The First Circuit, not known for being easy on debtors, upheld a flexible approach not requiring bankruptcy courts to appoint chapter 11 trustees reflexively just because transfers seem fraudulent at first blush.
The case involved an individual debtor who owned two gasoline stations. He and the stations were in financial distress. Before filing his chapter 11 petition, he transferred the stations, one to a family trust and another to a corporation he controlled. Both of the transfers were presumptively fraudulent under Puerto Rico law.
In chapter 11, the debtor amended his schedules several times. Charitably speaking, he was sloppy. One creditor, who sought appointment of trustee, contended that the debtor was failing to disclose assets and transfers.
The bankruptcy judge denied the creditor’s motion for appointment of a trustee under Section 1104(a), where fraud is listed as one of the rounds for ousting the debtor in possession. The Bankruptcy Appellate Panel upheld denial of the trustee motion.
The creditor fared no better in the First Circuit, where Circuit Judge David J. Barron handed down an opinion on Aug. 9 upholding the lower courts.
Although the transfers were presumptively fraudulent because they were made to family for little or no consideration, Judge Barron could not upset the bankruptcy court’s fact-finding that the transfers had “no materially adverse impact on the bankrupt estate” because the separately incorporated gasoline stations had negative net worth.
Adopting a “totality of the circumstances” test, Judge Barron said there is no “authority to suggest that, in evaluating the totality of the circumstances, the effect of the transfer on the estate’s value is an impermissible consideration under Section 1104(a)(1).”
Next, Judge Barron rejected the creditor’s reliance on Husky International Electronics Inc. v. Ritz, 136 S. Ct. 1581, 194 L. Ed. 2d 655, 84 U.S.L.W. 4270 (2016), where the Supreme Court held that a debt can be nondischargeable under Section 523(a)(2)(A) even if the debtor made no misrepresentation to the creditor. He said that Husky does not purport to address what constitutes “fraud” under Section 1104(a)(1).
The debtor explained that he made the two transfers “to protect his assets from the aggressive collection actions of just one unsecured creditor,” not the creditor that sought a trustee. The creditor moving for a trustee contended that the debtor’s admission showed the type of fraudulent intent requiring appointment of a trustee.
Judge Barron said there was “no clear authority, from this or any other court,” to support the idea that motivation to protect an asset from one creditor “for the benefit of other creditors automatically makes his transfers fraudulent for the purposes of Section 1104(a)(1).”