CHAPTER 3 BANKRUPTCY: THE TRUSTEE'S AVOIDING POWERS, LIEN PRIORITIES AND CONSTRUCTIVE TRUSTS
| Jurisdiction | United States |
(May 1986)
BANKRUPTCY: THE TRUSTEE'S AVOIDING POWERS, LIEN PRIORITIES AND CONSTRUCTIVE TRUSTS
Fulbright & Jaworski
San Antonio, Texas
I. SCOPE
This paper will present an analysis of the avoiding powers of a trustee under the Bankruptcy Reform Act of 1978, Pub. L. No. 95-598, 92 Stat. 2549 (codified at 11 U.S.C. §§ 101 -151326 (1982) (amended 1984)) as amended by the Bankruptcy Amendments and Federal Judgeship Act of 1984, Pub. L. No. 98-353, 1984 U.S. CODE CONG. & AD. NEWS (98 Stat.) 333.
II. SHORTHAND REFERENCES
The Bankruptcy Reform Act of 1978, as amended, will be referred to throughout this paper as the Bankruptcy Code. All citations in the format of 11 U.S.C. § _____ will be to the amended statute. All references will be to the voiding powers of the trustee. In Chapter 7 (liquidation) or Chapter 13 or (individual debt adjustment) Cases there will be a trustee who holds the voiding powers. In Chapter 11 (reorganization) Cases, a trustee will not be appointed unless a party in interest moves for the appointment of a trustee and prove the grounds for appointment of a trustee. If there is a debtor-in-possession, rather than a trustee, the debtor-in-possession will hold all of the voiding powers otherwise exerciseable by a trustee and is to perform all of the functions of the trustee, except certain reporting and investigative duties. 11 U.S.C. § 1107(a).
III. INTRODUCTION
Until a few years ago, the oil and gas world was generally limited to individuals who grew up in the business. Deals were made on the basis of a handshake, and fortunes were established by gushers or lost by a trickle. Many of the individuals in the business were in it not so much for the money involved as for the adventure. For those who treated it as a business, the cost of dealing with dry holes and marginal wells made handling the technicalities of the transaction uneconomical, and the niceties of contracts and recording laws were intentionally ignored. The developer usually had low overhead, and the profit margin was generally small.
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Because the business was traditionally limited to a few sophisticated individuals and companies, and because those individuals and companies were prepared philosophically for disaster, financial problems were handled by negotiation and settlement. When an owner or operator found it impossible to pay the bills, the persons who had supplied goods and services formed an informal committee that appointed a new operator, managed the income and expenses, and paid the suppliers from production. If funds or mineral interests remained after payout, the suppliers returned the excess to the owner. The few creditors who supplied office equipment and commercial credit frequently were not represented and went unpaid.
Then when oil prices skyrocketed, oil development became more of an investment tool, with developers establishing grand offices with high overhead. Individuals who had no previous experience became involved as investors. Unscrupulous developers oversold wells, and lackadaisical suppliers of well equipment and services failed to perfect their liens. Financial institutions, thrilled with the prospect of high interest rates and high deposits, failed to investigate the nature of the mineral interests owned by the borrower and the other obligations owned by the borrower. Like everyone else, bankers unfortunately believed the incredibly high prices predicted in the valuations submitted with the loan applications.
Prices slid. Overoptimistic investors refused to accept their losses, and reasonably zealous representatives of printing companies, office equipment suppliers and other unsecured creditors began to demand proof that suppliers of equipment and services to the wells deserved the preferred treatment they sought. Commercial lawyers became involved in unravelling the fabric of oil and gas transactions. Bankruptcy court trustees, creditors' committees and debtors agreed that the primary purpose of the bankruptcy laws in pro rata distribution and that investors and suppliers should be treated as if oil and gas transactions were simple. Novice oil field investors and veteran suppliers of oil field equipment and services agreed that their claims and liens tested under ordinary principles of reorganization and liquidation law as if oil and gas transactions were simple commercial transactions. Oil and gas lawyers argued that the industry was so unique that the custom and practice of the industry should prevail and that the rigid tests of voidable preference and fraudulent transfer laws should not apply. Bankruptcy lawyers responded that the oil and gas industry simply not unique enough for special treatment. Both sides have ably presented their arguments in negotiations and, occasionally, in court. In some instances, the battles have been fought, won and then ultimately lost when
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production from the wells failed to meet expectations and prices continued to fall. In other instances, the values of the mineral interests have been sufficient to pay the cost of the litigation, but the issues have been resolved by settlement before the rulings became public. As with most other bankruptcy law problems, many of the answers are unclear and compromise is indicated.
