involuntary chapter 7 bankruptcy case.  See Bray, B.A.P. No. CC-17-1373-SKuF (9th Cir. BAP Aug. 7 2018).

Our prior blog posts on similar decisions from the Ninth Circuit regarding rights and standing to appeal bankruptcy court orders are available here and here.

Appeal

In determining whether the debtor here had appellate standing, the Court explained that “reopening a closed case is a ‘ministerial act’ that primarily enables the clerk to manage the case as an active matter.”  Id. at 10 (citation omitted).  The Court further elaborated that a bankruptcy court order reopening a case “lacks legal significance and determines nothing with respect to the merits of the case.”  Id. (citation omitted).

The Court considered the person aggrieved standard, which provides that “‘those persons who are directly and adversely affected pecuniarily by an order of the bankruptcy court’ have standing to appeal.” Id. at (citation omitted).  In order to meet this standard, the debtor would have to show that the order on appeal “diminished his property, increased his burdens or otherwise detrimentally affected his rights.”  Id. at 11.

The Court found that the order reopening the case did not impact Bray in any of these ways, and thus he lacked standing to appeal the bankruptcy court’s order reopening the case.  Id. at 11 (dismissing appeal).

Bruce J. Borrus writes:

Bernie Madoff in New York, Tom Petters in Minneapolis, Allen Stanford in Houston, and Darren Berg in Seattle lead a rogues’ gallery of infamous Ponzi schemers.  All are now serving time in prison.  But the civil litigation arising from their Ponzi schemes and the Ponzi schemes of other less notorious fraudsters is not over.  Ponzi schemes have spawned thousands of fraudulent transfer cases.  Anglo-American fraudulent transfer law has a long history dating back four centuries to the Statute of 13 Elizabeth, enacted in 1571, and to the first reported fraudulent transfer case, Twyne’s Case, decided in 1601.  But fraudulent transfer law is far from settled.  In recent years, especially in fraudulent transfer cases arising out of Ponzi schemes, the law developed rapidly in a direction favoring the plaintiffs.  However, in 2015 and 2016, the direction began to turn.

Ponzi Scheme Word CloudIn an effort to obtain funds for the victims of the Ponzi schemes, bankruptcy trustees and receivers have commenced fraudulent transfer cases to recover payments made by the Ponzi schemer.  Many of the defendants had no knowledge of the Ponzi scheme.  The defendants had innocently loaned money or provided goods and services.  These defendants did nothing wrong.  Nevertheless, most of the defendants lost—at least in federal courts.

The federal courts frequently apply Ponzi scheme presumptions that set high barriers for defendants.  In 2015 and 2016, however, opinions issued by the highest courts of Minnesota and Texas rejected the Ponzi scheme presumptions.  Before discussing these recent state court decisions, it is best to put the decisions into context—first by discussing Ponzi schemes and then by describing the federal courts’ Ponzi scheme presumptions.

There is no precise definition of a Ponzi scheme.  The Ninth Circuit describes a Ponzi scheme as:

. . . a financial fraud that induces investment by promising extremely high, risk-free returns, usually in a short time period, from an allegedly legitimate business venture.  The fraud consists of funneling proceeds from new investors to previous investors in the guise of profits from the alleged business venture, thereby cultivating the illusion that a legitimate profit-making business opportunity exists and inducing further investment.

Donell v. Kowell, 533 F.3d 762, 767 n.2 (9th Cir. 2008).

The Fifth Circuit describes a Ponzi scheme as:

. . . a pyramid scheme where earlier investors are paid from the investments of more recent investors, rather than from any underlying business concern, until the scheme ceases to attract new investors and the pyramid collapses.

Janvey v. Democratic Senatorial Campaign Comm., 712 F.3d 185, 188 n.1 (5th Cir. 2013).

