Recently, the Bankruptcy Court for the District of Massachusetts ruled in In re Duplication Management, Inc., (Riley v. Countrywide)[1] that courts can shift the burden of production[2] to a defendant to quantify the value of indirect benefits purportedly received by a debtor accused of making a fraudulent transfer.[3] Duplication Management is notable not only in shedding light on what is meant by the “burden of production,” but also under what circumstances this burden might shift to a defendant.
Background
The chapter 7 debtor, Duplication Management Inc. (“Duplication”), was a printing manufacturer in Woburn, Massachusetts. Michael Jenoski was its president and sole shareholder.[4] Prior to filing its petition for bankruptcy relief, Duplication made over $400,000 in payments to satisfy a loan mortgaged upon Jenoski’s home. However, Duplication had no obligation to repay Jenoski’s loan—it was neither a co-maker nor guarantor of the note.[5] The trustee thus filed an adversary complaint alleging fraudulent conveyances and unjust enrichment against the servicers of Jenoski’s loan, Countrywide Home Loans Inc. and Bank of America NA (the “Banks”).[6] After taking several depositions, the trustee sought summary judgment upon her claims.
Ruling upon the summary judgment motion, the court first determined that Duplication was insolvent at the time of the transfers. The court then turned to whether the Banks received reasonably equivalent value in exchange for the transfers. The undisputed evidence revealed that the Banks provided no direct benefit to Duplication in exchange for the loan repayments it made on Jenoski’s behalf.[7] Therefore, the court reasoned that the issue was what, if any, indirect benefit Duplication received from Jenoski’s services.[8]
Burden of Production as to Indirect Benefits
The court then addressed which party had the duty to present evidence as to the value of indirect benefits. The court held:
To make out the elements of a fraudulent conveyance claim, a plaintiff must prove that a debtor did not receive direct benefits reasonably equivalent to the value which it gave up. If the plaintiff meets that burden, the burden is then on defendants to produce (if they can) evidence that the debtors indirectly received sufficient, concrete value[9] . . . the burden on Defendants includes a requirement to show that the “indirect benefits” were tangible and concrete, and to quantify their value with reasonable precision.[10]
The court did not place the burden of proof (i.e. the burden of persuasion) upon the Banks with respect to reasonably equivalent value. Indeed, the trustee carries the burden of proof on all elements, and this burden always remains with the trustee.[11] The court shifted to the Banks a different burden: the burden of production. The court explained:
The burden of the issue [burden of proof] and the duty of going forward with evidence [burden of production] are two very different things. The former remains on the party affirming a fact in support of his case, and does not change at any time throughout the trial. The latter may shift from side to side as the case progresses, according to the nature and strength of the proofs offered in support or denial of the main fact to be established.[12]
In shifting the burden of production, the court relied upon a holding from the First Circuit in Rowanoak Corp. v. Walsh, which held that once a trustee makes its prima facie case establishing a fraudulent conveyance, “the burden of going forward with the evidence [i.e., burden of production] may shift” to the defendants.[13] The policy behind shifting the burden of production is sensible. As discussed in Rowanoak, “[o]nce the Trustee establishes his prima facie case, he need not affirmatively disprove every other potential theory.”[14]
Indirect Benefits and Reasonably Equivalent Value
The court further reasoned that because reasonably equivalent value is intended to protect creditors against the depletion of a bankruptcy estate, a determination of whether indirect benefits suffice as fair consideration turns on whether Duplication’s net worth had been preserved.[15] Put another way, the issue was whether the value of Jenoski’s services to Duplication were equivalent to the payments.[16]
The evidence revealed that they were not. During his deposition, Jenoski testified that Duplication treated the mortgage payments as repayment of a “loan” Jenoski had purportedly provided to Duplication.[17] However, Jenoski’s testimony related to the specifics of the “loan” was so vague and equivocal that it strained credibility.[18] And his testimony was contradictory—he testified that: (i) the repayments were not compensation for his services to Duplication; (ii) the repayments were “made in lieu of” payments for his services to Duplication; and (iii) that he did not remember what the rationale was for having Duplication pay his mortgage.[19] The testimony of Duplication’s accountant also failed to provide evidence of indirect benefits to Duplication. The accountant testified that the mortgage payments to the Banks “depleted the assets of [Duplication],” and that Duplication made the payments “because Mr. Jenoski could not afford to make them.”[20]
