First State Bank of Red Bud v. Official Committee of Unsecured Creditors (In re Schaffer), No. 10-198- GPM, 2011 WL 1118666 (S.D. Ill. March 28, 2011)

CASE SNAPSHOT

A bank made three loans to finance a business. Two loans were made to the corporate entity and personally guaranteed by the principals. The third loan was made directly to the principals. In connection with a later forbearance agreement, the principals executed a mortgage in favor of the bank to secure their loan and guaranties. Six months later, the principals filed for chapter 11 bankruptcy. The Official Committee of Unsecured Creditors sought to avoid the mortgage as a fraudulent transfer under section 548 of the Bankruptcy Code. The Committee argued that the debtors had not received reasonably equivalent value in exchange for the mortgage. The Bankruptcy Court agreed with the Committee, finding that the antecedent debt did not provide reasonably equivalent value. The bank appealed, and the District Court overturned the Bankruptcy Court, holding that all value received by the debtors must be considered when determining “reasonably equivalent value,” and the antecedent debt, together with the bank’s forbearance, provided the debtors with reasonably equivalent value.  

FACTUAL BACKGROUND

Roger and Eva Schaffer, the principals, were in the pork farming business. They were also the shareholders in Premium Pork, Inc., a pork production business. The First State Bank of Red Bud made one loan to the Schaffers and two to the corporation, which the Schaffers personally guaranteed. In connection with a later forbearance agreement, the Schaffers executed a mortgage in favor of the bank, securing the loans and guaranties against real property they owned. Six months later, the Schaffers filed for chapter 11 bankruptcy and commenced an adversary proceeding against their creditors to determine the validity and priority of the liens against and security interests in the real property. The Committee cross-claimed in the adversary proceeding, seeking to avoid the mortgage as a fraudulent transfer.

The Bankruptcy Court held for the Committee, and the bank appealed.  

COURT ANALYSIS

Section 548(a)(1)(B) of the Bankruptcy Code authorizes a debtor to avoid any transfer made within two years before the petition date, if the debtor received less than reasonably equivalent value in exchange for the transfer. Under this section, “value” means “property, or satisfaction or securing of a present or antecedent debt of the debtor.” In the present case, there was no dispute regarding insolvency, and there was no dispute that the antecedent debt constituted value. The parties’ sole dispute was whether the debtors had received reasonably equivalent value in exchange for the mortgage.

The Bankruptcy Court had focused on the antecedent debt and the fact that, at the time the mortgage was executed, no money had changed hands and no new funds were loaned to the debtors personally, and determined that the debtors had not received reasonably equivalent value. The District Court concluded that the Bankruptcy Court had applied the incorrect standard, and all value received by the debtors must be considered when determining reasonably equivalent value.  

The District Court noted that the Committee had stated that the mortgage “was done in connection with an out of court work out or forbearance, where the [bank] agreed not to foreclose on its various security interests in exchange for certain promises by the Debtors and the Mortgage.” The bank had admitted this allegation in its answer, and further answered that: “The [Bank] also extended the terms of the Debtor’s notes and lowered the Debtor’s interest charges as further consideration for the granting of the third mortgage to secure prior Debtor debts of $5,074,906.09.”

The District Court then found that the debtors had received the following value: the antecedent debt, the extended maturity dates, and the bank’s forbearance. Taken together, the District Court held that the debtors had received reasonably equivalent value in exchange for the mortgage. The court held that a fraudulent transfer had not occurred, and therefore ordered that the bank’s lien be reinstated.  

PRACTICAL CONSIDERATIONS

Obtaining new or additional collateral to secure antecedent debt is often a primary goal of restructuring and forbearance agreements. This case points out that lenders must give enough in return for the collateral to protect the transfer from avoidance. Of course, what is “enough” will differ in every factual situation. Thus, the structure of such agreements should be carefully considered in light of the surrounding circumstances.