In fraudulent transfer cases in which the transferor has been running a Ponzi scheme, many courts apply what have become known as Ponzi scheme presumptions.  All of the reported decisions that have applied the Ponzi scheme presumptions are from federal courts.  The cases typically originate as suits brought by bankruptcy trustees or receivers in cases in which the Ponzi schemer or one of his or her companies is the debtor.  The bankruptcy trustee seeks a judgment in the amount that the Ponzi schemer paid to the defendant.  Even though many fraudulent transfer cases are brought pursuant to a state’s version of the Uniform Fraudulent Transfer Act (“UFTA”), the federal courts that apply the Ponzi scheme presumptions cite as authority other federal cases.  No state supreme court has yet applied the Ponzi scheme presumptions. Continue Reading For the Defense: State Courts Reject the Ponzi Scheme Presumptions in Fraudulent Transfer Actions

In a recent opinion, the Fifth Circuit affirmed a district court ruling that found that a debtor was judicially estopped from claiming a stay violation by a mortgagee, who foreclosed on the debtor’s property, due to the debtor’s failure to disclose the affected property or his putative claims in his bankruptcy.

The Fifth Circuit explained that the “doctrine of judicial estoppel is equitable in nature and can be invoked by a court to prevent a party from asserting a position in a legal proceeding that is inconsistent with a position taken in a previous proceeding.” The Fifth Circuit further emphasized that judicial estoppel “is particularly appropriate where . . . a party fails to disclose an asset to a bankruptcy court, but then pursues a claim in a separate tribunal based on that undisclosed asset.”

Examining the facts of the case, the Court determined that “Chapter 13 debtors have a continuing obligation to amend financial schedules to disclose assets acquired post-petition,” and the debtor failed to fulfill this duty.  By failing to amend his asset schedule the debtor “impliedly represented” to the bankruptcy court that his financial status was unchanged.

Read the full opinion here.

When a trademark licensor files for bankruptcy, can the licensees of their trademarks continue using those marks, or does the licensor have the right to prohibit their continued use? On Fox’s Above the Fold blog covering advertising law, partner Elizabeth Patton recently wrote a post discussing this open question, which sits at the heart of a case that may be heard by the U.S. Supreme Court.

We invite you to read Elizabeth’s post covering the case and its potential impact:

How Bankruptcy Effects Rights Under Trademark Licenses

An opinion issued yesterday by the U.S. Court of Appeals for the Ninth Circuit reiterates the importance of filing written objections and appearing in the Bankruptcy Court to preserve rights to appeal.  The opinion clarifies the Ninth Circuit’s recent opinion on this issue, which we covered in a recent blog post.  In Reid and Hellyer, APC v. Laski (In re Wrightwood Guest Ranch, LLC), No. 16-56856, D.C. No. 5:16-cv-07168-MFW, the Ninth Circuit considered an appeal of an order issued by the U.S. Bankruptcy Court for the Central District of California that approved a settlement between a chapter 11 trustee and a secured creditor.

GavelIn August 2015, an involuntary petition was filed against the Debtor, Wrightwood Guest Ranch, LLC (the “Debtor”) and a trustee was appointed.  The Trustee elected to settle a $9.6 million claim secured by the estate’s principal asset, a large piece of real estate, by allowing an affiliate of the secured creditor to purchase the property for $8.5 million and having the secured creditor limit its claim to that amount and also carve out funds for estate professionals, expenses and unsecured creditors.

The Official Committee of Unsecured Creditors (the “Committee”) and an individual creditor filed written objections to the proposed settlement.  The Debtor’s counsel and the Committee’s counsel (the “Administrative Claimants”) did not file any written objections on behalf of themselves despite that they had administrative claims in the case.

The bankruptcy court held a hearing on the sale of the property and the settlement and attorneys from the law firms representing the Committee and the Debtor appeared on behalf of the Committee and the Debtor, respectively.  Neither Administrative Claimant stated during the hearing that it was appearing on its own behalf.  The Bankruptcy Court granted the sale motion and approved the settlement under Federal Rule of Bankruptcy Procedure 9019.

