Opinion
Bankruptcy Case No. 20-12377 EEB Bankruptcy Case No. 20-12380 EEB Jointly Administered Under Case No. 20-12377 EEB Adversary Proceeding No. 22-01075 EEB
2023-01-31
IN RE: SKLAR EXPLORATION COMPANY, LLC, EIN No: 72-1417930 Debtor. In re: Sklarco, LLC, EIN No: 72-1425432 Debtor. Thomas M. Kim, Creditor Trustee, Plaintiff, v. White Resources, LLC, Defendant.
Christopher D. Johnson, Diamond McCarthy LLP, Houston, TX, for Plaintiff. Jack Lazarus, L. Jackson Lazarus, Natchez, MS, for Defendant.
Christopher D. Johnson, Diamond McCarthy LLP, Houston, TX, for Plaintiff.
Jack Lazarus, L. Jackson Lazarus, Natchez, MS, for Defendant.
ORDER GRANTING IN PART AND DENYING IN PART PLAINTIFF'S MOTION FOR SUMMARY JUDGMENT
Elizabeth E. Brown, Bankruptcy Judge
THIS MATTER comes before the Court on Plaintiff's Motion for Summary Judgment. This is a straightforward preference action. The Defendant sold chemicals to Debtor Sklar Exploration Company, LLC ("Debtor") for use in its drilling operations. Debtor fell behind in payments but issued two checks aggregating approximately $30,000 shortly before filing bankruptcy. Under the Debtor's plan of reorganization, Plaintiff was named as a liquidating trustee under a creditor trust to, among other things, bring avoidance actions to recover preferential payments.
The Defendant argues that there are factual disputes on three material issues preventing summary judgment. But it has failed to identify any facts or evidence to support these assertions. "An opposition to summary judgment cannot rely on mere allegations or general denials in either its pleadings or its briefs; rather, specific and material facts for trial, together with probative evidence supporting such facts, must be identified." Am. Express Bank v. Mowdy, (In re Mowdy) , 526 B.R. 63, 73 (Bankr. W.D. Okla. 2015) (citing State Farm Fire and Cas. Co. v. Edie (In re Edie) , 314 B.R. 6, 18 (Bankr. D. Utah 2004) ).
This Court's local rules on summary judgment procedure specify how litigants must support their positions with evidence. L.B.R. 7056-1(c). Statements in support of, or against, a motion for summary judgment "must be followed by citation to admissible evidence either by reference to a specific paragraph number of an affidavit under penalty of perjury or fact contained in the record." Id. Furthermore, "[w]here facts referred to in an affidavit are contained in another document, such as a deposition, interrogatory answer, or admission, a copy of the relevant excerpt from the document must be attached with the relevant passages marked or highlighted." Id. Otherwise, allowing self-serving, unsupported statements to effectively controvert undisputed and properly supported material facts set forth in a motion for summary judgment would divest the summary judgment process of any real effectiveness. Garrett v. Vaughan (In re Vaughan) , 2006 WL 751388, *3 (10th Cir. B.A.P. Mar. 22, 2006).
Nevertheless, the Court must still ensure that the Plaintiff is legally entitled to a judgment, regardless of whether the Defendant has appropriately controverted Plaintiff's request. Celotex Corp. v. Catrett , 477 U.S. 317, 322, 106 S.Ct. 2548, 91 L.Ed.2d 265 (1986). The Tenth Circuit has instructed us to examine the factual record and to draw reasonable inferences from the evidence in a light most favorable to the party opposing summary judgment. Schwartz v. Bhd. of Maint. of Way Employees , 264 F.3d 1181, 1183 (10th Cir. 2001). The movant bears the burden of showing that no genuine issue of material fact exists. Sports Unlimited, Inc. v. Lankford Enter., Inc. , 275 F.3d 996, 999 (10th Cir. 2002). If the moving party makes a prima facie case, only then will the burden shift to the non-moving party. Whitesel v. Sengenberger , 222 F.3d 861, 866 (10th Cir. 2000).
To establish a prima facie case for an avoidable preference under § 547(b) , the Plaintiff must show that the transfer at issue: "(1) is of an interest of the debtor in property; (2) is for the benefit of a creditor; (3) is made for or on account of an antecedent debt owed by the debtor before the transfer was made; (4) is made while the debtor is insolvent; (5) is made on or within ninety days before the date the bankruptcy petition was filed; and (6) allows the creditor to receive more than the creditor would otherwise be entitled to receive from the bankruptcy estate." Bailey v. Big Sky Motors, Ltd. (In re Ogden) , 314 F.3d 1190, 1196 (10th Cir. 2002). The Plaintiff has the burden of proof on each of these elements. 11 U.S.C. § 547(g) ; Lowrey v. Mfrs. Hanover Leasing Corp. (In re Robinson Bros. Drilling, Inc.) , 6 F.3d 701, 703 (10th Cir. 1993). But the Defendant bears the burden to prove that one of the § 547(c) defenses to preference liability applies. Id. ; In re C.W. Min. Co. , 798 F.3d 983, 987 (10th Cir. 2015).
