The following is a case update written by Adam A. Lewis, Senior Counsel, Morrison & Foerster LLC, analyzing a recent decision of interest:
In Peterson v. Premier Electric Services Corp. (In re Mack Industries, Ltd.), ___ B.R. ___, 2021 WL 2005463 (Bankr. N.D. Ill., May 19, 2021)) (“Mack”), the United States Bankruptcy Court for the Northern District of Illinois (the “Court”) dismissed a chapter 7 trustee’s adversary proceeding against the defendant electrical company for avoidance of an alleged constructive fraudulent conveyance because it rejected the trustee’s theory that the defendant failed to provide any value, let alone reasonably equivalent value, to the debtor by fulfilling its contract with the debtor to provide services to a property owned by a third party with whom the debtor had contracted to manage a portfolio of properties that included the subject.
Mack can be found here.
The debtor contracted with a client to manage for a fee a large portfolio of properties the client owned. The contract obligated the debtor to provide such services as leasing the properties, collecting rents and maintaining the properties. The debtor kept the rents and paid a fee to the owner. Under contract with the debtor, the defendant provided its services to one of properties managed by the debtor for the owner. The debtor paid the defendant their contract price.
Facing financial distress, the debtor tried to renegotiate its contract with owner, threatening to strip itself of net worth so that the owner would have no meaningful remedy against it. The threat failed, although the property owner claimed the debtor had followed through it with it, so the debtor filed its bankruptcy. The chapter 7 trustee sued a number of counterparties to contracts with the debtor to benefit the properties it managed for the owner to whom the debtor had paid contractual sums due. The trustee alleged that the transactions were constructive fraudulent conveyances benefitted the owner of the properties, not the debtor. In essence, his theory was that the transfers to the defendant (and the other similarly-situated defendants) were per se not for a reasonably equivalent value because the debtor got no benefits from them, the benefits all flowing to the property owner.
The defendant moved to dismiss the complaint on the ground that the debtor did benefit from its services because the work helped the debtor to earn its management fee by fulfilling its obligations to the owner. The Court granted the motion with prejudice.
Noting that it already had decided two similar cases against defendants in other adversary proceedings in the underlying bankruptcy, the Court denied the motion because absent any evidence to the contrary, the debtor did benefit from the defendant’s services because providing those services was part of how the debtor fulfilled its obligations to the owner and thereby earned its fee under the owner/debtor management contract. The underlying issue, it pointed out, is not “the transaction’s overall value to the debtor as it relates to the welfare of the debtor’s business,” but the specific quid pro quo between the defendant and debtor.
Because the trustee did not allege any other grounds supporting a possible finding of lack of reasonably equivalent value (such as that the fee for the defendant’s services was excessive or the defendant botched the job) and did not contend in his response to the motion that he could do so, the Court made the dismissal with prejudice.
Mack clearly is right. Were it not, a lot of unremarkable transactions suddenly would be vulnerable to attack. For example, the salary paid by a construction company to one of its carpenters for a days’ work on a housing project the company contracted to build for a developer would be avoidable as a constructive fraudulent conveyance because the work directly benefitted the developer by adding value to its project but put no measureable value directly in the construction company’s pocket. It appears that the trustee was relying in some way on the existence of the debtor’s alleged scheme to denude itself to “poison” the payment to the defendant, a sort of “inadvertent aiding and abetting” notion that would go way too far.
These materials were authored by Adam A. Lewis, Senior Counsel, Morrison & Foerster LLC, a member of the ad hoc group, with editorial assistance by Meredith Jury, (bankruptcy judge, C.D. Cal. (Ret.)), a member of the ad hoc group. Thomson Reuters holds the copyright to these materials and has permitted the Insolvency Law Committee to reprint them. This material may not be further transmitted without the consent of Thomson Reuters.