Docket: Case No. 14-10569 (KG); Adv. Pro. No. 16-50739 (KG)
Court: United States Bankruptcy Court, D. Delaware; December 5, 2017; Us Bankruptcy; United States Bankruptcy Court
On March 16, 2014, Simplexity, LLC, and its affiliates (collectively referred to as the "Debtors") filed for Chapter 11 bankruptcy. Subsequently, on January 7, 2016, the bankruptcy cases were converted to Chapter 7, and a Chapter 7 Trustee was appointed. The Trustee initiated an adversary proceeding against Sprint Corporation, claiming that payments totaling $3,842,961.86 (the "Transfers") were avoidable under 11 U.S.C. § 547(b) and recoverable under 11 U.S.C. § 550. The Trustee later revised the recoverable amount to $968,198.68.
Sprint filed a motion for summary judgment to dismiss the Trustee’s avoidance action, while the Trustee submitted a cross-motion for partial summary judgment in his favor. The Court evaluated whether the Trustee met his burden of showing that Sprint received more from the Transfers than it would have in a Chapter 7 case, and whether Sprint could assert a new value defense for two specific payments of $506,151.63 and $125,000.00 made to Simplexity.
The Court concluded that the Trustee adequately demonstrated his tracing burden under Section 547(b)(5). However, it granted summary judgment in favor of Sprint for the payment of $506,151.63, recognizing its new value defense, while denying summary judgment regarding the $125,000.00 payment. A preference claim of $328,047.05 remains unresolved.
Jurisdiction for this proceeding is established under 28 U.S.C. §§ 157(a) and 1334, confirming it as a core proceeding. Simplexity, once a leading online activator of mobile phones, experienced financial difficulties leading to its bankruptcy filing, despite its previous success and significant client base, including Sprint. The discussion of pertinent agreements and events preceding the bankruptcy is essential for understanding the complexities of the case.
On March 23, 2009, Simplexity and Sprint Solutions, Inc. entered into an Online Authorized Representative Agreement (OAR Agreement), which allowed Simplexity to solicit and subscribe customers to Sprint Solutions' products and services. Simplexity could purchase products from Sprint Solutions for resale or sell directly from Sprint Solutions' inventory. For products bought on credit, Sprint Solutions secured a purchase money security interest (PMSI) in the products and their sale proceeds, which was recorded with the Delaware Secretary of State on September 30, 2009. The OAR Agreement included a commission schedule that outlined payments to Simplexity for achieving specific performance goals, last amended in July 2013, with payments made at the end of each monthly commission period. Notably, before the March 2014 reconciled payment, Sprint Solutions provided a mid-month estimated commission and retained the right to set off commissions against amounts owed by Simplexity, requiring five days' notice before doing so. Amendments made in January and March 2014, referred to as the Commission Offset Agreements, included a provision to offset $5,795,084.69 of Simplexity's overdue balance with $1 million in commission payments from March to August 2014. However, Sprint Solutions could not implement these offsets as the Debtors filed for bankruptcy shortly afterward.
A Private Label Services Agreement (PLS Agreement) was established on January 8, 2012, between Sprint Spectrum L.P. and Simplexity MVNO Services, LLC. Simplexity MVNO was designated as a limited purpose reseller for marketing PCS and 4G services. Under an amended agreement, Simplexity MVNO committed to a Loyalty Trial Program with travel-related companies, with Sprint Spectrum agreeing to pay Simplexity MVNO based on performance milestones. A $125,000 payment from Sprint Spectrum under this program cleared on March 7, 2014, with provisions for a refund to Sprint Spectrum if Simplexity MVNO failed to meet specified goals by March 31, 2014, and if a written refund request was submitted by June 30, 2014.
The Debtors had a Credit Agreement with Fifth Third Bank, which included a $15 million revolving loan and a $30 million term loan, secured by their assets. Simplexity and Simplexity MVNO were also part of a second lien credit facility with Adeptio Funding, LLC. The relationship between Fifth Third Bank and Adeptio Funding was governed by a Subordination Agreement.
The Debtors filed for bankruptcy on March 16, 2014, following significant cash decline and liquidity issues. Just ten days prior, Fifth Third Bank notified Simplexity of its intention to sweep all cash deposits and halt further funding, which it executed on March 10, 2014, leading to the termination of approximately 219 employees and 285 contractors by Simplexity.
Simplexity and Sprint had a longstanding business relationship prior to Simplexity's bankruptcy petition, characterized by significant financial interactions, including a $12 million line of credit and favorable payment terms. Simplexity paid Sprint approximately $57.1 million in 2012 and $49.1 million in 2013, while accumulating an outstanding balance of $6 million to $10 million by the time of the petition. Although Sprint did not file a proof of claim in the bankruptcy, it was noted as having the largest general unsecured claim of $7,084,990.66 and a disputed secured claim of an unspecified amount. Sprint raised objections to Simplexity's motions for debtor-in-possession financing and bid procedures, leading to amendments in those orders. Sprint’s inventory of 1,114 handsets was returned due to its first priority purchase money security interest (PMSI), and Simplexity claimed that no post-petition accounts receivable were linked to Sprint's inventory.