All references to "section" and "§" refer to Title 11, United States Code, unless expressly stated otherwise.
In this case, the Plaintiff has made a prima facie showing of elements 1 through 3 and element 5. He has done so by providing evidence of two checks payable to the Defendant that were drawn on the Debtor's bank account: (1) no. 7744, dated February 14, 2020, in the amount of $16,369.08; and (2) no. 7864, dated February 20, 2020, in the amount of $14,537.93 (collectively, the "Payments"). The Defendant's bank honored the Payments within one week, on February 24, 2020, and February 25, 2020, respectively. He has established that the Payments were made on account of past due invoices. The Debtor filed its chapter 11 petition on April 1, 2020, less than two months later. The Defendant has not disputed these facts.
But the Defendant does dispute element 4 (that the Debtor was insolvent at the time of the transfer) and element 6 (that the Payments enabled the Defendant to receive more than it otherwise would have received in a hypothetical chapter 7 distribution). It has also asserted that the payments were made in the ordinary course of business, invoking § 547(c)(2) ’s defense. We turn now to these allegedly disputed facts.
A. Insolvency
The term "insolvent" is defined in the Code as a "financial condition such that the sum of such entity's debts is greater than all of such entity's property ..." 11 U.S.C. § 101(32). Courts refer to this as the "balance sheet test." Connolly v. Fiber Instrument Sales, Inc. (In re Western Integrated Networks, LLC) , 2006 WL 2460702, *3 (10th Cir. B.A.P. Aug. 25, 2006). Plaintiff has alleged that the Debtor's debts were greater than its assets at the time it made the Payments. For purposes of a § 547(b) inquiry, a transfer of a debtor's interest in property via check occurs on the date the debtor's bank honors the check. Barnhill v. Johnson , 503 U.S. 393, 400, 112 S.Ct. 1386, 118 L.Ed.2d 39 (1992). Therefore, the operative dates here are February 24, 2020, and February 25, 2020. Given the bankruptcy filing on April 1, 2020, the Payments occurred within 37 and 38 days of the petition date.
Section 547(f) provides that "[f]or the purposes of this section, the debtor is presumed to have been insolvent on and during the 90 days immediately preceding the date of the filing of the petition." This statute creates a presumption in favor of the Plaintiff. To establish his prima facie case, he does not need to offer any other evidence of insolvency. The burden then shifts to the Defendant to produce some evidence to rebut the presumption. Carlson v. Rose (In re Rose) , 86 B.R. 193, 194 (Bankr. W.D. Mo. 1988) (citing Sandoz v. Fred Wilson Drilling Co. (Matter of Emerald Oil Co.) , 695 F.2d 833, 837-38 (5th Cir. 1983) ). If the Defendant had done so here, then this fact would have to be tried in court.
Instead, the Defendant merely states that the Debtor "may have been solvent at the time of the transfers, because of the products [Defendant] delivered to its wells." Aside from this equivocal statement, Defendant does not present any admissible evidence, or any evidence for that matter, to suggest that the Debtor was solvent at the time of the Payments. Therefore, Plaintiff has made a prima facie showing of insolvency by virtue of the statutory presumption, and Defendant has failed to offer any evidence to rebut it. Accordingly, there is no genuine dispute of material fact as to the insolvency element.
B. The Hypothetical Chapter 7 Distribution
The sixth element of a preference requires the Plaintiff to demonstrate that the Defendant received more because it received the Payments than it otherwise would have received if it had only received a distribution from a hypothetical chapter 7 liquidation of the Debtor. This requires the court "to construct a ‘hypothetical Chapter 7 case;’ i.e., to determine what the creditor would have received in a liquidation." Still v. Rossville Bank (In re Chattanooga Wholesale Antiques, Inc.) , 930 F.2d 458, 464 (6th Cir. 1991). But this is not as daunting as it sounds. The Plaintiff does not need to offer convoluted financial records to show how much this creditor would have received if the Debtor had filed a chapter 7 petition.
