Redmond v. GMAC Insurance Management Corp. (In re Brooke Corp.)
Docket: CASE NO. 08-22786; ADV. NO. 10-6197
Court: United States Bankruptcy Court, D. Kansas; September 29, 2015; Us Bankruptcy; United States Bankruptcy Court
Christopher J. Redmond, as the Chapter 7 Trustee of Brooke Capital Corporation, sought to recover approximately $1 million from GMAC-Insurance Management Corporation (GMAC) as preferential transfers and fraudulent conveyances. These payments were made by Brooke Capital within 90 days prior to its bankruptcy filing under Title 11. The case involved cross-motions for summary judgment, with hearings held on June 25, 2015. The court confirmed its jurisdiction over the matter.
Brooke Agency Services Company, LLC (BASC), a wholly-owned subsidiary of Brooke Corp, acted as an insurance agent for GMAC. BASC's producers collected insurance premiums from insureds, which were then transferred through multiple entities before reaching GMAC. The Trustee aimed to avoid these premium transfers made by Brooke Capital.
The document outlines the operational structure of Brooke Corp and its subsidiaries, including the historical context of their insurance business, the establishment of a franchise model, and the financial arrangements with franchisees. Brooke Capital functioned as the franchise arm, providing loans to franchisees for acquiring insurance agencies. Revenue from commissions paid to Brooke Capital helped service these loans. Additionally, the document notes that BASC, established in 2002, contracted with insurance carriers and managed premium collection through various payment methods, facilitating the flow of funds between insureds, franchisees, and GMAC.
The Brooke Insurance Transactions System processes online bill payments by having agents receive premiums from insured parties and record these transactions in Brooke’s proprietary software. Agents concurrently notify the respective insurance carriers of the premium receipts and deposit the funds into one of approximately 90 sweep accounts maintained by BASC nationwide. A reconciliation team at Brooke verifies the total funds deposited by the agents and, upon successful verification, transfers the funds into the Consolidated Receipts Trust Account (CRTA) at First National Bank of Phillipsburg, Kansas. Commissions from insurance carriers are also deposited into the CRTA.
Disbursement from the CRTA varies over the preference period, generally directing funds either to the Master Receipts Trust Account (MRTA) at BONY or to Brooke Capital's primary account at the same bank. Brooke Capital manages online sweep accounts for 133 carriers, ensuring adequate funds are available for carriers to withdraw owed premiums, with GMAC payments processed via ACH requests.
An expert report indicated that tracing individual receipts through BASC and Brooke Capital’s accounts to their final disbursement is infeasible due to significant commingling of funds and delays in payment processing (typically 3 to 7 days). While GMAC has not contested this report or attempted tracing, it highlights that Brooke reconciled deposits daily and maintained detailed records of premium payments. The court finds that the commingling of premiums, commissions, and operating funds is undisputed and central to its decision.
Additionally, GMAC provided insurance coverage for vehicles and established an agency relationship with Brooke Corp in 2000, transferring this agreement to BASC in 2002. Under the Agency Agreement, agents are required to collect and remit initial premiums within specified time frames, as detailed in Article V regarding direct billed or premium financed policies.
The Company is responsible for billing renewal or adjustment premiums directly to the insured or a designated lending institution, which must be paid in full to the Company. If the Agent receives any premiums, they must remit these in full to the Company within the specified timeframe, holding the collected premiums in trust for the Company. Under the Agency Agreement, GMAC had the authority to withdraw premiums from a “GMAC Sweep Account” owned by Brooke Capital at First National Bank of Phillipsburg, Kansas. Brooke franchisees utilized an online payment system to collect premiums, which allowed immediate quotes and enabled producers to bind policies upon customer approval and premium payment. Premiums were deposited into an agency account, swept into the GMAC Sweep Account, and subsequently transferred to the CRTA. GMAC would initiate ACH transfers for premium amounts four days after input into the online system. Until six days prior to Brooke Capital filing for Chapter 11, the GMAC Sweep Account had sufficient funds for withdrawals. GMAC was unaware that the account was in Brooke Capital's name or that funds were commingled and misused by Brooke Capital. GMAC only recognized the account as “out of trust” shortly before the Chapter 11 filing. During the preference period, Brooke Capital transferred over $1.1 million to the GMAC Sweep Account.
