Goldstein v. Wilmington Savings Fund Society, FSB (In re Universal Marketing, Inc.)
Docket: Bky. No. 09-15404 ELF; Adv. No. 11-512
Court: United States Bankruptcy Court, E.D. Pennsylvania; November 24, 2015; Us Bankruptcy; United States Bankruptcy Court
The legal opinion by Chief U.S. Bankruptcy Judge Eric L. Frank outlines proceedings related to Universal Marketing, Inc. (UMI), which filed for Chapter 11 bankruptcy in July 2009 and later converted to Chapter 7. UMI was part of a larger entity, the Universal Network, consisting of over seventy entities operating gas stations and distributing gasoline. The Trustee, Charles R. Goldstein, sought substantive consolidation of UMI’s estate with other Universal Network entities, including Universal Delaware, Inc. (UDI), which was contested by Wilmington Savings Fund Society (WSFS), the bank providing commercial credit and cash management services to UDI.
The court's order on August 4, 2010, granted the consolidation but excluded WSFS from certain provisions. The opinion details the relationships between UDI and WSFS, including various agreements and the impact of alleged breaches. Key findings include:
1. **Summary Judgment**: The court found WSFS entitled to summary judgment on the Trustee's contract claims, determining that UDI's material breach excused WSFS's non-performance under the Cash Management Services Agreement (CMA) and that WSFS did not breach the contract by exercising remedies without prior notice.
2. **Implied Covenant**: The Trustee's claims under the implied covenant of good faith and fair dealing were also denied.
3. **Fraudulent Transfers**: Summary judgment was granted to WSFS regarding the Trustee's claims of constructive fraud, clarifying that WSFS was not an initial transferee of the UDI transfers due to lack of control over the accounts, nor was it liable as a subsequent transferee.
4. **Setoff Claim**: The Trustee's claim under 11 U.S.C. § 553(b) regarding setoff was not granted summary judgment, as it hinged on substantive consolidation, which was still a matter for determination.
The opinion concludes with jurisdictional considerations and clarifications on the nature of the court's order regarding the motions, underscoring that some claims are non-core or fall under Stern claims, thus limiting the court's resolution authority.
The Trustee is pursuing recovery of funds from WSFS through three main legal claims. First, under 'common law' claims, the Trustee alleges that WSFS breached their contract by imposing a 'post no debits' policy on UDI's bank accounts in July 2009, which allegedly caused a liquidity crisis and financial failure for the Universal Network. Second, the Trustee brings a statutory claim under 6 Del. C. 4A related to the same events. Third, the Trustee invokes bankruptcy transfer avoidance theories, including preference and fraudulent transfers, citing 11 U.S.C. sections 544, 547, 548, 550, and 553(b), complicated by substantive consolidation issues. WSFS counters that the Trustee's claims are exaggerated and that it acted within its contractual rights after UDI breached their agreement. WSFS also denies the occurrence of any avoidable transfers. Currently, both parties have filed cross-motions for partial summary judgment regarding liability. The court notes that all claims are either non-core, requiring findings to be sent to the district court, or core claims for which it lacks constitutional authority to issue a final judgment without consent, which WSFS does not provide. Consequently, the court cannot grant a final judgment for either party and determines WSFS is entitled to summary judgment on all but one of the Trustee’s claims, where material facts are disputed. The court will dismiss the Trustee's claims (except one) for trial in the bankruptcy court and will subsequently issue a Report and Recommendation to the district court regarding claims lacking final judgment authority.
The Universal Network was a vertically integrated entity engaged in purchasing gasoline for resale to both its own divisions and third-party businesses. Each gas station within the network was owned or leased by a single purpose entity (SPE). UMI was responsible for buying gasoline from major oil companies and selling it to the SPEs and third parties, while UDI managed UMI and the SPEs, with Daniel Singh as the principal of both UDI and many other Universal Network entities. By 2009, UMI and UDI had separate banking relationships with TD Bank and WSFS, respectively, while other entities in the network banked with institutions like Wachovia Bank and PNC Bank. Inter-company money transfers frequently occurred, often reaching hundreds of thousands of dollars daily.
In July 2009, both TD Bank and WSFS restricted UMI’s and UDI’s accounts, prompting the current dispute regarding their lending and cash management arrangements. The relationship between UDI and WSFS began in November 2008 when Singh sought banking services from WSFS. Following discussions and a presentation on cash management services, Singh provided UDI's financials, which were deemed strong by WSFS. He requested a $5 million line of credit, leading to a Credit Memorandum submitted by WSFS’ Vice President, William Foley, on January 26, 2009, which sought approval for the line of credit and related services. The terms included immediate repayment on demand, a blanket UCC on business assets, and a personal guarantee from Singh. WSFS did not require financial information from UMI, considering UDI's creditworthiness and profitability, and recognized UMI's banking relationship as separate.
In March 2009, UDI and WSFS formalized two key agreements: a lending relationship for UDI's working capital and a banking services relationship for cash management. The lending relationship involved a line of credit transaction dated March 19, 2009, documented through several agreements, including a Business Loan Agreement (BLA), a Promissory Note (the Note), a Security Agreement, and a Guaranty. The BLA provided UDI with a commercial line of credit totaling $5 million, with UDI committing to repay the loan as outlined in the Note.
The BLA contained several representations from UDI, including the absence of pending legal actions that could adversely affect its obligations, full disclosure of any material facts, the accuracy of financial statements, and the absence of other encumbrances on UDI's assets. UDI was required to maintain its primary banking relationship with WSFS throughout the Loan term. The BLA listed specific events of default, including any materially false statements and failure to make timely payments, while stating that WSFS was not obliged to notify UDI of defaults. In case of default, WSFS had remedies such as loan acceleration and an increased interest rate.