The hypothetical test rests upon figures that existed on the petition date. Sloan v. Zions First Nat'l Bank (In re Castletons, Inc.) , 990 F.2d 551, 554 (10th Cir. 1993). And it requires the Court to consider the type of creditor that the Defendant is. The Bankruptcy Code categorizes creditors into three basic types: secured creditors (whether their liens are voluntary or involuntary), priority unsecured creditors, and nonpriority unsecured creditors. Under these broad categories, some creditors may hold more than one type of claim. For example, the bank that obtained a security interest on all the debtor's assets may hold both a secured claim and a nonpriority, unsecured claim if the value of its collateral on the petition date was less than the amount of its outstanding loan. 11 U.S.C. § 506(a).
These categories have significance in determining this sixth element. A fully secured creditor (whose collateral value is equal to or exceeds the amount of its debt) will rarely be exposed to preference liability. Generally, bankruptcy does not abrogate the secured creditor's lien. Thus, whatever it received during the preference period will not be greater than what it would receive in a chapter 7 liquidation. For example, if the bank was owed $1 million on the petition date and its collateral's value was $1.2 million, then any payments on the loan made during the preference period will not make it better off. In a chapter 7, the bank would still receive full payment on its loan through the liquidation of its collateral. It would make little sense for a trustee to sue to recover $10,000 in payments made during the ninety-day period pre-bankruptcy, only to give the full $1 million back to the bank in chapter 7. The exception to this general principle is the creditor who receives a new or additional lien during the preference period, making that new lien subject to avoidance itself.
It is a tougher call with priority, unsecured claims. If there is enough money in the hypothetical chapter 7 to pay the secured portions of claims, and still enough money left over to cover the priority claims, then maybe the priority creditor is no better off for having received something during the preference period.
But with the nonpriority, unsecured creditors it is usually easy for the plaintiff to establish this element. "[U]nless [nonpriority,] unsecured creditors would receive a 100% payout, any unsecured creditor ... who receives a payment during the preference period is in a position to receive more than it would have received under a Chapter 7 liquidation." Connolly v. Asbestos Abatement, Inc. (In re Iley) , 606 B.R. 871, 889-90 (Bankr. D. Colo. 2019) (quoting Chattanooga Wholesale Antiques , 930 F.2d at 465 ). Consider the following hypothetical balance sheet of a debtor on the petition date:
Assets:
Real estate $10,000,000
Accounts Receivable $250,000
Cash on Hand $50,000
Total Assets: $10,300,000
Liabilities:
The Bank $10,000,000 owed; liens on all assets
100 nonpriority, unsecured creditors owed $5,000,000
Total Liabilities: 15,000,000
In this scenario, the Bank will be fully repaid and there will be $300,000 in assets left to pay the $5,000,000 in unsecured claims. This would entitle each unsecured creditor to a distribution representing the fraction of $300,000/$5,000,000 or a 6% distribution.
Now assume unsecured Creditor ABC Co. received a $50,000 payment during the preference period extinguishing its debt. If the chapter 7 trustee sues ABC to recover the $50,000, then the balance sheet would look like this:
Assets: $10,300,000 as before + $50,000 recovered from ABC = $10,350,000
Liabilities: 101 nonpriority, unsecured creditors owed $5,000,000 + the $50,000 owed to ABC = $15,050,000
After paying the Bank, the trustee would now have $350,000 to distribute. But as the assets grew, so did the creditor pool by a corresponding amount. The fraction would then be $350,000/$5,050,000, resulting in a distribution slightly less than 7%. Overall, the unsecured creditors fair slightly better due to the preference recoveries. But turning back to the sixth element, we see that ABC was better off for having received the $50,000 preference payment. In this hypothetical chapter 7, it would only receive 7% of its claim or $3,000.
This is why we say that, unless the estate is fully solvent, anything that nonpriority, unsecured creditors receive during the preference period will enable them to receive more than they otherwise would from a chapter 7 distribution alone. In support of his prima facie case, the Plaintiff offered the Debtor's Summary of Assets and Liabilities for Non-Individuals , that presents the following balance sheet:
Assets: $10,319,289.23
Liabilities:
The Bank owed $22,885,690.48, with a blanket lien on all assets
Unsecured, priority claims of $466,448.00
Unsecured, nonpriority claims: $22,544,337.73
Total Liabilities: $45,896,476.21
With these figures, all the asset value would go to the Bank, and the Bank would have a deficiency claim added to the nonpriority pool of roughly an additional $12 million. The unsecured creditors, both priority and nonpriority, would receive no distribution in chapter 7.