Subsequently, the Trustee initiated an adversary action against Sprint, seeking to avoid and recover a total of $3,842,951.86 in transfers made in 2013 and 2014 under specific bankruptcy code sections. The amount was later amended to $958,198.58, with the characterization of the transfers clarified as being for antecedent debts rather than prepayments for future goods or services. Limited discovery occurred prior to the filing of motions, and a mediation attempt in February 2017 was unsuccessful. A scheduling order was issued extending the discovery deadline to June 2, 2017, with subsequent extensions allowing for additional discovery and the revision of Sprint's motion.
A bankruptcy court is required to grant summary judgment when there are no genuine disputes over material facts, and the moving party is entitled to judgment as a matter of law, as per Fed. R. Civ. P. 56(c). The court reviews evidence favorably for the non-moving party, which must then demonstrate the existence of a material fact that precludes summary judgment. In the case at hand, Sprint challenges the avoidance of preferential transfers under 11 U.S.C. § 547 and § 550, specifically focusing on Count I regarding the Trustee's ability to avoid and recover these transfers. The Trustee has met the first four requirements of § 547(b), which pertains to transfers made to benefit a creditor, for antecedent debts, during the debtor's insolvency, and within specified time frames before filing the petition. However, Sprint disputes the Trustee's ability to prove the fifth requirement of § 547(b)(5), claiming the Trustee cannot show that Sprint received more from the preferential payments than it would have in a Chapter 7 liquidation. This fifth element is crucial for preference claims, and the court must examine the specifics of this case, particularly as it pertains to a purchase money security interest (PMSI), which has not been previously adjudicated by the court.
The burden of proof regarding the elements of Section 547(b) lies with the Trustee, as established by Section 547(g), which states that the trustee must prove the avoidability of a transfer under subsection (b), while the creditor must prove the nonavoidability under subsection (c). The Trustee argues that since Purchase Money Security Interests (PMSIs) are governed by state law, in this case, Virginia law, the burden should shift to the creditor, Sprint. However, the Court affirms that the statutory language clearly assigns the burden to the Trustee. Citing case law, the Court emphasizes that while creditors may be better positioned to prove the source of alleged preferential payments from their collateral, the Trustee has greater access to the debtor’s financial records. Ultimately, the statute’s plain language mandates that the Trustee must demonstrate the sources of the preferential payments, even if this requires proving a negative—that the creditor is not a fully secured creditor.
The Trustee's interpretation threatens to invalidate the burden structure outlined in Section 547(g). The determination of secured status is pivotal and must be assessed either at the time of the transfer or the petition date. Courts are divided on this issue; for instance, the Eighth Circuit in *In re Falcon Products, Inc.* supports the petition date for analysis under Section 547(b)(5), while the Delaware Bankruptcy Court in *Forman v. IPFS Corp.* favors the transfer date. The timing of the transfer is significant to balance the protection of individual creditor transfers during the preference period against maximizing distributions to unsecured creditors. Prepetition payments based on secured claims typically do not create preferences, as creditors recovering their collateral do not gain any advantage beyond what they would receive in bankruptcy. Sprint claims it holds a first priority lien due to its Purchase Money Security Interest (PMSI) in inventory and its proceeds, asserting that payments made merely reduced existing lien debt without offering preferential treatment to Sprint over unsecured creditors. Compounding the situation, Simplexity's funds were commingled, and the funds were swept by FTB on March 10, 2014. Sprint argues that it is the Trustee's responsibility to demonstrate that the Transfers did not originate from Sprint's collateral sales, despite the commingling with other funds.
Simplexity argues for measuring secured status as of the petition date, citing the Supreme Court case Palmer Clay Products Co. v. Brown, which established that the petition date is the appropriate point for determining a creditor's treatment in preference actions under the Bankruptcy Act. Justice Brandeis emphasized that Congress did not intend for courts to disregard the actual results of transfers or require hypothetical determinations based on each payment date. This interpretation, however, has been contentious, particularly because the creditor in Palmer Clay was unsecured, leading some courts, like Sprint, to assert that the ruling is not applicable to secured creditors. Sprint references In re Alabama Aircraft Industries to support its position that a transfer date analysis is more logical, arguing that reliance on Palmer Clay is misplaced. The court finds that while Alabama Aircraft Industries acknowledged a narrow reading of Palmer Clay, this is not definitive and does not dictate that lower courts must apply Palmer Clay to secured creditors. As a result, the court deems Sprint's reliance on Alabama Aircraft Industries to be potentially incorrect.
