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No Trustee Left Behind – Another Bankruptcy Court Requires Colleges to Return Tuition to the Bankruptcy Estate

b09036864402bfedc690a2f80d6de804Another bankruptcy trustee catches another hapless college unaware.  In Roach v. Skidmore College (In re Dunston), Bankr. S.D. Ga. (Jan 31, 2017), a trustee appears to win the next battle of “bankruptcy estates v. child’s college,” ruling that an insolvent parent who paid the college tuition of an adult child made a fraudulent transfer to the college.  Thus, the unsuspecting college will likely have to return the tuition to the parent’s bankruptcy estate.

The theory is simple (albeit unsettling to some).  Under Section 548 of the Bankruptcy Code (and applicable state law, as a back-up), if any debtor makes a transfer to a third party while insolvent, and does not receive reasonably equivalent value in return, the debtor’s bankruptcy trustee may reclaim such transfer for the benefit of unsecured creditors (and for the benefit of the trustee’s fees, of course).  In plain English, the recipient got the money, and didn’t provide anything to the insolvent party which made the payment.  That’s unfair to the insolvent payor’s other creditors (who are left with crumbs, or nothing), and thus a “fraudulent transfer” can be reclaimed for all such other creditors.  Congress has excluded some charitable contributions and tithes from attack. 11 U.S.C. § 548(a)(2).  But Congress did not include tuition paid for an adult child in the list of exceptions, and so it is not the place of courts to graft a “adult child college tuition” exclusion to the statute.

We had a prior post on this, here.  In that post, we went over a contrary ruling from the District of Massachusetts, DeGiacomo, as Chapter 7 Trustee v. Sacred Heart Univ. (In re Palladino), Bankr. D. Mass. (Aug. 10, 2016).  In that case, the Bankruptcy Court ruled against the Chapter 7 trustee by holding that the future benefits an adult child may get from a college education can provide “reasonably equivalent value” such that the parent’s tuition payment to the college is not voidable.  As the Palladino Court held, “[a] parent can reasonably assume that paying for a child to obtain an undergraduate degree will enhance the financial well-being of the child which in turn will confer an economic benefit on the parent.  This, it seems to me, constitutes a quid pro quo that is reasonable and reasonable equivalence is all that is required.”  (Other coverage of Palladino and opinions like it, including this recent ruling from Georgia, can be found in the outstanding coverage of Katy Stech of the Wall Street Journal  here, here, and here (alas, WSJ subscriptions required)).

Now, in Roach v. Skidmore College (In re Dunston), the Bankruptcy Court for the Southern District of Georgia has ruled to the contrary.  In Dunston, the Court rejected the argument that an indirect economic benefit of having a well-educated and (hopefully) a gainfully employed adult child is “reasonably equivalent value.”  Instead, according to Dunston, paying an adult child’s tuition is simply honoring a “moral obligation,” and not any legal duty or actual, monetary obligation of the parent.  The college – in this case, the august institution Skidmore College, near beautiful Saratoga Springs and home to some seriously rockin’ a cappella – provided no value to the debtor parent.  Thus, the Dunston court allowed the fraudulent transfer action to go forward – and its will eventually be successful, in The Bankruptcy Cave’s view.

Our previous post on this issue criticized what we believed was a results-oriented decision in Palladino.  To be sure, few like the idea of our educational institutions having to fully refund tuition payments which they accepted innocently, without knowing of the parent’s insolvency.  But despite these misgivings, Palladino was incorrect under a plain reading of the statute – any time an insolvent debtor gives money to a third party, and receives nothing in return, that money should come back to the bankruptcy estate to benefit all other innocent creditors.  The Dunston decision is right.

This problem cries out for a legislative solution.  Until then, bankruptcy courts will honor the wording of the fraudulent transfer status and require colleges to return the tuition (Dunston) or find “future economic value” to the parent that is, in the view of The Bankruptcy Cave, entirely speculative (Palladino).  While there are many problems with our current bankruptcy statutes, this one really needs a solution.