To counter these facts, the Defendant makes an argument (albeit without supporting evidence). It says, "it would be logical to assume the unsecured creditors in a hypothetical Chapter 7 case might actually receive a substantial dividend, given the fact that [the Debtor] owned substantial assets and given the fact that it appears that millions of dollars in cash and equipment may have been misappropriated from [the Debtor] before, during, and after the [bankruptcy filing]." Thus, the Defendant argues that it is not a foregone conclusion that the transfers caused it to receive more than it would have in a chapter 7 liquidation. But as the Court has explained above, unless the unsecured creditors would receive a 100% distribution on their claims, anything they received during the preference period will still make them better off than they would have been if they had only received a chapter 7 distribution. If the Plaintiff recovers substantial assets from transferees, such as recipients of fraudulent conveyances, then the Defendant will enjoy a greater recovery from the estate. But to assume that the Plaintiff will recover enough to make this a solvent estate is such an unlikely event that the Court cannot find that a reasonable trier of fact would place any weight on this argument. Moreover, the Defendant has not supported this theory with any admissible evidence. Accordingly, there is no genuine dispute of material fact as to this element.
C. The Ordinary Course of Business Defense
Defendant has invoked the "ordinary course of business" exception, which provides for the nonavoidability of "such transfer ... in payment of a debt incurred by the debtor in the ordinary course of business or financial affairs of the debtor and the transferee, and such transfer was ... (A) made in the ordinary course of business or financial affairs of the debtor and the transferee; or (B) made according to ordinary business terms[.]" 11 U.S.C. § 547(c)(2). While "ordinary course of business" or "ordinary business terms" are not defined within the Bankruptcy Code, "case law is in agreement that [ § 547(c)(2) ] was intended to ‘protect recurring, customary credit transactions which are incurred and paid in the ordinary course of business of the Debtor and the transferee.’ " Waldschmidt v. Ranier (In re Fulghum Const. Corp.) , 872 F.2d 739, 743 (6th Cir. 1989) (quoting Energy Co-Op, Inc. v. Socap Int'l Ltd. (In re Energy Co-op Inc.) , 832 F.2d 997, 1004 (7th Cir. 1987) ).
This statute requires proof of two things: (1) the debt arose in the ordinary course of business and either one of two possibilities: (2) the payments were made in the ordinary course of business that existed between these two business partners (a subjective test) or (3) the payments were made in accordance with industry standards (an objective test). Originally, the statute required proof of all three elements to establish the defense, but, in 2005, Congress relaxed the requirements by rewriting the statute in the disjunctive form. No one appears to contest the first element, that the Debtor's purchase of chemicals from the Defendant that formed the basis for the debt, arose in the ordinary course. But they differ on whether the Payments were made in the ordinary course.
Ordinarily the burden of proving this defense rests on the Defendant but given that Plaintiff is the movant for summary judgment, it is incumbent upon Plaintiff to show that Defendant's affirmative defense need not be tried. To satisfy that burden, Plaintiff must show that, under the evidence presented in connection with the motion for summary judgment, if that same evidence were presented to a jury, there could be but one reasonable conclusion as to the verdict. Anderson v. Liberty Lobby, Inc. , 477 U.S. 242, 250, 106 S.Ct. 2505, 91 L.Ed.2d 202 (1986).
In support of the Motion, Plaintiff attaches excerpts from the deposition of Mr. Danny Hankins, the sole manager for Defendant during the relevant time period. In the attached excerpts from his deposition, Mr. Hankins concedes that the payment history between the Debtor and Defendant was irregular. In fact, most of the Defendant's clients, except for the Debtor, paid invoices within 30 to 45 days. The Payments by the Debtor, however, reflect payments on invoices that had been outstanding for 161 days and 121 days, respectively. The Defendant offered no evidence to controvert these facts. This evidence is sufficient to defeat any claim that the Debtor made the Payments according to ordinary business terms, the third prong of the ordinary course of business defense.
But neither party has offered any evidence of the usual timing between invoices and payments that existed between these two parties. Defendant argues that they were involved in a longstanding relationship, and that the transfers were made in a "customary way" such that the ordinary course of business exception applies. But this is a conclusory statement. It does not back this up with any facts as to their past pattern of practice. Perhaps the Debtor always paid the Defendant's invoices between four and six months after the invoice date, but no one presented any such evidence. At trial, this would be fatal to the Defendant's defense. But for purposes of summary judgment, it means that Plaintiff has not carried his initial burden on this issue. As a result, the Court grants summary judgment on the ordinary course defense only to the extent of customary industry practices. It cannot do so as to the pattern and practice that existed between these two parties.
For these reasons, the Court hereby ORDERS that the Motion is GRANTED in part and DENIED in part. Partial summary judgment shall enter in favor of the Plaintiff and against the Defendant on Plaintiff's preference claim, and on the industry practices prong of the ordinary course defense. But the Court denies summary judgment as to the practice between these parties. By separate Order, the Court will schedule a status conference to set a trial date on the remaining issue.