Contributed by Debra McElligott
The Massachusetts Bankruptcy Court recently shed light on the burdens of fraudulent transfer litigation in Riley v. Countrywide Home Loans, Inc. (In re Duplication Management). While a trustee always has the burden of proof in fraudulent transfer cases, meaning that he or she has the responsibility to persuade the judge that that each element of the claim is true, some courts have held that the burden of production may shift to the defendant after the plaintiff proves its prima facie case. This means that where a defendant asserts an affirmative defense to the trustee’s claims, it must provide some evidence proving its defense to prevail. The court in Duplication Management adopted this rule, and in doing so emphasized the equitable concerns underlying the fraudulent transfer provisions of the Bankruptcy Code.
In Riley, the chapter 7 trustee was seeking to avoid and recover payments made by the debtor on a loan as fraudulent transfers under both section 548 of the Bankruptcy Code and the Massachusetts Uniform Fraudulent Transfer Act (MUFTA). Five different entities were involved in the transfers: the debtor company, Duplication Management; its affiliate, DMI; the president and sole shareholder of both entities, Michael Jenoski; the defendant bank, Countrywide; and its successor, Bank of America. Mr. Jenoski had taken out a mortgage in order to purchase his former co-owner’s interest in both the debtor and its affiliate. The debtor then made monthly payments on this loan, receiving nothing in return from the defendants. The debtor continued these payments until its bankruptcy in 2010, after which the affiliate continued the payments until it ceased operations in August 2012. It was undisputed that the transfers were made within the time periods required by the Code and MUFTA. Thus, the case turned on whether the debtor was insolvent at the time of the transfer, and whether it received reasonably equivalent value in return.
Before deciding either issue, the bankruptcy court examined the allocation of the burdens between the parties. The trustee asserted that the debtor’s balance sheets and the defendants’ admission that they provided no value in exchange for the transfer satisfied her prima facie case. She argued that the burden thus shifted to the defendants to support their two main assertions: first, that the finances of the debtor and its affiliate should be considered together to determine solvency, and second, that Mr. Jenoski’s indirect benefits to the debtor constituted reasonably equivalent value. The bankruptcy court rejected the defendants’ contention that Massachusetts has not adopted a burden-shifting framework in fraudulent transfer cases. Citing the United States Court of Appeals for the First Circuit in Braunstein v. Walsh (In re Rowanoak Corp.), the court recognized that although the burden of proof always rests on a trustee seeking avoidance of a fraudulent transfer, the intermediate burden of production may shift to a defendant to quantify the value of the services provided in relation to the transfer.
Applying this rule to the issue of the debtor’s insolvency, the bankruptcy court held that the trustee sustained her burden of proof. The defendants’ only evidence of solvency was testimony of the debtor’s accountant that the two companies were combined for financial statement purposes since their inception, and that their finances would have to be considered together to evaluate solvency. The court found that there was no basis for the combination of the corporate entities, and that even if there was, the defendant failed to meet its burden of production by failing to submit any consolidated balance sheets showing that the value of the assets of the combined entities exceeded their combined liabilities.
The bankruptcy court similarly found that the trustee sustained her burden of proof on the issue of reasonably equivalent value. The court relied on the decision of the United States Bankruptcy Court for the District of Maryland in Rosen v. Moreno (In re Rood), in which a group of landlords received rental payments on behalf of a lessee from debtor entities who were not liable on the lease. Although the landlords claimed that the debtor entities received reasonably equivalent value in the form of indirect benefits, the court held in favor of the chapter 7 trustee, noting that the landlords did not attempt to quantify the value of those benefits. The Duplication Management court also discussed the opinion of the United States Bankruptcy Court for the Central District of California in Cooper v. Centar Investments Ltd. (In re Trigem America Corp.). In that case, relied upon in Rood, the court asserted that indirect benefits can suffice as reasonably equivalent value if they are “fairly concrete and identifiable,” and that once the plaintiff makes a showing that there was no direct benefit to the debtor, it is the defendant’s burden to prove “sufficient indirect benefit that is tangible and concrete.”
The defendants in Duplication Management could not sustain the burden of quantifying the value of indirect benefits. They asserted that the debtor made mortgage payments in lieu of compensating Mr. Jenoski for his services, but failed to produce a written compensation agreement or any other evidence valuing to the services he performed. Additionally, the mortgage had an adjustable rate allowing a choice of different payment options, leading the mortgage payments to differ significantly each month. The court noted that in order to hold that the services constituted reasonably equivalent value, it would have to make the “untenable inference” that the value of Mr. Jenoski’s services fluctuated in response to the payment option he elected when he caused the debtor to make the payments. Finally, the debtor made a payment on the loan after it ceased operations and was no longer utilizing Mr. Jenoski’s services. These factors, coupled with the defendants’ failure to prove the debtor’s solvency, led the court to hold in favor of the trustee.
As the bankruptcy court noted in this case, the “reasonably equivalent value” requirement under the Bankruptcy Code is intended to protect creditors against the depletion of the estate. The Duplication Management opinion aligns with this overarching policy concern, as a defendant who cannot factually demonstrate the reasonably equivalent value of indirect benefits in a particular case necessarily cannot demonstrate that the debtor’s net worth was preserved in a particular case. Applying the burden-shifting framework where a defendant claims that the debtor received indirect benefits in exchange for a transfer balances competing interests, furthering the objective of protecting creditors while also allowing debtors who can sufficiently support their assertions of reasonably equivalent value to prevail.
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