The Note established a $5 million revolving credit facility beginning March 19, 2009, requiring monthly interest payments and allowing WSFS to demand repayment at any time. UDI was obligated to reduce the principal to zero annually upon WSFS's request and maintain a zero balance for 30 days before re-accessing funds. The Note detailed both monetary and non-monetary events of default, including missed payments and failure to uphold the banking relationship with WSFS. WSFS had the right to accelerate the loan upon default without notice, and UDI waived any requirement for notice of default or payment demands.
Singh acted as an absolute and unconditional guarantor for a Loan under a Guaranty, enabling WSFS to pursue Singh directly upon default without needing to first target other properties. The Guaranty specified various default events, including inaccuracies or omissions in financial documents provided by Singh or UDI. In case of default, WSFS had the right to accelerate repayment of the Loan, demanding immediate payment from Singh.
On March 13, 2009, UDI entered a Cash Management Services Agreement (CMA) with WSFS, which outlined the provision of financial services, including multiple deposit accounts and automated fund transfers. Concerns arose for WSFS in May 2009, shortly after formalizing its relationship with UDI, due to unusual Automated Clearing House (ACH) activity and a significant $1 million transfer. UDI had rapidly drawn down a $5 million credit line, contrary to its intended short-term working capital purpose, prompting an inquiry into the situation.
In June 2009, UDI requested an additional $2.1 million, which raised red flags for Glenn Kocher, Chair of the Loan Committee, who questioned UDI's financial health based on the rapid depletion of its credit line. Following this, WSFS requested further financial documentation from UDI, including prior tax returns and financial statements. Due to ongoing concerns, WSFS decided against approving the additional credit request and postponed its review of UDI's existing credit facility by ninety days, extending the internal review date from June 30, 2009, to September 30, 2009.
On July 14, 2009, WSFS discovered that Singh may also be known as 'Daminder Batra,' who was wanted in India for fraud and money laundering. WSFS verified this information through an INTERPOL website displaying a 'Red Notice' for Batra, which detailed charges including counterfeiting and fraud, and included an arrest warrant from India. The following day, the Red Notice was escalated to WSFS’ security department, confirming that the individual on the notice was indeed Singh. In response, WSFS management decided to implement a 'post no debits' (PND) restriction on UDI accounts effective July 16, 2009, to halt automated debiting while they reviewed account activity. Despite the PND, two significant transfer orders to TD Bank were processed on July 15 and 16, 2009, totaling over $5 million. WSFS successfully reversed the first transfer order but was unable to reverse the second due to insufficient funds. By July 16, after consulting with FBI agents, WSFS confirmed the authenticity of the Red Notice and the existence of an arrest warrant. They then decided to transfer $5 million from UDI’s accounts to a suspense account to secure funds for a loan repayment and enacted additional precautions, including restricting cash orders and designating Foley as the sole point of contact for communications regarding Singh.
On July 16, 2009, Mark Turner, President of WSFS, sent an email emphasizing the need to give UDI the benefit of the doubt while safeguarding the bank's interests. At that time, WSFS had not communicated with UDI regarding concerns about Singh's identity or internal actions concerning UDI's accounts. The next day, WSFS retained Garvan McDaniel as counsel for the UDI matter. McDaniel informed UDI’s attorney, Kevin Ryan, about several key issues: the Red Notice, Singh’s alias, the PND restriction, and the necessity for both parties to ensure adequate funds in the account before withdrawals. WSFS also deposited $5 million in a suspense account and asserted its right to demand payment of the Loan. Ryan subsequently requested access to funds beyond what was needed to cover the loan, leading to a scheduled conference call for the following Monday.
On July 20, 2009, McDaniel informed Ryan that the PND restriction was lifted and online banking was reinstated. That afternoon, WSFS formally repaid the Loan by applying the previously deposited $5 million to its general ledger. During the PND restriction on July 15 and 16, UDI received over $11.6 million from UMI and UEI and transferred over $11 million out to various parties, excluding the $5 million repayment to WSFS. On July 23, 2009, just three days after the Loan repayment, UMI filed for Chapter 11 bankruptcy.
On July 23, 2009, UMI initiated a Chapter 11 bankruptcy case, which was converted to Chapter 7 on August 18, 2009. By September 24, 2009, Goldstein was appointed as Chapter 7 trustee. On April 19, 2010, the Trustee filed a motion for substantive consolidation of the UMI bankruptcy estate with certain non-debtor Universal Network affiliates, including UDI. The Trustee argued that significant inter-company transfers occurred without formal records, assets were commingled, and reconciling the accounting records would be prohibitively expensive. TD Bank settled with the Trustee, supporting the consolidation request. WSFS objected to the motion, but a global settlement was reached, approved by the court on August 4, 2010. This order allowed for substantive consolidation of UMI with five affiliates, excluding WSFS, which retained its rights and was treated as having filed for bankruptcy as of that date.
The Trustee initiated an adversary proceeding on July 18, 2011, which WSFS sought to dismiss. The court partially granted this dismissal on June 14, 2012, allowing the Trustee to file a second amended complaint. WSFS responded to the amended complaint on July 18, 2012. After further motions and objections, the second amended complaint was filed on January 24, 2014. WSFS answered on February 19, 2014. Six of the original ten claims from the amended complaint survived dismissal, including breaches of contract and fraudulent transfers under various sections of the U.S. Bankruptcy Code.
A pretrial order issued on September 24, 2012, established July 31, 2013, as the deadline for completing discovery, which ultimately concluded on June 18, 2014, following several extensions. The Trustee filed a motion for partial summary judgment on May 30, 2014, regarding liability for specific counts, supported by evidence and legal memoranda. WSFS responded on July 31, 2014, with its own motion for summary judgment and additional evidence. Both parties submitted reply memoranda, with the final one filed on September 11, 2014.