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Losing Both Ways: Debtor Diligence in the Identification of Claims

Two recent cases serve as reminders the devil is truly in the details. As to the front-end risks associated with an early § 363(f) sale, in In re Motors Liquidation Company[1](the “GM” case) we have seen a $10 billion reminder that identification and actual notice to persons with claims against the Debtor is an indispensable element to the “free and clear” result intended by such a sale.  On the back-end risks of a confirmed Chapter 11 Plan, In re AmCad Holdings, LLC[2]teaches that failing to specifically identify claims of the Debtor against others for retained jurisdiction under the Plan can defeat the intended jurisdiction of the Bankruptcy Court to adjudicate those omitted claims.

GM involves the ongoing troubles from the 2009 insolvency of the General Motors Corporation, the United States’ largest car manufacturer.  As opposed to the usual reorganization procedures of 11 U.S.C. §§ 1121?1129, which can take years to accomplish (if ever), the debtor opted for an expedited sale under § 363, which can close in a matter of weeks and did so even here.  The sale resulted in a split between “Old GM”, the seller who remained the debtor-in-possession with limited assets, and “New GM”, the purchaser of substantially all of the Old GM assets which would use the purchased assets to carry on the majority of the business of the prior Old GM.   The proposed sale, the hundreds of objections, and resulting Sale Order all anticipated that New GM would take these assets “free and clear” of liabilities under § 363(f) and that the Sale Order would therefore act as a liability shield to prevent individuals with claims against Old GM from suing New GM.  Among its findings in the GM case, the Second Circuit effectively held that New GM was not shielded from certain large categories of tort claims related to defects in its cars because the debtor had the ability to notify the owners of such cars of the bankruptcy filing and of the proposed § 363(f) sale, yet failed to do so.  (This was not the first ruling out of the GM case addressing snafus – for our prior coverage on the mistaken release of $1.5 billion in liens, see here.)

AmCad Holdings involved the more traditional route of reorganization and Plan confirmation. As part of the Plan, a liquidation trust was established and certain estate assets, including causes of action, were assigned to the liquidating trust. Five months after confirmation, the Trustee brought an adversary proceeding against some prior managers and officers of the debtor, including three counts asserting defendants breaches of fiduciary duty.  The defendants moved to dismiss the fiduciary claims for lack of subject matter jurisdiction.  The Trustee asserted the Court had jurisdiction over the fiduciary claims under the Plan’s provisions for retention of post-confirmation jurisdiction over “Causes of Action”, which were defined in a very broad and inclusive, but annoyingly general manner.  The Plan had no specific retention of claims for breach of fiduciary duty.  In dismissing the fiduciary claims, the Court noted that its post-confirmation jurisdiction over non-core but related matters was narrow and limited to matters that had a close nexus to the Plan.  The Court reasoned that while a Chapter 11 Plan that retains jurisdiction over a specific cause of action generally satisfies this nexus, a wholesale assignment of causes of action to the post-confirmation trust did not.

In both cases, we observe that the attention to detail in the identification of claims – and in the case of AmCad Holdings, a proper disclosure of those claims – is not only important, but can be dispositive. Setting aside the sheer scale of the GM case, it’s still illustrative of the very basic issues of fairness and notice present in any § 363(f) sale on the front-end of a bankruptcy.  AmCad Holdings is on a more common scale, yet illustrates the back-end, post-confirmation risk of relying on broad-brush treatment of retained jurisdiction and perfunctory, generic disclosures of claims to be brought in the future. But once you have processed the facial lessons: (1) give actual notice to potential claimants and creditors in § 363 sale, (2) specifically identify claims for retention of post-confirmation jurisdiction, there is still more to be observed.

If the specific identification of claims and claimants can prove dispositively important, then isn’t the indicated level of diligence in this area of practice of like import? We live in the Information Age and practice among colleagues and clients of high sophistication.  Both the law firms and the clients hold information now measured in gigabytes and terabytes.  It is not a good bet that Courts will accept the proposition that it was too hard to identify a debtor’s customers, or to be aware of potential claims, or to foresee the claims that might be brought by an estate or liquidating trust post-confirmation.  But we also practice in a commercial and legal environment that is increasingly demanding, competitive, fast-paced, specialized, and that inherently involves delegation of detail work—both within the organization of the client and in that of the attorney.  These two recent cases should remind attorneys and clients in this area that attention to the identification of claims and the indicated parties to claims are important enough to support the investment of time, information, and data management, adequate staffing, full communications between client and counsel, and both factual and strategic scrutiny.  We can all learn from these cases – and adjust our habits and practices accordingly.

