Opinion
Case No. 02-82003-SSM, Adversary Proceeding No. 02-8199-SSM.
February 8, 2005
James P. Campbell, Esquire, Campbell Miller Zimmerman, P.C., Leesburg, Virginia, Counsel for plaintiff.
Matthew Zapf, Esquire, Goldberg, Kohn, Bell, Black, Rosenbloom, Chicago, Illinois, Counsel for defendants.
Harry M. Johnson, III, Esquire, Hunton Williams, Richmond, Virginia, Local counsel for defendants.
H. Jason Gold, Esquire, Wiley Rein Fielding LLP, McLean, VA, Counsel for the debtor and Trustee of the DANA Liquidating Trust.
Jack Frankel, Esquire, Office of the United States Trustee, Alexandria, VA, Counsel for W. Clarkson McDow, Jr., United States Trustee, Region Four.
MEMORANDUM OPINION
In this consolidated adversary proceeding and claim objection, the Official Committee of Unsecured Creditors (now known as the Plan Monitoring Committee) objects to identical proofs of claim in the amended amount of approximately $146 million filed by Fairchild Dornier GmbH and Dr. Eberhard Braun, and seeks to subordinate the claim, or, alternatively, to recharacterize it as equity rather than debt.
Prior to trial, the court had granted partial summary judgment recharacterizing approximately $44 million of the claim as equity. A trial was held in open court without a jury from January 26 to January 30, 2004, on the remaining issues. At the close of the plaintiff's case, the court granted judgment in favor of the defendants on the equitable subordination claim. Following the trial, the court set a schedule for the filing of post-trial briefs and took the issues under advisement.
In August 2004 — approximately 8 months after the conclusion of the trial and 6 months after the filing of post-trial briefs — the Committee filed motions to reopen the evidentiary record and to amend the claim objection. The court denied the motion to reopen the evidentiary record, but allowed the claim objection to be amended to assert GmbH's alleged receipt of an avoidable preference as an additional ground for disallowance to the extent such a preference is established in separate litigation brought for that purpose.
For the reasons stated, the court concludes that the remaining claim is overstated by approximately $10 million and that an additional $84 million should be recharacterized as equity, leaving a net claim of approximately $6.475 million. This opinion constitutes the court's findings of fact and conclusions of law under Fed.R.Bankr.P. 7052 and Fed.R.Civ.P. 52(a).
Background and Findings of Fact I.
Dornier Aviation (North America) Inc. ("DANA" or "the debtor") is an indirect subsidiary of Fairchild Dornier GmbH ("GmbH"), a German aircraft manufacturer. DANA provided sales and maintenance support to GmbH in North America and Asia. In early April 2002, insolvency proceedings were commenced against GmbH in Weilheim, Bavaria, Germany, under German insolvency law. Approximately three weeks later (April 24, 2002), an involuntary petition under chapter 7 of the Bankruptcy Code was filed against DANA in this court by twenty-eight of its former employees. The debtor did not contest the petition, and both an order for relief and an order converting the case to chapter 11 were entered on May 20, 2002. After an unsuccessful attempt to reorganize, DANA ultimately proposed a plan of liquidation, which was confirmed on February 14, 2003. Under the plan, the Official Committee of Unsecured Creditors was continued in existence as the Plan Monitoring Committee and was given standing to object to GmbH's claim.
There are a total of 23 companies that make up the Fairchild Dornier group. A simplified corporate family tree that shows the relationship of the key players to the present controversy is attached as an exhibit to this opinion.
The estimated distribution on general unsecured claims is between 3.5 cents and 41.1 cents on the dollar, largely depending on the result of the present litigation, since the GmbH claim is by far the largest single claim in the case. It has been estimated that the other claims that have been allowed or are likely to be allowed are in the range of $17 million to $20 million.
Dr. Eberhard Braun was appointed by the German Insolvency Court as Insolvency Administrator for GmbH. Uncertain as to which of them possessed a claim against the debtor, and out of an abundance of caution, both Dr. Braun and GmbH filed otherwise identical proofs of claim (Claim Nos. 104 and 106) in the amount of $162,082,129.11. GmbH subsequently amended its proof of claim twice (Claim Nos. 189 and 198), with the most recent amendment being in the amount of $146,143,823.06. On September 27, 2002, the Committee filed a complaint seeking to equitably subordinate the entire claim of the defendants or, in the alternative, to reclassify the claim as an equity investment, and then on November 26, 2002, filed an objection to the original proofs of claim. The court consolidated the claim objection and the adversary proceeding for trial.
The defendants' claim can be broken down into several major components. One of them, referred to as the wing operation loan, was in the amount of $43,543,000. On December 23, 2003, the court granted partial summary judgment in favor of the Committee recharacterizing the wing operation loan, together with $1,422,404.66 in associated interest, as an equity investment. The remaining $101,178,418.40 of the claim was reserved for trial and will be discussed below after a brief discussion of the overall corporate structure and history of the parties.
II. Overview of Corporate Structure and History
Both the debtor and GmbH are indirect subsidiaries of Fairchild Dornier Corporation ("FDC"). FDC is a holding company and held direct and indirect interests in a total of 22 companies. GmbH and DANA are three and five levels removed, respectively, from FDC on one branch of the corporate family tree. Along a separate branch is Fairchild Aircraft, Inc. ("FAI"), a wholly owned direct subsidiary of FDC. The immediate parent of DANA (and immediate subsidiary of GmbH) is a company known as Dornier Aviation Holdings North America ("DAHNA"). DANA is one of two subsidiaries of DAHNA; the other is a company known as Dornier Aviation Marketing Support, Inc. ("DAMSI"), which provided financing and leasing support to GmbH.
An involuntary chapter 7 petition was filed against FDC in this court at the same time as the petition against DANA. FDC's case was converted to chapter 11 but ultimately reconverted to chapter 7.
FAI is itself a chapter 11 debtor in the Western District of Texas, at San Antonio.
GmbH is (or more accurately, was) an aircraft manufacturer located in Oberpfaffenhofen, Germany, and is the successor to Dornier Luftfahrt GmbH (referred to in some of the exhibits as "DoLuft"), a company that had been around since 1934. DANA was incorporated in Virginia in 1986, and has had its principal place of business at various times in Texas and Virginia. DANA's balance sheet for September 30, 2001 — the end of the last fiscal year prior to the bankruptcy filing — reflects capital stock of $5,000 and additional paid-in capital of $45,000, for a total equity capital of $50,000. Def. Ex. 492. The same balance sheet shows retained earnings of negative $48,073,361 and total shareholder equity of negative $48,023,361.
DANA's relationship with GmbH dates back to the incorporation of DANA; however, the current corporate structure — with both companies as subsidiaries of FDC — came into existence in 1996 when financier Carl Albert, who had previously purchased the assets of the former Fairchild Aircraft Corporation out of bankruptcy, purchased the Dornier companies from Daimler-Chrysler, thus forming the Fairchild Dornier family. The Fairchild Dornier group was then purchased in 2000 by Clayton, Dubillier Rice and the Allianz Group. At this time, according to the testimony, the operational "center of gravity" shifted from San Antonio to Germany, where management promoted what was described as a "one company" philosophy under which the various companies were viewed (and to a large extent operated) as a single entity.
At the time Fairchild and Dornier joined forces, the combined company sold two models of commercial aircraft, a 19-seat turboprop (the Fairchild Metro) and a 32-seat turboprop (the Dornier Do328). Soon thereafter, production of a jet version of the 328 model, the 328JET, began, and the company began planning larger regional jet models, including a 428JET and 728JET. Neither of these latter projects had come to fruition before the company's investors pulled the plug, forcing GmbH into insolvency proceedings.