The standard for summary judgment under Fed. R. Civ. P. 56(a), applicable through Fed. R. Bankr. P. 7056, dictates that a motion must be granted when there are no genuine material facts in dispute and the moving party is entitled to judgment as a matter of law. The court's function is to assess whether any material facts remain for trial, not to weigh the evidence. A genuine issue exists if sufficient evidence could allow a reasonable jury to side with the non-moving party. If evidence overwhelmingly favors one party, judgment should be entered for that party.
When the moving party carries the burden of proof, it must provide credible evidence to support its case. Conversely, if the moving party does not bear that burden, it can still obtain judgment by demonstrating the absence of evidence for an essential element of the opposing party's claim. In this case, WSFS argues that the Trustee's evidence is inadequate to warrant proceeding to trial, which may fulfill WSFS's obligation to show the lack of evidence supporting the Trustee's claims.
WSFS is entitled to summary judgment on the Trustee's breach of contract claims (Counts One and Two) related to the Loan and the CMA. The Trustee claims a breach of express contractual provisions and a breach of the implied covenant of good faith and fair dealing. A critical issue is whether the Loan and CMA are viewed as separate contracts or part of an integrated business transaction. WSFS argues for the latter, suggesting UDI's material breach of the Loan excuses performance under the CMA.
Delaware contract law emphasizes that the written contract best reflects the parties' intent, and courts must uphold the plain meaning of unambiguous contract language without considering extrinsic evidence. Related agreements are to be interpreted together, harmonizing all documents from a single transaction. The parol evidence rule prohibits altering a written contract with prior or contemporaneous oral agreements. Additionally, contracts can be classified as either totally or partially integrated, with total integration not allowing any contradictions or supplements from prior agreements, while partial integration permits consistent supplementary evidence.
To determine if a contract is fully or partially integrated, courts evaluate factors such as the presence of a merger or integration clause, contract length and detail, the setting's formality, and whether it is a form contract. An integration clause suggests a fully integrated contract but is not definitive. In this case, the Loan includes an integration clause, while the CMA's integration status remains undetermined at summary judgment. The Note incorporates the BLA and describes the Loan Documents as interconnected, mandating that UDI maintain a primary deposit account and cash management relationship with WSFS, with failure constituting an event of default. This indicates that the CMA is part of a larger transaction involving a $5 million loan for working capital. The Trustee did not present extrinsic evidence to challenge the characterization of the Loan and CMA as two components of a unified transaction. Each agreement represents the final understanding of its respective subject but collectively does not embody the entire agreement. Thus, the Loan and CMA should be interpreted together as a single contract.
To establish a breach of contract claim in Delaware, three elements must be proven: the existence of a contract, the breach of an obligation within that contract, and the resulting damages to the plaintiff. The burden of proof lies with the plaintiff to demonstrate these elements by a preponderance of the evidence. Additionally, WSFS's non-performance under the CMA was justified due to UDI's material breach of the Loan.
The Trustee argues that WSFS breached the Commercial Master Agreement (CMA) by restricting UDI's use of services and failing to perform its obligations without prior notice. In contrast, WSFS contends it was excused from performance due to UDI's material breach of the Loan Documents, supported by legal precedent that allows for such an excuse in cases of material breach. The CMA and Loan are considered parts of a single transaction, making it illogical for WSFS to declare a default under the Loan while simultaneously being bound to the CMA. The determination of the Trustee’s breach of contract claim hinges on two questions: whether UDI defaulted on the Loan and whether that default was material. The summary judgment record confirms that UDI was indeed in material breach when WSFS acted after discovering the Red Notice, thereby allowing WSFS to accelerate the Loan and not requiring strict performance under the CMA. Additionally, WSFS identified at least two events of default under the Borrowing and Loan Agreement (BLA), including UDI providing materially false statements regarding its financial condition and obligations.
WSFS has presented unchallenged evidence that UDI made several significant misrepresentations, including overstating its cash position by over $2 million and net worth by more than $3.3 million. UDI also falsely claimed there were no inter-company balances and misrepresented its lack of guarantee obligations, which totaled $32 million. Additionally, UDI failed to disclose substantial losses from environmental issues at their gas stations, which were subject to litigation at the time.
An event of default occurred under the BLA due to defaults in other Loan Documents, particularly under the Guaranty, which states that inaccuracies in information provided by Singh or UDI can constitute an event of default. Singh falsely certified the absence of any pending legal actions against him, failing to disclose ongoing litigation in India and a Red Notice associated with his undisclosed alias, Batra. This omission also constituted an event of default.
The material breaches by UDI and Singh regarding their financial representations and the nondisclosure of legal issues were substantial enough to excuse WSFS from further performance under the contract. A material breach is one that undermines the essence of the agreement, and significant misrepresentations can lead a reasonable person to act differently. Notably, a party may claim that nonperformance is justified by the other party's material breaches, regardless of prior knowledge of those breaches. This principle has been supported by various case law, affirming that later-discovered misconduct can serve as a defense in breach of contract claims.
Materiality is primarily a factual question, as established in Norfolk S. Ry. Co. v. Basell USA Inc., but can be treated as a legal question if only one reasonable conclusion can be drawn. Prior to extending credit to UDI, WSFS required financial statements and assessed UDI's financial strength through a credit memo presented to its Senior Loan Committee, which noted UDI's cash position of $2.1 million as sufficient. Singh's guaranty was also necessary before this credit memo was submitted. The memo analyzed Singh's financial status separately, confirming that misrepresentations in UDI’s financial disclosures significantly influenced WSFS's decision to extend credit. A misrepresentation is considered to induce assent if it substantially affects the decision-making process, with the assumption that the recipient values the truth of such representations. The BLA indicates that financial covenants were pivotal in WSFS's decision to grant the loan. Singh's failure to disclose pending legal proceedings in India constituted a material breach of his contractual obligations under the Guaranty. The evidence shows that WSFS's decision to grant the loan was heavily reliant on UDI's expected cash flow and Singh's role as the principal of UDI and Universal Network entities, highlighting the importance of personal guarantees in small business lending practices.
