Opinion
Case No. 98-80044-SSM, Adversary Proceeding No. 99-8010
December 23, 1999
Kermit A. Rosenberg, Esquire, Tighe, Patton, Tabackman Babbin, PLLC, Washington, D.C., Of Counsel for Plaintiff
Thomas P. Gorman, Esquire, Tyler, Bartl, Burke Albert, PLC, Alexandria, VA, Of Counsel for Defendant
MEMORANDUM OPINION AND ORDER
Before the court is the motion of plaintiff (and reorganized debtor), FastComm Communications Corporation ("FastComm" or "the debtor"), for summary judgment. A hearing was held on October 26, 1999, at which both parties were represented by counsel. The major point of dispute was whether a prepetition settlement of the defendant's claim against the debtor fixes the amount of that claim for the purpose of preference avoidance. After hearing the arguments of the parties, the court took the motion under advisement. Upon review of the record and the applicable law, the court concludes that the motion should be granted in part and denied in part.
Background
This is an action to set aside, as a preference, a transfer of $50,000 to the defendant, Michael L. Donnelly ("Mr. Donnelly"). FastComm filed a voluntary petition under chapter 11 of the Bankruptcy Code in this court on June 2, 1998, and remained in control of its estate as a debtor in possession. On March 30, 1999, this court confirmed the Third Amended Plan of Reorganization filed by the debtor. Of importance, as will be explained later, is the plan's treatment of "Class 3: Allowed Unsecured Nonpriority Claims Greater than $1,000." Briefly, these creditors are to receive 25% of their allowed claims in cash and the remaining 75% in convertible debentures. The reorganized debtor filed the present adversary proceeding on April 22, 1999, seeking to recover a $50,000 payment made to Mr. Donnelly 33 days prior to the bankruptcy filing. Mr. Donnelly had not been listed as a creditor, but the $50,000 payment was listed on the Statement of Financial Affairs, and the debtor's Third Amended Disclosure Statement revealed that preference actions would be commenced within thirty days of the effective date of the plan.
The payment in question was made in settlement of a lawsuit between the parties in state court. Mr. Donnelly was the former Vice President of Technical Services for the debtor. In March 1998, he filed a third-party motion for judgment against the debtor in the Circuit Court of Fairfax County, Virginia, seeking damages in the amount of $1,350,000 for breach of contract, defamation, and abuse of process. Mr. Donnelly and FastComm successfully negotiated a settlement agreement, which was signed on April 28, 1998. Relevant to the present discussion, Mr. Donnelly agreed to release all claims, known and unknown, arising prior to the settlement, provided that the debtor tendered on April 30, 1998, "a cashier's or treasurer's check from or on behalf of FastComm, representing immediately cleared funds, in the amount of $50,000[.]" Pl. Ex. at 2. The agreement was not subject to further reservations or conditions (precedent or subsequent). The debtor fulfilled its obligation, and the parties filed in state court the same date a stipulation dismissing the lawsuit. The state court then entered an order dismissing the third-party action against FastComm with prejudice.
Discussion I.
Under Federal Rule of Civil Procedure 56(c), as incorporated by Federal Rule of Bankruptcy Procedure 7056, summary judgment is appropriate "if the pleadings, depositions, answers to interrogatories, and admissions on file, together with the affidavits, if any, show that there is no genuine issue as to any material fact and that the moving party is entitled to a judgment as a matter of law." In ruling on a motion for summary judgment, a court should believe the evidence of the non-movant, and all justifiable inferences must be drawn in his favor. Anderson v. Liberty Lobby, Inc., 477 U.S. 242, 255, 106 S.Ct. 2505, 91 L.Ed.2d 202 (1986). At the same time, the Supreme Court has instructed that summary judgment "is properly regarded not as a disfavored procedural shortcut, but rather as an integral part of the Federal Rules as a whole, which are designed `to secure the just, speedy and inexpensive determination of every action.'" Celotex Corp. v. Catrett, 477 U.S. 317, 327, 106 S.Ct. 2548, 2555, 91 L.Ed.2d 265 (1985). Additionally, not every dispute as to the facts will preclude the entry of summary judgment, but only those disputes over facts that might affect the outcome of the suit under the governing law. Anderson at 248, 106 S.Ct. at 2510.