On September 11, 2008, the Bank of New York Mellon (BONY) filed a complaint against Brooke for improperly depositing funds into a Brooke Savings account instead of a designated BONY account for securitization payments. BONY sought the appointment of a receiver, opposed by Brooke, which resulted in a consent order appointing Albert A. Riederer as Special Master. He maintained the relationship with GMAC until October 22, 2008, when he informed all parties that the payment method would end, leading to the closure of the GMAC Sweep Account. Brooke Corp and Brooke Capital filed for Chapter 11 on October 28, 2008, with Riederer appointed as the Chapter 11 Trustee the following day.
On June 28, 2009, the Bankruptcy Court converted the Debtors’ bankruptcy cases to Chapter 7 and appointed Riederer as the Chapter 7 Trustee. Riederer filed an original complaint against GMAC on October 25, 2010, which was later amended on July 12, 2012. Trustee Redmond, Riederer’s successor, seeks summary judgment for: (1) avoidance of $1,109,567.67 in transfers from Brooke Capital to GMAC as preferential transfers under section 547(b); (2) recovery of this amount from GMAC under section 550; (3) prejudgment interest retroactive to October 10, 2010; and (4) reimbursement of the Trustee’s costs. The Trustee notes that if the transfers are deemed to be for antecedent debts under 547(b), the fraudulent conveyance claim becomes moot.
GMAC opposes the preferential transfer claims, arguing that the Trustee cannot prove the transfers were of the Debtor’s property or that GMAC was a creditor. Additionally, GMAC asserts defenses of ordinary course and contemporaneous exchange, aiming for summary judgment on these grounds. The Trustee also filed a motion in limine to exclude certain deposition testimony from GMAC’s expert, but the Court deems this motion moot, as it can rule on the summary judgment motions without the contested testimony.
The Court finds that the Trustee has established a prima facie case for avoidable preferential transfers, which requires proof of several elements under section 547(b). GMAC only challenges the first two elements: whether the transfers were of an interest of Debtor Brooke Capital in property and whether GMAC was a creditor. The Court concludes that the Trustee has satisfied these elements, rejecting GMAC’s challenges.
Brooke Capital's transfers to GMAC constituted a transfer of an interest in property, satisfying the criteria of 11 U.S.C. § 547(b). The Bankruptcy Code allows for the recovery of preferential transfers from the debtor's estate, defined broadly under 11 U.S.C. § 541, often utilizing state law to ascertain property interests. The Tenth Circuit employs a dominion or control test, determining that a debtor's transfer qualifies as an interest if the debtor maintained control over the property. Brooke Capital clearly had dominion over the funds transferred to GMAC, as the transfers were initiated from an account held in Brooke Capital's name.
GMAC argues that the earmarking doctrine applies, which protects certain transfers from being considered preferential if a new lender provides funds specifically to pay off a prior creditor. For the doctrine to be applicable, three requirements must be met: an agreement to use new funds for a specific old debt, adherence to that agreement, and no overall reduction in the estate's value from the transaction. Historically, this doctrine has been associated with guarantor or surety situations, and the Tenth Circuit has been hesitant to expand its application beyond these scenarios.
In this case, no guarantor exists for Brooke Capital’s obligation to GMAC, leading to the court's rejection of the earmarking doctrine's applicability. Additionally, GMAC's analysis lacks the necessary inclusion of Brooke Capital as a debtor, failing to establish the requisite three-party framework for earmarking. Instead, BASC, which provided the funds for the payment, did not become a new creditor of Brooke Capital, as there was no expectation of repayment from Brooke Capital for the transferred funds used to satisfy GMAC.
GMAC became a creditor of Brooke Capital only after BASC transferred premium funds to it, indicating that GMAC was not a pre-existing creditor. The earmarking doctrine, which requires an agreement to pay a debt using specific earmarked funds, did not apply here as no such agreement existed between Brooke Capital and BASC. The transfers to GMAC were for the benefit of a creditor to settle an antecedent debt of Brooke Capital, fulfilling the requirements of 11 U.S.C. § 547(b)(2) and (3). The Bankruptcy Code defines a 'creditor' as an entity with a claim against the debtor, and a 'claim' includes any right to payment. The Agency Agreement mandated BASC to remit collected premiums to GMAC through a system established by Brooke Capital. GMAC contended it did not consent to a debtor-creditor relationship with Brooke Capital, believing it was only with BASC. However, the Court, referencing a prior case (Redmond v. CJD), established that mutual consent is not necessary to form a debtor-creditor relationship, thereby rejecting GMAC’s argument.
