In Advanced Telecommunication Network Inc. v. Allen (In re Advanced Telecommunication Network Inc.), 490 F.3d 1325 (11th Cir. 2007), the U.S. Court of Appeals for the Eleventh Circuit adopted the approach set forth by the Seventh Circuit Court of Appeals in In re Xonics Photochemical, 841 F.2d 198, 200 (7th Cir. 1988) to reduce a contingent liability to its present, or expected, value in order to determine whether a debtor was insolvent on a given date.
Bankruptcy court judges are often faced with the daunting task of discarding their Bankruptcy Code in favor of a calculator in order to determine the pre-petition solvency of a debtor in the context of fraudulent-transfer litigation. The solvency analysis is often complicated by the need to attribute value to contingent assets and liabilities. In its 1988 decision in Xonics, the Seventh Circuit Court of Appeals recognized the need to discount the value of contingent liabilities by the probability that such contingency will actually occur, and stated that the asset or liability determination must be reduced to its present or expected value before a determination can be made on whether the debtor’s assets exceed liabilities. Xonics, 841 F.2d at 200. In reversing the decisions of the Florida Bankruptcy and District Courts, the Eleventh Circuit has now expressly adopted this method of discounting.
In Advanced Telecommunication, a dispute arose between the two shareholders of Advanced Telecommunication Network (ATN), Allen and Carpenter, which eventually led to a $6 million settlement in favor of Allen. Despite the fact that the suit was between shareholders, the settlement agreement provided for the payment to be made to Allen by ATN rather than Carpenter. Sometime later, Carpenter caused ATN to recharacterize the payments to Allen as loans to Carpenter and also executed backdated promissory notes to ATN. The notes retroactively recharacterized the transfers as purchases by Carpenter of Allen’s stock in exchange for Carpenter’s promise to pay ATN and assume Allen’s shareholder loan liability. Concurrently, ATN also had a second ongoing dispute with WATS/800 Inc. (WATS), a competitor, which was eventually settled by Carpenter relinquishing control of ATN to WATS and ATN paying $10.5 million to WATS. ATN subsequently filed chapter 11 three years later and filed suit seeking to recover the money transferred to Allen in 1999 as, among other things, a fraudulent transfer. The bankruptcy and district courts rejected ATN’s claims and found that the claims were barred by the statute of limitations, and furthermore, that ATN was solvent at the time the transfers were made and received reasonably equivalent value in exchange for the transfers.
The Eleventh Circuit reversed the lower courts on both grounds. With regard to the statute of limitations, the court found that the obligation did not arise until ATN actually executed the formal agreement, thus the claim was not time-barred. The court then turned its attention to the insolvency prong of the fraudulent transfer inquiry.
The Eleventh Circuit analyzed the adjustments that the bankruptcy court made to ATN’s bottom line and found that it erred in adjusting the value of the loan to Carpenter, since he was unable to repay it, and in valuing the contingent claim for the litigation with WATS. ATN argued that the full $10.5 million value of the WATS settlement should be a downward adjustment to its assets at the time of the transfer because it was plainly foreseeable. Allen argued that the obligation did not arise until after the transfer at issue, so it could not have been reasonably foreseen and no downward adjustment was necessary. The Eleventh Circuit rejected both of these extreme positions and found that the proper approach is to calculate the present value by discounting the expected cost by the probability of it occurring. A precise prediction is not required. The evidence in the case showed that ATN faced the very real prospect of a multi-million dollar judgment in favor of WATS at the time of the transfer to Allen. Further, almost a year before the settlement with Allen, ATN had offered $2 million to settle and its attorneys were concerned about the risk. So a zero value could not be assigned to the contingent liability. The court stated that the bankruptcy court should have adjusted ATN’s assets downward to give some negative value to its contingent debts, namely the WATS claim.
Based on this decision, courts in the Eleventh Circuit now have guidance for the next time they are asked to pull out their calculators to resolve an insolvency fight. Rather than adopting an extreme position with respect to the value of contingent liabilities, judges now have the formula at their fingertips to adjust values according to the facts in the case.