The Essential Resource for Today’s Busy Insolvency Professional
Feature
By Christopher J. Giaimo, Ferve E. Ozturk and Dena S. Kessler1
Cash-Management Accounts
and Fraudulent Transfer Actions
C
Christopher J. Giaimo
BakerHostetler
Washington, D.C.
Ferve E. Ozturk
BakerHostetler
New York
ompanies with multiple subsidiaries use
cash-management systems for the administrative efficiencies of running a complex
business operation. However, they can raise numerous tricky issues for the parent, its subsidiaries and
the subsidiaries’ vendors if the company files for
chapter 11. A popular course of action for debtors
and trustees is to bring fraudulent transfer claims
when the parent directs payments from its centralized cash-management system (CMS) to its subsidiaries’ vendors when the parent is not the recipient
of the vendor’s goods or services and is not contractually obligated to pay for such expenses. These
actions are primarily based on the lack of reasonably equivalent value received by the parent (even
if the subsidiaries received such value).
While fact-specific, two recent decisions illustrate potential weaknesses with the evolving theories behind such claims. In one case, the bankruptcy court ruled that the parent/debtor received
reasonably equivalent value for paying the subsidiaries’ electric bills because it was the beneficiary
of the subsidiaries’ revenues, which were then upstreamed to the parent. The court further held that
there was an implied obligation of the parent to pay
its subsidiaries’ expenses in connection with the
CMS. In the other case, the appellate court affirmed
on judicial estoppel grounds that the bankruptcy
court proceedings established that the CMS account
from which the funds were transferred did not actually belong to the parent/debtor, thus precluding the
trust’s fraudulent transfer claims.
There are few published opinions addressing the
issues raised in fraudulent transfer cases related to a
CMS. However, two recent opinions may help provide guidance to plaintiffs and defendants alike as
they navigate this emerging field of litigation.
1 The views expressed herein are solely those of the authors.
Cash Value and Implied Obligation
to Pay Subsidiaries’ Expenses
In LandAmerica Financial Group Inc. v.
Southern California Edison, 2 Hon. Kevin R.
Huennekens concluded that a parent company that
paid its subsidiaries’ expenses from a CMS received
reasonably equivalent value not only from the revenue that was up-streamed to it from its subsidiaries,
but also from satisfaction of antecedent debt arising
from the parent’s obligation to make these payments
despite the lack of any written obligation to do so. By
satisfying this implied obligation, the parent received
reasonably equivalent value even though it did not
receive the services provided to the subsidiaries.
Background
LandAmerica Financial Group Inc. (LFG) was
a Richmond, Va.-based holding company that operated title insurance businesses and other real estate
transaction services through numerous subsidiaries.3
LFG did not provide any services to customers, but
rather operated exclusively through its subsidiaries,
which up-streamed 100 percent of their revenues to
a CMS.4 LFG used these funds to pay its obligations, as well as those of its subsidiaries.5
During the period leading up to its 2008 chapter
11 filing, LFG paid approximately $240,000 from
the CMS to Southern California Edison for electricity that was provided to two of its subsidiaries.6 No
written contract required LFG to make these payments,7 but LFG sought to recover the payments as
fraudulent transfers, arguing that it did not receive
reasonably equivalent value in exchange for the
2 Case No. 10-03819-KRH (Bankr. E.D. Va. filed Nov. 24, 2010).
3 LandAmerica Fin. Grp. Inc. v. S. Cal. Edison (In re LandAmerica Fin. Grp. Inc.), AP No.
10-03819-KRH, 2014 Bankr. LEXIS 2213, at *7 (May 19, 2014).
4 Id.
5 Id. at *8-9.
6 Id. at *11.
7 Id.
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payments because (1) LFG was not contractually
obligated to Southern California Edison for the obligation of its subsidiaries, (2) LFG did not use the
services provided, and (3) the intercompany receivable that it received from the subsidiaries did not
constitute reasonably equivalent value.8
Bankruptcy Court Grants Summary
Judgment in Defendants’ Favor
Dena S. Kessler
BakerHostetler
Washington, D.C.
Christopher Giaimo
is a partner and
Dena Kessler is
an associate with
BakerHostetler in
Washington, D.C.
Ferve Ozturk is an
associate in the
firm’s New York
office and serves as
a coordinating editor
for the ABI Journal.
The court disagreed with LFG’s theories and
granted summary judgment in favor of Southern
California Edison.9 The court began by recognizing that the focus of a fraudulent transfer under
11 U.S.C. § 548 is the extent of the value that was
received by the estate, not the entity from whom this
value is received (i.e., the transferee).10 The court
further noted that payment of an antecedent debt can
constitute reasonably equivalent value.11
In considering these facts, the court did not limit its
focus on the relationship between LFG and Southern
California Edison. Rather, it focused on the entirety of
the transactions under the CMS and found that during
the avoidance period, LFG received revenues from the
subsidiaries far in excess of the subsidiaries’ expenses
paid by LFG in the amount of approximately $40 million.12 As a result, “LFG’s creditors were not harmed”
by the payments,13 perhaps even suggesting that the
creditors benefited from the transfers.
