Delaware Business Bankruptcy Report : Delaware Business Bankruptcy Report : Morris James LLP Lawyers & Attorneys

Burtch v. Huston (In re USDigital, Inc.), Case No. 09-10374 (CSS), Adv. Pro. No. 09-50469 (CSS) (January 5, 2011) (J. Sontchi)

On March 26, 2007 (the “Petition Date”), USDigital filed a voluntary Chapter 7 petition, subsequent to which Jeoffrey L. Burtch was appointed as successor interim Chapter 7 Trustee (the “Trustee”). The Trustee filed a complaint on March 18, 2009 seeking to avoid prepetition transfers and alleging breaches of fiduciary duty, aiding and abetting breaches of fiduciary duty, usurping corporate opportunity, corporate waste, unjust enrichment, accounting, disallowance of claims, equitable subordination, and recharacterization against NexGen Telecom, LLC (“NexGen”), Infinidi Media, Inc. (“Infinidi Media”), Stonebridge Marketing, LLC (“Stonebridge”), and directors of USDigital, Inc. (collectively, the “Defendants”).

On November 12, 2009, the Defendants filed a motion to dismiss, to which the Trustee objected on January 14, 2010. The Defendants filed a reply brief on February 12, 2010 and the Court entered its order and issued its opinion on January 5, 2011.

By way of background, USDigital was one of four separate, but interconnected, corporations formed between 2003 and 2006. The corporate quartet consisted of: (1) USDigital; (2) USDigital Television, LLC (“USDTV”); (3) NexGen; and (4) Infinidi Media. Each of these corporations shared the same source of capital, had many of the same directors and officers, and entered into transactions with one another. In relevant part, on June 13, 2006, USDTV executed a promissory note in favor of NexGen in the amount of $104,160.00 secured by set top boxes owned by USDTV, which transaction was documented by a security agreement (the “USDTV Security Agreement”). 

Following USDTV’s bankruptcy petition in 2007, USDigital and USDTV entered into an asset purchase agreement (the “APA”) for the sale of substantially all of USDTV’s assets to USDigital, as well as USDigital’s assumption of USDTV’s liabilities to NexGen including the USDTV Security Agreement, which sale was approved on September 12, 2006.

Discussion:

The Court’s ruling and rationale concerning each of the counts of the complaint are set forth below.

Count I: Preferential Transfers to NexGen

Count I of the Complaint alleged that USDigital made two preferential transfers to NexGen: (i) a security interest in the set top boxes, and (ii) a $44,421 payment for expense reimbursement for a payment NexGen made to ESPN on USDTV’s behalf. The issue with respect to both transfers was whether the payment was made “for or on account of an antecedent debt,” as required by 11 U.S.C. § 547(b)(2). The Court determined that neither payment was made on account of an antecedent debt because: (i) the transfer of the security interest occurred on the same day as USDigital incurred the obligation to make such transfer, both of which events either occurred on the date USDigital entered into the APA or on the date the Court approved the asset sale; and (ii) the expense reimbursement payment was made on August 8, 2006, comfortably before the Debtor became obligated to make such payment pursuant to the September 12, 2006 approval of the APA. Accordingly, Count I was dismissed.

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Wahoski v. Classic Packaging Co. (In re Pillowtex Corp.), Adv. Pro. No. 05-30182 (KJC) (April 14, 2010) (J. Carey)

John Wahoski, as liquidating trustee of Pillowtex Corporation (the “Liquidating Trustee”) sought to recover $61,761.32 in allegedly preferential payments (the “Transfers”) from Classic Packaging Company (“Classic”), which had sold plastic bags and packaging printed with the Pillowtex brand names to the Debtors prior to the petition date.  The Liquidating Trustee was also pursuing a claim to recover allegedly fraudulent transfers. 

Classic filed a motion for summary judgment with regard to the Transfers, arguing that the ordinary course of business defense applied to each Transfer and a motion to dismiss arguing that the complaint did not set forth fraudulent transfer claims with sufficient specificity.  For the reasons articulated below, the Court denied the motion for summary judgment and granted the motion to dismiss.

