On December 2, 2011, the Bankruptcy Court for the Northern District of Illinois issued a detailed and thorough opinion discussing important issues for determining the bankruptcy remoteness of special purpose vehicles. The decision results from an August 2010 remand by the Seventh Circuit in Paloian v. LaSalle Bank, N.A. We previously reported on the facts of the case and the Seventh Circuit’s opinion here and here. In its December 2, 2011 opinion, the bankruptcy court denied the chapter 11 trustee’s post-remand motion for partial summary judgment in an adversary proceeding to avoid prepetition payments as fraudulent transfers and in doing so, discussed the Seventh Circuit’s “operational separateness” standard for “bankruptcy-remote” entities.
As a recap of the facts pertinent to the motion, the debtor in Paloian was Doctor’s Hospital of Hyde Park, which was part of the same corporate family as MMA Funding, L.L.C., a non-debtor that was intended to be a “bankruptcy-remote vehicle,” and HPCH LLC, a non-debtor that owned the Hospital’s building and land. Prior to its bankruptcy, the Hospital purportedly transferred all its current and future accounts receivable to MMA. Among the prepetition loans extended to the corporate group was a $50 million loan made by Nomura Asset Capital Corporation to HPCH, which was secured by incremental rent that the Hospital agreed to pay to HPCH through MMA, the HPCH lease, the Hospital real estate and equipment, accounts receivables, and other intangibles relating to the Hospital. The Hospital also guaranteed HPCH’s obligations under the Nomura loan. Nomura sold its loan, and the loan rights were ultimately transferred to a securitization trust, of which LaSalle National Bank acted as trustee. The Hospital’s chapter 11 trustee commenced the adversary proceeding against LaSalle, as indenture trustee, claiming various portions of the transactions constituted fraudulent transfers. After the Seventh Circuit’s remand, the chapter 11 trustee moved for partial summary judgment, seeking a determination that MMA was not a bankruptcy remote entity and that all payments of rent from the Hospital during a certain time period were actually transfers of the Hospital’s funds.
The bankruptcy court considered two issues in connection with the trustee’s summary judgment motion: (i) whether MMA was actually separate from the debtor so that it was a legitimate “bankruptcy-remote” entity, and, if so (ii) whether the Hospital’s sale of accounts receivable to MMA was a “true sale” such that the Hospital’s chapter 11 trustee could not recover payments by MMA to Nomura as fraudulent transfers.
First, the court discussed the factors necessary to achieve a bankruptcy-remote entity. The status of MMA was relevant because, if it was a separate business entity dealing with its own assets, instead of the Hospital’s assets, then LaSalle would have a defense that the transfers the chapter 11 trustee was seeking to recover were not transfers of property of the Hospital’s estate.
The bankruptcy court noted that the Court of Appeals’ remand opinion suggested an expanded legal criterion for bankruptcy remoteness: that the special purpose vehicle must have its own distinct operations. This criterion is in addition to and beyond legal separateness (i.e., that the entity “must be legally separate from all related entities so that its property can be distinguished from property of the bankruptcy estate”). Much of the bankruptcy court’s discussion reviews scholarly commentary of the Seventh Circuit’s opinion (including this Blog), and, in particular, criticism of the operational separateness standard, which analysis has noted that the Court of Appeals’ reasoning is reminiscent of case law on substantive consolidation (although the Court of Appeals’ opinion did not clearly involve substantive consolidation). The bankruptcy court, however, also cited this Blog’s analysis of the ways in which the Seventh Circuit’s opinion expands on existing case law on corporate separateness. At the end of the day, the bankruptcy court determined that detailed evidence as to indicia of entity operations had yet to be produced by the parties, and, therefore, material issues of fact existed as to whether, during the time period relevant to the underlying transactions, MMA was truly separate from Hospital under the operational separateness test.
The bankruptcy court then focused on a number of typical factors in a true sale analysis, including recourse, post-transfer control over the assets and administrative activities, accounting treatment, adequacy of consideration, and the parties’ intent. Although the Seventh Circuit’s opinion questioned whether a true sale occurred and explicitly remanded the issue of whether there had been a true sale of receivables, it did not identify which factors might be dispositive for the bankruptcy court’s analysis. The bankruptcy court concluded that some elements of a true sale existed, while others did not. For example, there was no record of a purchase price, although there was evidence that the Hospital was granted some cash, an equity interest in MMA, and satisfaction of an existing loan to the Hospital by MMA in exchange for the receivables. In addition, there was evidence that the receivables appeared on both MMA’s and Hospital’s balance sheets, although the loan closing documents reflected that the Hospital was made servicer of the accounts and retained the accounts on its balance sheet out of administrative convenience. Thus, material issues of fact existed as to whether the Hospital made a true sale of its accounts receivables – essentially its sole source of cashflow – to MMA prior to the bankruptcy.
Summary Judgment Denied
The material issues of fact regarding the issues on remand precluded summary judgment in favor of the chapter 11 trustee, and the issues will now proceed to trial. One wonders what additional evidence will be proffered at trial – the parties provided extensive evidence in the underlying litigation and in connection with the post-remand motion for partial summary judgment, and the trial will involve transactions that occurred during the late 1990s. Nonetheless, it is clear that the bankruptcy court must adhere to the Seventh Circuit’s guidance on what are complex and fact-intensive issues, as the operational separateness test is now the governing standard for bankruptcy remoteness in the Seventh Circuit.