Opinion
Case No. 98-33110-T, Adv. Proc. No. 99-3047-T, Chapter 7
January 5, 2000
Watson M. Marshall, Nicole L. Fox, Esq., MARSHALL AND MARSHALL, Richmond Va., Counsel for C.A. Guard Masonry Contractor, Inc.
Christopher A. Jones, Esq., MALONEY, HENNEKENS, PARKS, GECKER PARSONS, Richmond, Va., Counsel for Chapter 7 Trustee.
Greff R. Nivala, Esq., OFFICE OF THE U.S. TRUSTEE, Richmond Va., Assistant United States Trustee.
MEMORANDUM OPINION
Hearing was held December 15, 1999, on cross-motions for summary judgment filed by defendant, C.A. Guard Masonry Contractor, Inc., and plaintiff, Sherman B. Lubman, chapter 7 trustee for the bankruptcy estate of GEM Construction Corporation of Virginia. For reasons stated in this memorandum opinion, the court will enter an order (1) granting the trustee's motion for summary judgment against C.A. Guard as follows: the court finds that debtor's payment in the amount of $21,209.06 to defendant, C.A. Guard Masonry Contractors, Inc., by check dated January 21, 1998, was a preferential transfer under § 547(b); (2) denying both parties' motions for summary judgment on the issue of whether the payment falls within the "new value" defense under § 547(c)(1); and (3) denying the trustee's motion for summary judgment requesting the court to declare that the payment fell outside the "ordinary course of business" defense under § 547(c)(2).
Facts.
Defendant performed subcontract work for debtor, GEM Construction, at two separate locations. On December 23, 1997, defendant filed two mechanic's liens: one against property of Whitehall/Robins covering a portion of the invoice dated July, 22, 1997, and the other against property at the Genito Mini Storage facility covering amounts billed in an invoice dated October 24, 1997. Defendant filed no action to enforce either lien and on January 6, 1998, released both liens based on debtor's promise to pay. Debtor transferred $21,209.06 to defendant by check dated January 21, 1998, which cleared debtor's bank account on January 23, 1998. The transfer was applied to part of the amount due under the July 22, 1997, invoice, and the total amount due under the October 24, 1997, invoice.
On April 23, 1998, an involuntary chapter 7 bankruptcy petition was filed against debtor. According to the schedules filed by debtor, on the petition date debtor had liabilities of $1,044,582.65 and assets of $229,150.00.
Debtor's assets on the petition date consisted of the following:
Cash $ 1,000.00 Accounts receivable Due from Genito Mini Storage 40,150.00 Due from Brandt Building 20,000.00 Due from Watts Hall 135,000.00 Tax refund receivable 20,000.00 Equipment 13,000.00 Total $229,150.00
Position of the Parties.
On April 7, 1999, the chapter 7 trustee filed a complaint seeking to avoid payments to several creditors as preferential transfers.
On April 20, 1999, defendant, C.A. Guard filed an answer. Defendant asserted that the transfer does not fall within the ambit of § 547(b). While defendant admits the first element under § 547(b), that it was a creditor (§ 547(b)(1)), defendant denies the remaining elements: that the transfer was for an antecedent debt (§ 547(b)(2)), that transfer was made while debtor was insolvent (§ 547(b)(3)), that the transfer was received within ninety days before the filing of the petition (§ 547(b)(4)), and that it received more through this transfer than it would if debtor filed a chapter 7 bankruptcy petition and no transfer was made (§ 547(b)(5)). Defendant further asserts that the transfer was made in the "ordinary course of business" dealing (§ 547(c)(2)).
Section 547(b) provides, in pertinent part, as follows:
Except as provided in subsection (c) of this section, the trustee may avoid any transfer of an interest of the debtor in property —
(1) to or for the benefit of a creditor;
(2) for or on account of an antecedent debt owed by the debtor before such transfer was made;
(3) made while the debtor was insolvent;
(4) made —
(A) on or within 90 days before the date of the filing of the petition; . . .
(5) that enables such creditor to receive more than such creditor would receive if —
(A) the case were a case under chapter 7 of this title;
(B) the transfer had not been made; and
(C) such creditor received payment of such debt to the extent provided by the provisions of this title.