In further analyzing the CMS, the court found
that LFG was obligated to make payments on the
subsidiaries’ behalf.14 In exchange for the subsidiaries up-streaming their revenue to the CMS, LFG
was obligated to act as their “disbursement agent.”15
Despite the lack of a written agreement detailing
the parties’ obligations, LFG conceded that there
must have been an oral or implied obligation relating to the subsidiaries’ participation in the CMS.16
Therefore, “LFG not only had a contractual duty, but
also a fiduciary obligation to make disbursements
on behalf of its subsidiaries. The absence of express
contracts between LFG on the one hand and [the
subsidiaries] on the other requiring LFG to make
the Transfers is of no moment. The contractual obligation between the companies was implied.”17 The
court concluded that the parties’ intent was “clear
and unambiguous,” the subsidiaries up-streamed
their cash to LFG with the “very clear expectation” that LFG would pay their expenses through
the CMS, “which was specifically designed for that
purpose.”18 Based on these findings, the court held
that LFG received reasonably equivalent value in
the form of the excess cash that it received from the
8 Id. at *6-7.
9 Id. at *22.
10Id. at *14-15.
11Id. at *17-18.
12Id.
13Id.
14Id.
15Id.
16Id.
17Id. at *18-19.
18Id. at *19.
subsidiaries and the satisfaction of its obligations as
the disbursing agent under the CMS.19
Transferred Funds Must Be Property
of the Estate
In Adelphia Recovery Trust v. Goldman, Sachs
& Co.,20 the U.S. Court of Appeals for the Second
Circuit upheld the granting of summary judgment in
favor of the transferee on judicial estoppel grounds
on the basis that the CMS account from which the
funds were transferred did not belong to the parent/
debtor. The implications of the decision for fraudulent transfer actions involving a CMS are limited
by the facts of the case, but further highlight the
nuanced issues that arise with the use of a CMS.
Adelphia Background
The Adelphia decision arises from the high-profile
2002 chapter 11 filing of Adelphia Communications
Corp. and its subsidiaries largely due to fraudulent
concealment of debt by its founder, John Rigas, and
his family members.21 In 2003, a fraudulent conveyance action was instituted against Goldman, Sachs
& Co., which was subsequently prosecuted by the
Adelphia Recovery Trust as a successor-in-interest.22
While the action was pending, Adelphia confirmed and
substantially consummated its reorganization plan.
The suit arose from a 1999 margin loan by
Goldman to Highland Holdings II LLP, an entity
owned by the Rigas family.23 The loan was secured
by Adelphia stock that was owned by Highland.24
Once Adelphia’s fraud was disclosed, its stock price
began decreasing, and Goldman issued several margin calls to Highland.25 To satisfy these margin calls,
the Adelphia Recovery Trust alleged that Adelphia
made cash payments of $63 million to Goldman.26
The Adelphia Recovery Trust further alleged that
Adelphia drew the $63 million directly or indirectly
from a CMS concentration account.27 The concentration account held most of the funds in the CMS through
which Adelphia managed its enterprise, including its
subsidiaries’ cash.28 The Adelphia Recovery Trust
alleged that the transfer of funds from the concentration
account to Goldman constituted a fraudulent transfer.29
The district court granted summary judgment
for Goldman.30 It recognized that the concentration
account was not held by Adelphia but was held in the
name of one of Adelphia’s subsidiaries, which had paid
all of its scheduled creditors in full and did not include
Adelphia.31 As a successor-in-interest to Adelphia, the
19Id. at *19-20.
20748 F.3d 110 (2d Cir. 2014).
21Adelphia Recovery Trust v. Goldman, Sachs & Co., 748 F.3d 110, 113 (2d Cir. 2014).
22Id.
23Id. at 113-14.
24Id. at 114.
25Id.
26Id.
27Id.
28Id.
29Id. at 113-14.
30Id. at 114 (citing Adelphia Recovery Trust v. Bank of Am. NA, No. 05-cv-9050, 2011 WL
1419617, at *2 (S.D.N.Y. April 7, 2011)).
31Adelphia, 748 F.3d at 114.