Banks' demand for personal guarantees acts as a means to circumvent the legal principle of limited liability, serving as a bonding mechanism to mitigate excessive corporate risk. The nondisclosure of prior legal proceedings against an individual in India, along with the existence of a Red Notice international arrest warrant, constituted events of default under relevant contractual agreements. In RTP LLC v. ORIX Real Estate Capital, Inc., a guarantor's failure to disclose a lawsuit was deemed a material breach of a loan agreement. Consequently, since WSFS established that UDI was in material breach of the Loan when it discovered the Red Notice, the Trustee's claim for breach of WSFS' contractual obligations is unlikely to succeed.
Additionally, the Trustee's assertion that WSFS breached contract terms by failing to notify UDI before exercising remedies under the Loan Documents lacks merit. The BLA explicitly allowed WSFS to accelerate the Loan without declaring a default or providing notice. The Trustee contends that the notice provisions are ambiguous because some require notice and others do not. He invokes the doctrine of contra proferentum, suggesting that the court should interpret the ambiguous provisions against the drafter. However, contract terms should be interpreted according to their plain meaning, and ambiguity arises only when provisions can be interpreted in multiple ways. The Trustee did not adequately identify the specific remedies necessitating prior notice, implying he references sections that do require notice before declaring certain defaults. Nevertheless, the subsequent subparagraphs may complicate his argument further.
WSFS is authorized to declare a default without notice if there is a materially adverse change in UDI's financial condition or concerning the collateral for the Loan. The Loan Documents contain clear provisions indicating that WSFS can accelerate the Loan and take default remedies without notifying UDI. The Trustee's claim of ambiguity regarding notice requirements is unfounded, as the BLA allows for actions without notice in cases of non-monetary default, despite other provisions that may require notice for different types of default. The specific provisions do not conflict with the general terms but coexist, with WSFS acting within its rights.
Additionally, the implied covenant of good faith and fair dealing obligates contracting parties to avoid arbitrary conduct that undermines the contract's intended benefits. Breaching this covenant can result in liability if a party's actions frustrate the contract's overarching purpose. However, reliance on express contract terms does not constitute bad faith, and employing an express right under the agreement cannot typically lead to a breach of the implied covenant. The application of this covenant is rare and context-sensitive, requiring evidence that parties would have explicitly prohibited the contested actions had they contemplated them during negotiations.
Delaware's implied duty of good faith and fair dealing serves as a limited legal remedy for breach of an implied contractual obligation, rather than an equitable remedy for adjusting economic imbalances post-event. A breach of this implied covenant is treated as a contractual claim, with elements identical to those of a standard breach of contract claim, except that the obligation in question is implied rather than express. Successful claims require identification of a specific implied obligation and proof that its breach denied the plaintiff benefits of the contract; general allegations of bad faith are insufficient.
In this case, following a material breach by UDI, WSFS implemented default remedies, which the Trustee argues were executed in bad faith by freezing UDI’s accounts and sequestering funds without notice. However, evidence indicates that during the brief period of the freeze, WSFS allowed UDI to conduct significant transactions, transferring over $11 million and making funds available, which contradicts claims of arbitrary conduct. The restrictions only halted automatic transfers, and UDI had continued access to its funds, undermining the assertion that WSFS acted unreasonably or in bad faith. The record shows that UDI was able to complete various transactions while the restrictions were in place, demonstrating that the accounts were not entirely frozen.
WSFS continued to process transactions for UDI, albeit more slowly and without the automatic provisional credit that was typically granted under the CMA. The PND merely suspended UDI's access to this credit facility. The Trustee failed to demonstrate that the segregation and set-off of $5 million constituted a default by UMI, UDI, or any related parties. Regarding the Trustee's claim of breach due to lack of prior notice, the Loan Documents did not obligate WSFS to provide such notice. Furthermore, WSFS promptly notified UDI the day after the PND's implementation about the actions taken, including the segregation of funds and intent to set off against the Loan. WSFS's actions were in line with the terms of their agreement; in case of default, it was permitted to set off the Loan against UDI's accounts without prior notice. The security provided by UDI's cash management system at WSFS was integral to the Loan's terms. WSFS's response to its concerns about UDI's principal being an international fugitive was measured and reasonable, reflecting a cautious approach rather than an overreaction. The conduct of WSFS did not meet the threshold for a breach of the implied covenant of good faith and fair dealing. WSFS is entitled to summary judgment on the Trustee’s claim under 6 Del. C. 4A, which governs electronic funds transfers and defines key terms related to payment orders, including sender, receiving bank, beneficiary bank, and beneficiary. A payment order encompasses a series of transactions that can be accepted or rejected at various stages.
A receiving bank has the discretion to accept or reject payment orders transmitted by the sender. Acceptance occurs when the bank executes the payment order, while rejection is indicated through notice to the sender in various forms (oral, electronic, or written). Once a payment order is accepted, it cannot be rejected later, and vice versa. Payments through electronic funds transfers, compliant with Article 4A, are treated as cash and are irrevocable unless stated otherwise. Execution of a payment order involves the bank issuing a payment order to fulfill the received order.
Section 4A-305 outlines a receiving bank's liability in cases of late or improper execution. If a completed funds transfer is delayed due to the bank's breach of Section 4A-302, it must pay interest for the delay to the originator or beneficiary, with additional damages not recoverable unless specified. If improper execution leads to noncompletion of the transfer or noncompliance with the originator's terms, the bank owes the originator for expenses and losses, again with limited recoverability for additional damages unless expressly agreed upon.
Under the Funds Transfer Services Rider (FTS Rider) of the Cash Management Agreement (CMA), WSFS has outlined eight services related to payment orders, using "may" rather than "shall," indicating discretion in execution. WSFS may execute payment orders in the name of UDI if sufficient funds are available. WSFS retains the right to reject orders that do not meet the Services Agreement or transfer rules. If WSFS fails to execute or rejects an order, it must notify UDI by the close of business on the execution date. The FTS Rider also details fees and costs associated with these services.