II.
A preference is an odd creature. Outside of bankruptcy, a creditor whose just claim is paid while a financially-strapped debtor is fighting off the wolves at the door need not account to other, less-fortunate creditors when the debtor ultimately proves insolvent. In bankruptcy, however, the rule is different. Certain creditors who have received payment in the period leading up to bankruptcy can be forced to disgorge what they have received, so that all similarly situated creditors may receive an equal distribution on account of their claims. Specifically, a transfer of the debtor's property may be avoided as a preference if it was made on account of an antecedent debt within 90 days of the filing of the bankruptcy petition while the debtor was insolvent, thereby enabling the creditor to receive more than it would have received in a chapter 7 liquidation. § 547, Bankruptcy Code. In the present action, there is no dispute that the $50,000 payment was made to Mr. Donnelly, and that it was made well within the 90-day period leading up to the bankruptcy petition. Nor does Mr. Donnelly deny that the payment, which was made to settle a disputed and unliquidated claim, constituted payment on account of an antecedent debt. Bob Grissett Golf Shoppes, Inc. v. Confidence Golf Co., 44 B.R. 156, 158-59 (Bankr. E.D. Va. 1984); see also Energy Coop., Inc. v. SOCAP Int'l, 832 F.2d 997, 1002 (7th Cir. 1987); Aero-Fastener, Inc. v. Sierracin Corp. (In re Aero-Fastener), 111 B.R. 120, 136 (Bankr. D. Mass. 1994); cf. Smith v. Creative Fin. Management, Inc. (In re Virginia-Carolina Fin. Corp.), 954 F.2d 193, 197 (4th Cir. 1992 ("A common sense approach for determining whether . . . [payment] is `for or on account of [a] . . . debt owed by the debtor' is to consider whether the creditor would be able to assert a claim against the estate, absent the [payment].").
The creditor who is forced to give up a preference has a claim in the bankruptcy case for the amount given back and has 30 days from the date of the judgment ordering disgorgement to file its proof of claim. § 502(h), Bankruptcy Code; F.R.Bankr.P. 3002(c)(3).
Section 547, Bankruptcy Code, reads in pertinent part as follows:
(b) Except as provided in subsection (c) of this section, the trustee may avoid any transfer of an interest of the debtor in property —
(1) to or for the benefit of a creditor;
(2) for or on account of an antecedent debt owed by the debtor before such transfer was made;
(3) made while the debtor was insolvent;
(4) made —
(A) on or within 90 days before the date of the filing of the petition;
(B) between 90 days and one year before the date of the filing of the petition, if such creditor at the time of such transfer was an insider; and
(5) that enables such creditor to receive more that such creditor would receive if —
(A) the case were a case under chapter 7 of this title;
(B) the transfer had not been made; and
(C) such creditor received payment of such debtor to the extent provided by the provisions of this title.
A.
On the present record, the only elements of a preference which are seriously disputed are whether FastComm was insolvent when the $50,000 payment was made, and whether the payment enabled Mr. Donnelly to recover more than he would have received in a chapter 7 liquidation. The latter element, sometimes referred to as "the improvement-of-position" test, places on the plaintiff the burden of showing that the transfer enabled "[the] creditor to receive more than the creditor would otherwise [have] received if, instead, the creditor were limited to his or her share of a distribution resulting from a Chapter 7 liquidation." In re Wilkinson, 196 B.R. 311, 320 (Bankr. E.D. Va. 1996). In other words, the court is left to construct a hypothetical chapter 7 case to determine whether the creditor obtained a benefit at the expense of other unsecured creditors. See Alvarado v. Walsh (LCO Enterprises), 12 F.3d 938, 941 (9th Cir. 1993).