Initially, the wings for the 328JET were manufactured in Germany. Later, the wing production was transferred to FAI in the United States after GmbH began development of the 428JET and 728JET. In September 2001, FAI and DANA entered into an agreement under which DANA purchased the 328 wing operation from FAI — which had consistently lost money on it — for a final price of $43,543,000. The transfer of the wing operation was part of a larger restructuring in which many of the functions previously provided by FDC and FAI were transferred to DANA because of a concern that loans "up" the corporate ladder from GmbH to FAI (through FDC) might violate German law. The wing operation, although transferred on paper, physically remained at FAI's facility in San Antonio. GmbH loaned DANA the $43,543,000 purchase price for the wing operation. DANA paid those funds to FAI, which in turn used the money to repay amounts it owed (through FDC) to GmbH. It is this $43,543,000 that the court previously recharacterized as an equity investment.
A complete statement of the reasons for the ruling (including additional relevant facts) were set forth orally at a hearing held on December 17, 2003. Tr. 12/17/03 at 88-104.
In October 2001, all of FAI's and FDC's employees were transferred to DANA as part of the restructuring. As a result, DANA's workforce was increased from approximately 100 employees to 700.
III. Breakdown of the Amended Claim
As previously stated, the claim before the court is the amended proof of claim (Claim No. 198) filed on January 21, 2004, in the amount of $146,143,823.06. The amended claim may be broken down as follows:
Description Amount
Wing operation loan $43,543,000.00 Misc. charges $19,474,899.13 Spare parts $76,926,051.65 Simulator rent $3,271,969.26 Wing production costs $382,401.58 Cash sent $9,958,138.78 Interest (post-FY 2001) $3,166,920.89 Interest on wing loan $1,422,404.66 Line of credit $1,500,000.00 _______________ sub-total of charges $159,645,785.95Credits
Aircraft wings delivered ($2,333,817.06) Performance of guaranty ($590,910.65) Misc. credits ($8,469,983.06) Misc. mfg. services by DANA ($2,107,252.12) __________________ sub-total of credits ($13,501,962.89)
Total Claim $146,143,823.06
The "miscellaneous charges" claimed by GmbH are broken down as follows:
Additional Line of Credit $18,627,295.56 FY 2001 interest on total balance $5,236,716.01 Aggregate of misc. debits/credits ($4,389,112.44) __________________ Sub-total $19,474,899.13
Thus, the remaining claim, after deduction of the wing operation loan and associated interest as to which partial summary judgment has already been granted, and after separating out the $19 million in miscellaneous charges into its components, is as follows:
Basis of Claim Amount
Spare Parts Billed to DANA $76,926,051.65 Flight Simulator Rent $3,271,969.26 Line of Credit $1,500,000.00 Additional line of credit $18,627,295.56 FY2001 interest on total balance $5,236,716.01 Interest (post-FY 2001) $3,166,920.89 Wing Production Costs $382,401.58 Cash Sent $9,958,138.78 _______________ Subtotal before credits $119,069,493.73Credits
Aircraft wings delivered ($2,333,817.06) Performance of guaranty ($590,910.65) Misc. credits ($8,469,983.06) Misc. mfg. services ($2,107,252.12) Aggregate of misc. debits/credits ($4,389,112.44) _________________ Subtotal of credits ($17,891,075.33)
Net (exclusive of wing loan) $101,178,418.40
The resulting amount, it should be noted, is very close to the $103,643,752 balance reflected as being due to GmbH on DANA's balance sheet for September 2001 (the end of the fiscal year immediately preceding the bankruptcy filing). It is also close to the figure shown on the last fiscal year-end accounting summary that GmbH and DAHNA were in the habit of preparing and that both parties signed acknowledging the sums due to and from the two companies. For the fiscal year ending September 30, 2001, the amount which DAHNA acknowledged due to GmbH (all of which appears to relate to DANA rather than DAMSI) was $104,395,438.44. Finally, the claim amount is also consistent, at least as to general order of magnitude, with a letter sent from DANA to GmbH on July 13, 2001, stating "As of June 30th 2001, Dornier Aviation North America, Inc. ows [ sic] USD 115.730.103 in total as intercompany loans to Fairchild Dornier GmbH," and notifying GmbH that DANA was making a payment of $27,298,779 against that sum. Def. Ex. 582. This of course would have left a remaining intercompany balance owed of $88,431,324. It should be noted that none of the documents just mentioned include the wing loan, since the loan had not yet been made at that time.
See Def. Ex. 492 at Pltf. 1899 (DAHNA consolidating balance sheet for 9/01) which shows a total of $60,093,575 in receivables to DANA from DoLuft (i.e., GmbH) and $163,737,327 in payables from DANA to DoLuft and, for a net owed by DANA to GmbH of $103,643,752. The line items that make up this sum are marked with the curious notation, "Items to be eliminated in the DoLuft Consolidation."
The reconciliation is not, however, without its problems. The two companies organized their accounts differently, and while the net of the GmbH's accounts equals the net of DANA's accounts, individual accounts (with the exception of the $1,500,000 line of credit) do not correspond in any readily apparent way.
It is this $27,298,779 payment that the Committee contends was preferential. The source of the funds used to make the payment is not well-developed in the record.
A. Spare Parts Billed to DANA
GmbH's spare parts claim can be broken down into three time periods and amounts: (1) payables accrued prior to October 1, 1996 in the amount of $18,487,953.20; (2) payables accrued from October 1, 1996 to September 30, 1999 in the amount $12,726,163.48; and (3) payables accrued after October 1, 1999 in the amount of $44,708,935.84.
The relationship between DANA and GmbH concerning their spare parts dealings is rather complicated, and the fact that both companies are in insolvency proceedings further complicates matters. DANA received parts from GmbH for three main purposes: (1) to provide warranty parts to GmbH's customers; (2) to provide initial provisioning parts to GmbH's customers; and (3) to make a profit selling parts to non-warranty, non-initial provisioning customers of DANA. The parts shipped to DANA were either purchased by GmbH from its own vendors (nonproprietary parts) or were produced by GmbH itself (proprietary parts). GmbH sold both proprietary and nonproprietary parts to DANA at 10% over cost. This price was still at a 20-30% discount on nonproprietary parts and a 30-40% discount on proprietary parts in relation to GmbH's general price list (the price GmbH would sell the parts to the rest of the world). DANA therefore, at least theoretically, could sell the nonproprietary parts at a 10-20% profit and the proprietary parts at a 20-30% profit.
As noted, the parts shipped to DANA included warranty parts and initial provisioning parts. When customers purchased aircraft from GmbH, not only were the aircraft covered by warranty, but customers were given the option to purchase an initial provisioning package. The package allowed the customer to have an initial set of replacement parts readily available. Although the customer purchased the initial provisioning package from GmbH, DANA handled the parts distribution. Warranty and initial provisioning parts were invoiced to DANA in the same manner as parts intended for resale. After receiving the part (or if the part was in stock), DANA supplied the parts to the warranty or initial provisioning customer. It was DANA's responsibility to determine if the part supplied was either a warranty or initial provisioning part, and if so, to bill the amounts back to GmbH. GmbH was then to give DANA a credit against the accounts receivable.
A great part of the difficulty in this case arises from the fact that the credits to DANA from GmbH for warranty and initial provisioning parts were not tied in GmbH's accounting system to specific invoices but were simply netted against the gross amounts billed to DANA for parts shipped. As a result, there appears to be no way to distinguish between "open" and "paid" invoices. Additionally, although the invoices contained payment terms requiring payment within 30 days "unless otherwise agreed," DANA did not pay invoices within 30 days or for that matter within any fixed period of time. As will be discussed, GmbH determined that DANA would not have to pay for the parts until DANA became profitable. As explained by Thomas Brandt, GmbH's Chief Financial Officer:
DANA was treated specially. The money of course was a receivable or payable as carried in the books of both sides but they didn't have to pay it until the whole operation turned positive. This was in a way a market investment and the most important market of the GmbH. They [GmbH's Board of Management] said, we need to build that as an investment into the market.
Tr. 1/26/2004 at 143 (emphasis added). Mr. Brandt did testify that GmbH expected DANA to ultimately achieve profitability. In this connection, Mr. Brandt noted that DANA's spare parts sales had tripled in the two years preceding the bankruptcy and that its gross (although not net) profit was close to even.