Section 547(c)(2), the "ordinary course of business" defense, provides as follows:
(c) The trustee may not avoid under this section a transfer —
. . .
(2) to the extent that such transfer was —
(A) in payment of a debt incurred by the debtor in the ordinary course of business or financial affairs of the debtor and the transferee;
(B) made in ordinary course of business or financial affairs of the debtor and the transferee; and
(C) made according to ordinary business terms. . . .
On October 12, 1999, defendant, C.A. Guard filed a motion requesting summary judgment because the transfer falls within the ambit of § 547(c)(1).
Section 547(c)(1), the "new value" defense, provides as follows:
(c) The trustee may not avoid under this section a transfer —
(1) to the extent that such transfer was —
(A) intended by the debtor and the creditor to or for whose benefit such transfer was made to be a contemporaneous exchange for new value given to the debtor; and
(B) in fact a substantially contemporaneous exchange. . . .
"New value" is defined in 11 U.S.C. § 547(a)(2) as follows:
[M]oney or money's worth in goods, services or new credit, or release by a transferee of property previously transferred to such transferee in a transaction that is neither void nor voidable by the debtor or the trustee under any applicable law, including proceeds of such property, but does not include an obligation substituted for an existing obligation. . . .
On October 21, 1999, the trustee filed a motion requesting summary judgment because (1) the transfer to C.A. Guard is a voidable preferential transfer (§ 547(b)); (2) C.A. Guard gave the debtor no new value for the transfer (§ 547(c)(1)(A)); (3) the transfer was not in fact contemporaneous (§ 547(c)(1)(B)); and (4) C.A. Guard has identified no facts supporting an "ordinary course of business" defense (§ 547(c)(2)).
On November 1, 1999, defendant, C.A. Guard filed a response to the trustee's motion for summary judgment and memorandum of law in support thereof. Defendant admitted that the transfer was for an antecedent debt (§ 547(b)(2)) and presumably was within the ninety day preference period (§ 547(b)(4)), but stated that the insolvency issue (§ 547(b)(3)) still required further litigation. Defendant alleges two facts that it contends rebut the statutory presumption of insolvency contained in § 547(f): (1) debtor had approximately $66,873.61 in its checking account on January 30, 1998; and (2) debtor paid out approximately $300,000.00 to other defendants between the time of the transfer and when the involuntary petition was filed. Moreover, defendant contends that if the court finds that the payment was a preference, it is excepted from the trustee's avoidance powers because debtor's payment of debt and defendant's release of security constitutes a contemporaneous exchange for "new value" (§ 547(c)(1)) and it was made in the "ordinary course of business dealing" (§ 547(c)(2)).
See Defendant C.A. Guard Masonry Contractor, Inc.'s Motion for Summary Judgment.
See Defendant's Answer to Trustee's Complaint.
On November 4, 1999, the trustee filed a reply memorandum in support of its motion for summary judgment against C.A. Guard. The trustee continues to assert that the payment was a preferential transfer within the meaning of § 547(b) and that § 547(c)(1), the "new value" defense, is not applicable because the "new value" was not given to debtor and the transfer was not in fact substantially contemporaneous. Finally, the trustee asserts that defendant fails to identify any facts that would support a defense under § 547(c)(2), the "ordinary course of business" defense.
Conclusions of Law.
The first issue is whether debtor's payment and defendant's release of the mechanics' liens was a preferential transfer within the meaning of § 547(b). Essentially, the transfer, to be preferential, must diminish the fund to which other creditors can legally resort for the payment of their debts, thus making it impossible for other creditors of the same class to obtain as great a percentage as the favored one. See 5 COLLIER ON BANKRUPTCY ~ 547.03[2] (Lawrence P. King ed., 15th ed. rev. 1999). By the defendant's admissions, the only issue under § 547(b) is whether debtor was insolvent when it made payment to the defendant.
A trustee may recover Code-defined preferential transfers of property made while debtor was insolvent. See 11 U.S.C. § 547. The debtor is presumed to be insolvent on and during the ninety days preceding the date the petition is filed. See 11 U.S.C. § 547(f). This presumption requires defendant to come forward with evidence to rebut the presumption. See Miller Rhoads, Inc. Secured Creditors' Trust v. Robert Abbey, Inc. Airways Indus., Inc. (In re Miller Rhoads, Inc.), 146 B.R. 950, 955 (Bankr.E.D.Va. 1992).