The court thus held that the Banks failed to meet their burden of production, and that evidence as to the value of Jenoski’s services to Duplication was unconvincing. Specifically, the court noted that: (i) there was no written agreement regarding Jenoski’s compensation (let alone an agreement for Duplication to make his mortgage payments); (ii) Jenoski testified that he could not ascribe a value to the services he performed in exchange for payment of the mortgage; and, (iii) since Jenoski’s mortgage payments fluctuated from month to month, the court would have to make an “untenable inference” that the value of Jenoski’s services to Duplication also fluctuated from month to month.[21] The court further noted that Jenoski was a salesperson for Duplication and he did not oversee Duplication’s production facility, which was staffed by a fulltime manager and shift supervisors.[22]
In sum, the court held that the Banks failed to produce evidence of the cognizable value of Jenoski’s services, such that the amount of the mortgage payments equaled the value of those services.[23] It was up to the Banks to “do more than rely upon the inconsistent testimony of Mr. Jenoski” as to the potential value of his services to Duplication, and the reason that Duplication made the mortgage payments.[24] The court held that the trustee was not required to disprove the Banks’ theory that Duplication’s mortgage payments to the Banks were reasonably equivalent in value to the services Jenoski provided to Duplication. Accordingly, the court granted summary judgment in favor of the trustee, finding that Duplication’s payments to the Banks constituted fraudulent transfers.
Conclusion
Although the trustee always retains the burden of proof in fraudulent transfer actions, the burden of producing evidence of the value of indirect benefits—when asserted as a defense—can shift to the defendant after the trustee makes a prima facie case that the debtor received no direct benefit for the transfers. Going forward, those who prosecute (or defend against) fraudulent transfer actions must be aware that a defendant cannot simply rely on the testimony of the debtor related to supposed indirect benefits for an alleged transfer. The defendant must be prepared to produce quantifiable “concrete” evidence that due to indirect benefits, the debtor’s net worth was preserved.
[1] Riley v. Countrywide Home Loans, Inc., et al. (In re Duplication Management, Inc.), 501 B.R. 462 (Bankr. D. Mass. 2013).
[2] The Handbook of Federal Evidence explains that the burden of producing evidence “is satisfied by evidence which, viewed in the aspect most favorable to the burdened party, is sufficient to enable the trier of fact reasonably to find the issue for him . . . failure to satisfy the burden of producing evidence requires a decision by the court as a matter of law on the particular issue adverse to the burdened party. Michael H. Graham, 2 Handbook of Fed. Evid. § 301:4 (7th ed. 2013).
[3] Duplication Management, 501 B.R. at 484–85.
[4] Id. at 465.
[5] Id. at 467–68.
[6] Id. at 464–65.
[7] Id. at 469.
[8] Id. at 479.
[9] Id. at 483 (citing Official Comm. of Unsecured Creditors of TOUSA v. Citicorp N. Am. (In re TOUSA, Inc.), 422 B.R. 783, 866 (Bankr. S.D. Fla. 2009) (partially rev’d on other grounds, 444 B.R. 613 (S.D. Fla. 2011)) (emphasis added) (citations omitted).
[10] Id. (emphasis in original).
[11] Id. at 476–77 (citing Braunstein v. Walsh (In re Rowanoak Corp.), 344 F.3d 126, 131–32 (1st Cir. 2003)).
[12] Id. (internal citations omitted).
[13] Id. at 477 (citing Rowanoak, 344 F.3d at 131–32).
[14] Rowanoak, 344 F.3d at 132 (emphasis added).
[15] Duplication Management, 501 B.R. at 484 (citing TOUSA, Inc., 422 B.R. at 867-68) (citations omitted).
[16] Id. at 485.
[17] Id. at 471.
[18] Id. (Among other things, Jenoski testified that: (i) he did not know if his “loan” to the Duplication was a loan or an equity investment; (ii) there were no documents evidencing the “loan,” such as a promissory note; (iii) Jenoski was not entitled to interest on the “loan;” (iv) he did not know if the “loan” or equity investment had a maturity date; and (v) he did not know if the board of directors had met to approve the loan or equity investment.)
[19] Id. at 472-73.
[20] Id. at 472 (emphasis added).
[21] Id. at 485–86.
[22] Id. at 485.
[23] Id. at 486.
[24] Id. (emphasis added).