Simplexity challenges Sprint's position by referencing In re Falcon Products, Inc., arguing against the notion that payments on fully secured claims could be preferential under § 547(b). Simplexity asserts that blending the hypothetical liquidation test with § 547(c) preference defenses is inappropriate and emphasizes the need to keep these analyses distinct. It critiques Sprint's cited cases for lacking specificity relevant to the current situation, particularly regarding premium financing and diminishing lien value, which do not apply here. Simplexity contends there are no exceptional circumstances that would necessitate deviation from the norm of evaluating a secured creditor's status as of the Petition Date. The Court concurs with the Trustee, determining that Sprint's secured status should indeed be assessed on the Petition Date, particularly noting Sprint's possession of a Purchase Money Security Interest (PMSI), which is more limited than a floating lien. Additionally, the Court finds that the valuation of Sprint’s PMSI in headsets and their proceeds is unlikely to fluctuate significantly. While acknowledging that certain unique factual scenarios could justify a different approach, the Court concludes that the current case does not present such circumstances.
Liquidation analysis must be conducted as of the petition date, raising the question of whether this should occur at the transfer date or the petition date. The court must also decide the appropriate tracing methodology, with Sprint asserting that the Trustee bears the burden of establishing inventory value and tracing proceeds, as supported by the case Batlan v. Transamerica Commercial Fin. Corp. (In re Smith's Home Furnishings, Inc.). In Smith's, the Ninth Circuit determined that the Trustee must trace funds related to preferential payments, emphasizing that Section 547(g) places this burden on the Trustee. The court found the Trustee's use of the "add-back" method inadequate for meeting this burden. Sprint argues that the circumstances in Smith's Home Furnishings are akin to the current case, where Simplexity's accounts were swept days before bankruptcy. Sprint contends that the Trustee's reliance on the rejected "add-back" method and the Forensic Report by Anne M. Eberhardt is flawed, as it was based on limited data and lacked access to the Debtors' accounting system. Sprint criticizes the report for focusing on cash fungibility rather than precise tracing and for disregarding asset-based sources of lending due to offsetting transactions.
Simplexity counters Sprint's claims by highlighting key points from the Forensic Report, which analyzed a specific transfer of $1,001,095.20 on February 28, 2014, asserting that the transfer date is central to Sprint's allegations. The Forensic Report is based on the Debtors' bank records and covers a limited timeframe due to the lender's sweeping of accounts, focusing on this one transfer. It also references Smith's Home Furnishings to support the methodology used in the report. The analysis shows that the Debtors' bank account balances fell from $606,917.05 to $257,054.93 in February 2014, with significant cash inflows primarily from Simplexity's lenders, including $990,000.00 from Adeptio Funding. Simplexity argues it is illogical to consider these inflows as proceeds from Sprint’s collateral or receivables.
Furthermore, Simplexity asserts that payments made to repay lenders do not count as "proceeds" subject to Sprint's lien, invoking U.C.C. § 9-332, which protects a purchaser from a perfected security interest unless collusion is present, which has not been alleged. The Trustee's liquidation analysis, based on Falcon Products, involves three steps: accounting for outstanding debt to Sprint ($7,292,167.55), adding back transfers ($958,198.58), resulting in a total debt of $8,250,366.13, and comparing this with the available collateral valued on a liquidation basis. Simplexity suggests that the financial situation makes it unlikely that Sprint could be fully collateralized, particularly given that senior creditors could not be paid in full.
Simplexity returned Sprint's collateral of 1,114 handsets and argued that to match the Transfer amount, the handsets would need to be liquidated at $860.14 each, which is deemed unlikely due to costs associated with handling and shipping. Sprint contested Simplexity's analysis on the tracing of payment sources, asserting that Simplexity could only trace 16% of the funds back to the proceeds of Sprint's collateral. The Court accepted the Trustee's add-back method for tracing payments, distinguishing the case from Smith's Home Furnishing, where the trustee's tracing efforts were deemed insufficient due to the specific circumstances involving a fully secured creditor. In contrast, Sprint was not fully secured, and there were no funds in the Debtors' accounts at the Petition Date. The Court noted that a Purchase Money Security Interest (PMSI) is a more limited security interest than a floating lien, which alleviates concerns of allocating proceeds in commingled accounts. Consequently, the Trustee's tracing of payments was upheld. Under Section 547(c)(4), a defendant can offset preference exposure by showing that they provided "new value" to the debtor after the transfer, with the section's defenses typically interpreted narrowly, but with an expansive view on what constitutes "new value."