The FTS Rider permitted WSFS to debit UDI’s accounts without prior notice for various fees. WSFS was obligated to pay UDI if it did not execute an order due to insufficient funds on the execution date. In Count Three, the Trustee alleges that WSFS intentionally failed to execute two TD Bank Transfer Orders to benefit itself, invoking 6 Del. C. 4A-305. WSFS argues it is not liable due to UDI's material breach of contract, asserting that it executed the orders before reversing them and that UDI lacked sufficient funds. The undisputed facts show that the orders were executed and accepted by TD Bank, which reversed the first order but not the second. The Trustee's claim fails because the completed payment orders cannot be rejected post-acceptance, and current circumstances do not meet the narrow recovery provisions of Article 4A. The Trustee has not suggested alternative legal remedies. Thus, summary judgment is granted in favor of WSFS on Count Three.
In Counts Six and Seven, the Trustee claims fraudulent transfers under 11 U.S.C. 544 and 548, referencing actual intent but failing to provide evidence of intentional fraud. The analysis is limited to constructive fraud claims, as no arguments were made regarding intentional schemes to defraud creditors by UMI, UDI, or WSFS.
The Transfers at issue include the initial UMI-UDI Transfers and the Setoff, the latter being UDI’s involuntary transfer to WSFS that satisfied a Loan. The Trustee presents two legal theories to argue that these Transfers were constructively fraudulent. First, the Trustee claims that WSFS was the "initial transferee" since it exerted dominion over UDI’s accounts by imposing a PND restriction before taking funds for its benefit, despite the initial deposit into UDI’s account. The Trustee asserts that no consideration was given for the Transfers, as UMI did not owe WSFS any money, and WSFS provided no value to insolvent UMI for the $5 million received.
The second theory posits that the Trustee can recover the Transfers as a subsequent transferee, arguing that UMI did not receive reasonably equivalent value for the transfers to UDI. WSFS counters the Trustee’s claims, disputing the specificity of the Transfers identified. WSFS contends that UDI was the initial transferee and that there was value exchanged in both the inbound transfers from UMI to UDI and the outbound transfers from UDI to WSFS, specifically for the repayment of an antecedent debt. Furthermore, WSFS argues that the Transfers were made in good faith without knowledge of their avoidability.
Under 11 U.S.C. 548, a constructive fraud claim requires the Trustee to demonstrate that, within two years before the petition was filed, the debtor received less than reasonably equivalent value in exchange for a transfer while being insolvent or becoming insolvent as a result of that transfer. The criteria for constructive fraudulent transfers can generally be distilled into four elements, starting with the debtor having an interest in the property.
A transfer of interest made within two years prior to the filing of a bankruptcy petition can be deemed a constructive fraudulent transfer if the debtor received less than equivalent value in exchange for the transfer, and either was insolvent at the time of the transfer, became insolvent as a result, or intended to incur debts beyond their ability to pay. The burden of proof lies with the party challenging the transfer to establish these elements. The determination of whether the debtor received reasonably equivalent value involves a two-step analysis: assessing whether any value was received and whether that value was reasonably equivalent to what was transferred.
Courts in this jurisdiction evaluate the value from a creditor's perspective, focusing on what the debtor gave up versus what was received that could benefit creditors. Value can include both direct and indirect benefits. The key measure is whether the debtor’s realizable commercial value after the transaction matches or exceeds its value before the transaction. Factors considered include whether the transaction was at arm’s length, the good faith of the transferee, and the disparity between fair market value and the price paid.
If the benefits received are deemed minimal compared to the significant assets transferred, precise value does not need to be established for a claim to succeed. Furthermore, under 11 U.S.C. § 544(b), a trustee may avoid any transfer of the debtor's property that is voidable under applicable law by a creditor with an allowable unsecured claim, effectively allowing the trustee to act as a creditor to contest fraudulent transfers under state law, specifically invoking Delaware's fraudulent transfer statutes.
A debtor's transfer or obligation is deemed fraudulent to a creditor if it occurs without receiving reasonably equivalent value, regardless of when the creditor's claim arose. This applies if the debtor was engaged in a business with insufficient remaining assets or intended to incur debts beyond their ability to pay. Under 6 Del. C. 1305, a transfer is fraudulent if made without equivalent value while the debtor was insolvent or became insolvent due to the transfer. Transfers to insiders for antecedent debts are also fraudulent if the debtor was insolvent and the insider knew of this insolvency. To prove fraudulent transfer under Delaware law, a Trustee must demonstrate that the debtor made a transfer for less than equivalent value and was rendered insolvent.
The Trustee contends that WSFS was the initial transferee of the UMI Transfers, but the term “initial transferee” stems from 11 U.S.C. § 550, which allows recovery of transferred property after establishing an avoidable transfer. Courts have set standards for defining “initial transferee,” noting that simply receiving a transfer does not automatically confer this status.
The court in European American Bank established that the minimum requirement for being classified as a "transferee" under the Bankruptcy Code is having dominion over the asset in question, meaning the right to use the funds for one's own purposes. This is known as the "dominion-and-control test," which has been widely adopted in various jurisdictions. The Ninth Circuit differentiated between "dominion" and "control," with dominion focusing on legal authority and the right to use funds as desired, while the control standard examines the overall transaction to identify who truly controlled the funds.
Past Ninth Circuit decisions have consistently upheld the dominion test, excluding the control test. In contrast, the Third Circuit has not defined a specific test for evaluating transferee status. The Trustee advocates for employing a combined dominion and control test, emphasizing the examination of the relationship between the transferee and the property, particularly in cases where funds are held in an account with potential restrictions on their use.
Conversely, WSFS contends that the dominion test should apply as articulated in Incomnet, asserting that it did not exercise dominion over the transfers from UMI since it had no legal right to use those funds. WSFS characterizes the restrictions on fund usage as a precautionary measure rather than an assertion of dominion, arguing that such a temporary suspension does not equate to control over the funds.