Thereafter, Administrative Claimants both filed appeals of the settlement order.  The District Court for the Central District of California consolidated the appeals and the Trustee moved to dismiss the appeals claiming that neither Administrative Claimant / appellant had standing to appeal because neither, in its own capacity, objected to the settlement or appeared at the hearing.  The District Court agreed and dismissed the appeals.

In their appeals to the Ninth Circuit, the Administrative Claimants / appellants argued that despite their failure to “explicitly object” below, the Bankruptcy Court and Trustee were aware of their positions and their intent to object on their own behalves.  The Ninth Circuit noted its recent decision in In re Point Center Fin., Inc. wherein the Ninth Circuit “clarified that attendance and objection are not prudential standing requirements in bankruptcy cases, but rather relate to whether a party has waived or forfeited its right to appeal a given order of the bankruptcy court.”  Wrightwood, at 8.

Here, the Court found that “the law firms have forfeited their claims regarding the propriety of the settlement order because neither firm attended the hearing or objected to the settlement in its own capacity.”  Id. at 9.  The Ninth Circuit further explained its Point Center ruling – “[t]here, although the appellants did not file a written objection or attend the hearing, they quickly realized the error and ‘filed a motion to reconsider with the bankruptcy court before it had issued a written order on the motion,’ which the bankruptcy court considered and rejected on the merits.'”  Id. at 10 (citing Point Center).  Accordingly, the Ninth Circuit affirmed the judgement of the District Court.

The Ninth Circuit’s ruling in Wrightwood is a good reminder – “When a party has not objected to an order in writing and the record contains no explicit indication that a party meant to object, a party has normally failed to preserve its objection to that order.”  Id. at 16.

A recently issued opinion by the U. S Bankruptcy Court for the District of New Mexico provides some guidance on the relevant date for the transfer of real property for purposes of the statute of limitations applicable to fraudulent transfer claims.

In Gonzales v. Sexton (In re Esquibel), Adv. No. 17-1042-j (Bankr. D.N.M. July 23, 2018) the Bankruptcy Court considered a chapter 7 trustee’s summary judgment motion regarding the trustee’s claims for avoidance and recovery of actual and constructive fraudulent transfers under the Bankruptcy Code and state law.

real estate transferPre-petition, the Debtor owned unencumbered real property (the “Property”).  This Property was transferred to the Defendant on May 19, 2014 via a quitclaim deed.  In exchange for the Property, the Defendant (recipient of the Property) promised to maintain the property, provide the Debtor with a rent-free place to live, and care for Debtor if she was unable to care for herself.  Id. at ¶ 27.

Several years later, on September 7, 2016, just 177 days before the Debtor filed her voluntary bankruptcy petition, Defendant recorded the quitclaim deed.  Id. at ¶ 29.  The Trustee brought suit against the Defendant claiming that the transfer of the Property was avoidable under Section 548 of the Bankruptcy Code and state law because it constituted both actual and constructive fraudulent transfers.

The threshold issue for the Court was when the Property was transferred for purposes of statute of limitations – in 2014 when the deed was executed or in 2016 when the deed was recorded.  Section 548 allows a trustee to avoid transfers of estate property that occurred during the 2 years before the bankruptcy.  The Defendant asserted that the transfer occurred when the deed was signed in 2014, and the Court disagreed, finding that the transfer for the purposes of a Section 548 fraudulent transfer occurred when the deed was recorded, in 2016.

The Court looked to Section 548(d), which states “a transfer is made when such transfer is so perfected that a bona fide purchaser from the debtor against whom applicable law permits such transfer to to be perfected cannot acquire an interest in the property transferred that is superior to the interest in such property of the transferee.”  Id. at 10.  The Court further explained that the purpose of 548(d) is to “prevent fraudulent transfers from becoming impregnable to attack by keeping them secret until the limitation period has lapsed.”  Id. (citation omitted).