The court finds that defendant has failed to rebut the presumption of insolvency. The Bankruptcy Code defines insolvency as a "`financial condition such that the sum of [an] entity's debts is greater that all of such entity's property, at fair valuation. . . .'" See id. (citation omitted). "Thus, a `balance sheet' test . . . is used for the purpose of establishing insolvency in a preference action under § 547." Id.; accord 5 COLLIER ON BANKRUPTCY at ~ 547.03[2] (stating that "[a] rough `balance sheet' test determines insolvency; the debtor is insolvent when its liabilities exceed the fair value of its nonexempt assets. A debtor that is unable to pay its debts as they mature is thus not necessarily insolvent for purposes of a preference action."). The bankruptcy schedules filed by debtor indicate that on the petition date debtor had total liabilities of $1,044,582.65 and total assets of $229,150.00. Defendant's allegation that debtor's checking account had approximately $66,873.61 on January 30, 1998, has already been included in the total assets portion of the insolvency calculation. Even if the court, looking in the light most favorable to the defendant, assumes the alleged $300,000.00 debtor paid to other defendants should be added back to assets but not liabilities, the total liabilities would still exceed total assets. Thus, defendant has cited no facts which rebut the statutory presumption of insolvency and the trustee is entitled to judgment as a matter of law on this issue.
The next issue is whether debtor's payment of debt and defendant's release of the mechanics' liens constitutes a contemporaneous exchange for new value that is excepted from the trustee's avoidance powers under § 547(c)(1).
Whether payment made in exchange for the release of a lien falls within the "new value" exception depends on whether there is release of a potentially secured claim against debtor's property. See, e.g., Nordberg v. Arab Banking Corp. (In re Chase Sanborn Corp.), 904 F.2d 588, 595-96 (11th Cir. 1990); Gulf Oil Corp. v. Fuel Oil Supply Terminaling, Inc. (In re Fuel Oil Supply Terminaling, Inc.), 837 F.2d 224, 229-30 (5th Cir. 1988). Had the defendant-subcontractor not been paid by debtor-contractor, the defendant could have asserted a claim against the property owner. Ultimately, a claim for indemnification would have been asserted against debtor-contractor. The purpose of the "new value" defense is to protect transactions that do not result in a diminution of the bankruptcy estate.
The trustee questions whether the mechanic's lien was perfected. See Trustee's Response to C.A. Guard's Motion for Summary Judgment at 8 n. 5 ("[A] mechanic's lien does not attach until it is perfected" and "[defendant] has provided no competent evidence that it provided notice to the owner as required by the statute which would result in the liens' perfection.").
For example, in O'Rourke v. Coral Construction, Inc. (In re E.R. Ferget, Inc.), 88 B.R. 258, 260 (9th Cir. BAP 1988), aff'd, 887 F.2d 955 (9th Cir. 1989), the entity for whom the contract was being performed held retention funds due to debtor under the contract. See Cocolat, Inc. v Fisher Dev., Inc. (In re Cocolat, Inc.), 176 B.R. 540, 548 n. 4 (Bankr.N.D.Cal. 1995) (discussing the court's analysis of In re E.R. Fegert, Inc., 88 B.R. 258, in Angeles Elec. Co. v. Superior Court, 32 Cal.Rptr.2d 660 (1994)). Had the subcontractor asserted a claim against the surety, the surety would have had the right to an equitable lien against the funds. See id. Under these circumstances, the preference defendant-subcontractor's release of its claim against the surety resulted in the release of a potential secured claim against debtor-general contractor's property, thereby freeing up property for the benefit of debtor's unsecured creditors. See id. Such a release was properly viewed as "new value" because a payment to a secured creditor in exchange for the release of a lien of equal amount does not diminish the bankruptcy estate for the unsecured creditors. See id.
However, courts in other jurisdictions have consistently rejected preference defendants' contentions that the "release" of their unsecured claims to the extent of the payments received constitute "new value" under § 547(a)(2). See, e.g., In re Cocolat, 176 B.R. at 548.