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Adelphia Recovery Trust was not a creditor of the subsidiary and
therefore lacked standing to sue on its behalf.32 To overcome the
standing issue, the Adelphia Recovery Trust argued that Adelphia
was the real owner — and thus payor — of the concentration
account.33 The district court was not persuaded, finding that the
Adelphia Recovery Trust had admitted in its pleadings that payments were not made by Adelphia, but by its subsidiary, on whose
behalf the Adelphia Recovery Trust lacked standing to sue.34
Second Circuit Affirms
The Second Circuit affirmed the district court’s decision.35 The court framed the issue as whether the margin loan
payments to Goldman from the concentration account were
transfers of Adelphia’s property or should be deemed so.36 In
its argument, the Adelphia Recovery Trust relied on Matter
of Southmark Corp.,37 in which the court determined that a
subsidiary’s settlement payment from a cash-management
account owned by the debtor could be avoided because the
funds were under the complete control of the debtor.38 The
Adelphia Recovery Trust also directed the court to In re
Amdura Corp.,39 in which the court held that funds in a commingled cash-management account belonged to the debtor,
even though the subsidiaries had contributed to the account,
because the debtor was listed as the owner of the account and
had “other cognizable indicia of ownership.”40
The Second Circuit distinguished Southmark and Amdura
on the grounds of judicial estoppel. It recognized that unlike
those cases, in numerous filings before the bankruptcy court,
the concentration account was consistently listed as an asset
only of Adelphia’s subsidiary, not Adelphia itself, and that the
parties had four-and-a-half years to challenge ownership of the
account but failed to do so until the adversary proceeding.41
The Second Circuit recognized that the principles of judicial estoppel were established by the bankruptcy context of the
case, in which “[d]‌etermination of ownership of assets is at the
core of the bankruptcy process.”42 It stated that the subsidiary’s
schedules identified the concentration account as its property,
while Adelphia’s schedules did not.43 From its bankruptcy filing in 2002 until 2009, Adelphia did not claim ownership of
the account and did not seek substantive consolidation of its
estate with the subsidiary’s estate.44 The schedules played a
“key” role in the reorganization plan because the plan was
premised on the fact that the subsidiary owned the account.45
The plan had since been substantially consummated, involving
distributions of billions of dollars to Adelphia’s creditors.46
The court reasoned that in the unique bankruptcy context,
judicial estoppel applies to a debtor’s later claim to assets that
is inconsistent with its earlier positions.47 It recognized that a
different holding would “threaten the integrity of the bank32Id.
33Id.
34Id.
35Id. at 116.
36Id. at 115.
3749 F.3d 1111 (5th Cir. 1995).
38Adelphia, 748 F.3d at 114.
39Id.
4075 F.3d 1447 (10th Cir. 1996).
41Adelphia, 748 F.3d at 115-16.
42Id. at 116, 118.
43Id. at 118.
44Id.
45Id. at 119.
46Id.
47Id. at 118-19.
ruptcy process” and encouraged “sharp practices,” in which
parties shift from denying or affirming ownership of assets as
needed as the case progresses.48 Such tactics are “precisely
what the doctrine is intended to prevent.”49 The court concluded that in light of the “centrality of asset allocation to
the integrity of the bankruptcy process,” a party seeking to
change its litigation position must bear the “heavy” burden of
showing that the change would have a de minimus effect on
the bankruptcy proceeding.50 The Second Circuit held that the
Adelphia Recovery Trust did not meet this burden.
Takeaway from LFG and Adelphia
The outcomes in both LFG and Adelphia are certainly specific to the facts of each case. However, given the dearth of
published opinions addressing fraudulent transfers in relation
to a CMS, the presence of these two cases may prove insightful to those bringing and defending against such claims.
The LFG case is meaningful in that it shows that courts
may take a holistic view of the transactions arising from a
CMS rather than simply focusing on the relationship between
the debtor and the transferee. Like the Watergate adage, by
“following the money” a court may determine what the bottom line is for the debtor’s estate with the ultimate focus
on the harm, if any, to the estate as a result of the transfers.
While the $40 million in net revenue in LFG certainly provided a significant independent basis to dismiss the claims,
the court’s recognition of the debtor’s implied obligation to
pay its subsidiaries’ expenses by virtue of the CMS may provide a meaningful independent defense, absent such favorable facts. Of course, it remains to be seen whether a court
would reach the same outcome if payments made on a subsidiary’s behalf resulted in a net loss for the estate.
While the Adelphia decision was squarely rooted in principles of the judicial estoppel doctrine and its precedential value
may be limited, the Second Circuit’s decision may be meaningful for reasons that are similar to LFG in that courts will
closely scrutinize the CMS to determine whether the entirety
of the transactions will ultimately harm the debtor’s estate.
The court’s conclusion, based on judicial estoppel, was that
Adelphia did not own the account; accordingly, § 548’s requirements could not be met because there was not a “transfer of
property of the debtor.” Therefore, the takeaway for practitioners is to not only be cognizant of prior filings in a case, but to
carefully analyze a company’s CMS as a whole to determine
whether its operation during its avoidance period resulted in
harm to the estate recognizable by the Bankruptcy Code. abi
Editor’s Note: For more on this topic, purchase Advanced
Fraudulent Transfers: A Litigation Guide (ABI, 2014), available in the ABI Bookstore (bookstore.abi.org).
Reprinted with permission from the ABI Journal, Vol. XXXIII,
No. 8, August 2014.
The American Bankruptcy Institute is a multi-disciplinary, nonpartisan organization devoted to bankruptcy issues. ABI has
more than 13,000 members, representing all facets of the insolvency field. For more information, visit abi.org.
48Id. at 119.
49Id. at 119-20.
50Id. at 119.
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