GmbH relies upon a 155-page summary log of invoices (Def. Trial Ex. 450) which lists, among other details, a receivable invoice number, a date, and the amount due in United States dollars. Generally, the summary lists invoices from GmbH to DANA for spare parts shipped from October 1, 1999, forward. However, included in this list is an entry dated September 30, 1999, titled "SALDO 99" in the amount of $32,317,116.68. The parties do not dispute that this entry refers to the receivables due from October 1, 1996, through September 30, 1999. There is also an entry named "Simulator" with a date of September 30, 2001, in the amount of $3,271,969.26. The total dollar amount of all the invoices listed on the exhibit is $80,235,406.07. If, as GmbH argues, the simulator entry is subtracted and other minor adjustments are made from the total invoice amount, then GmbH's spare parts claim totals $76,926,052.52.
GmbH presented at trial (on five CD-ROMs) copies of the actual invoices consisting of over 66,000 pages. Def. Ex. 122. The court reserved ruling on the motion to admit the exhibits. Given the court's decision to admit the summary, and in light of the testimony by Mr. Malek — which in the court's view adequately demonstrated the reliability of the summary — the court finds that admission of the actual invoices would be cumulative and would unreasonably burden the record.
"Saldo" is the German word for "balance" and in this context seems to refer to a balance carried forward.
The simulator rent portion of the claim is discussed later in the opinion.
Kenneth Malek, testifying as an expert witness for GmbH, opined that GmbH's records were accurate and the claim as filed was correct. To substantiate the payables in the amount of $44,708,935.84 accrued after October 1, 1999 to April 23, 2002, Mr. Malek determined that there were 12,999 invoices in the total population. Out of those invoices and based on statistical sampling methodology, he determined that he needed to review a minimum of 574 invoices to have a statistically significant sample. He then used a random number generator to determine which invoices would actually be used in his sample. He instructed the random number generator to produce 600 random numbers between 1 and 12,999. Of the 600 numbers produced, 19 were duplicate numbers. He subtracted the duplicate invoices and used the remaining 581 invoices as his actual sample size. Mr. Malek testified that out of the 581 listed invoices, 85% had an actual invoice and all of those invoices matched the listing on the summary log. Thus, Mr. Malek opined — with what he testified was a 96% degree of certainty — that GmbH's spare parts claim was accurate.
In further support of its claim, GmbH submitted a statement of account — signed by both DAHNA and GmbH for the period ending September 30, 1999. The statement shows account number # 22161201 with a total balance of $32,317,116.68 due to GmbH from DANA as of September 30, 1999. This is the same amount as the "SALDO 99" entry on the summary log of invoices. The parties recognized and agreed that DAHNA had a liability on account # 22161201 in the amount of $32,317,116.68 by signing the statement. Rich Baron of DANA signed the statement on January 24, 2000. The $32,317,116.68 reflects the amounts that DANA incurred through September 30, 1999.
On the September 30, 2000, Statement of Account, account #22161201 shows an entry for "Spares DANA" in the amount of $46,177,625.66. This Statement of Account was signed on November 9, 2000, by Chris Lowe, the Vice President of Finance and Chief Financial Officer of DANA.
The September 2001 yearly Statement of Account is a GmbH document. Mr. Brandt testified that account number 80600010 reflected the spare parts receivable. On this statement, the receivable is shown in the amount of $73,144,253.94. Chris Lowe signed the statement on December 3, 2001.
On Defendant's Exhibit 484, GmbH 008305, the account number 80600010 is reflected by various entries. On January 10, 2000, there is an entry entitled "SALDO" for spare parts in the amount of $46,177,625.66. This is the exact amount as reflected in the September 30, 2000, statement of account. There are credits entered on July 26, 2000, and October 7, 2000, in the amounts of $273.00 and $382,656.00 respectively. The next entry, by time period, is an entry for spare parts on September 30, 2001, in the amount of $19,574,537.41. If added to the previous balance of $46,177,625.66, and a credit is given in the amount of $382,929.00, then GmbH had a spare parts claim of $65,369,234.07 as of September 30, 2001. The 2001 Statement of Account showed a total spare parts claim of $73,144,253.94. There are no other entries on Defendant's Exhibit 484, GmbH 008305 prior to December 3, 2001. Therefore, there is a difference of approximately $8 million between Defendant's Exhibit 484, GmbH 008305 and the September 2001 Statement of Account. In any event, Defendant's Exhibit 484, GmbH 008305 shows a total spare parts claim, with the last entry of March 31, 2002, of $74,483,022.32.
The Committee argues that GmbH's claim for spare parts includes initial provisioning and warranty parts for which DANA did not receive a credit. In particular, the Committee points to Committee's Exhibit 58. Exhibit 58 is an invoice (No. 50610097) for "Spare part(s) for A/C Dornier 328JET" in the amount of $19,762.00. The parts shipped were part of an initial provisioning package purchased by Atlantic Coast Airlines ("ACA"). The Committee points out that Defendant's Exhibit 450 (the defendant's summary of invoices on which it bases its spare parts claim), GmbH 003051, includes Invoice 50610097, dated October 24, 2001, in the amount of $19,762.00. Likewise with Committee's Exhibit 59, GmbH billed DANA for "Spare part(s) for A/C Dornier 328JET" in the amount of $9,050. The invoice specifically states that the parts were for initial provisioning for ACA. Defendant's Exhibit 450, GmbH 003055, shows this invoice included in GmbH's overall claim. The gist of the Committee's argument is that since the Committee rebutted the prima facie effect of the filed proof of claim, and since the Defendant has not explained why these initial provisioning invoices were included in its overall spare parts claim, then the Defendant has not substantiated its spare parts claim.
B. Flight Simulator Rent
Dornier Luftfahrt GmbH (GmbH's predecessor) and DANA entered into a "Simulator Lease Agreement" on January 14, 1994. Def. Tr. Ex. 366, at GmbH_001221. DANA was to provide training services to pilots who flew Dornier jets. Under the agreement, DANA agreed to lease a flight simulator from Dornier Luftfahrt for a monthly basic rent of $81,700.40. This monthly rent was subject to a downward adjustment of 40% "as long as FAA certification [was] less than level B" or a 20% reduction "as long as FAA certification [was] less than Level D, but at least Level B." In all, GmbH claims that DANA owes $3,271,969.26 in simulator rent for the period from 1993 to 1998. Although no one from DANA signed the simulator lease agreement, Donald G. Giesl, Vice President of Finance and Administration for DANA, signed a "Documentation of the Acceptance Date" acknowledging that DANA received and accepted the simulator "pursuant to Section 1 of the Simulator Lease Agreement."
For support, GmbH relies upon the monthly intercompany balance sheets and the yearly statements of account. On the fiscal year 1996 monthly report for January, for example, a simulator rent payable in the amount of $1,337,251.06 is shown being due as of January 1, 1996. At the end of the month, DANA owed GmbH $1,402,611.38 for an increase of only $65,360.32 for the month. The payable for simulator rent continued to increase by $65,360.32 per month until and including August 1996. From September 1996 through December 1997, the payable increased by $49,020.24 per month. Apparently, DANA first received a 20% downward adjustment of the basic rent and then later, a 40% downward adjustment.
In any event, the simulator rent is also provided for on the companies' yearly Statements of Account. As previously stated, the simulator rent payable was included in GmbH's summary log of spare part invoices, which had account number 80600010. On the September 30, 1999, and September 30, 2000, Statements of Account, there is an entry for simulator rent in the amount of $3,271,959.25. The final statement in September 2001 no longer showed a separate line item for the simulator rent. The simulator rent payable was now shown in conjunction with the spare parts payable at account # 80600010. In the summary log of invoices, there is an entry for "Simulator" in the amount of $3,271,969.26. See Def. Tr. Ex. 450 at GmbH_002928. GmbH subtracted this amount from its spare part claim and requested simulator rent as a separate item.
