Delaware Court Applies “Kiwi” Defense to Preferential Transfers
In In re NewPage Corporation, et al., Adversary Proceeding No. 13-52429 (Bankr. D. Del. Feb. 13, 2017), a Delaware Bankruptcy Court applied a unique defense to certain preferential transfers targeted by a liquidating trustee. The defense focuses on a commonly overlooked element of a preferential transfer, section 547(b)(5).
Attempting to facilitate the principle of equality of distribution among creditors of a debtor, section 547(b) of the Bankruptcy Code provides, in relevant part, that a trustee or debtor may avoid any transfer of an interest of the debtor in property:
- to or for the benefit of a creditor;
- for or on account of an antecedent debt owed by the debtor . . .;
- made while the debtor was insolvent;
- made . . . (A) on or within 90 days before the date of the filing of the [bankruptcy] petition . . .;
- that enables such creditor to receive more than such creditor would receive if—
- the case were a case under chapter 7 of this title;
- the transfer has not been made;
- such creditor received payment of such debt to the extent provided by the provisions of the [Bankruptcy Code].
11 U.S.C. § 547(b) (emphasis added). By allowing the avoidance of such transfers (or payments), any creditor that received a greater payment prepetition than others of its similar class is required to disgorge such payment so that all similarly-classed creditors may share equally.
At the base level, without taking into consideration affirmative defenses (which the Bankruptcy Code separately provides), a trustee or debtor must meet all five elements in order to avoid a prepetition transfer.
Kiwi International Airlines
In Kiwi International Air Lines, Inc., 344 F.3d 311 (3rd Cir. 2003), the Third Circuit Court of Appeals took a hard look at whether a chapter 7 trustee could meet the fifth element of a preferential transfer.
The debtor (Kiwi) was in the business of operating a commercial airline. Within 90 days of filing bankruptcy, the debtor paid $3.9 million to three creditors who facilitated the debtor’s operations (collectively, the “Transfer Recipients”).
Because of a lack of liquidity, the debtor ended up selling its assets during the bankruptcy to a third party. As part of the sale, the debtor assumed the executory contracts with the Transfer Recipients and assigned them to the buyer, as such contracts were necessary for the ongoing business operations of Kiwi.
Significantly, the sale did not include an assignment of any bankruptcy avoidance actions (i.e., preference actions) to the buyer. These avoidance actions remained with the bankruptcy estate.
Two years after Kiwi filed bankruptcy, the case was converted to chapter 7 and a chapter 7 trustee was appointed to liquidate the remaining assets of Kiwi, including the avoidance actions.
When the chapter 7 trustee brought actions against the Transfer Recipients, seeking to disgorge the $3.9 million in prepetition payment they had received, the Transfer Recipients did not dispute the first four elements under section 547(b), and instead argued that the trustee could not disgorge these payments because he could not prove the fifth element of a preferential transfer, i.e. that the payments caused the recipients to receive more than they would have received in a hypothetical chapter 7 case. See 11 U.S.C. § 547(b)(5).
The Third Circuit agreed with the Transfer Recipients, finding that, because Kiwi had assumed the executory contracts with the Transfer Recipients, it had placed these recipients in a different category than general unsecured creditors. Pursuant to section 365(b)(1), upon the assumption of these contracts, the Transfer Recipients were entitled to have all of their prepetition defaults cured. Such default would have included nonpayment of any portion of the $3.9 million to which they were entitled.
While the trustee argued that a hypothetical chapter 7 trustee (which was not in existence when the debtor filed bankruptcy) would not have necessarily assumed the contracts with the Transfer Recipients, the Third Circuit found that the trustee would more likely than not have made the same decision as the debtor, since the assumption and assignment of such contracts was part of a sale that brought value to the debtor’s estate.
