Contributed by Jessica Diab
The Supreme Court’s decision in Till v. SCS Credit Corp. created quite a stir among bankruptcy practitioners because of its effect on what interest rate might constitute the proper rate to compensate secured lenders forced to accept loans pursuant to a chapter 11 plan. For some, this was troubling, as the decision in Till involved a chapter 13 case and the collateral securing the secured claim was a single pickup truck — certainly not the facts of a large commercial chapter 11 case.
Today’s post isn’t about interest rates; however, it does involve a truck — a GMC pickup truck, to be specific. And although this decision is not likely to have the same sort of notoriety that the Till decision has had, this decision from Bankruptcy Court for the District of Idaho is, nevertheless, worthy of a read as it provides practitioners with some noteworthy reminders on the law of fraudulent and preferential transfers.
Tom Floyd and Evelyn Floyd were the sole members of Action AG, LLC, a limited liability company engaged in farming and commodity trading. In late 2012, Action AG was facing some financial difficulties due to a lawsuit and lack of cash flow. In an effort to commence negotiations to reduce Action AG’s outstanding debts, Tom Floyd mailed letters to Action AG’s creditors offering to trade some equipment for debt relief.
This initiated negotiations between Tom Floyd and one of Action AG’s suppliers, Kevin Rowley. Rowley, who was owed a substantial amount from Action AG, was being threatened by his lender who would cease financing Rowley’s operations, if Rowley did not collect on his receivable from Action AG or receive a personal guarantee from Tom. On December 14, 2012, Tom executed a personal guarantee of “all monies owed by Action AG” to Rowley for certain commodities supplied in 2011 and 2012. In addition, on January 25, 2013, Action AG executed: (i) a note to Rowley in the total amount of $135,000, payable at $13,500 per year, plus 6% interest, which also granted Rowley a lien on twenty-one vehicles (trucks and trailers), including a 2005 GMC pickup truck owned by the Floyds, and (ii) a “trade/note” whereby Rowley agreed to take, as partial payment, certain real property owned by the Floyds, ascribed a value of $75,000. A warranty deed was recorded transferring such real property to Rowley.
These transactions provided Rowley with the relief necessary to assuage his own lender, allowed the Floyds to salvage a working relationship between Action AG and Rowley, and provided the Floyds with time to attempt to rehabilitate Action AG’s business.
Unfortunately, Action AG could not rehabilitate and, in October 2013, Action AG filed for chapter 7. Shortly thereafter, Tom Floyd and Evelyn Floyd filed joint voluntary chapter 7 petitions. With evidence clearly establishing that, in late 2012 and early 2013, at the time when Action AG executed the note and the trade/note, the Floyds’ liabilities significantly outweighed their assets, the chapter 7 trustee of the Floyds’ cases, initiated an adversary proceeding against Rowley asserting, among other things, that:
(i) The personal guarantee of Tom for Action AG’s obligations to Rowley lacked consideration; and
(ii) The transfer of title to the GMC truck and the warranty deed transferring the real property to Rowley constituted (a) preferential transfers, avoidable under section 547(b) of the Bankruptcy Code or (b) fraudulent transfers, avoidable under section 548(a)(1)(B) of the Bankruptcy Code.
The Bankruptcy Court for the District of Idaho considered each of the Trustee’s contentions in turn:
Issue 1: Validity of the Guarantee
The Court dismissed the Trustee’s claim that Tom received nothing of value in exchange for the personal guarantee and held that the extension of credit to a debtor is sufficient consideration for the guarantor of that debtor’s obligation. On this basis, the forbearance by Rowley was deemed sufficient consideration for Tom’s guarantee of Action AG’s debt.
Issue 2: Transfers as Preferences
The Court then considered the Trustee’s argument that the transfers of title to the GMC truck and the real property to Rowley constituted a preferential transfer under section 547(b) of the Bankruptcy Code. Section 547(b) allows a trustee to avoid certain transfers of an interest in the debtor’s property that occurred prior to the petition date where such transfers benefited a creditor on account of an antecedent debt and where such transfers occurred while the debtor was insolvent, so long as such transfers occurred within the statutory “lookback” period of 90-days or up to one year from the petition date if the creditor is an insider. Because the transfers at issue occurred in January 2013, more than ninety days from the petition date, the Trustee could only sustain the preference claim by establishing that Rowley constituted an “insider.” Unfortunately for the Trustee, Rowley clearly did not qualify as an “insider” under the enumerated examples set forth in the definition of “insider” in section 101(31)(A) of the Bankruptcy Code. The Trustee argued, however, that Rowley was a “non-statutory insider.” The Court agreed that, under certain facts, a counterparty could be deemed a “non-statutory” insider, but held that on these facts, where the parties negotiated at arms’-length and there was simply no evidence to show that the counterparty could exert control over debtor, there was an insufficient basis to deem Rowley a “non-statutory” insider. In so holding, the Court noted that the evidence of the parties’ modest personal relationship that involved sharing meals and attending basketball games was unpersuasive.
Issue 3: Transfers as Fraudulent Transfers
Finally, the Trustee contended that the transfers of title to the GMC truck and the real property to Rowley were avoidable as fraudulent transfers under section 548(a)(1)(B). Under section 548(a)(1)(B), a trustee may avoid a transfer of an interest of the debtor in property if the transfer was made within two years before the petition date, the debtor received less than reasonably equivalent value in exchange for such transfer, and the debtor:
(i) was insolvent on the date of such transfer or became insolvent as a result of such transfer;
(ii) was engaged in business or a transaction, or was about to engage in business or a transaction, for which any property remaining with the debtor was unreasonably small capital;
(iii) intended to incur or believed that it would incur debts that would be beyond the debtor’s ability to pay as such debts matured; or
(iv) made such transfer to or for the benefit of an insider.
The evidence clearly established that the transfers occurred within two years of the filing of the petitions and, as noted above, the Floyds were insolvent on the date of the transfer. Accordingly, the only element at issue was whether the Floyds received less than reasonably equivalent value at the time of the transfers. The Court noted that reasonable equivalence “does not require exact equality of value, but rather must be approximately or roughly equivalent, and is fundamentally a question of common sense.” There must, however, be at least be a quantifiable basis for the valuation – “some rough or approximate understanding of the financial value of the transfer.” The Court also noted that indirect benefits to a debtor may constitute value, but only if such indirect benefits are sufficiently concrete and identifiable. The primary focus should be the net effect of the transaction on the debtor’s estate. With this legal framework set out, the Court considered the facts: the transfers at issue removed $75,000 of value in real estate and $10,000 of equity in the vehicle from the Floyds’ estates. In return for these transfers (and for guaranteeing Action AG’s debt), the Floyds received only the ability, as Action AG’s members, to see if that entity’s financial situation could be saved. This, the Court determined, was not reasonably equivalent to the value transferred. The Court entered judgment in favor of the Trustee on this count.
Sometimes, simple facts can make precedent setting law (take Till, for example). Other times, simple facts allow a court to issue a decision that serves as a helpful reminder on the state of the law. Today, it’s the latter. This decision is a reminder that (i) a counterparty to a transfer may be deemed a non-statutory insider for purposes of a preference action where the counterparty exercises control and influence over the debtor, and the parties fail to negotiate at arms’-length and (ii) where a party transfers value for the benefit of a related third party, the indirect benefit received by the transferee may not be considered reasonably equivalent value if such benefit is not both concrete and identifiable.
Jessica Diab is an Associate at Weil Gotshal & Manges, LLP in New York.