[1]               In re Motors Liquidation Company, Case No. 15-2844 (2d Cir., July 13, 2016).

[2]               Gavin Solmonese, LLC v. Shyamsundar (In re AmCad Holdings, LLC), United States Bankruptcy Court for the District of Delaware, Adv. No. 15-51979 (June 15, 2016) (Walrath, J.).

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Some Much Needed Transparency Required on Liquidating Trustees, Liquidating Trusts, Plan Documents, and Other Post-Confirmation Matters

We at The Bankruptcy Cave applaud the recent ruling by Judge Whipple of the Bankruptcy Court for the Northern District of Ohio, seeking to make the post-confirmation parties, processes, and procedures far more transparent. In In re Affordable Med Scrubs, LLC,[1] Judge Whipple declined to approve a disclosure statement for a secured creditor’s liquidating plan.  The key deficiencies were as follows:

 

  1. Disclosure Must be Provided about the Liquidating Trustee: While the secured creditor’s disclosure statement did state who the liquidating trustee would be, it provided no disclosures about the putative trustee’s connections to key creditors and other parties in interest. We applaud this effort to require disclosures about a proposed liquidating trustee or plan administrator. The selection of a liquidating trustee or plan administrator is a murky process – at best, it is based on some vague (and undisclosed) considerations of pricing and experience of the individual or company that will serve in this role.  At worst, selection of a liquidating trustee or plan administrator may reek of “payola,” favors being returned, or other completely inappropriate (and also undisclosed) factors.  It is not much to ask, at all, for any proposed post-confirmation parties to make a full disclosure under Bankruptcy Rules 2014 and 2016.

 

  1. The Same Disclosure Must be Made About any “Plan Oversight Committee”: See above – the same rules apply to Oversight Committees or other parties involved in supervising post-confirmation actions.

 

  1. Better Disclosure of Litigation Claims Against Key Parties: The Affordable Med Scrubs disclosure statement also did not clearly deal with potential claims against the largest creditor (which is not very surprising, as the largest creditor was the party submitting the disclosure statement).  References, cross-references, and unclear descriptions of claims don’t help anyone – plan proponents should carefully and plainly describe in one place in the disclosure statement what they know about various claims, and whether they plan on pursuing them or recommending that the liquidating trustee pursue them (or not pursue them).  No one should be surprised later that a claim is brought, or that a claim against a key party is not brought by the Liquidating Trustee (see above, in relation to the risk that side-deals may be involved in selection of Liquidating Trustees or Oversight Committees).[2]

 

  1. The Liquidating Trust Agreement and Other Key Documents Should be Filed with the Disclosure Statement: We at The Bankruptcy Cave are increasingly annoyed with the massive dump of “plan documents” being filed 5-10 days before confirmation.  The Affordable Med Scrubs court was not pleased with the failure of the parties to file the proposed Liquidating Trust agreement with the disclosure statement.  This is particularly important as such agreement often has key terms on the authority of the liquidating trustee, fees paid to the liquidating trustee and his or her professionals, and other items about which creditors should be aware (some or all of which, such as post-confirmation professional fees, may be shielded from future court or creditor scrutiny altogether).

 

This is an important case on issues that are not typically addressed. We look forward to a raising of the bar in our collective practices to require more disclosure of post-confirmation parties, how they came to be chosen and their connections with creditors and other parties in interest, and expected post-confirmation events and claims.

[1]           Case No. 15-33448, Bankr. N.D. Ohio, Order Disapproving Disclosure Statement, Docket No. 267 (July 5, 2016).

 

[2]           We don’t intend to imply, at all, that anything improper was going on among the parties in the Affordable Med Scrubs case – many of the deficiencies the court notes with the disclosure statement could simply be oversight, or a desire for expediency.  The Affordable Med Scrubs court does not even hint at any impropriety, and we didn’t see any in the facts at all – just a lack of disclosure.  But we have seen other cases in which substantial litigation claims are not brought, or settled for small amounts, as to creditors that had a major role in selecting the parties that will control those very same post-confirmation events.

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