For example, in Nordberg, the court reasoned that had debtor-contractor not made the payments to the subcontractors, the subcontractors would presumably have foreclosed their liens on property of the owners, and the owners would then have asserted their unsecured rights of indemnification against debtor-contractors. See Nordberg, 904 F.2d at 596. By making these types of payments, debtor-contractors gain nothing more than release of a contingent obligation (i.e., an antecedent debt) owed to an unsecured creditor. See id. Such release cannot constitute "new value" under § 547 because the released right of indemnity provided nothing of tangible value to debtor's estate. See id.; Gulf Oil Corp., 837 F.2d at 230. The bankruptcy estate would be depleted by debtor's payment to the detriment of the unsecured creditors. See Nordberg, 904 F.2d at 596.
In this case, there are genuine issues of material fact as to whether defendant-subcontractor's release of its mechanics' liens resulted in the release of a potential secured claim against debtor-contractor's property, thereby freeing up property for the benefit of debtor's unsecured creditors. It is possible that debtor's accounts receivable due from Genito Mini Storage Facility is a retainer upon which that property owner could have asserted an equitable lien had debtor sought to enforce his mechanic's lien. The parties also dispute whether the transaction was contemporaneous. Thus, assessing the evidence in the light most favorable to the party opposing the motion, neither party is entitled to judgment as a matter of law on this issue.
The final issue is whether defendant's execution of lien waiver and receipt of payment on debt was in the "ordinary course of business" that is excepted under § 547(c)(2). While defendant has not asserted this as an affirmative defense, the trustee argues that defendant cannot avail itself of the "ordinary course of business" defense because it has identified no facts supporting an "ordinary course of business" defense and it applied pressure on debtor in order to receive payment.
There are three elements of this defense. The defendant can easily satisfy the first element, that the debt was incurred in the "ordinary course of business" of debtor and defendant. The latter two elements are in dispute. The second element of this defense — whether a payment was made in the "ordinary course of business" — is judged by a subjective standard (i.e., whether the parties themselves consider the transaction ordinary). See In re Cocolat, Inc., 176 B.R. at 549. Whether payment was made according to ordinary business terms is judged by an objective standard (i.e., whether the relevant industry would consider the payment to have been made according to ordinary business terms). See id.
"Courts have generally recognized that creditors may exert some degree of collection pressure without rendering a resulting payment outside the ordinary course of business." Id. at 550 (holding that to the extent defendant's reference to its mechanic's lien rights constituted collection pressure, it did not exceed the bounds of ordinary business practice); Harrison v. Ink Spot (In re Rave Comm., Inc.), 128 B.R. 369, 373 (Bankr.S.D.N.Y. 1991) (holding that tacit threat not to deliver more goods unless balance paid did not destroy ordinary course nature of payment where creditor had no reason to believe debtor was insolvent); Bernstein v. Sukolsky-Brunelle Photographics (In re Kahn Assoc., Inc.), 135 B.R. 251, 254 (Bankr.W.D.Pa. 1991) (holding that payment was in ordinary course despite modification of past practices to require past balances to be paid before further credit extended).
In this case, should the defendant wish to assert this defense, there would be a genuine issue of material fact as to whether defendant's actions exerted collection pressure outside the "ordinary course of business." Thus, assessing the evidence in the light most favorable to the party opposing the motion, the trustee is not entitled to judgment as a matter of law on this issue.
An order consistent with this opinion will be entered.
ORDER
For reasons stated in the court's memorandum opinion entered today:
IT IS ORDERED that the trustee's motion for summary judgment against C.A. Guard Masonry Contractors, Inc., is granted as follows: the court finds that debtor's payment in the amount of $21,209.06 to defendant C.A. Guard Masonry Contractors, Inc., by check dated January 21, 1998, was a preferential transfer under § 547(b);
IT IS FURTHER ORDERED that both the trustee and defendant's motions for summary judgment on the issue of whether the payment falls within the new value defense under § 547(c)(1) is DENIED; and
IT IS FURTHER ORDERED the trustee's motion for summary judgment requesting that the court declare that the payment fell outside the ordinary course of business defense under § 547(c)(2) is DENIED.