The debtor here contends that Mr. Donnelly's receipt of the $50,000 payment improved his position in that he received 100% of his claim as compared with the 10% the debtor calculates that Mr. Donnelly would have received had FastComm been liquidated under chapter 7. The debtor's argument is premised on the assumption that the settlement of the lawsuit liquidated Mr. Donnelly's claim as a matter of law. It is urged that Mr. Donnelly has only a $50,000 claim against the bankruptcy estate because, through settlement, he gave up his right to sue on his original claim of $1.35 million. The defendant counters by contending that the unliquidated damages sought in his lawsuit, not the amount agreed to in the settlement, serves as his claim. Mr. Donnelly argues that, but for the payment of the $50,000, he would have not released his $1.35 million claim against the debtor. He further argues that had he waited for the filing of the bankruptcy petition, he could have asserted as his claim the full measure of damages he sought in the state court action.
The calculation is set forth in the disclosure statement to the debtor's confirmed plan.
Assuming the defendant's position is correct, the court would have to rule on the merits of the state suit and estimate Mr. Donnelly's claim to determine the amount of the distribution he would have received in a hypothetical Chapter 7 case.
The issue before the court is primarily a question of state law. In order to apply the "improvement-of-position" test under § 547(b), the court, as a threshold matter, must determine what claim the creditor would have had in a hypothetical chapter 7. Since the validity of a claim is a function of state law, the court must look to Virginia law. In his brief, Mr. Donnelly cites to Bob Grissett and Smith in support of his "but for" argument, but these cases do not stand for the proposition that the court can ignore the effect of a settlement agreement under state law and only consider the creditor's underlying claim for purposes of § 547(b)(5). What Mr. Donnelly fails to appreciate is that he voluntarily entered into an arms-length settlement agreement with the plaintiff. In Virginia, a compromise and settlement of a disputed claim is a valid and binding contract that is favored by law. 4 A Michie's Jurisprudence of Virginia and West Virginia, Compromise and Settlement § 10 (1999). Consequently, "an agreement to compromise and settle litigation constitutes a merger and a bar of the claim which is the subject of the litigation." Noland Co. v. Holsapple, 20 Va. Cir. 265, 1990 WL 751409, at *2 (Va.Cir.Ct. 1990). As the United States Supreme Court noted in United States v. Armour Co., 402 U.S. 673, 681, 91 S.Ct 1752, 1757, 29 L.Ed.2d 256 (1971):
Consent decrees are entered into by parties to a case after careful negotiation has produced agreement on their precise terms. The parties waive their right to litigate the issues involved in the case and thus save themselves the time, expense, and inevitable risk of litigation. Naturally, the agreement reached normally embodies a compromise; in exchange for the saving of cost and elimination of risk, the parties each give up something they might have won had they proceeded with the litigation.
Accordingly, Mr. Donnelly cannot ignore the consequences of his act and cry foul simply because the debtor's subsequent act of filing for bankruptcy made the settlement worth less to him than he anticipated at the time he entered into it.