C. The $1.5 Million Line of Credit
DANA and Dornier Luftfahrt entered into a loan agreement on December 21, 1986, whereby Dornier Luftfahrt agreed to lend DANA not more than $1.5 million. Attached to the loan agreement at Def.'s Ex. 352 is a blank promissory note; none of the essential terms are completed, including the amount borrowed, the applicable interest rate, or the date the note matures. GmbH tracked the $1.5 million line of credit receivable by account number 80600023. Not only is the $1.5 million line of credit shown in the September 2001 yearly Statement of Account on GmbH's side as a receivable, but the same amount is shown on DANA's side as a payable. This Statement was signed by a GmbH representative on November 3, 2001, and by a DANA representative on December 3, 2001. See Def.'s Ex 490, GmbH_008676.
D. The Additional Line of Credit
GmbH also asserts a claim for $18,627,295.56 for additional loans advanced to DANA between 1989 and 1995. GmbH's 2000 Statement of Account shows a receivable owing by DANA to GmbH in the amount of $20,127,295.56 for "Line of Credit." GmbH asserts that this line of credit reflects the total amount that GmbH loaned to DANA, which includes the $1.5 million line of credit. Indeed, if the $1.5 million loan is subtracted from the $20,127,295.56 total, the remaining amount owing is $18,627,295.56. This, according to GmbH, substantiates its claim for the additional line of credit. GmbH, however, does not give any explanation why the $1.5 million line of credit receivable is a separate entry on the 2001 yearly Statement of Account, and why there is no additional entry for the $18,627,295.56 line of credit receivable.
E. Interest Claim
GmbH asserts as part of its claim $5,236,716.01 for interest accrued on intercompany balances from October 1, 2000, to September 30, 2001 (FY 2001). GmbH calculated interest at the rate of 8% on the net balances due from DANA. GmbH, however, does not claim any interest on simulator rent. For support, GmbH points to Def.'s Ex 484, GmbH_008294. On this accounting record there is an entry for "Zins 2001 DANA" dated September 30, 2001.
"Zins" is the German word for "interest."
GmbH does not appear to have tracked the interest portion of the claim by a separate account number and the interest claim is not broken out on any of the yearly Statement of Accounts that had been signed by GmbH and DAHNA. GmbH asserts that the $5,236,716.01 interest claim can be verified by looking at the DAHNA/DoLuft Intercompany Billing Reports for October 2000 through September 2001. The interest claim is tracked by DoLuft account number 22165201 on the monthly intercompany billing reports. To understand the billing statements, it must be pointed out that the October 2000 billing statement shows the previous month's interest (i.e., October 2000 statement shows interest accrued for September 2000; November 2000 statement shows interest accrued for October 2000, etc.).
Billing Statement Interest Claimed
Oct-00 $440,148.41 Nov-00 $307,872.14 Dec-00 $388,900.08 Jan-01 $484,782.34 Feb-01 $527,194.54 Mar-01 $569,560.96 Apr-01 $425,528.75 May-01 $521,813.39 Jun-01 $452,906.96 Jul-01 $544,117.36 Aug-01 $225,738.15 Sep-01 $348,152.93 _______________ TOTAL $5,236,716.01
GmbH submits three spreadsheets to show how the interest for the months of February (March 2001 intercompany balance sheet), July (August 2001 intercompany balance sheet), and August 2001 (September 2001 intercompany balance sheet) was calculated. Def.'s Ex. 484, DANA 004116, 004122, 004141. These three spreadsheets show that DANA owed a total of $1,218,812.04 in interest for March, July, and August 2001. The intercompany billing report shows for those same three months that DANA owed $1,143,425 in interest. The spreadsheet verification of DANA's intercompany billing reports is actually approximately 6% lower than what is showed on the March, July, and August intercompany balance sheets.
F. Accruing Interest
GmbH claims $3,166,920.89 in interest on intercompany balances due post FY-2001 from October 1, 2001, through April 23, 2002. In support, GmbH relies upon the invoices it sent along with parts to DANA. Specifically, GmbH relies on the following language on the invoices: "Payment is to be made net within 30 days after receipt of invoice." See, e.g., Pl.'s Trial Ex. 59. Mr. Brandt testified that DANA was not to pay the invoice within 30 days of receiving the invoice, but instead was to pay the invoice when DANA became profitable. In essence, since DANA was not paying each invoice within 30 days, GmbH charged interest on the outstanding balances at the rate of 8% per annum.
GmbH tracked the interest claim with account number 80600074. Def. Trial Ex. 490 at GmbH_3522. The printout showing the activity on this account number shows a total amount due of $3,721,920.89. GmbH, however, charged DANA $450,000 per month in interest from September 1, 2001, through April 23, 2002. However, the September 2001 yearly statement of account reflects a balance due of $0.00 for this account. Therefore, if interest is calculated from October 2001 through April 23, 2002, at the rate of $450,000 per month, the interest owed is $3,044,999.97.
G. Wing Production Costs
GmbH claims $382,401.58 in wing production costs. This part of the claim is based upon repairs that GmbH had to perform on defective wings manufactured by DANA. GmbH used account number 80600022 to track this amount due. This claim accrued from November 30, 2001, to March 6, 2002.
H. Cash Sent
GmbH claims $9,958,139 for cash sent directly to DANA from January 1, 2002, to March 31, 2002. This amount is reflected by GmbH account number 80600072. GmbH argues that the monies transferred to DANA were used by DANA for operating expenses. Chris Lowe testified at the trial by deposition that all the cash sent from October 1, 2001, through the time the bankruptcy petition was filed was monies owed to DANA under various agreements (i.e., the Services and Support Agreement) and was not sent to DANA as part of any loan agreement. In his testimony, Mr. Brandt agreed that money was sent during this time period under the Services and Support Agreement.
IV. The PricewaterhouseCoopers Audit Report
In 2000, GmbH instructed PricewaterhouseCoopers ("PwC") to audit as of September 30, 2000, GmbH's financial statements and the Management Report for fiscal year 1999/2000. The financial statements were based on GmbH's underlying accounting records. PwC issued its unqualified audit report to GmbH on March 30, 2001. In the report, PwC opined that
the annual financial statements give a true and fair view of the net assets, financial position and results of operations of the Company in accordance with German principles of proper accounting. On the whole, the management report provides a suitable understanding of the Company's position and suitably presents the risks of future development.
PwC Audit Report, page 29.
The plaintiff argues that this audit report completely contradicts GmbH's entire claim, especially the spare parts portion of the claim. First, the audit report shows the receivable due from DAHNA to GmbH as being 61,576 TDM, or $27,799,799.55, as of September 30, 2000, a figure that is approximately $55 million less than the $83,027,903.05 shown as being due from DANA to GmbH on the annual reconciliation that had been signed some three months earlier. More tellingly, the Committee argues, the report shows that GmbH agreed to "assume" DAHNA's losses, which primarily consisted of sums due from DANA. Specifically, PwC stated that GmbH's negative financial result for fiscal year 2000 in the amount of DM 170.1 million "mainly resulted from the assumption of losses of the subsidiary DAHNA and an increase in interest charges on account of the level of bank loans." PwC Audit Report, page 20 at ¶ 67. In comparing GmbH's net worth in 2000 to 1999, PwC reported that "[t]he receivable from DAHNA was reduced by TDM 68,674 as additional payments to DAHNA were no longer required in view of the fact that the losses, incurred by DAHNA were taken over by [GmbH]." Id. at p. 72. PwC explained that GmbH assumed DAHNA's losses because the two companies
As noted, DAHNA had two subsidiaries: DANA and DANA's sister, DAMSI. The audit report shows the combined amount due without distinguishing between the amounts owed by each of DAHNA's subsidiaries. There is no dispute, however, that the bulk of the receivable originated with DANA.
TDM is an abbreviation for "Thousand Deutsche Marks." The exchange rate on September 30, 2000, was DM 2.21498 to the dollar.
are so close that there is an extensive and also financial dependency of DAHNA and its two subsidiaries to [GmbH]. In particular, there is a continual relegation of the interests of DAHNA as a result of the assumption of warranty obligations which both subsidiaries (DAMSI and DANA) assume for the business of [GmbH]. . . .
