In a recent ruling likely to be of great interest to debtors and creditors alike, the United States District Court for the Northern District of Georgia (the “Court”) ruled in MC Asset Recovery v. Southern Company1 (the “Southern Co. Litigation”) that fraudulent transfer claims held by a bankruptcy trustee or debtor in possession under the Bankruptcy Code continue to be viable at the conclusion of a bankruptcy case, even if all creditors’ claims have already been satisfied in full pursuant to a plan of reorganization. In so ruling, the Court reaffirmed the accepted rule that a trustee who brings an action to avoid and recover a fraudulent transfer pursuant to sections 544(b) and 550 of the Bankruptcy Code may avoid and recover the transfer in its entirety, even when the value of the transfer exceeds the amounts due to the creditors whose avoidance claims gave rise to the fraudulent transfer action.
Factual and Procedural Background
The Southern Co. Litigation arose out of the bankruptcy case of Mirant Corporation (“Mirant”). Mirant was initially a wholly-owned subsidiary of The Southern Company (“Southern”) and was then spun off by Southern in April 2001. Due to its unsustainably high debt load at the time of the spin-off2, Mirant was forced to file for Chapter 11 protection on July 14, 2003 (the “Petition Date”) in the United States Bankruptcy Court for the Northern District of Texas (the “Bankruptcy Court”).
During the course of Mirant’s bankruptcy proceedings, which, as of the Petition Date, involved approximately $4.8 billion in unsecured claims, the United States Trustee appointed several committees to represent the interests of different groups, including the Mirant Committee, which was tasked with representing the interests of unsecured creditors of Mirant and certain of its affiliates. The Mirant Committee joined with Mirant and affiliates of Mirant in bringing the original complaint against Southern as an adversary proceeding in the Bankruptcy Court, seeking, among other relief, to avoid and recover purported fraudulent conveyances made by Mirant to or for the benefit of Southern.3
Prior to the confirmation of Mirant’s Second Amended Joint Chapter 11 Plan of Reorganization (the “Plan”), Southern filed a motion to withdraw the adversary proceeding from the Bankruptcy Court, asserting, among other claims, a constitutional right to a jury trial. Shortly after the confirmation of Mirant’s Plan, the District Court for the Northern District of Texas (the “District Court”) granted Southern’s motion for withdrawal of the reference and later transferred venue of the Southern Co. Litigation to the Court on February 15, 2006. Prior to transferring venue, however, the District Court granted a motion to substitute MC Asset Recovery, LLC (“MCAR”) as the sole plaintiff in the Southern Co. Litigation. Thus, the Southern Co. Litigation was transferred to the Court following the confirmation of Mirant’s Plan, with MCAR acting as sole plaintiff.
During the course of the Mirant bankruptcy case and more than two years after Mirant filed its Chapter 11 petition, an increase in the value of certain Mirant-owned assets prompted a dispute as to whether Mirant’s value was greater than its then-outstanding debts. Although the Bankruptcy Court undertook an extensive evidentiary hearing to determine Mirant’s value, achievement of a global settlement (reflected in Mirant’s Plan) between Mirant, its creditors and shareholders prevented conclusive resolution of the issue.
Under the global settlement, the Plan established classes of creditors, with Mirant’s unsecured creditors designated under “Class 3,” and Mirant’s stockholders under “Class 5.” Among other things, the Plan provided for (i) a distribution of cash, stock, and warrants of newly-reorganized Mirant (“New Mirant”) to Mirant’s Class 3 and other unsecured creditors; (ii) a distribution of stock and warrants to Class 5 shareholders; and, additionally, (iii) the entitlement of Class 3 creditors and Class 5 shareholders to a 50/50 split of the proceeds from certain lawsuits, including the Southern Co. Litigation. The Plan became effective on January 3, 2006, at which time the value of the distributions received by holders of Class 3 claims resulted in such claimants receiving in excess of 100 percent of the value of their claims.