The Court then looked to New Mexico state law to determine when a real property transfer is perfected and found that such a transfer is perfected “when it is recorded with the county clerk of the state in which the real estate is situated.”  Id. at 11 (citation omitted).  Given this, the Court found that the transfer of the Property occurred upon recording in 2016, which was within 177 days of the chapter 7 filing, and therefore was “within the two-year look-back period under §548(a).”  Id. 

 

In Beskrone v. Int’l Educ. Corp., Adv. No. 17-50523 (CSS) (Bankr. D. Del. July 2, 2018), the Bankruptcy Court for the District of Delaware held that a chapter 7 trustee’s adversary proceeding to recover alleged prepetition accounts receivable fell under the Court’s “related to” jurisdiction. Pursuant to 28 U.S.C. §§ 1334 and 157(a), bankruptcy courts have jurisdiction over the following types of matters: cases under title 11 of the United States Code, i.e., the Bankruptcy Code; proceedings arising under title 11; proceedings arising in a case under title 11; and proceedings related to a case under title 11. In Beskrone, the Court assessed its jurisdiction under this last prong.

In this case, PennySaver USA Publishing, LLC and affiliated entities (the “Debtors”) filed voluntary petitions for relief under chapter 7 of title 11 of the United States Code and Don A. Beskrone was appointed to serve as the chapter 7 trustee of the Debtors’ bankruptcy estates (the “Trustee”). Before the close of the Debtors’ cases, the Trustee filed a single-count complaint against International Education Corporation (“IEC”), who had entered into a prepetition agreement with PennySaver for advertising services. Id. at 3. The Trustee sought to collect payments allegedly requested by PennySaver that IEC did not pay in full. Id. at 3-4. IEC moved to dismiss the Trustee’s complaint for lack of subject-matter jurisdiction. Although IEC made both facial and factual challenges to the Court’s jurisdiction over the Trustee’s claim, the Court held that it should hold IEC’s factual challenges for a later proceeding and evaluate only IEC’s “facial” challenge. Id. at 7. In a “facial” challenge to a court’s jurisdiction, a court accepts as true all factual allegations in the plaintiff’s complaint and only examines the pleadings to determine if jurisdiction exists.

In Beskrone, the Court held that it did have subject-matter jurisdiction. Principally, the Court reasoned that in assessing whether it had “related to” jurisdiction over the Trustee’s claim, the test articulated by the Third Circuit in Pacor, Inc. v. Higgins, 743 F.2d 984 (3d Cir. 1985) still provided useful guidance. In Pacor, the Third Circuit reasoned that a bankruptcy court had “related to” jurisdiction over a matter if the “outcome of [the] proceeding could conceivably have any effect on the estate being administered in bankruptcy.” 743 F.2d at 994. The Court noted that the Pacor test is satisfied if a proceeding “may impact . . . debtor’s rights, liabilities, options, or freedom of action or the handling and administration of the bankrupt estate.” Op. at 9-10. As applied to the Trustee’s claim against IEC, the Court held that the claim satisfied the Pacor test. The claim was an action held by the debtor pre-petition, and thus was property of the estate, and the Trustee’s recovery under his claim might increase funds available to the body of the Debtors’ creditors. Id. at 10.

IEC argued that if the only conceivable effect on the Debtors’ bankruptcy estates was a greater dividend for creditors, that finding jurisdiction over such an action would overly extend “related to” jurisdiction in chapter 7 liquidations. Id. at 11. In support thereof, IEC cited cases applying jurisdictional analyses in post-confirmation proceedings. The Court acknowledged that a proceeding’s effect on a bankruptcy case may be different in a reorganization versus a liquidation, and pre-confirmation versus post-confirmation, but ultimately dismissed IEC’s argument.