PwC further noted that the
warranty obligations . . . have resulted in substantial losses being incurred by the dependent DAHNA group in the past. In view of the fact that the continued existence of the DAHNA group is in the interests of [GmbH], the company has therefore made a liability provision for the losses incurred by the DAHNA group. The provision includes compensation for the losses incurred for the three companies. In particular, [GmbH] records expenses incurred by the DAHNA group which are directly financed by [GmbH] as a provision of utilization.
Id. p. 29, at ¶ 109.
In conducting the audit, PwC relied in part upon the Management Report for the Fiscal Year from October 1, 1999, to September 30, 2000. This document was produced by the GmbH Management Board and is dated March 2001. In the report, Management states that
DANA's losses which have been taken over were based on the negative economic development of its spare parts business for Fairchild Dornier aircraft on the US-American market. [Management is] anticipating positive results in the medium-term in view of the restructuring of our customer services. In the near future, we are however assuming that DAHNA will generate losses which will have to be borne by [GmbH].
Management Report attached to PwC Audit Report at App. IV, page 17, ¶ 1.2.2; see also id. p. 24, at ¶ 4.3.3.
Thomas Brandt, the CEO of GmbH in insolvency and former GmbH Chief Financial Officer and a member of the Board of Management at the time the Management Report and PwC Audit Report were issued, testified that although GmbH would not seek repayment of DANA's spare part debt until after DANA was profitable, GmbH ultimately expected to be paid. According to Mr. Brandt, GmbH and DANA had this "pay me when you turn profitable" relationship to allow DANA to build up its service and support business. This in turn would provide a direct benefit to GmbH by making its aircraft more attractive to North American customers.
The Committee further contends that even if GmbH did not assume all the losses of DAHNA, the PwC report shows that DAHNA owed only $27,799,799.55 as of September 30, 2000. DANA is the daughter of DAHNA and the sum showed as owing on the report primarily consists of sums that DANA owes to GmbH. The Committee points out that the September 30, 2000, Statement of Account showed that DANA owed GmbH a total of $83,027,903.05. The plaintiff argues that since the PwC report and the fiscal year 2000 Statement of Account cannot be reconciled, the audit report should carry the most weight since it was conducted by an independent third party. Therefore, the Committee argues that GmbH's claim should be reduced at a minimum bu $55,228,103.50 (the difference between $83,027,903.05 and $27,799,799.55).
Conclusions of Law and Discussion I.
A claim for which a proof of claim has been filed is allowed unless an objection is filed. § 502(a), Bankruptcy Code. If an objection is filed, the court is required to determine the amount and validity of the claim as of the date of the filing of the petition. § 502(b), Bankruptcy Code. A properly filed claim is prima facie evidence of the amount and validity of the claim. Fed.R.Bankr.P. 3001(f). For this reason, the objecting party has the initial burden of presenting sufficient evidence to overcome the prima facie effect of the filed proof of claim. C-4 Media Cable S., L.P. v. Reds T.V. Cable, Inc. (In re C-4 Media Cable S., L.P.), 150 B.R. 374, 377 (Bankr. E.D. Va. 1992). Once the objecting party has done so, the burden of proof shifts to the creditor to establish the amount and validity of its claim. Id.
II. A.
As a threshold matter, the Committee argues that a significant portion of GmbH's claim is barred by the statute of limitations. However, prior to determining the limitation period, the court must determine the substantive basis upon which GmbH's claim is based.
In diversity cases, federal district courts apply the substantive law of the state in which the federal court sits. Erie R.R. Co. v. Tompkins, 304 U.S. 64, 78, 58 S.Ct. 817, 822, 82 L.Ed. 1188 (1938). The substantive law includes the forum state's conflict of law rules. Klaxon Co. v. Stentor Elec. Mfg. Co., 313 U.S. 487, 496, 61 S.Ct. 1020, 1021, 85 L.Ed. 1477 (1941). The Klaxon rule also applies in the bankruptcy arena. Compliance Marine, Inc. v. Campbell (In re Merritt Dredging Co.), 839 F.2d 203, 206 (4th Cir. 1988) ("[I]n the absence of a compelling federal interest which dictates otherwise, the Klaxon rule should prevail where a federal bankruptcy court seeks to determine the extent of a debtor's property interest.").
The parties argue that the Klaxon rule does not apply in this case; rather, German law applies to the unpaid spare parts invoices. Each invoice contains a forum selection clause: "Place of jurisdiction is the court of Munich." A forum selection clause will generally be enforced by Virginia courts. See, e.g., Ash-Will Farms, L.L.C. v. Leachman Cattle Co., 61 Va. Cir. 165, 168 (2003) ("The freedom to choose a forum by contract is also recognized under Virginia law [and] absent a showing that the contract forum selection clause is unreasonable or was imposed by fraud or unequal bargaining power, the parties' choice should be enforced."). Unlike a forum selection clause that states where the action is to be brought, a choice of law provision is an agreement by the parties on whose law the contract is governed. See, e.g., Bryant Elec. Co. v. City of Fredericksburg, 762 F.2d 1192, 1196 n. 8 (4th Cir. 1985) ("[Virginia courts have held that] the contracting parties may by agreement choose what law will govern their contract."); Woodson v. Celina Mut. Ins. Co., 211 Va. 423, 426, 177 S.E.2d 610, 613 (1970) ("The nature, validity and interpretation of contracts are governed by the law of the place where made, unless the contrary appears to be the express intention of the parties."). Nowhere on the invoices is there a choice of law provision. More importantly, this court sits in Virginia and GmbH has consented to the jurisdiction of this court by filing a proof of claim and DANA consented to this court's jurisdiction when the order for relief was entered. Therefore, the court must look to Virginia's conflict of law rules to determine whose substantive law applies.
B.
Under Virginia conflict of law rules, the law of the place where the contract was made governs issues concerning the interpretation, validity, and enforceability of the contract. Johnson v. MPR Assocs., Inc., 894 F. Supp. 255, 257 n. 1 (E.D. Va. 1994). A contract is made where the final act completing the contract occurs. Chesapeake Supply Equip. Co. v. J.I. Case Co., 700 F. Supp. 1415, 1417 (E.D. Va. 1988). However, the law of the place of performance governs issues concerning performance of the contractual duties. Ins. Co. of N. Am., Inc. v. United States Gypsum Co., 639 F. Supp. 1246, 1248 (W.D. Va. 1986). In other words if the issue is one of breach of contract, then the law where performance occurred applies.
The September 30, 2001, Statement of Account was signed by an officer of GmbH on November 3, 2001, and by Chris Lowe on behalf of DAHNA (DANA's and DAMSI's direct parent) on December 3, 2001. As previously stated, the spare parts claim is listed in this statement of account in the amount of $73,144,253.94. If the statement of account is binding, then it is this contract that the court must look at to determine the validity of the claim. In any event, once Chris Lowe signed the Statement of Account it presumably became binding on DANA. In determining the validity and enforceability of the Statement of Account, Virginia courts would look to the substantive law of Texas. It should be noted that there is no direct evidence concerning where this contract was completed. However, the court can surmise that Chris Lowe signed the Statement of Account while in Texas. Chris Lowe worked out of the Texas location. In addition, the parts were sent from GmbH to DANA at its Texas location. Since the court believes that the last act that would make the Statement of Account binding as a new contract occurred in Texas, Texas law applies to the validity and enforceability of the Statement of Account.
C.
Under Texas law, an account stated is "an agreement between parties who have had previous transactions of a monetary character that all the items of the account representing such transactions, and the balance struck, are correct, together with a promise, express or implied, for the payment of such balance." Beijing Metals Minerals Imp./Exp. Corp. v. Am. Bus. Ctr., Inc., 993 F.2d 1178, 1182 (5th Cir. 1993) (citation omitted). An account stated is prima facie evidence of the validity and amount of the obligation. See Eastern Dev. Inv. Corp. v. City of San Antonio, 557 S.W.2d 823, 826 (Tex.Civ.App. 1977).