WSFS characterizes the $5 million transfer to satisfy UDI’s loan as a subsequent transaction, maintaining that its obligation to UDI as a deposit customer remained intact. WSFS asserts that UDI was the initial transferee of the funds received from UMI, gaining title and control over them before WSFS applied the funds to UDI’s loan. The conclusion drawn is that WSFS lacked the requisite dominion or control over UDI’s accounts to be considered an initial transferee, as WSFS did not completely restrict outgoing transfers and continued to honor transfer requests during a brief period when a provisional notice of default (PND) was in effect.
Having established WSFS as a subsequent transferee, the document evaluates whether it is liable for a fraudulent transfer. The Trustee must demonstrate that UMI did not receive reasonably equivalent value for the transfers made to UDI. However, the Trustee failed to provide evidence to support the claim that UMI received no value from UDI, merely speculating that funds should have flowed the other way. In contrast, WSFS presented evidence, including $1.7 million in credit card receivables owed to UDI and liquidity benefits from cash management services provided to UDI, indicating that UMI did receive value. The Trustee has not quantified any inadequacy in value received by UDI, failing to meet the burden of proof required.
The summary judgment record indicates that the UMI-UDI Transfers were supported by some value, leading to a lack of evidentiary support for a critical element of the Trustee's claim. Consequently, WSFS is entitled to summary judgment on this claim. The appropriate time for the Trustee to demonstrate evidence supporting each element of his claims is at the summary judgment stage.
Regarding the Trustee's setoff claim under 11 U.S.C. § 553(b), it is contingent upon the nunc pro tunc extension of substantive consolidation to WSFS. The Trustee seeks to avoid a $5 million setoff against UDI's bank accounts, which is governed by § 553(b). This section allows the trustee to recover setoff amounts if a creditor offsets a mutual debt against a claim within 90 days prior to the bankruptcy filing, provided the offset results in an improvement of the creditor's position.
Key definitions under § 553(b) include "insufficiency," which refers to the amount by which a claim against the debtor exceeds a mutual debt owed by the creditor. The mechanics for recovery involve comparing the insufficiency at the time of setoff to the insufficiency 90 days prior. Here, the Trustee claims an insufficiency exceeding $5.75 million before the setoff, but argues that on the day of the setoff, there was no insufficiency since the setoff cleared the indebtedness.
The success of the Trustee's § 553(b) claim hinges on substantive consolidation of UDI’s estate with WSFS. However, the court's earlier order specified that WSFS's rights would remain unaffected. Consequently, treating UDI as having filed for bankruptcy on August 4, 2010, would undermine the Trustee's position, as there would be no insufficiency at the time of WSFS's setoff.
The July 2009 setoff is deemed outside the ninety-day look-back period established by 11 U.S.C. § 553(b)(1)(A). In this adversary proceeding, the Trustee seeks to extend substantive consolidation to WSFS, effective from July 23, 2009, coinciding with UMI's bankruptcy filing. The Trustee argues that if UDI is considered to have filed on the same date, the ninety-day requirement can be satisfied. A key legal question is whether the Trustee can pursue substantive consolidation against WSFS. WSFS contends that the Trustee cannot use substantive consolidation to create a claim under § 553(b) to the detriment of creditors, citing *Owens Corning*, and argues that it is being unfairly targeted by the Trustee. The Trustee counters that his aim is to benefit all creditors by consolidating the estates and facilitating asset recovery.
Substantive consolidation is characterized as an equitable remedy that merges separate legal entities into one, eliminating inter-entity liabilities. The Third Circuit classifies it as an "extreme" and "last-resort remedy," which could significantly impact creditor distributions. The test established in *Owens Corning* requires the proponent to demonstrate either: (1) pre-petition disregard for separateness leading creditors to treat the entities as one, or (2) post-petition assets and liabilities so intertwined that separation is impractical and detrimental to all creditors. The court emphasizes that substantive consolidation should only occur in compelling circumstances, with the presumption being that separate entities will be respected unless significant disregard for separateness is shown. Benefits to case administration alone do not justify its use, reinforcing its rarity and the need for careful judicial discretion.
Substantive consolidation can only be used defensively to address identifiable harms from entangled affairs, not offensively to disadvantage creditors or alter their rights. WSFS argues that extending substantive consolidation to it is inappropriate based on a specific legal principle from Owens Corning. However, this argument is countered by the case's procedural history. The Trustee's original motion for substantive consolidation included WSFS, citing significant inter-company transfers, asset commingling, and the reliance of large creditors on the financial position of UMI as a single entity, all of which provided justifiable reasons for consolidation under Owens Corning. The Trustee aimed for nunc pro tunc consolidation to preserve chapter 5 claims, which would benefit the creditor body. Notably, only WSFS objected to this consolidation request. An agreement was reached to implement substantive consolidation for all parties except WSFS, allowing for further investigation and potential litigation without immediate resource expenditure from WSFS. This resulted in a standstill agreement deferring the substantive consolidation dispute.
The litigation is treated as resuming from the August 2010 truce, indicating that no substantive consolidation occurred for non-UMI entities. The Trustee is permitted to argue for substantive consolidation against WSFS if he can present a case that would have allowed it in 2010, as failing to do so would mean waiving his right to seek retroactive consolidation. The agreement from August 4, 2010, supports this position. WSFS's argument that the extension of substantive consolidation represents an inappropriate use of the doctrine is unconvincing. The Trustee’s request for a nunc pro tunc extension should be evaluated on its merits, and his setoff claim is not legally barred by the ninety-day look-back requirement of 11 U.S.C. § 553(b)(1)(A). There are unresolved material facts regarding the Trustee’s evidence for substantive consolidation and the elements of his setoff claim, making summary judgment inappropriate for WSFS on several counts. Bankruptcy jurisdiction under 28 U.S.C. § 1334(a) and (b) pertains to various types of Title 11 matters, with the district court holding the authority to refer cases to the bankruptcy court.