First, the Court noted that the notion that the nature of a bankruptcy filing could create different scopes of jurisdiction has been criticized, and that the nature of a chapter 7 liquidation “does not upend the logic of Pacor.” Id. at 13. The Court reasoned that the Trustee’s action to recover accounts receivable would directly benefit the Debtors’ estates, and that there was nothing noteworthy about the Trustee’s claim that implicated characteristics “unique to a chapter 7 liquidation.” Id. at 14. Second, the Court rejected IEC’s contention that the Trustee’s claim should be dismissed for lack of jurisdiction because the matter did not satisfy the test established by the Third Circuit in Binder v. Price Waterhouse & Co., LLP (In re Resorts Int’l, Inc.), 372 F.3d 154 (3d Cir. 2004) for determining jurisdiction over post-confirmation proceedings in chapter 11 cases.  In Resorts Int’l, the Third Circuit reasoned that a bankruptcy court has “related to” jurisdiction over certain post-confirmation proceedings that “affect an integral aspect of the bankruptcy process – there must be a close nexus to the bankruptcy plan or proceeding.” Op. at 14-15 (citing Resorts Int’l). But, as the Court noted, post-confirmation proceedings diminish connections to the bankruptcy estate when the parties “have purposefully and by agreement removed a debtor from court oversight.” Id. at 15. In contrast, pre-closing chapter 7 liquidations, such as the Debtors, are “less attenuated to the estate.” Id. at 16. Lastly, the Court found IEC’s argument that there are similarities between chapter 7 and chapter 11 liquidations that make the application of the jurisdictional standard set forth in Resorts Int’l proper, to be unpersuasive.

Ultimately, the Court denied IEC’s motion to dismiss for lack of subject-matter jurisdiction and found that the Trustee’s proceeding to recover prepetition accounts receivable fell within the Court’s “related to” jurisdiction.

In an appeal from the U.S. Bankruptcy Court for the District of Hawaii, the U.S. District Court for the District of Hawaii determined when the date of the transfer occurred for the purposes of a preferential transfer asserted by a trustee pursuant to 11 U.S.C. §547.  See Coulson v. Kane (In re Price), Civ. No. 17-00437-LEK-KSC (D. Hi June 29, 2018).  Generally, a preferential transfer under Section 547 of the Bankruptcy Code involves a transfer of the debtor’s funds or property shortly before filing for bankruptcy (within 90 days) and such a transfer can be avoided (and the funds/property returned to the bankruptcy estate) if certain conditions are met.

In this case, the Appellant was sued by a bankruptcy trustee for receipt of funds out of escrow that occurred during the 90 days immediately preceding the debtor’s bankruptcy filing. The appellant argued, among other things, that the transfer actually occurred outside the 90-day period because the transfer occurred at some earlier time when the funds were put into escrow because bankruptcy courts have previously held that escrow funds are not property that vests in the bankruptcy trustee.  Id. at 16.

Honolulu, Hawaii
Honolulu, Hawaii

The Court explained that “[t]o prevail on his escrow theory, Appellant must show the ultimate transfer of funds to him, which occurred outside the preference period, did not ‘deplete the assets of the estate available for distribution,'” or, in other words, that the “Escrow Instructions diminished the Debtor’s interest in the escrowed funds sufficiently so that they were not property of the bankruptcy estate.”  Id. at 17 (citations omitted).

For example, escrow instructions that have left a debtor with only a “contingent right” to the funds might sufficiently diminish the debtor’s interest in escrow funds such that the funds are no longer estate property.  Id.  Here, however, the Escrow Instructions at issue did not contain any particular terms that caused the Debtor’s interest to be “without value to the bankruptcy estate.”  Id. at 18.

Accordingly, the Hawaii District Court affirmed the Bankruptcy Court’s ruling that the trustee could recover the transfer of the escrowed funds to appellant because that transfer occurred within the 90-day preference period.  Although sometimes receipt of a preferential transfer can’t be avoided, this case serves as an important reminder to review escrow instructions carefully to the extent they could be used as a defense.