District Court Rules on Property of the Debtor Requirement for Fraudulent Transfer Claims
Section 548 of the Bankruptcy Code enables trustees to avoid certain pre-bankruptcy transfers of “an interest of the debtor in property,” where the transfer was intended to defraud creditors or where the transfer was made while the debtor was insolvent and was not for reasonably equivalent value. 11 U.S.C. § 548(a). Section 544 of the Bankruptcy Code enables trustees to avoid a transfer of “property of the debtor” where a creditor of the debtor would have such a right under state law. 11 U.S.C. § 544(a). The statutory requirement that the transfer be “of an interest of the debtor” or “property of the debtor” (emphasis added) has important implications for claims brought under sections 544 and 548 in the aftermath of a merger or acquisition. This point is illustrated by a recent decision from the District Court of Delaware, affirming the dismissal of fraudulent transfer claims brought under sections 544 and 548 for failure to allege transfer of property by a debtor. Miller v. Matco Electric Corp. (In re NewStarcom Holdings), Civ. No. 17-309 (D. Del. Sept. 6, 2019).
The debtors are NewStarcom Holdings (“NewStarcom”) and two of its operating subsidiaries, Constar International (“Constar”) and Port City Electric (“Port City”). Along with a third former subsidiary, Matco Electric Corporation (“Old Matco”), the companies provided electrical services. In response to financial problems at Port City, NewStarcom shut down Constar and Port City, and Old Matco’s assets were sold to a new entity created by Old Matco’s management, also called Matco Electric Corporation (“New Matco”). NewStarcom’s equity stake in Old Matco was sold to another new entity, the New Matco Stock Trust, for a nominal sum. The transaction closed in December 2007, and NewStarcom, Constar, and Port City (but not Old Matco) filed chapter 7 petitions in January 2008.
After some discovery, the chapter 7 Trustee initiated an adversary proceeding against New Matco and the former Old Matco managers involved in the sale (the “Defendants”). The Trustee did not include the New Matco Stock Trust as a defendant. The Trustee alleged that Old Matco had been sold to New Matco for a fraction of its value, and that the sale should therefore be voided as a fraudulent transfer under section 548 and section 544. The Defendants moved to dismiss these claims, arguing that the Trustee had failed to allege that the challenged transfer involved property of the debtors: Old Matco’s assets had been sold to New Matco, but Old Matco was not a debtor.
The bankruptcy court granted the motion to dismiss. After further discovery, the Trustee filed a motion for reconsideration, alleging that the Defendants had failed to produce certain documents about the transaction in response to the Trustee’s pre-filing discovery requests, and had the Defendants produced those documents, the Trustee would have properly alleged a fraudulent transfer. The bankruptcy court denied this motion as well. It ruled that the Trustee’s motion for reconsideration effectively sought to assert a new claim related to the transfer of stock from the debtors to the New Matco Stock Trust, rather than the asset transfer from Old Matco to New Matco that was the focus of the complaint. The bankruptcy court also held that the Trustee had failed to justify its delay in bringing this claim. The Trustee appealed both the initial dismissal of the claims and the denial of the motion for reconsideration.
The district court affirmed. The district court rejected the Trustee’s argument that the Trustee’s complaint adequately alleged a fraudulent transfer under sections 544 and 548. First, the court held that the allegations in the complaint that described the transfer related to the transfer of Old Matco’s assets to New Matco, a transfer that did not involve any transfer of property of the debtors. Second, in response to the Trustee’s argument that the Trustee did not need to allege the specifics of a complicated corporate transaction at the pleading stage, the court held that the Trustee’s complaint failed to give proper notice to the appropriate defendant for that claim. The court ruled that insofar as the complaint related to the stock transfer, the Trustee had not named the New Matco Stock Trust, or its trustee, as a defendant. The New Matco Stock Trust, as the transferee of the debtor’s equity stake in Old Matco, was the proper defendant for a claim related to the stock transfer, not New Matco, which was the transferee only of Old Matco’s assets. The court also noted that most courts have declined to impose liability for fraudulent transfers on non-transferees.
Third, the court rejected the Trustee’s argument that the stock transfer and the asset transfer should be collapsed into a single transaction and regarded as a transfer from the debtors to New Matco. Relying on the district court and Third Circuit decisions in Crystallex Int’l Corp. v. Petróleos de Venezuela, 213 F. Supp. 3d 683 (D. Del. 2016), aff’d, 879 F.3d 79 (3d Cir. 2018), the court held that the collapsing doctrine was not available to recharacterize the parties to a transaction. The failure to name the New Matco Stock Trust as a defendant was therefore fatal to the Trustee’s claims.
The court likewise affirmed the bankruptcy court’s denial of the motion for reconsideration. The court found that the nature of the transaction was adequately disclosed to the Trustee and that the bankruptcy court had not abused its discretion in not finding any manifest injustice requiring reconsideration.
 The court noted that Crystallex involved claims under the Delaware Uniform Fraudulent Transfer Act, but observed also that the Third Circuit has held that the relevant provisions are nearly identical to those in the Bankruptcy Code and have been interpreted uniformly.