The Trustee successfully proved the insolvency of Brooke Capital as per § 547(b)(3) by relying on the presumption of insolvency outlined in § 547(f), as GMAC did not challenge this presumption. The Trustee also established that all relevant transfers occurred within the 90-day period preceding the bankruptcy filing, satisfying § 547(b)(4). For § 547(b)(5), the Trustee argued that the total claims against Brooke Capital far outweighed its current assets, which GMAC did not dispute. However, the Trustee could not avoid the preferential transfers to GMAC because they qualified as ordinary-course transactions under § 547(c)(2). This provision requires that the transfer was for a debt incurred in the ordinary course of business and made in accordance with ordinary business practices.
GMAC argues that it can defend against claims of avoidable preferential transfers from Brooke Capital based on the ordinary-course-of-business defense. As the preference defendant, GMAC bears the burden of proof, which is interpreted narrowly. There is disagreement among courts regarding the "debt-incurred" element under 11 U.S.C. § 547(c)(2), with two primary interpretations: the subjective test, which considers the ordinary nature of the debt between the specific debtor and defendant, and the objective test, which assesses the ordinary nature of the debt from a broader business context. The court in Redmond v. CJD acknowledged merit in both tests and noted that neither is exclusively required by the Bankruptcy Code, allowing for flexibility based on circumstances.
The Tenth Circuit applied the objective test in C.W. Mining due to a lack of prior transactions between the debtor and creditor. The Ninth Circuit's Ahaza Systems case emphasized that the ordinary nature of transactions should consider the specific dealings between the actual parties involved. GMAC relies on the subjective test, citing a long-standing business relationship with Brooke Capital, while the Trustee asserts the objective test is not met due to improper handling of insurance premiums, which were commingled contrary to the Agency Agreement and state law. GMAC maintains that its debt was incurred in the ordinary course of business, with established procedures for premium payments remaining unchanged until a significant procedural termination in October 2008. Throughout the agency relationship, premiums were consistently collected and paid to GMAC via established processes.
Brooke Capital's debt to GMAC originated from the Brooke Insurance Transactions System, where premiums collected by Brooke agents for GMAC policies were processed through a series of accounts before being allocated to Brooke Capital for accounting and debt obligations, including payments to GMAC. There were no irregular transfers to GMAC or unfulfilled payment requests during the preference period, and the payment procedures for GMAC were consistent with those for other insurance carriers linked to BASC. The Trustee argued that the ordinary-course defense should not apply to GMAC because the debt was not typical of an arms-length, market-based transaction and claimed that the commingling of funds constituted a breach of trust. The Court, however, rejected these claims, determining that the debt was incurred in the ordinary course of business, unaffected by Brooke’s financial issues. The Court also found no breach of trust that would negate the ordinary-course defense. Although the Tenth Circuit’s C.W. Mining decision was cited by the Trustee, the Court noted that it did not support the argument against GMAC's ordinary-course evidence. Additionally, the Court referenced the Tenth Circuit's Fidelity case, which established that the ordinary-course defense applies to transactions integral to business operations, even if there are subsequent deficiencies. In this context, the Court concluded that Brooke Capital’s operations were not outside the ordinary course despite any operational weaknesses.
The Court examines whether Brooke Capital's commingling of GMAC's premium payments affects the satisfaction of the debt-incurred element of the ordinary-course defense. The Trustee argues that the debts are suspect for two reasons: first, the BASC-Brooke payment procedures allegedly breached the GMAC Agency Agreement; second, they violated Kansas law. The Trustee cites Article V(3) of the Agency Agreement, asserting that it mandates the agent to hold collected premiums in a traceable trust for GMAC. However, the Court rejects this interpretation, stating that a plain reading of the full Article V indicates that the trust requirement applies only to renewal, additional, or adjustment premiums, which GMAC bills directly. The Trustee provides no evidence that the preferential transfers were for such premiums. Instead, Article V(1) pertains to initial premiums, which are the central issue, and there is no requirement for these to be held in trust. Testimony from GMAC's representative, Douglas Hanes, supports this view, indicating GMAC's primary concern was ensuring funds were available when requested, rather than the specifics of how premiums were held beforehand. The Court's interpretation aligns with established insurance law, which typically treats agents as debtors to insurers rather than trustees of premium funds.