The Complaint Against Southern
The Southern Co. Litigation was brought (and maintained by MCAR) in an attempt to avoid and recover fraudulent transfers made by Mirant to or for the benefit of Southern and also to recover damages Southern allegedly caused Mirant by other conduct. Specifically, in its complaint, MCAR alleged that certain transactions directed by Southern left Mirant insolvent or in the zone of insolvency prior to the spin-off, thereby contributing directly to Mirant’s decline into bankruptcy. MCAR’s complaint listed causes of action against Southern for avoidance of fraudulent transfers (the “Fraudulent Transfer Claims”), breach of fiduciary duties, restitution and unjust enrichment, recovery of claims against Southern as the alter ego of Mirant, objections to Southern’s proofs of claim, and equitable subordination of Southern’s claims. This article discusses only the issues relating to the Fraudulent Transfer Claims.
Southern’s Motion for Summary Judgment
On May 19, 2006, Southern filed its Motion for Summary Judgment (the “Motion”)4 in which it argued that because Mirant’s unsecured creditors were paid in full under the Plan,5 the claims of MCAR must fail as a matter of law. As the Court noted in its ultimate ruling, the fundamental question raised in Southern’s Motion was whether MCAR’s claims were dependent upon Mirant’s unsecured creditors not having been satisfied in full, or, stated differently, whether MCAR could recover on behalf of Mirant’s creditors if those creditors had already received payment in full in connection with Mirant’s Plan. In answering this question in the affirmative, the Court reinforced the rule that a creditor’s recoveries as part of a plan of reorganization will not eradicate the claims of a bankrupt estate against third parties for fraudulent transfers.
Rejection of Southern’s Challenges to the Fraudulent Transfer Claims
Section 544(b) of the Bankruptcy Code generally vests trustees acting on behalf of a bankruptcy estate—such as MCAR—with the authority to avoid any transfer of an interest of the debtor in property or any obligation incurred by the debtor that is voidable under applicable law by a creditor holding an allowable unsecured claim.6 Notwithstanding this authority, Southern, through its Motion for Summary Judgment, sought to prevent MCAR from enforcing its avoidance powers under section 544(b) by arguing that because Mirant’s creditors had been “paid in full,” MCAR’s right to pursue claims on their behalf should fail as a matter of law. Specifically, Southern argued that (i) MCAR lacked standing to assert its claims to avoid the allegedly fraudulent transfers, (ii) MCAR lacked the ability to avoid those transfers (even if it did have standing), and, finally, (iii) avoidance and recovery of the alleged transfers would constitute an inequitable windfall to MCAR, as Mirant’s unsecured creditors had already been satisfied in full. The Court rejected each of these arguments and denied Southern’s request for summary judgment on MCAR’s Fraudulent Transfer Claims. To understand the Court’s reasoning, it is helpful to analyze each of Southern’s arguments in turn.
With regard to standing, Southern argued that to maintain an avoidance action under section 544(b) of the Bankruptcy Code, a trustee must demonstrate the existence of (i) an unsecured creditor, (ii) who holds an allowable unsecured claim under section 502 of the Bankruptcy Code, and (iii) who could avoid the transfers at issue under applicable (i.e., state) law.7 As all of Mirant’s creditors’ claims had purportedly been satisfied in full at the conclusion of Mirant’s Chapter 11 case, Southern argued that MCAR could not demonstrate the existence of a creditor holding allowable unsecured claims against Mirant as required for MCAR to maintain its action against Southern under section 544(b) of the Bankruptcy Code.
The Court rejected Southern’s reasoning, emphasizing that no basis exists in either case law or the Bankruptcy Code for testing the existence of a “triggering creditor”8 at the conclusion of a bankruptcy case. Rather, the authorities require that any such determination must be made as of the petition date. Accordingly, the Court concluded that MCAR had standing to pursue its fraudulent transfer claims against Southern so long as triggering creditors with allowable claims who could have avoided the transfers existed as of the Petition Date. Since neither MCAR nor Southern disputed the existence of a triggering creditor on the Petition Date, the Court held that MCAR had standing to pursue its fraudulent transfer claims.
Ability to Seek Avoidance After Creditors Paid in Full
Second, Southern argued that even if MCAR had standing to avoid the transfers, MCAR had no legal right to avoid the transfers because (i) Mirant’s creditors had been paid in full pursuant to the Plan and (ii) applicable state law provided that creditors could avoid fraudulent transfers only “to the extent necessary to satisfy the creditor’s claim.”9 Accordingly, because Mirant’s unsecured creditors were allegedly paid in full at confirmation, Southern argued that MCAR’s claims were not voidable under state law. Further, because transferred property may only be recovered under section 550 of the Bankruptcy Code “to the extent a transfer is avoided under section 544,”10 Southern argued that MCAR had no right to recover on its fraudulent transfer claims as MCAR lacked the authority (according to Southern) to avoid those transfers under state law. Stated differently, Southern argued that MCAR could not recover what it could not avoid.