In this district, the district court has established guidelines for categorizing bankruptcy matters into two types: core proceedings, which arise under Title 11, and non-core proceedings, which relate to a Title 11 case but do not arise directly under it. The distinction between core and non-core is crucial as it determines the bankruptcy judge's authority. Core matters can be conclusively determined by bankruptcy judges, whereas non-core matters require proposed findings and conclusions to be submitted to the district court for de novo review unless all parties consent to a final judgment by the bankruptcy court.
The Supreme Court ruling in *Stern v. Marshall* introduced a third category, impacting how bankruptcy courts issue final orders in matters classified as core under 28 U.S.C. 157(b). These "Stern claims" are now treated similarly to non-core claims. Consequently, bankruptcy courts must first classify a claim as core or non-core and then check if it qualifies as a Stern claim.
In the current case, the Trustee asserts all claims as core, which is contested by WSFS. Core proceedings stem from jurisdictional bases in 28 U.S.C. 1334(b) and consist of two subsets: those that arise under or in the bankruptcy case. Core proceedings are essential to the bankruptcy process, allowing bankruptcy judges to make final determinations. A claim is core if it involves a right created by federal bankruptcy law or if it arises exclusively in bankruptcy contexts. Conversely, a claim that does not invoke a substantive right from federal bankruptcy law and could exist outside of bankruptcy is considered non-core, potentially related to the bankruptcy due to its effects.
The excerpt addresses the classification of claims within bankruptcy proceedings. It identifies the first three claims of the Trustee—breach of the implied duty of good faith and fair dealing, breach of contract, and violation of Delaware law—as non-core proceedings, as they are not listed under 28 U.S.C. § 157(b)(2) and are based on non-bankruptcy law. In contrast, the fraudulent transfer claims (Counts Six and Seven) are categorized as core proceedings under 28 U.S.C. § 157(b)(2)(H), but their treatment as Stem claims raises questions about the bankruptcy court's constitutional authority to issue final judgments on these matters. Citing the case In re InCl Auction, the court agrees that such claims are private rights, and thus, the bankruptcy court cannot issue a final ruling since WSFS has not filed a proof of claim, indicating that the claims do not affect the court's core function regarding the bankruptcy estate.
The excerpt concludes by discussing the implications of granting WSFS's summary judgment motion while recognizing that Count Eight (11 U.S.C. § 553) remains active. It notes that issuing a recommendation for dismissal of some claims would be premature and could lead to piecemeal appeals, which contradicts judicial policy. The court emphasizes the need to handle the proceedings comprehensively rather than in parts.
An order has been issued to dismiss the Trustee’s claims, specifically Counts One, Two, Three, Six, and Seven, for trial in the bankruptcy court, while Count Eight will proceed to trial. The bankruptcy court will later provide a Report and Recommendation to the district court regarding the dismissed claims, as it lacks authority to enter a final judgment on them, necessitating a claim-by-claim analysis for jurisdiction. The Trustee's motion for summary judgment is denied, and WSFS' motion is partially granted. A status conference is scheduled for December 9, 2015, at 10:00 a.m. in Bankruptcy Courtroom No. 1, U.S. Courthouse, Philadelphia, PA. The financial operations of the Universal Network involve daily inter-company transfers among various entities, with accounts structured to facilitate liquidity, lacking formal records beyond bank statements. These transfers can amount to significant sums, reflecting the interconnected financial activities within the network.
The restrictions imposed by WSFS on transfers from UDI's accounts are significant to the case and are detailed in Parts V and VII of the document. Foley initially proposed a $4 million demand line on January 8, 2009, which was later increased to $5 million on January 14, 2009. A Credit Memorandum described UDI's operations, detailing its ownership of 36 retail gas stations and its wholesale fuel purchasing from UEI, both owned by Daniel Singh. A clerical error mistakenly referred to UEI instead of UMI in the memorandum, which was corrected in a June 2009 loan request for an additional $2.1 million, subsequently denied by WSFS.
Foley indicated that financing Universal Delaware, Inc. would not be contingent on its supplier, emphasizing the business's operational independence. The representations made were categorized under “Conditions,” “Representations and Warranties,” and “Covenants” in the BLA. The CMA outlined cash management services selected by UMI, including ACH Debit Block, Credit, and others, and was subject to "General Terms and Conditions." This attachment allowed either party to terminate the CMA with 30 days' notice but permitted WSFS to terminate immediately under specific conditions, including material misrepresentations or failure to comply with obligations. These terms are pivotal as the Trustee's claims hinge on WSFS's failure to provide prior notice before enforcing default remedies, yet the authenticity of the General Terms and Conditions Attachment is contested.
WSFS produced the General Terms and Conditions Attachment on the final day of discovery, claiming it was discovered on an internal drive. The Trustee finds this timing suspicious and questions the document's authenticity, which has not influenced the ruling on the pending motions. Kocher, prior to approving additional credit for UDI, sought more information regarding UDI's use of its existing credit line. He noted that UDI, a retail operation with minimal capital assets, consumed $5 million in working capital, raising concerns about the alignment between UDI's financial statements and the actual use of the credit facility. An interoffice memo from WSFS credit analyst Erin Crozier identified the extension of the credit line as a “Minor Modification,” explaining that the line had a high balance of $5 million and a low balance of $2 million during the review period and did not meet the requirement for consecutive rest periods. A 90-day extension was recommended to reevaluate UDI’s financial situation. Additionally, on July 14, 2009, a WSFS teller recognized a customer, Singh, as Batra, initiating events leading to current litigation. The excerpt also references INTERPOL's role in international law enforcement, explaining that Red Notices are issued for individuals wanted by national jurisdictions for prosecution or to serve sentences, facilitating their identification and location for arrest or extradition.