An agency contract may specify that an agent holds premiums as a trustee for the insurer, but the agent is not obligated to keep the collected funds intact. The Court dismisses the Trustee's claim that transfers violated the Agency Agreement, concluding that the handling of GMAC premiums under the Brooke Insurance Transactions System complied with Kansas statutes. K.S.A.2014 Supp. 40-247(a) states that an insurance agent or broker who collects premiums is deemed to hold them in trust for the insurer, and failure to pay after a written demand can suggest misuse of funds. Violations of this statute can lead to felony or misdemeanor charges based on the premium amount. The leading Kansas case outlines three purposes of the statute: protecting insured parties, providing insurers with enhanced remedies against brokers, and establishing prima facie criminality for agents failing to account for premiums. There is no Kansas case law requiring agents to maintain premiums in a segregated account or to be traceable, as the statute indicates premiums are merely to be "deemed" held in trust. Although the Trustee's expert suggested that the handling of premiums by BASC and Brooke Capital was atypical, this does not imply fraudulent intent. The ordinary-course exception in bankruptcy aims to maintain normal financial relations, and the Court finds no inherent fraud in Brooke Capital’s methods, which allowed for timely premium payments to GMAC until the Special Master intervened shortly before Brooke Capital's bankruptcy filing.
The GMAC premiums, if collected by BASC and properly transferred to Brooke Capital without commingling, would not have altered the antecedent debt or transfer payments, as the Trustee suggests should have occurred. The traceability of premiums does not affect the preferential transfers. Under 11 U.S.C. § 547(c)(2), the ordinary-course defense requires that the transfer be made in the ordinary course of business for both the debtor and creditor, or according to ordinary business terms. GMAC argues that its longstanding business relationship with the Debtor satisfies this requirement, remaining unchanged during the 90 days preceding the petition filing. The Trustee asserts the transfers were not ordinary for Brooke Capital due to changes in the Brooke Insurance Transactions System during the preference period, arguing GMAC's lack of awareness of these changes is irrelevant.
The Court, however, finds the transfers were in the ordinary course of business for both parties. It assesses four factors to determine the ordinary course: 1) the length of time the parties engaged in the transactions; 2) whether the amount or form of payment deviated from past practices; 3) any unusual collection or payment activities; and 4) the circumstances under which payments were made. The Court concluded these factors were satisfied, noting GMAC's established agency relationship with BASC since October 4, 2002, and the consistent payment method and timing. GMAC did not alter its payment procedures and was unaware of Brooke Capital's financial issues, including the BONY litigation leading to a Special Master’s appointment. The Trustee's reliance on the Milwaukee Cheese case, which involved unusual withdrawal demands from a thrift savings plan, is deemed inapplicable. In that case, the debtor's repayment of all depositors during the preference period was considered abnormal, thereby disallowing the ordinary-course defense.
Transactions must be considered ordinary not only from the transferees' views but also from the debtor's perspective. Evidence indicated that the transfers were atypical for the debtor, whose managers were aware of the firm's financial distress. The firm's operational plan was critical for working capital, and repayments to depositors occurred regardless of requests. These disbursements constituted around 15% of the firm's total value, significantly exceeding available cash and were funded by a bank loan. The Trustee compared the situation to Milwaukee Cheese, but the court found that the similarity was limited to GMAC's unawareness of the debtor's financial issues. Notably, special circumstances, including changes in fund flow and the appointment of a Special Master, did not affect the transfers to GMAC.
The court noted that a complete payment to a favored class of creditors, especially in anticipation of bankruptcy, exemplifies a preference under Section 547, which aims to prevent a rush to repay debts before bankruptcy, imposing costs on other creditors and the firm. Exceptions in Section 547(c) apply to transactions with minimal risk of such a race. Routine payments, even to favored creditors, would be protected under Section 547(c)(2), distinguishing them from the problematic transfers Section 547 seeks to address.
The transfers in question were likened to regular utility payments, as the flow of funds remained stable during the preference period, with no impact on Brooke Capital's operating capital. Consequently, the court upheld GMAC's ordinary-course-of-business defense against the Trustee's preference claims. Additionally, GMAC failed to establish that the transfers constituted contemporaneous exchanges for new value under Section 547(c)(1).
