• Creditors: Not All Post-Petition Extraordinary Transfers Are Prohibited
  • November 30, 2004 | Author: Howard N. Gorney
  • Law Firm: Nixon Peabody LLP - Boston Office
  • Among the many transactions prohibited by the Bankruptcy Code (the "Code") are those under Section 549. This section bars transfers from a debtor that take place after the filing of a bankruptcy petition and that are outside a debtor's ordinary course of business.1 The policy consideration behind this statute is simple: a bankruptcy debtor must conduct its business under bankruptcy court supervision. Therefore, transactions which are not in a debtor's ordinary course of business must be examined by the court so that all creditors and other parties in the bankruptcy case are on notice of any deals that may affect their interests.

    Examples of proscribed post-petition transactions would include placing a lien on the debtor's assets,2 post-petition payment to a creditor for a pre-petition obligation,3 or any substantial change in a debtor's method of doing business with a vendor.4 However, there may be times when out of the ordinary post-petition transfers by a debtor will be permitted by a bankruptcy court. Admittedly, these instances are unusual, but the fact that they occur means that counsel representing clients whose post-petition dealings with a bankruptcy debtor are challenged should examine the details of these transactions with great scrutiny before rendering advice.

    In this connection, it is important to understand the effect and operation of another section of the Code. Section 105(a) of the Code5 essentially permits a court to effect an order that, so long as it doesn't contravene any other Code section, helps to carry out the Code's operation. Accordingly, bankruptcy courts have used Section 105(a) to:

    • order the substantive consolidation of two separate bankruptcy estates, thereby merging their assets.6
    • regulate the claims process, especially where the claims are of a type not specifically addressed in the code.7
    • issue civil contempt orders.8

    In the case of allowing otherwise prohibited post-petition transfers, therefore, a court could retroactively allow a transfer by a bankruptcy debtor which does not diminish estate assets or, in fact, leaves the estate better off than if the transaction had not taken place. Consider the case of Dobin v. Presidential Financial Corporation of Delaware Valley (In re Cybridge Corp.).9 In that case, a Chapter 7 trustee sued the debtor's former lender, which had collected accounts receivable from the debtor while it was in Chapter 11 proceedings. The lender, because it had no knowledge of the debtor's Chapter 11 filing, had continued to finance the debtor's accounts without the benefit of a court order allowing such arrangements and, prior to the debtor's conversion to Chapter 7, had collected significant amounts of the debtor's accounts receivable.

    The trustee alleged that the lender had collected the accounts receivable in violation of Section 549 and should be ordered to return them to the estate for distribution to creditors according to the hierarchy established by the Code. The lender countered that it had advanced loans to the debtor that exceeded the amounts it had collected. It defended the trustee's action on the basis that, while it may have technically violated Section 549, it had actually loaned more to the estate than it had received in post-petition receivables. Therefore, the lender stated, it should not be made to pay what would amount to a double recovery to the estate.

    The court agreed with the trustee that the lender's actions were not permitted by the Code and that, in ordinary circumstances, the trustee should be able to recover the transferred assets (the accounts receivable and their proceeds) from the lender.10 However, the court stated that the statute does not permit the estate to reap a windfall in circumstances where a post-petition transferee has already made the estate whole.11 Instead, the court invoked its power under Section 105(a) to "do equity" and permit the lender to keep the accounts receivable it had collected while allowing the estate to retain the monies that it had taken as loans during its life as a Chapter 11 debtor.12 In short, the debtor and the lender engaged in an even exchange and both parties were essentially in statu quo, a just result in the court's view.

    Certainly, the circumstances of Dobin are unusual, but not unique. They do present some object lessons that are valuable for creditors' counsel. First, when a client has notice of a bankruptcy filing, the method of doing business with the debtor must be carefully examined. For any transaction that smacks of a deal that is outside of the debtor's ordinary course of business, court approval is a must and no lawyer should let his client engage in any out-of-the-ordinary transfer of the debtor's property without such approval.

    Second, while it is rare, creditors sometimes do not have any notice that their business counterpart is in bankruptcy proceedings. Nevertheless, they may find themselves challenged as the recipient of an unauthorized post-petition transfer. In that instance, it is a must for counsel to examine every detail of the transaction, especially with respect to the net result of the transfers. If the transfer has resulted in a net benefit for the estate, then the Dobin case provides a good example of how a party can seek an equitable result from the court. Even if the result is not entirely to the estate's net benefit, it would do counsel well to get the court to consider that might be some benefit to the estate, so that the effect of any judgment can be minimized.

    111 USC Sec. 549, which states, in relevant part:

    (a) Except as provided in subsection (b) or (c) of this section, the trustee may avoid a transfer of property of the estate-

    (1) that occurs after the commencement of the case; and
    (2) (A) that is authorized only under section 303(f) or 542(c) of this title; or (B) that is not authorized under this title or by the court.

    2In re Halabi, 1989 BR 538 (Bankr. S.D. Fla. 1995).

    3In re Gray Elec. Co., 192 BR 706, 711-12 (Bankr. E.D. Mich. 1996).

    4Sapir v. C.P.O. Colorchrome Corp. (In re Photo Promotion Assoc.), 881 F.2d 6 (2d Cir. 1989) (debtor traded photograph processing services for accounts receivable instead of paying cash).

    511 USC Sec. 105(a) states:

    (a) The Court may issue any order, process, or judgment that is necessary or appropriate to carry out the provisions of this title. No provision of this title providing for the raising of an issue by a party in interest shall be construed to preclude the court from, sua sponte taking any action or making any determination necessary or appropriate to enforce or implement court orders or rules, or to prevent an abuse of process.

    6FDIC v. Colonial Realty Co., 966 F.2d 57 (2d Cir. 1992); Eastgroup Properties v. Southern Motel Assocs., Ltd., 935 F.2d 245 (11th Cir. 1991).

    7This most often occurs in cases involving mass torts, so courts have used Section 105(a) in cases involving asbestos litigation. See, e.g., In re Forty-Eight Insulations, Inc., 58 BR 476, 477 (Bankr. ND Ill. 1986).

    8In re Duggan, 133 BR 671 (Bankr. D. Mass. 1991).

    9312 BR 262 (DNJ 2004).

    1011 USC Section 550(a) permits a trustee to recover, for the benefit of the estate, property, or its equivalent value, transferred in violation of Section 549. But Section 550(d) permits only "a single satisfaction" under subsection (a). This was crucial to the judge's decision since the judge felt that the funds advanced to the debtor constituted a single satisfaction under Section 550(a).

    11312 BR at 270, 271.

    12312 BR 272.