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Mervyn’s LLC v. Lubert-Adler Group IV, LLC (In re Mervyn’s Holdings, LLC), Adv. Pro. No. 08-51402 (KG) (March 12, 2010) (K. Gross).

The Official Committee of Unsecured Creditors (the “Committee”) asserted a subsequent transferee claim pursuant to 11 U.S.C. § 550(a)(2) against Bank of America (in its capacity as successor trustee of a trust) to recover certain liens granted to the former trustee on transferred real estate. Due to numerous omissions in the original Complaint, which Bank of America addressed in a timely filed motion to dismiss, the Committee sought to amend its Complaint. Bank of America opposed the amendments, arguing that they would prove futile because Bank of America was not a “transferee” for purposes of 11 U.S.C. § 550.

The Court agreed with Bank of America, denying the Committee’s Motion to Amend as futile and granting Bank of America’s Motion to Dismiss.

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Plassein Int’l Corp. v. B.A. Capital Co. LP (In re Plassein Int’l Corp.), No. 03-14489, 2008 WL 2073495 (D. Del. May 15, 2008) (Judge Joseph J. Farnan, Jr.)

The Debtors’ Chapter 7 Trustee (the “Trustee”) commenced an adversary proceeding against B.A. Capital Co. LP alleging that a series of fraudulent transfers rendered the Debtors insolvent or with unreasonably small capital for its businesses. The Bankruptcy Court had dismissed the Complaint because the court concluded (i) the transfers were settlement payments, pursuant to 11 U.S.C. § 546(e) and thus, not subject to avoidance under 11 U.S.C. § 544(b); (ii) the Complaint failed to state a claim upon which relief could be granted because it failed to assert that Plassein or any of the related Debtors made the allegedly fraudulent transfers; and (iii) the allegations within the Complaint could not be collapsed because neither the intent to defraud nor bad faith was alleged. The District Court affirmed.

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Miller v. McCown De Leeuw & Co., Inc. (In re Brown Schools), No. 05-10841, Adv. No. 06-50861 (Bankr. D. Del. April 24, 2008) (Judge Mary F. Walrath)

The Bankruptcy Court reaffirmed that Delaware does not recognize a deepening insolvency cause of action. However, the Court determined that a breach of the duty of loyalty claim could still be asserted. Unlike a breach of the duty of care, a breach of the duty of loyalty is not a disguised deepening insolvency claim. Further, damages based on deepening insolvency could be used in the damages calculations. Finally, a claim for aiding and abetting fraudulent transfers is not a recognized cause of action in Delaware.

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Stanziale v. Pepper Hamilton LLP (In re Student Finance Corp.), No. 04-1551 (JJF), 2007 WL 2936195 (D. Del. Oct. 5, 2007) (Judge Joseph J. Farnan, Jr.)

In this adversary proceeding in the United States District Court for the District of Delaware, certain defendants moved to strike damages claims alleged by the trustee of the estate of Student Finance Corporation.  The Court granted the motion, finding that the trustee failed to provide fair notice of these damages claims, as required under Fed. R. Civ. P. 8(a) (made applicable to this adversary proceeding by Fed. R. Bankr. P. 7008(a)). 

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In re Scott Acquisition Corp., 364 B.R. 562 (Bankr. D. Del. 2007) (Judge Peter J. Walsh)

The Chapter 7 Trustee of the estate of debtors Scott Acquisition Corporation and Scotty’s Inc. filed a complaint against the debtors’ pre-petition counsel, asserting legal malpractice, breach of fiduciary duty and fraudulent transfer claims. The claims arose from a series of transactions between the debtors and insiders of the debtors, in which the defendants represented both the debtors and the insiders. The defendants filed a motion to dismiss the legal malpractice and breach of fiduciary duty claims, asserting that the trustee was estopped from prosecuting those claims by the equitable defense of in pari delicto. The United States Bankruptcy Court for the District of Delaware granted the motion, finding the in pari delicto defense barred those claims, but permitted the fraudulent transfer count to go forward.