The Court rejected Southern’s arguments, stressing that the Bankruptcy Code distinguishes between a trustee’s right to seek avoidance of a fraudulent transfer (which depends upon the existence of a creditor holding avoidance rights under state law) and a trustee’s right to recover that transfer when avoidance is proper (which is governed solely by federal bankruptcy law). Thus, while state law may limit a creditor’s recovery in a fraudulent transfer action to the amount necessary to satisfy the creditor’s claim, section 544(b) of the Bankruptcy Code does not contain any provision that would limit the potential amount of a trustee’s recovery in any such manner. Rather, in keeping with Supreme Court precedent upon which both sections 544(b) and 550 are based,11 “[a] transaction that is voidable by a single, actual unsecured creditor may be avoided in its entirety, regardless of the size of the creditor’s claim.”12 In other words, section 550 allows trustees to recover not only the amount of the triggering creditor’s claim, but also the entirety of the “property transferred,” so long as the recovery is made for the “benefit of the estate.” 11 U.S.C. §550(a). Having already found that the right to avoid is based on the existence of triggering creditors as of the Petition Date, the Court subsequently held that MCAR had the authority to recovery on its fraudulent transfer claims even if Mirant’s creditors had been paid in full pursuant to the Plan. Thus, the Court ultimately held that any state law limitation on the amount of recovery was inapplicable for purposes of section 550 of the Bankruptcy Code.
Recovery of Transfer as Inequitable Windfall
Finally, Southern challenged the viability of the Fraudulent Transfer Claims because allowing those claims to proceed would violate principles of equity. According to Southern, because Mirant’s unsecured creditors had purportedly been satisfied in full, permitting MCAR to avoid the allegedly fraudulent transfers would constitute an undeserved windfall for both Mirant and the creditors that MCAR represented.
The Court rejected this challenge, observing that any recovery by MCAR would, among other things, inure to the benefit of prepetition creditors holding an equity stake in New Mirant. The Court cited precedent in this regard, noting that:
in instances where prepetition creditors were given an equity stake in a reorganized debtor in partial (or full) satisfaction of their prepetition claims, the increase in value of the reorganized debtor realized from the recovery of an avoidable transfer constituted a benefit to those prepetition creditors and therefore a “benefit to the estate.”13
The Court further emphasized that the terms of the Plan settlement included a combination of cash, an equity stake in New Mirant and the right to the proceeds from further litigation, including the Southern Co. Litigation. Denying MCAR the ability to litigate its claims against Southern would, in the Court’s opinion, inequitably alter the terms of Mirant’s Plan, which vested Class 3 creditors and Class 5 shareholders with a 50/50 interest in the proceeds of the Southern Co. Litigation. Absent evidence that settlement negotiations were either conducted in bad faith or not conducted at arm’s length, the Court held that the Bankruptcy Code and existing case law required that the parties receive the benefit of their bargain. Thus, even if Mirant’s unsecured creditors had been paid in full, the Court found no basis in equity for protecting Southern from MCAR’s fraudulent transfer claims. Thus, the Court denied Southern’s Motion for Summary Judgment with regard to the Fraudulent Transfer Claims.
In issuing its decision in the Southern Co. Litigation, the Court clarified that the ability of a trustee (or, as was the case in the Southern Co. Litigation, a substituted plaintiff standing in the shoes of the trustee) to bring fraudulent transfer claims under sections 544(b) and 550 of the Bankruptcy Code is in no way linked to the value of distributions made in connection with a debtor’s plan of reorganization. Rather, the ability to pursue such fraudulent transfer claims flows from rights accruing to the trustee as of the filing date of the debtor’s Chapter 11 petition. Even though the unsecured creditors in the Mirant case may have enjoyed the unique advantage of receiving stock and warrants in New Mirant which later exceeded the original value of their claims against prepetition Mirant, the value of the distributions had no impact upon the fixed right of MCAR to pursue its claims.