In the present case, the September 30, 2001, Statement of Account qualifies as an account stated under Texas law. Representatives of GmbH and DAHNA signed the statement on November 3, 2001, and December 3, 2001, respectively. DAHNA's side of the ledger shows that DAHNA owes GmbH a total amount of $104,395,438.44 as of September 30, 2001. GmbH's side of the ledger shows that DANA owes GmbH that same amount with DAMSI owing GmbH nothing. In fact, the title of the document is shown at the top of the document as a "Statement of Account." The following account numbers are shown on GmbH's side of the ledger as due and owing from DANA:
Account No. USD Account Description
80600010 $73,144,253.94 Spare parts/simulator rent 80600623 $1,500,000.00 Line of credit 80600072 $9,800,000.00 Cash sent 80600074 $0.00 Accruing interest claim 80600073 $19,951,184.50 Additional line of credit/interest claim ________________ DANA total: $104,395,438.44
Although the DANA breakdown is different, the total is the same (but negative, to indicate an amount owed): Account No. USD Account Description
The DANA account titles are not shown on the Statement of Account and instead are taken from the DAHNA/DoLuft Intercompany Billing Report for the same period. Def. Ex. 492 at Pltf 1868. That document reflects that Account No. 145100 includes the following sub-accounts: warranty transactions under MIDAS, warranty transactions under SAP, Training — Satena Airlines, and accounts receivable. Account No. 145101 includes the following sub-accounts: Atlantic Coast Airlines — Spare Parts Credit, Skyway Spare Parts Credit, PSA Airlines Simulator Training Credits, and PSA FY 2001 MCG Exposure. Account No. 315101 includes the following sub-accounts: accrued interest plus various DAMSI-related fees and liabilities. Account No. 315100 includes the following sub-accounts: spare parts payable, simulator rents, additional line of credit, and GmbH wire to DANA.
145100 19,878,692.73 I/C A/R DoLuft 145101 39,465,195.44 I/C A/R DoLuft JE 315101 (57,108,422.19) I/C A/P DoLuft 315100 (105,130,904.42) I/C A/P DoLuft JE 423000 (1,500,000.00) Intercompany Note Payable ________________ Total (104,395,438.44)
Therefore, DANA agreed that as of September 30, 2001, it owed GmbH a total of $104,395,438.44. Although the PwC Audit Report for the previous fiscal year stated that GmbH had "assumed" the liabilities of DANA, it seems clear that for internal accounting purposes GmbH was still tracking the intercompany account receivable. In any event, the signed Statement of Account is clearly an admission by DANA that it owed GmbH $104 million as of September 30, 2001.
D.
As previously stated, the Creditors' Committee argues that a portion of GmbH's spare parts claim is barred by the applicable statute of limitations. Under Virginia law, statute of limitations are procedural and are therefore controlled by the law of the forum state. Holdford v. Leonard, 355 F. Supp. 261, 263 (W.D. Va. 1973). In this case, that forum is Virginia. However, when an action is based on contract which is governed by the laws of another state and the right of action is barred by that state, then the right of action is likewise barred in a Virginia forum. Va. Code Ann. § 8.01-247. In other words, in this case, if the cause of action would be barred in either Virginia or Texas, then GmbH cannot recover.
Actions in Texas on a stated account are barred by the statute of limitations unless the action is brought within four years after the day that the cause of action accrued. Tex. Civ. Prac. Rem. Code Ann. § 16.004. In Virginia, actions based on an account stated theory are barred after five years. See Va. Code Ann. § 8.01.246 (2) (five-year limitation on written contracts not otherwise specified by the statute) and Va. Code. Ann. § 8.01-229(G) (action on new promise in writing can be brought within such number of years after such promise as it might be maintained if such promise was the original cause of action); see also Ellison v. Weintrob, 139 Va. 29, 36-37, 123 S.E. 512, 514 (1924) ("[W]here there is an account stated this constitutes a new promise, new cause of action, and fixes the time from which the statute begins to run[.]"). Since the cause of action based on the account stated arose in December 2001, when Chris Lowe signed the September 2001 Statement of Account, GmbH's claim is not barred by either the Virginia or Texas statute of limitations.
E.
Even though the claim is not barred by the statute of limitations — and putting to one side the issues of subordination and recharacterization — there remain a number of other challenges to the amount of the claim. Most notably, the Committee argues that GmbH is unable to prove the amount of its claim for unpaid parts; that GmbH has not given DANA proper credit for warranty and initial provisioning parts; that warranty claims to which DANA was entitled were not submitted to GmbH after October 1, 2001; that the amount claimed is inconsistent with the figures shown on the audited financial statement; and that much or all of the claim for "cash sent" represents sums to which DANA was entitled as a management fee after the management functions were transferred from FDC to DANA.
The court must reject the argument that GmbH has not substantiated the amount of its spare parts claim. The fact that GmbH's accounting system does not tie payments and credits to specific invoices (so that it is not readily possible to determine whether a particular invoice has been paid), while perhaps a weakness, is not sufficient, in and of itself, to defeat the claim. Nor is the claim defeated simply because the invoices prior to October 1, 1996, have been destroyed, or because the amount due as of September 30, 1999, is represented simply by a line entry showing a balance forward. The invoices, payments, and credits were regularly entered into GmbH's automated accounting system. There has been no showing that the automatic accounting system was flawed or otherwise failed to report accurate figures. Indeed, DANA's own balance sheet for the fiscal year end prior to the bankruptcy filing reflected a figure that is within a few percent of the overall amount GmbH now claims due. Most importantly, DAHNA and GmbH reconciled their accounts each year and routinely came to the same conclusion as to the amount due from DANA to GmbH. The fact that the agreed balance for the fiscal year ending September 30, 2000, differs by approximately $55 million from the amount shown by the PwC audit report for the corresponding period may well be important on the recharacterization issue — a point to which the court will return. It does not mean, however, that the accounts were out of balance, only that GmbH (as the report explains) had determined to "assume" some of DANA's and DAMSI's liabilities. The accounting records reflect that DANA did receive initial provisioning and warranty credits, and that those credits are included in calculating the balance due from DANA.
The only serious doubt relates to warranty claims after October 1, 2001, and to the "cash sent." With respect to the former, a changeover in GmbH's automated accounting systems was taking place in the October 2001 to February 2002 time frame, and testimony was presented that the processing of warranty claims ceased for a period of time. The testimony is conflicting as to whether and when the processing resumed. To the extent it was not, GmbH's spare parts claim would necessarily be overstated. The evidence before the court, however, is insufficient for the court to determine even a reasonable approximation, let alone an exact amount, of the unbilled warranty claims. While GmbH has the ultimate burden of proof on the amount of its claim, the Committee has the burden as to any special credits to which DANA might have been entitled. Any attempt to put a dollar value on the amount of unbilled warranty claims would be little more than speculation. Accordingly, the court finds no basis for reduction of the spare parts claim.
The court reaches a different result, however, with respect to the "cash sent." The testimony seems clear that all of the cash transmitted by GmbH to DANA after the October 2001 restructuring that transferred most of FDC's functions to DANA represented sums to which DANA was entitled for management services (including payroll) under the intercompany service agreements. Mr. Brandt's testimony did not really deny this: he simply took the position that it was up to DANA to bill GmbH for the services, and DANA had not done so before both companies slid into insolvency. The fact that the parties had a "send money today/reconcile tomorrow" relationship does not change the underlying reality that the money was sent to pay for services DANA was performing for GmbH's benefit as part of management's "one company" philosophy and for which GmbH had an obligation to reimburse DANA. Accordingly, that portion of the GmbH claim representing the $9,958,139 in cash sent from January 1, 2002, to March 31, 2002, will be disallowed. The interest associated with this portion of the claim will likewise be disallowed. In default of evidence supporting a more exact computation, the court will simply disallow a pro-rata portion of the post-September 30, 2001, interest based on the ratio of the cash sent to the total claim (less the FY 2001 interest, since the practice of DANA and GmbH was not to compute interest on interest). By the court's calculation, the pro-rata interest attributable to the cash sent component of the GmbH claim is $328,726.39.
The net amount of the claim after deduction of the FY2001 interest is $95,941,702.39 (i.e., $101,178,418.40-$5,236,716.01). The "cash sent" represents 10.38% of that amount. Applying that percentage to the $3,166,920.89 of post-FY2001 interest gives $328,726.39 as the amount of interest attributable to the cash sent.