A transfer typically deemed preferential can be defended against by the trustee if three conditions are met: (1) the preference defendant provided new value to the debtor; (2) both parties intended the new value and the debtor's reciprocal transfer to occur simultaneously; and (3) the exchange indeed took place contemporaneously. This exception, part of section 547(c), aims to encourage creditor engagement with distressed debtors without the risk of having to return payments for value provided.
The burden of proof lies with the defendant. In GMAC's case, the failure to demonstrate the new value provided to Brooke Capital undermines its defense. "New value," as per section 547(a)(2), encompasses money or equivalent goods and services. GMAC did not offer any goods, services, or new credit directly to Brooke Capital, as its services were rendered to customers of BASC's agents, unrelated to Brooke Capital.
GMAC references the Eighth Circuit's decision in Jones Truck Lines, where the debtor received new value via employee services in exchange for transfers, despite no direct provision of goods or services by Central States to the debtor. However, GMAC's analogy fails as it cannot identify a third party that provided new value to Brooke Capital akin to the employees in Jones.
GMAC claims indirect benefits from the payments, such as maintaining relationships with Brooke Capital’s franchisees and generating income from insurance sales. However, these benefits do not constitute new value under section 547(c)(1), which requires that new value be directly given to the debtor by the creditor as part of a contemporaneous exchange. The focus must be on the direct benefit received, not on secondary effects.
Section 547(c)(1) limits the protection of transfers to instances where the transfer is a contemporaneous exchange for new value, which must be roughly equivalent to the value of the assets transferred. A preference defendant invoking this section must demonstrate both the intent of the parties for the new value and reciprocal transfer to be contemporaneous and that the exchange indeed occurred contemporaneously. The Trustee contends these elements are lacking; however, the Court is unable to assess them due to the unidentified new value provided by GMAC to the Debtor.
The Court concludes that summary judgment should be granted to GMAC, denying the Trustee’s motion for summary judgment. Although the Trustee has established that a transfer of $1,109,567.67 from Brooke Capital to GMAC constituted a preferential transfer under Section 547(b), GMAC successfully argued that the transfers were made in the ordinary course of business, thus falling under Section 547(c)(2), which protects such transfers. The Court finds GMAC did not sufficiently demonstrate applicability of the contemporaneous-exchange defense under Section 547(c)(1).
Since the funds transferred were deemed property of Brooke Capital, the Trustee's fraudulent conveyance claim is rendered moot. The same applies to the Trustee's claim for prejudgment interest due to the Court's ruling favoring GMAC on the preferential transfer claim. The findings constitute Findings of Fact and Conclusions of Law under Rule 7052 of the Federal Rules of Bankruptcy Procedure, and a judgment will be issued separately. The Court asserts jurisdiction under 28 U.S.C. § 157(a) and § 1334(a) and (b), and confirms its authority to adjudicate this core proceeding under 28 U.S.C. § 157(b)(2)(F) and (H). No objections to venue or jurisdiction have been raised. Brooke Investments’ Chapter 11 filing on November 3, 2008, is acknowledged, but it does not impact this case.
$1,109,567.67 in online bill funds was disbursed to GMAC from Brooke Capital during the Preference Period, sourced from Brooke Capital’s primary account at First National Bank of Phillipsburg, Kansas. The total of $1,115,123 transferred into the GMAC Sweep Account during this period included $1,109,673 from the FNB Primary Account and $5,450.03 in adjustments credited back by GMAC. The Court deemed the minor discrepancy in transfer amounts immaterial. The Trustee references various case law, including Gust v. Jones and Begier v. IRS, to support objections relating to the transfers. The summary judgment motions were filed before the Court clarified its approach to the subjective and objective tests for evaluating the transfers, but the Court found no need for further briefs as the parties’ positions were adequately presented. Brooke Capital maintained online sweep accounts for 133 carriers.
Article V referenced is fully quoted in Part C of the Uncontroverted Facts, with various citations from depositions of Hanes and legal texts. Evidence indicates that 133 carriers had online sweep accounts with Brooke Capital. The Trustee argues that GMAC failed to establish a sufficient baseline to demonstrate that preference period payments were ordinary compared to pre-preference dealings due to a lack of evidence regarding fund flow through Brooke Capital's accounts. However, the Court maintains that the relevant factor is the flow of premium dollars from Brooke Capital to GMAC within four business days, which remained unchanged. The court also references multiple bankruptcy law sources and case law to support its findings, clarifying that "Brooke" in GMAC's brief refers to Brooke Capital, as the debtor must be included in the new value analysis.
