Restructuring

Contributed by Kyle J. Ortiz
In deciding Onkyo Electronics v. Global Technovations Inc. (In re Global Technovations Inc.), the United States Court of Appeals for the Sixth Circuit became the first court of appeals to considered whether, following the Supreme Court’s decision in Stern v Marshall, a bankruptcy court has jurisdiction to enter a final judgment on a fraudulent transfer action (although the Sixth Circuit framed the question as whether the bankruptcy court had jurisdiction to enter a final order, most courts and many commentators (including this blog), have concluded that Stern addressed the authority of bankruptcy courts to issue final orders, and not whether they have jurisdiction to hear them).  The Sixth Circuit held that the bankruptcy court in question had jurisdiction to enter a final judgment on a fraudulent transfer because the creditor had filed a proof of claim.  The holding, however, implied that the Sixth Circuit would not have held that the bankruptcy court had such authority if the creditor had not filed a proof of claim.
The debtor, Global Technovations Inc. (“GTI”), filed a suit in the United States Bankruptcy Court for the Eastern District of Michigan seeking (i) to disallow Onkyo’s proof of claim based on GTI’s balance owed on promissory notes issued in connection with Onkyo’s sale of its subsidiary, Onkyo American Incorporated (“OAI”), to GTI, and (ii) to recover previous payments in connection with GTI’s purchase of OAI pursuant to section 544(b) of the Bankruptcy Code (which allows a trustee to avoid any transfer that is voidable under applicable law by a creditor holding an allowable claim).  GTI asserted that the transfer of OAI from Onkyo to GTI violated the Florida Uniform Fraudulent Transfer Act (“FUFTA”) which voids any transfer made or obligation incurred “without receiving a reasonably equivalent value in exchange.”
GTI had paid $21.6 million for OAI ($13 million in cash and $8.6 million in promissory notes that the bankruptcy court found the present discounted value of to be $12 million). The bankruptcy court, however, determined that OAI was only worth $6.9 million at the time of the transfer.  In conducting its fraudulent transfer analysis under FUFTA, the bankruptcy court not only had to determine whether GTI had received reasonably equivalent value, but also whether Onkyo was a good-faith-transferee under FUFTA in order to make a determination as to how much Onkyo may have to return to GTI.  If Onkyo was not a good-faith-transferee it would be required to repay the full $13 million previously received, but if they were found to be a good-faith-transferee under FUFTA, they would only have to return $6.1 million (the difference between the $13 million they had received and the $6.9 million value the bankruptcy court assigned to OAI).  The bankruptcy court held that the transfer of OAI to GTI was a fraudulent transfer and disallowed Onkyo’s $12 million proof of claim.  The bankruptcy court then turned to the question of how much of the $13 million that GTI previously paid Onkyo; Onkyo would have to return to GTI.  The bankruptcy court held that because Onkyo was a good-faith-transferee under FUFTA, Onkyo would only have to refund $6.1 million to GTI.
Onkyo appealed to the district court, the district court upheld the bankruptcy court’s decision, and Onkyo appealed to the Sixth Circuit.
Stern was decided shortly after the Sixth Circuit accepted appeal.  In response, the Sixth Circuit asked for supplemental briefing and argument from the parties as to both whether (i) the bankruptcy court had jurisdiction to enter a final judgment on the fraudulent transfer action, and (ii) if the bankruptcy court had authority to make a good-faith-transferee determination in connection with the fraudulent transfer action.  The Sixth Circuit examined the transfer of OAI in light of Stern, and Stern’s interpretation of Granfinanciera, specifically focusing on the Stern Court’s conclusion that when an action is based on “a state law action independent of the federal bankruptcy law and not necessarily resolvable by a ruling on the creditor’s proof of claim,” the bankruptcy court lacks authority to enter a final judgment.
The Sixth Circuit held that because Onkyo had filed a proof of claim in GTI’s chapter 11 case, the present case was “fundamentally unlike Granfinanciera, where the bankruptcy estate reached out to file a fraudulent-transfer claim against a party who had filed no claim against the [e]state.”  Thus, the Sixth Circuit held that it was “crystal clear that the bankruptcy court had constitutional jurisdiction under Stern to adjudicate whether the sale of [OAI] was a fraudulent transfer” because Onkyo’s proof of claim could not be resolved without addressing the fraudulent transfer question.
The question, however, of “whether the bankruptcy court had jurisdiction under Stern to make the additional finding that Onkyo was a ‘good-faith transferee’” under FUFTA was “not crystal clear.”  The Sixth Circuit noted that the good-faith-transferee provision in FUFTA and other similar state fraudulent transfer acts would make it necessary in many fraudulent transfer cases “for the bankruptcy court to make the good-faith-transferee finding in order to determine exactly how much of the debtor’s claim to disallow.”  In the present case, however, the bankruptcy court ultimately did not have to reach that issue because the claim was disallowed in its entirety due to the fact the bankruptcy court had determined that OAI was worth considerably less than the $13 million previously paid by GTI at the time of the transfer.  The Sixth Circuit held that even though a good-faith-transferee determination was not necessary to resolve Onkyo’s proof of claim, the bankruptcy court nonetheless had jurisdiction to make the determination.  The Sixth Circuit stated that it did not believe that Stern required a court “to determine, in advance, which facts will ultimately prove strictly necessary to resolve a creditor’s proof of claim.” Thus, the mere possibility that a claim dispute will be resolved in a way that requires the bankruptcy court to continue on and address unrelated matters does not deprive the court of jurisdiction.
Although the Sixth Circuit’s decision appears to allow some flexibility in interpreting the reach of Stern when a creditor brings itself before the bankruptcy court by filing a proof of claim, the Sixth Circuit’s focus on whether or not a fraudulent transfer action could be resolved in the claims resolution process suggests that the Sixth Circuit is in accord with a number of decisions broadly interpreting Stern to deprive bankruptcy courts’ of jurisdiction to hear fraudulent transfer claims.  Those decisions hold that, because fraudulent transfer actions are quintessentially actions at common law, the bankruptcy courts do not have final adjudicative authority over them unless they are necessary to resolve a proof of claim.  This is in contrast to the many courts that have held, following Stern, that fraudulent transfer actions are part of a federal statutory scheme and as such bankruptcy courts have final adjudicative authority over them under the public rights doctrine regardless of whether the creditor files a proof of claim.
The long-term significance of the Onkyo case will depend on how other circuits rule on this divisive issue.  We may not have to wait long for another circuit to rule on the issue as a decision on a related question is expected soon from the Ninth Circuit in In re Bellingham Insurance Agency Inc. In Bellingham, the Ninth Circuit invited supplemental briefs by amicus curiae to address whether Stern prohibits bankruptcy courts from entering final judgments in fraudulent conveyance actions.  One can only speculate how the Ninth Circuit and other circuits will rule on the issue of fraudulent transfers, but it is a highly litigated issue, and, thus, although the Sixth Circuit is the first court of appeals to weigh in on the issue, it won’t be the last.