Accordingly, the Third Circuit held that, because Kiwi had availed itself of the important right to assume contracts and bind the Transfer Recipients—and a hypothetical chapter 7 trustee would have likely done the same—the Transfer Recipients received the same distribution they would have received in a hypothetical chapter 7 case. Thus, the trustee could not meet section 547(b)(5) (fifth element) and could not avoid the prepetition payments made to the Transfer Recipients.
The NewPage Corporation case involved a slightly different set of facts than the Kiwi case. The debtor (NewPage) similarly filed for chapter 11 relief. But there was no sale of assets or conversion of the case. Instead, a liquidating trustee was appointed pursuant to a confirmed chapter 11 plan, and such trustee was empowered to bring the same types of preferential transfer actions as a regular chapter 7 trustee.
After appointment, the liquidating trustee did initiate a preference action against a vendor of services (CRM), seeking to avoid $2.3 million in prepetition payments made to this vendor. Prior to the bankruptcy, CRM had a long-standing relationship with NewPage, handling all of the debtor’s maintenance and construction needs at its various paper mill plants in the United States.
Pre-bankruptcy, CRM and the debtor entered into a Master Construction Agreement, which provided the terms and conditions of all work that CRM provided to New Page. While the Master Agreement appeared to cover all work performed by CRM, it contained several important provisions that:
- required CRM to enter into separate purchase orders for every job requested by the debtor;
- made each purchase order a separate contract (which incorporated the Master Agreement);
- required the debtor to make payments on account of each separate purchase order upon separate invoicing by CRM; and
- required the debtor to separately approve the services provided under each purchase order.
NewPage’s confirmed chapter 11 plan contained a catch-all provision that provided that the reorganized debtor would assume all of its executory contracts that were not expressly rejected during the bankruptcy case.
Because neither the Master Agreement, nor any of the purchase orders with CRM, was ever expressly rejected by the debtor, CRM argued in the preference action that the Kiwi defense applied, as NewPage would have been required to cure all prepetition nonpayments under the Master Agreement and each purchase order thereto, and therefore CRM did not receive more than it would have received in a hypothetical chapter 7 case.
The NewPage case essentially turned on two issues. First, there was the issue of whether the Master Agreement and the separate purchase orders constituted a single integrated contract. While it appeared clear that the Master Agreement was an executory contract (because it had continuing obligations on both sides), it was not clear whether the various purchase orders for which CRM was paid were executory contracts, as CRM had already been paid and the work had already been performed.
While CRM argued that the Master Agreement and the relevant purchase orders constituted one integrated contract, the bankruptcy court determined that pursuant to guiding state law (Michigan and Wisconsin), the Master Agreement and the separate purchase orders were each separate and divisible agreements. The court reasoned that the various provisions noted above indicated the parties’ intent to enter into such separate agreements with each purchase order.
The next issue was whether the separate purchase orders were executory and therefore assumable under NewPage’s confirmed plan. With respect to this issue, CRM argued, in conclusory fashion, that “both CRM and NewPage had multiple obligations to each other pursuant to various provisions of the Master Agreement and at least nineteen open Purchase Orders for Work to be completed . . .”
However, the bankruptcy court was not persuaded that, as a matter of law, each individual purchase order for which CRM was paid was an open order, with continuing obligations on both sides. Nonetheless, because this matter had come to the court for consideration in the context of a summary judgment proceeding, the Court ultimately elected simply to allow CRM and the trustee to develop their case at a later trial.
The NewPage case is a good reminder that preference actions do not always turn on affirmative defenses, like ordinary course, simultaneous exchange or subsequent new value. See 11 U.S.C. § 547(c). Rather, as illustrated in the Kiwi International case, a good defense can often be found in forcing a trustee or debtor to prove all five elements of section 547(b). While the Bankruptcy Code does give the trustee or debtor a presumption with respect to the insolvency element, see 11 U.S.C. § 547(f), the remaining elements are still open for much discussion and analysis. In NewPage, the preference defendant certainly appeared to be on its way to utilizing the same strategy that proved effective in the Kiwi International case.
One thought on “Delaware Court Applies “Kiwi” Defense to Preferential Transfers”