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Official Comm. of Unsecured Creditors of the IT Group, Inc. v. Acres of Diamonds, L.P. (In re the IT Group, Inc.), 359 B.R. 97 (Bankr. D. Del. 2006) (Judge Mary F. Walrath)

Within a year prior to the petition date of the IT Group, Inc. debtors, defendant Acres of Diamonds L.P. sold to Organic Waste Technologies, Inc. five shares of the common stock of Keystone Recovery, Inc. Organic Waste paid for the shares by making a wire transfer of $575,000 from debtor IT Corporation’s Citibank account. Prior to confirmation of the debtors’ Chapter 11 plan, the debtors commenced a preference action against Acres, seeking to avoid and recover the $575,000 payment. The complaint was thereafter amended to add a fraudulent transfer cause of action, and amended again to drop the preference claim. 

The court granted Acres’ motion for summary judgment, finding that the transfer was a payment for securities, made by a financial institution, and therefore excepted from avoidance under section 546(e) of the Bankruptcy Code.

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Burtch v. Dent, (In re Circle Y of Yoakum, Tx.), 354 B.R. 349 (Bankr. D. Del. 2006) (Judge Mary F. Walrath)

The Chapter 7 Trustee of debtor Circle Y’s estate asserted claims under sections 547 and 548 of the Bankruptcy Code relating to payments made to an insider more than one year before the petition date. The Bankruptcy Court held that those claims were time-barred. Also, because the Trustee’s fraudulent transfer claims pled no facts in support of the Trustee’s allegations, but merely recited relevant statutory language, the Bankruptcy Court dismissed those claims for failure to plead fraud with sufficient particularity. However, the Court granted the Chapter 7 Trustee leave to amend to add additional payments where those payments were part of a discernible pattern with payments alleged in the Trustee’s original complaint.

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Astropower Liquidating Trust v. Xantrex Tech (In re Astropower Liquidating Trust), Case No. 04-10322 (MFW), Adv. Pro. No. 05-50867, 2006 WL 2850110 (Bankr. D. Del. Oct. 2, 2006) (Judge Mary F. Walrath)

Defendants Merrill Lynch Asset Management and Merrill Lynch Investment Managers Limited moved to dismiss a fraudulent transfer complaint for lack of personal jurisdiction. Finding that the minimum contacts requirement for personal jurisdiction was not met, the Court dismissed the complaint.

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In re Oakwood Homes Corp., 342 B.R. 59 (Bankr. D. Del. 2006) (Judge Peter J. Walsh)

Defendants moved to dismiss an adversary complaint seeking recovery of funds related to a surety bond and to a letter of credit.

The Court dismissed the counts in the complaint that sought to recover the letter of credit and the proceeds of the letter of credit as neither was property of the estate. However, the Court denied the motion to dismiss counts which sought to recover for alleged contract breaches between the debtors and the Defendants because the estate had a recognized interest in the contractual and equitable claims of the debtor, which were property of the estate.
The Court also granted leave to amend two fraudulent transfer counts.

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Pension Transfer Corp. v. Beneficiaries Under the Third Amendment to Fruehauf Trailer Corp. Retirement Plan No. 003 (In re Fruehauf Trailer Corp.), 444 F.3d 203 (3d Cir. 2006) (Circuit Judge Thomas L. Ambro)

The Delaware District Court approved the avoidance of an alleged fraudulent transfer under §548(a)(1) of the Bankruptcy Code of a surplus from a union pension plan that was used to provide benefits to management through a pre-petition amendment to the debtor’s pension plan.

The pension plan had been amended on September 19, 1996 and the Debtor filed its bankruptcy petition approximately two weeks later.

The District Court found that there was not reasonably equivalent value provided to the Debtor for the loss of the surplus used to provide benefits to management. The Defendants had failed to prove that the plan amendment helped to retain key personnel so that the debtor could sell its assets as a going concern.

On appeal, the Third Circuit concluded that the amendment to the pension plan was fraudulent despite the lack of a precise calculation of the benefits conferred and received by the plaintiff.

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