Money or its equivalent in goods, services, or credit, as well as the release of previously transferred property by a transferee, is defined under Section 547(a)(2) of the Bankruptcy Code. This definition excludes obligations that merely substitute existing debts. Section 547(c)(4) establishes that if a transfer is made in exchange for new value, the estate and other creditors are not harmed, as this new value increases the estate proportionately. The section aims to encourage trade creditors to continue business with struggling companies and to fairly treat creditors who replenish the estate after receiving a preference.
In the context of a dispute, Sprint claims that two payments—a $505,151.53 commission payment on March 12, 2014, and a $125,000 advance on March 7, 2014—qualify as “Alleged New Value Payments” under Section 547(c)(4), which should be reflected in the Trustee’s Amended New Value Analysis. The Trustee challenges the legitimacy of the $505,151.53 payment, arguing that Sprint has not justified this mid-month payment or explained why it did not utilize offsets as per the Commission Offset Agreements. Simplexity contends that the payment represented a pre-existing debt owed to them by Sprint, implying that it does not constitute new value since it was merely paying off a debt rather than providing new goods or services.
Sprint argues that the Trustee's claim regarding the $505,151.53 payment merely substituting one asset for another overlooks that the account receivable would not have been collectible due to Sprint's rights under existing agreements and 11 U.S.C. § 553. Both the Debtor and Defendant acknowledge their involvement in the OAR Agreement and the Commission Offset Agreements, making the purpose of the payment central to the dispute. The Court emphasizes that the OAR Agreement's Commission Schedule clearly states that Sprint was to make reasonable efforts to pay commissions by the end of the following month, indicating that the payment was not yet due.
The Trustee contends that Sprint acted as a debtor when making the payment, necessitating rejection of the payment as new value. However, the Court finds that while Sprint may have had a debtor-like position, this was not definitive at the time of payment. The Trustee's argument regarding asset substitution is also considered, particularly in light of Sprint's right to set off under the OAR Agreement, which required five days' notice—a requirement the Court does not deem dispositive.
The Court views the payment as an advance rather than a scheduled payment, suggesting that Sprint aimed to enhance the Debtors’ estate. The close timing of the payment to the Petition Date and Sprint's status as a significant creditor further support the classification of the payment as new value. The Court notes the unusual nature of this mid-month payment, reinforcing its decision that the $505,151.53 payment qualifies as new value under Section 547(c)(4).
Sprint issued a $125,000 payment to Simplexity for Phase II of the Loyalty Trial Program, which cleared on March 7, 2014. This payment was contingent on Simplexity securing at least one Trial Participant by March 31, 2014, with a clawback provision if obligations were unmet. Sprint alleges that Simplexity failed to fulfill its duties and did not refund the payment. Simplexity counters that Sprint has not provided evidence of this failure and further claims there was no written refund request by the June 30, 2014, deadline. The court identifies the key issue as whether Simplexity enlisted a Trial Participant by the deadline. Due to existing genuine disputes over material facts, the court denies both Sprint's and Simplexity's motions regarding this payment.
In relation to the Trustee's claim of fraudulent conveyance under 11 U.S.C. § 548(a)(1)(B), both parties acknowledge that the transfers were made to settle an antecedent debt and not as prepayments for future goods or services. Consequently, the court cannot rule on this issue based on the current evidence. The Trustee also seeks to disallow Sprint's claims in Simplexity's bankruptcy case under Section 502(d), which allows for such disallowance if the claimant is liable for avoidance recoveries. The court determines that Sprint's claim is valid except for $328,047.05, recognized as a valid preference amount and the disputed $125,000 claim.
In conclusion, the court grants Sprint a new value defense for a $505,151.53 payment while denying both motions concerning the $125,000 payment.
The Court has approved a portion of Sprint's claim, allowing $505,151.53 while denying $126,000.00 of the claim. The Cross-Motion regarding claims allowance has been denied. Sprint's Amended Motion for Summary Judgment and supporting briefs were referenced. The Debtors' Schedule F indicates an unsecured debt of $207,174.93 owed to Sprint Nextel. The Court noted the relevance of certain language added at Sprint's request in previous orders and declarations. It highlighted that the presence of specific facts prevents the Trustee from pursuing a claim of Fraudulent Conveyance. Simplexity's cash flow and transfers between accounts were documented, indicating a daily zero balance in payroll and accounts payable accounts, funded by the operating account. Sprint criticized Simplexity's method for tracing cash but the Court found the argument inconsistent with legal precedents. Despite Sprint's objections regarding the timing of Simplexity's expert report, the Court deemed it unnecessary to explore further. Although Sprint contested the amounts due to setoff rights, the Court recognized that Sprint was owed significantly more than just the transferred value as of the Petition Date. The Trustee's total was adjusted to $11,135,119.41 based on the Amended New Value Analysis, with clarifications provided in the Court's discussions. The Court also acknowledged the limited time available for Simplexity to complete a specific phase of its operations, noting key dates around Sprint's payment and Simplexity's bankruptcy filing.