A Red Notice is described as an international arrest warrant, as per the U.S. Attorneys' Manual. The PND (Payment Notation Denial) restriction prevents automated debiting from accounts with uncollected funds by listing daily outgoing transfers for manual review, thereby protecting banks from overdrafts, particularly for high-risk customers like UDI. The summary judgment record was complicated by the Trustee's organization of documentary exhibits, with various transfers from UEI to UDI outlined. Notable transfers included $2,840,000 and $1,415,775 on July 15, 2009, and $2,925,000 and $1,242,050 on July 16, 2009. WSFS verified that the Debtor Transfers were collected funds before making them available to UDI, which withdrew over $16 million during the relevant period, with $5 million applied to repay a demand line. The Trustee acknowledged that outgoing transfers occurred while the PND was in effect, although the comparative statistics noted were not entirely parallel.
A substantive consolidation order allowed the Trustee to auction properties held by various Universal entities, which led to a reduction of TD Bank's secured claim against UMI and the bankruptcy estate. The Trustee retained a portion of the sale proceeds under a carve-out agreement with TD Bank. Various entities were involved, including UDI, UEI, Universal Management, Universal Distribution Inc., and Project Growth Technologies, Inc. Four claims were dismissed: Count Four (breach of fiduciary duty), Count Five (declaratory judgment regarding WSFS's secured creditor status), Count Nine (preference claim under 11 U.S.C. § 547), and Count Ten (disallowance of WSFS's claims until transfer payments are made). Count Three regarding the failure to execute payment orders was not dismissed, but consequential damages were not granted to the Trustee. For summary judgment motions, the movant must provide sufficient evidence to support claims of the nonmovant lacking crucial evidence. The agreements in question are governed by Delaware law, with an integration clause stating that the written contract represents the final agreement, superseding prior ones. A slight breach does not terminate the obligations of the injured party. The Trustee disputes the authenticity of the General Terms and Conditions Attachment related to the integration clause.
UDI managed multiple entities within Universal Network, which were involved in environmental litigation that could negatively affect UDI's business and financial state as per section 3.1(e) of the Business Loan Agreement (BLA). While UDI materially breached certain contractual provisions, Delaware law allows contracts to be voided based on misrepresentation—either fraudulent or innocent—which can serve as an affirmative defense in contract actions. To assert such a defense, one must prove: (1) a misrepresentation occurred, (2) the misrepresentation was fraudulent or material, (3) it induced the contract, and (4) reliance on it was reasonable.
The Trustee initially claimed that WSFS breached the Credit Management Agreement (CMA) by failing to provide necessary notice before altering its performance obligations; however, this argument was dismissed due to UDI's prior material breaches of the Loan. A variation of this argument was raised in the Reply brief, claiming WSFS breached notice obligations while exercising loan default remedies, but this also failed. The doctrine of contra proferentem, which interprets contracts against the drafter, does not apply here since both parties contributed to the contract's drafting.
Evidence showed that UDI continued to conduct significant transactions even after restrictions were imposed, with large transfers to other entities noted. The Trustee's expert report suggested WSFS did not follow standard practices in declaring a default and notifying UDI but was found to misrepresent the actions WSFS took upon discovering a Red Notice, indicating a misunderstanding of the situation.
The Schechter Report is deemed irrelevant to the current case, and it does not create any factual disputes that would hinder summary judgment. The Borrower Loan Agreement (BLA) permits WSFS to utilize all remedies outlined in the Loan Documents, with the Note allowing WSFS to exercise rights under the UCC and relevant law. WSFS's actions are compliant with the UCC and Delaware law, specifically regarding the right of setoff, which is outlined in 6 Del. C. 9-109(d)(10) with exceptions noted in sections 9-340 and 9-404, as well as case law supporting the common law right to setoff. While the reasonableness of WSFS's actions is generally a factual question for trial, it is concluded that no reasonable jury could find WSFS's actions unreasonable, arbitrary, or in bad faith, thus justifying summary judgment.
The Trustee seeks various damages related to WSFS’s failure to execute transfer orders, but their request for consequential damages has been dismissed, limiting potential recovery to transactional expenses and interest losses. The Trustee also references "actual intent" provisions and the "conduit theory," which suggests that a recipient of a transfer may not be the initial transferee if they are merely passing assets to another party, being bound by a contractual obligation to benefit a third party. The "dominion and control test" is used to determine if a party qualifies as an initial transferee, with the Eleventh Circuit applying a "conduit or control" test as an equitable exception to the statutory definition of an initial transferee.
In *In re Harwell*, the Eleventh Circuit introduced "good faith" as a requisite for equitable exceptions to the statutory language of 11 U.S.C. § 550(a)(1). Initial recipients of fraudulently-transferred funds must demonstrate that they lacked control over the assets and acted in good faith as innocent participants in the fraudulent transaction. WSFS contests this, referencing the Trustee's deposition, which indicated that substantive consolidation benefitted the bankruptcy estate by allowing a claim against WSFS. However, the Trustee failed to provide additional justification for extending substantive consolidation to include UDI retroactively to UMI’s petition date of July 23, 2009, and his testimony did not support WSFS's position since it described circumstances after consolidation had occurred for other creditors. The Third Circuit previously left open the possibility for creditors to exclude themselves from the effects of substantive consolidation, but in this case, there was an agreement that the Trustee could expand partial consolidation to include WSFS. The deadline for filing claims has passed, as indicated by an order dated March 10, 2010. An interlocutory order dismissed certain claims from the Trustee's Amended Complaint for lack of constitutional authority in the bankruptcy court, including Counts Four (breach of fiduciary duty) and Nine (11 U.S.C. § 547 preference), which were not re-pleaded in the Second Amended Complaint. The dismissal of these counts was for trial purposes, not a final judgment, and the forthcoming Report and Recommendation will address these claims appropriately.