F.
In summary, based on the evidence presented — and before consideration of whether sums other than the wing loan should be recharacterized as debt — the court fixes GmbH's claim at $90,891,553.23, calculated as follows:
Claim after deducting wing loan $101,178,418.40 Less cash sent ($9,958,138.78) Less interest on cash sent ($328,726.39) ________________ Tentative allowed claim $90,891,553.23
III.
This determination, however, does not end the inquiry. Regardless of the amount that might otherwise be due, the Committee argues that the entire claim must be equitably subordinated to other general unsecured claims or, in the alternative, recharacterized as equity. At the conclusion of the Committee's case, the court ruled that the Committee had not carried its burden of proof with respect to equitable subordination, and the court granted the defendants' motion under Rule 52(c) for judgment with respect to that claim. Thus, the only issue before the court at this time is whether the claim should be recharacterized as equity. However, because equitable subordination and recharacterization accomplish essentially the same goal and consider much of the same evidence, it is instructive to review the standards for each type of relief.
A. Equitable Subordination
The Bankruptcy Code allows the court, "under principles of equitable subordination [to] subordinate for purposes of distribution all or part of an allowed claim to all or part of another allowed claim or all or part of an allowed interest to all or part of another allowed interest[.]" § 510(c), Bankruptcy Code. The Supreme Court has explained that although Congress, in enacting § 510(c), "included no explicit criteria for equitable subordination," the language of the statute "clearly indicates congressional intent at least to start with existing doctrine." United States v. Noland, 517 U.S. 535, 539, 116 S.Ct. 1524, 1526, 134 L.Ed.2d 748 (1996). That existing doctrine, as the Court observed, was judge-made and was generally triggered by a showing that the creditor had engaged in "some type of inequitable conduct" that "resulted in injury to the creditors of the bankrupt or conferred an unfair advantage on the claimant." Id. at 538, 116 S.Ct. at 1526. In an often-cited opinion decided under the former Bankruptcy Act of 1898, the Fifth Circuit in Benjamin v. Diamond (In re Mobile Steel Co.), 563 F.2d 692 (5th Cir. 1977), set forth a number of principles to be considered in determining whether or not a particular claim should be equitably subordinated, among them that claims arising from the dealings between the debtor and its fiduciaries must be subjected to rigorous scrutiny. Id. at 701; see also Pepper v. Litton, 308 U.S. 295, 308-10, 60 S.Ct. 238, 246-47, 84 L.Ed. 281 (1939). However, simply because a creditor is an insider does not warrant subordination of an otherwise valid claim. See EEE Commercial Corp. v. Holmes (In re ASI Reactivation, Inc.), 934 F.2d 1315, 1320-1321 (4th Cir. 1991) (purchase by president with his own funds of note secured by assets of corporation did not warrant subordination). Nevertheless, courts must determine "whether or not under all the circumstances the transaction carries the earmarks of an arm's length bargain" when an insider or fiduciary is involved. Pepper, 308 U.S. at 306-07, 60 S.Ct. at 245 (concluding that if it is not an arm's length bargain, then equity will set the transaction aside). As the Tenth Circuit recently explained,
"Inequitable conduct" for subordination purposes encompasses three categories of misconduct: (1) fraud, illegality, and breach of fiduciary duties; (2) undercapitalization; or (3) claimant's use of the debtor as a mere instrumentality or alter ego.
In re Hedged-Invs. Assocs., Inc., 380 F.3d 1292, 1301 (10th Cir. 2004). It has been said that "equitable subordination is an extraordinary remedy which is applied sparingly." Bank of N.Y. v. Epic Resorts — Palm Springs Marquis Villas, LLC (In re Epic Capital Corp.), 307 B.R. 767, 773 (D. Del. 2004). For this reason, where the claimant is not an insider or a fiduciary, the party seeking equitable subordination must "demonstrate . . . egregious conduct such as gross misconduct tantamount to fraud, misrepresentation, overreaching, or spoliation." Hedged-Invs., 380 F.3d at 1301-02; Epic Capital Corp., 307 B.R. at 772 (plaintiff must show non-insider creditor engaged in "egregious conduct such as fraud, spoilation [sic] or overreaching"). Where the creditor is an insider or fiduciary, however, the standard is not as strict, and the party seeking subordination "need only show some unfair conduct, and a degree of culpability, on the part of the insider." Hedged-Invs., 380 F.3d at 1301. Although undercapitalization is a factor to be considered, mere undercapitalization by itself is not sufficient to justify equitable subordination, since automatic subordination of insider loans at a time when the borrower corporation was badly undercapitalized would discourage owners' efforts to salvage a troubled business. Id. at 1298 (citation omitted).
In the present case, there is no question that GmbH was an insider of the debtor, since it indirectly owned 100 percent of the debtor's common stock and was therefore a "person in control" of the debtor. § 101(31)(B)(iii), Bankruptcy Code. At the same time — and putting to one side the wing operation loan — the debts embodied in the proof of claim are the very kind of debts one would expect a company such as DANA to incur in the ordinary course of business. If DANA had not purchased spare parts from GmbH, it would have to have purchased them from someplace else. There is no evidence that the prices charged by GmbH exceeded what the debtor could have obtained elsewhere or that GmbH imposed terms relative to the various extensions of credit that were disadvantageous to the debtor. Nor is there any evidence that DANA was operated in a way designed to cheat its trade creditors. The most the evidence shows is that DANA was not making money at the time credit was extended and was not expected to make money in the immediate future. However, the court credits the testimony that GmbH expected DANA ultimately to be profitable. Taking the evidence as a whole, there was simply no showing of "some unfair conduct, and a degree of culpability" on the part of GmbH. For that reason, the court dismissed the equitable subordination claim at the close of the plaintiff's evidence.
B. Recharacterization of Debt as Equity
As an alternative to equitable subordination, the Committee seeks to have GmbH's claims recharacterized as equity. As a practical matter, recharacterization of a debt as equity achieves essentially the same result as equitable subordination, since equity receives distributions in bankruptcy only after creditors have been paid in full. Cohen v. KB Mezzanine Fund II, L.P. (In re SubMicron Sys. Corp.), 291 B.R. 314, 322 (D. Del. 2003). However, recharacterization proceeds from a different premise. Equitable subordination, as noted, focuses on the creditor's conduct vis-a-vis the debtor or other creditors. By contrast, "[w]hen a putative loan to a corporation is recharacterized, the courts effectively ignore the label attached to the transaction at issue and instead recognize its true substance." In re Hedged-Invs. Assocs., Inc., 380 F.3d 1292, 1297 (10th Cir. 2004) (emphasis added). As a result, "[t]he funds advanced are no longer considered a loan which must be repaid in bankruptcy proceedings as corporate debt, but are instead treated as a capital contribution." Id.
Courts have articulated a number of tests for determining whether to recharacterize debt as equity. The Sixth Circuit, for example, has suggested the following factors:
(1) the names given to the instruments, if any, evidencing the indebtedness;
(2) the presence or absence of a fixed maturity date and schedule of payments;
(3) the presence or absence of a fixed rate of interest and interest payments;
(4) the source of repayments;
(5) the adequacy or inadequacy of capitalization;
(6) the identity of interest between the creditor and the stockholder;
(7) the security, if any, for the advances;
(8) the corporation's ability to obtain financing from outside lending institutions;
(9) the extent to which the advances were subordinated to the claims of outside creditors;
(10) the extent to which the advances were used to acquire capital assets; and
(11) the presence or absence of a sinking fund to provide repayments.
Bayer Corp. v. MascoTech, Inc. (In re Autostyle Plastics, Inc.), 269 F.3d 726, 750 (6th Cir. 2001). The Tenth Circuit has identified a similar list of considerations:
[W]hile not exclusive, we consider the following factors to distinguish true debt from camouflaged equity:
(1) the names given to the certificates evidencing the indebtedness;
(2) the presence or absence of a fixed maturity date;
(3) the source of payments;
(4) the right to enforce payment of principal and interest;
(5) participation in management flowing as a result;
(6) the status of the contribution in relation to regular corporate creditors;
(7) the intent of the parties;
(8) "thin" or adequate capitalization;
(9) identity of interest between the creditor and stockholder;
(10) source of interest payments;
(11) the ability of the corporation to obtain loans from outside lending institutions;
(12) the extent to which the advance was used to acquire capital assets; and
(13) the failure of the debtor to repay on the due date or to seek a postponement.