IV. PREFERENTIAL TRANSFERS
A trustee can void a transfer if the elements of a voidable preference as set forth in Section 547 of the Bankruptcy Code are proved.
A. Elements. Under Section 547, the trustee can void a transfer that was made
(a) to or for the benefit of a creditor,
(b) for or on account of an antecedent debt,
(c) while the debtor was insolvent,
(d) within a certain period of time,
if the effect of the transfer was to provide for that creditor a greater percentage of its claim than it would have received had the transfer not occurred and the creditor simply received a distribution in a liquidation of the debtor's estate under Chapter 7 of the Bankruptcy Code. As to noninsiders, the time period is ninety days before the initiation of the bankruptcy court case. As to insiders, the period is extended to one year.
1. Transfer. Transfer is broadly defined. It includes "every mode, direct or indirect, absolute or conditional, voluntary or involuntary, of disposing of or parting with property or with an interest in property, including retention of title as a security interest and foreclosure of the debtor's equity of redemption[.]" 11 U.S.C. § 101(48).
2. Date of Transfer. The transfer is deemed to have occurred when the transfer "is so perfected that a bona fide purchaser from the debtor against whom applicable law permits such transfer to be perfected cannot acquire an interest in the property transferred that is superior to the interest in such property of the transferee[.]" 11 U.S.C. § 548(d)(1). If the transfer is not perfected before the commencement of the case, the transfer "is made immediately before the date of the filing of the petition." Id.
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3. Creditor. A creditor includes an entity that has a claim against the debtor that arose at the time of or before the order for relief, holders of certain postpetition claims, and holders of claims against certain community property of the debtor. 11 U.S.C. § 101(9). A claim is broadly defined and generally includes every right to payment and every right to an equitable remedy. It is immaterial whether the claim is liquidated, unliquidated, fixed, contingent, matured, unmatured, disputed, undisputed, legal, equitable, secured or unsecured. 11 U.S.C. § 101(4).
4. Antecedent Debt. The Bankruptcy Code does not define antecedent debt. Generally, however, courts have held that if goods or services were supplied before the filing of the bankruptcy court petition, the debt is an antecedent debt. Recently, the Third Circuit Court of Appeals held that an action for asbestos-related injuries does not exist until the manifestation of such injuries and that, consequently, a plaintiff who was exposed to asbestos prior to the reorganization but did not manifest any injury until after the plan was consummated did not hold a claim, contingent or otherwise, against the estate. Schweitzer v. Consolidated Rail Corp. (Conrail) and The Reading Co., 758 F.2d 936 (3rd Cir. 1985).
5. Insolvency. For the purposes of voiding preferences under the Bankruptcy Code, the test of insolvency is to a balance sheet test using fair valuations. If the total value of the debtor's debts is greater than the total value of its property at the time of the transfer, then the debtor is insolvent. The test excludes from the value side of the balance sheet property concealed or removed with intent to hinder, delay or defraud and property that may be exempted under the Bankruptcy Code. 11 U.S.C. § 101(29)(A). As to partnerships, the test includes and excludes the same property as for nonpartnership debtors, and also includes the excess value of the general partners' nonpartnership property over the general partners' nonpartnership debts. 11 U.S.C. § 101(29)(B).
6. Preference Period. The ordinary preference period begins ninety days before the filing of the bankruptcy court petition and ends on the date of the filing of the bankruptcy court petition. However, as to insiders, the period is extended to one year. Prior to the 1984 amendments to the Bankruptcy Code, if the trustee asserted an insider preference, the trustee was required to prove that the creditor was an insider and had reasonable cause to believe that the debtor was insolvent at the time of the transfer. That reasonable cause to believe requirement was eliminated by the 1984 amendments to the Bankruptcy Code.
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7. Greater Percentage. The liquidation distribution test requires a determination of the amount that the creditor in question would have received, had liquidation occurred and the transfer not been...
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