The question before the court is whether Virginia law would treat the recovery of the $50,000 payment by a bankruptcy trustee grounds for recission of the settlement agreement. This precise issue has never been decided by a Virginia court. Indeed, the case law in Virginia is surprisingly sparse on the remedies available in the event a settlement agreement is breached. Although not binding precedent, Noland, which was decided by the Circuit Court for the City of Charlottesville, is persuasive. There, Noland's lawsuit against Holsapple had been settled, with Noland agreeing to release its claim against Holsapple in exchange for a promise to pay $7,500 by a date certain. When the payment was not made, Noland filed suit on its underlying claim of $8,864.87. The court, however, held that "Noland [was] limited to a recovery for breach of the settlement agreement." 1990 WL 751409, at *1. Relying on general principals of contract law, the court reasoned that the settlement agreement was not executory, in that Noland had folly performed by executing a release in exchange for a promise of future payment. Accordingly, the court held that the underlying claim was extinguished. Commentators and courts in other jurisdictions appear to share the views expressed in Noland. See, e.g., S. R. Shapiro, Annotation, "Remedies for Breach of Valid Accord or Compromise Agreement Involving Disputed or Unliquidated Claim," 94 A.L.R.2d 504 (1964); Globe Metallurgical, Inc. v. Hewlett-Packard Co., 953 F. Supp. 876 (S.D. Ohio 1996); Fortuna v. Queen, 178 W. Va. 586, 363 S.E.2d 472 (1987); McKean v. St. Louis County, 964 S.W.2d 470 (Mo.Ct.App. 1998. But see Robert A. Chapman, Confronting Breach of a Settlement Agreement, 87 Ill. B.J. 217 (1999) (discussing several Illinois cases). Generally, whether a creditor may proceed with the underlying claim upon the breach of the settlement depends upon whether the agreement is treated as an executory accord or a substituted contract. If the agreement is an executory accord, which operates as a satisfaction of an antecedent claim only when performed, and is breached, the underlying cause of action is not barred. 15A Am.Jur.2d Compromise and Settlement § 38. However, if the settlement agreement is a substituted contract, whereby settlement is accepted as a substitute for the antecedent claim, the creditor is limited to the terms of the settlement. 15A Am.Jur.2d Compromise and Settlement § 37.
Of course, even if the claim is limited to $50,000.00, Mr. Donnelly does not go wholly unpaid. Under the confirmed plan, he is entitled to a $12,500 cash distribution, with the balance of his claim in the form of convertible debentures.
In the present action, the settlement agreement cannot be characterized in any sense as executory. Both parties have fully performed — FastComm by paying the $50,000, and Mr. Donnelly by releasing the balance of his claim. Furthermore, the settlement agreement resulted in a court order that dismissed the lawsuit with prejudice. Consistent with the analysis in Noland, the court concludes that the defendant's $1.35 million unliquidated claim vanished once the settlement agreement was no longer executory unless the agreement was subject to a condition subsequent or facts exist entitling Mr. Donnelly to equitable relief in the form of rescission.
Although not favored by law, a condition subsequent is "one which, if performed or violated, as the case may be, defeats the contract." State-Planter's Bank Trust Co. v. First Nat. Bank of Victory (4th Cir. 1935); see also BLACK'S LAW DICTIONARY 294 (6th ed. 1990) ("A condition subsequent is any condition which divests liability which has already attached on the failure to fulfill the condition as applied in contracts . . ."). In the case at bar, the court finds that neither the bankruptcy filing nor the present adversary proceeding serves as a condition subsequent which invalidates the settlement agreement. Nothing in the settlement agreement or the order dismissing the case expressly makes the settlement subject to any future condition, nor can the court find that a condition subsequent should be implied. While the possibility of bankruptcy may or may not have been foreseen by the parties, it was by no means unforeseeable. It is unfortunate that the benefit to Mr. Donnelly from the settlement may turn out to be far less than he had calculated; nevertheless, he was represented by counsel and could have taken precautions to avoid the consequences of a bankruptcy filing within the following 90 days. At oral argument, the debtor's counsel represented that during the settlement negotiations, Mr. Donnelly was made aware that the debtor might possibly file a voluntary bankruptcy petition. But regardless of whether Mr. Donnelly was advised of such a possibility, bankruptcy is not so rare a phenomenon, or the concept of preference recovery so arcane, that an attack on the payment could not have been anticipated. It was Mr. Donnelly's responsibility, if that was a concern, to draft the agreement in such a way as to preserve the underlying claim during the 90-day preference period. He could easily have insisted on a condition that FastComm not file for bankruptcy for at least 90 days. That he did not envision the need for doing so does not justify the court in rewriting the settlement agreement.