Hedged-Invs., 380 F.3d at 1298. Another court, surveying the case law, has summed up the holdings as follows:
Most of the criteria have to do with whether the transaction bears the earmarks of an arm's-length bargain. These criteria include the intent of the parties, whether there was an agreement for repayment, provision for interest, a fixed maturity date, a note or other document evidencing the debt, entries of a loan on the parties' books, lack of subordination to other debts, actual partial repayment, restriction on right to enforce collection, use of proceeds to acquire capital assets, loans proportionate to stock holdings, repayment to be made only from earnings, availability of outside financing, and enforcement of collection after default. The more the loans bear these earmarks of an arm's-length transaction, the more likely the courts are to treat the loans as loans and not capital investments. Shareholder Advances, 52 Am. Bankr. L.J. at 264. Additional factors include the timing of the advances, the amount or degree of the lender's control, and whether the ultimate financial failure was caused by undercapitalization. Hyperion Enterprises, 158 B.R. at 561; Shareholder Advances, 52 Am. Bankr. L.J. at 271-72. "[N]o one fact will result in the determination that putative loans are actually contributions to capital." Fett v. Moore (In re Fett Roofing and Sheet Metal Co., Inc.), 438 F. Supp. 726, 731 (E.D. Va. 1977). Also relevant to the inquiry into whether a debt should be recharacterized as equity is whether the debtor-corporation was undercapitalized. Id. at 265. See also Diasonics, 121 B.R. at 631 ("[s]hareholder loans may be deemed capital contributions in one of two circumstances: where the trustee proves initial undercapitalization or where the trustee proves that the loans were made when no other disinterested lender would have extended credit."); see also Hyperion Enterprises, 158 B.R. at 560.
Herzog v. Leighton Holdings, Ltd. (In re Kids Creek Partners, L.P.), 200 B.R. 996, 1019-1020 (Bankr. N.D. Ill. 1996).
In the present case, GmbH (through DAHNA) was the debtor's sole shareholder. The "instruments" evidencing the claim — in particular, the parts invoices and annual statements of account — are consistent with treatment of the claim as debt. The accrual of interest is likewise consistent with debt as opposed to equity. However, the lack of a fixed maturity date and the fact that payment would be made only when DANA became profitable (which amounted to a de facto subordination of the intercompany liability to the current claims of trade creditors) is more consistent with equity than debt. Indeed, the hope of payment out of future profits is exactly what characterizes an equity investor. Mr. Brandt's own testimony is that GmbH, although ultimately expecting to be paid, treated the DANA debt as a "market investment" for GmbH. Additionally, although no specific evidence was presented as to whether DANA could have obtained financing from a third party, its long history of unprofitability and the fact that its liabilities after the corporate restructuring far exceeded its assets certainly makes it unlikely that a third-party commercial lender would have considered DANA an attractive borrower. DANA's equity capital of $50,000 — while perhaps adequate for what DANA was doing in 1986 — seems wholly inadequate for the kind and volume of business that DANA was called upon to perform after the restructuring.
Most telling, however, is GmbH's decision to "assume" the DANA's losses with respect to the spare parts receivable. As noted, the March 2001 GmbH management report explained that "DANA's losses which have been taken over were based on the negative economic development of its spare parts business for Fairchild Dornier aircraft on the US-American market." Although the report then went on to state that management anticipated "positive results in the medium-term," it acknowledged that for the "near future . . . DAHNA will generate losses which will have to be borne by [GmbH]." The PwC audit report explained that the reduction in the receivable from DAHNA resulted from "the assumption of warranty obligations which [DANA and DAMSI] assume for the business of [GmbH]" and because "the continued existence of the DAHNA group is in the interests of [GmbH], the company has therefore made a liability provision for the losses incurred by the DAHNA group." The management report and audit report were important because GmbH was looking for additional capital investment at the time and the "assumption" is effectively an acknowledgment that the sums which GmbH had been carrying on its books as intercompany debt could not be characterized to outside investors as ordinary debt receivables.
Taking into account all the circumstances, the court concludes that the receivable owed by DANA, to the extent it represented the losses "assumed" by GmbH (and so reported on its audited financial statement) is properly characterized as equity rather than true debt. That said, it is nevertheless not easy to determine what portion of the present claim should be treated as having been "assumed." First, the audit report was for an accounting period ending more than 19 months prior to the bankruptcy filing. Clearly, many additional transactions occurred between then and the bankruptcy filing. Second, although the audit report reflects a write-down of the DAHNA receivable (which includes amounts owed by both DANA and DAMSI) to 61,576 TDM, or $27,799,799.55, as of September 30, 2000, this figure does not directly correspond to any line item, or combination of line items, on the intercompany statement of account that had previously been signed for the same fiscal year-end. All that is clear is that at least $27,799,799 was still considered by GmbH and its auditors to represent a viable receivable. Whether that determination was made with respect to specific components of the intercompany receivable or was simply an aggregate determination is not explained. (It is noteworthy, however, that almost precisely that same sum — $27,298,779 — was paid by DANA to GmbH approximately four months after the audit.) The uncertainty on this point is not helped by the fact that the write-down, although reflected in the audited financial statements for investors and the outside world, was not incorporated in the internal accounting records, which appear to have simply carried the pre-audit account balances forward. Nevertheless, given the explanation in the audit report, it seems clear that the write-down centered on that portion of the DAHNA receivable that involved DANA's spare parts business. There is no reason why the spare parts transactions after the audit should be treated as any less a "market investment" than those predating it.
Accordingly, the court concludes that the portion of the GmbH claim consisting of the spare parts receivable and associated interest is properly treated in this bankruptcy case as an equity investment rather than true debt. Again, in default of evidence allowing a more accurate allocation of interest, the court will simply pro-rate the interest claimed in the same ratio as the spare parts claim bears to the total claim, an amount the court calculates as $7,490,396.30.
For the purpose of pro-rating the FY2001 interest, the claim must be reduced by the cash sent (which was a subsequent liability) as well as by the FY2001 and post-FY2001 interest. The remaining claim balance is $82,816,642.72 ($101,178,418.40-$5,236,716.01-$3,166,920.89-$9,958,138.78). The spare parts claim is 92.89% of this amount. That percentage, applied to the FY2001 interest of $5,236,716.01, yields $4,864,385.50. For the post-FY2001 interest, the claim must be reduced by the FY2001 and post-FY2001 interest. The remaining claim balance for that period is $92,774,781.50 ($101,178,418.40-$5,236,716.01-$3,166,920.89). The spare parts claim is 82.92% of that amount. That percentage of the post-FY2001 interest of $3,166,920.89 amounts to $2,626,010.80. Thus, the total interest attributable to the spare parts claim is $7,490,396.30 ($4,864,385.50 + $2,626,010.80).
The resulting allowed claim, after recharacterization, is therefore as follows:
Tentative allowed claim $90,891,553.23 Less spare parts ($76,926,051.65) Less pro-rata portion of FY2001 interest ($4,864,385.50) Less pro-rata portion of post-FY 2001 interest ($2,626,010.80) ________________ Net allowed claim $6,475,105.28
IV.
In summary, the court determines that the Committee has carried its burden of proving that the spare parts claim and associated interest (a total of $84,416,447.95) should be recharacterized as equity and should not be allowed as an unsecured claim. When added to the wing loan and associated interest (a total of $44,965,404.66), the total amount recharacterized as equity is $129,381,852.61. The balance remaining after deducting the cash sent and associated interest (a total of $10,286,865.17) is $6,475,105.28. A separate judgment will be entered allowing the amended claim in this amount (subject to whatever ruling may ultimately be made with respect to the alleged $27 million preference payment) and disallowing the excess.
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