As noted, a settlement agreement is simply a contract, and like any other contract it may be rescinded in exceptional circumstances. Since rescission is an extraordinary remedy, it is not surprising that the grounds upon which it is granted are limited. As a general rule, a settlement agreement may be rescinded only upon a showing of fraud, mistake, or duress. 4A Michie's Jurisprudence of Virginia and West Virginia, Compromise and Settlement § 11 (1999); Metrocall of Delaware, Inc. v. Continental Cellular Corp., 246 Va. 365, 437 S.E.2d 189 (1993) (fraud in procurement); Pollard v. Patterson, 13 Va. (3 Hen. M.) 67 (1808). The record here is devoid of any evidence suggesting that the settlement agreement was entered into as a result of duress, mistake, or fraud. As discussed above, all that is revealed is a failure to appreciate the risk of a bankruptcy filing within the following 90 days. Standing alone, the failure to foresee that a bankruptcy trustee or debtor in possession might have a basis to recover the payment is not a sufficient basis for rescission of the agreement. Accordingly, the court is compelled to find, as a matter of law, that Mr. Donnelly's claim is fixed at $50,000.
B.
The remaining controverted issue is whether the debtor was insolvent when the transfer occurred. Mr. Donnelly faces an uphill battle in showing that the debtor was not insolvent in April 1998. Under § 547(f), Bankruptcy Code, "the debtor is presumed to have been insolvent on and during the 90 days immediately preceding the date of the filing of the petition." Moreover, the schedules filed in the debtor's bankruptcy case reflect $7,003,798 in assets and $7,578,834 in liabilities on the filing date. It is true, however, that some of those liabilities were disputed. Additionally, while a court may properly take judicial notice of the debtor's schedules to show insolvency on the filing date, the schedules, standing alone, do not necessarily prove that the debtor was insolvent on some earlier date when the transfer was made. In re Strickland, 230 B.R. 276 (Bankr. E.D. Va. 1999) (schedules did not satisfy trustee's burden of proof of insolvency at time alleged insider loan was repaid 9 months earlier). Finally, the defendant argues that summary judgment is premature because he has been unable to take the deposition of the plaintiffs representative to inquire on this issue, as there have been continuing discovery disputes between the parties.
The defendant is correct that the court should "refuse to grant summary judgment when an opposing party needs additional time to complete discovery and properly respond to the motion." Healthsouth Rehabilitation Hasp. v. American Nat. Red Cross, 101 F.3d 1005, 1009 (4th Cir. 1996); see also Anderson, 477 U.S. at 251 n. 5, 106 S.Ct. at 2511-12 n. 5. Although the court is unable to determine how much additional time is needed to complete discovery, that issue will be addressed at the next pre-trial conference. Thus, the motion for summary judgment will be granted with respect to fixing the amount of Mr. Donnelly's claim but denied at this time on the issue of insolvency.
Strictly speaking, Fed.R.Civ.P. 56(f) requires the party opposing a motion for summary judgment, and who needs further time for discovery, to file an affidavit showing the reasons why the party is unable to file affidavits opposing the summary judgment motion. Since, however, it is represented that the parties here have consented to an extension of the discovery deadline, the court is not inclined in this instance to stand upon ceremony. Counsel are nevertheless admonished that the requirements of Rule 56(f) should be complied with in the future.
The pretrial conference was continued to January 4, 2000, at 9:30 a.m.
ORDER
For the foregoing reasons, it is
ORDERED:
1. The motion for summary judgment is granted in part and denied in part. The court fixes the amount of the defendant's claim against the debtor, at the time of the alleged preferential payment, at $50,000, and the court further finds that the $50,000 payment from the debtor to the defendant on April 30, 1998, was made within 90 days of the filing of the debtor's chapter 11 petition and was made on account of an antecedent claim.
2. The clerk will mail a copy of this memorandum opinion and order to counsel for the parties and to the United States Trustee.