Derivative Standing, A Secured Lender and Fraudulent Transfer, Oh My.
09.03.24
In a recent Delaware Bankruptcy Court ruling, Judge Thomas M. Horan granted derivative standing to an Official Committee of Unsecured Creditors to bring suit against the Debtors’ secured lender due to questions over the lender’s influence over the Debtors during the time prior to the bankruptcy proceedings.[1] The Court disposed of three key issues when it decided that the Committee had standing to bring a claim to recoup the alleged fraudulent transfers:
- Fraudulent Transfer Under Section 544. In other jurisdictions, it is established that only a debtor’s transfer of its own property can be voided.[2] The AmeriFirst lender, therefore, argued that the Committee cannot avoid transfers of collateral secured by its liens. In dicta, Judge Horan determined that “the channeling of funds to a properly secured account by extracting unrequited obligations does not cleanse the subsequent transfer of funds solely because the account was subject to a perfected lien.”[3]
- Fraudulent Transfer to Insiders Under Sections 547, 548 and the Uniform Fraudulent Transfer Act. Third Circuit courts typically hold that a party may be a non-statutory insider when a close relationship between the debtor and creditor exists and something other than that relationship suggests that a transaction was not conducted at arm’s length.[4] In AmeriFirst, the Debtors’ secured lender signed a letter of intent to memorialize the Debtors’ commitment to a sale to cure a default to the secured lender which proceeded to call the loan the same day anyway. Judge Horan pointed out that this default provided the lender with significant leverage as other lenders accelerated their loans, and, eventually, the secured lender was left as the most senior lienholder. In finding a colorable claim, the Court concluded that a question existed on whether the lender was an insider given the extensive concessions the lender managed to extract from the Debtors in a purportedly arm’s length settlement.
- Refusal to Prosecute Transfer Claims. Finally, the Court refused to accept the Debtors’ refusal to prosecute the claims based upon the Debtors’ contention that their decision should be upheld because the negotiations with the secured lender were at arm’s length. Instead, the Court noted that the Debtors’ position “does not excuse the Debtors from prosecuting these claims. Whether the May 2023 Restructuring was negotiated at arms-length is a relevant fact, but sections 544, 547, 548(b)(1), and in the corresponding sections of the UFTA do not provide that arms-length negotiations create a complete defense to fraudulent transfers.”[5]
The Court’s opinion leaves us with several takeaways. One, in Delaware, at least, certain transfers might still be subject to avoidance regardless of a secured lender’s perfected lien. Two, while still relevant, arm’s length negotiations alone are not enough to avoid fraudulent transfer claims.
Co-authors Richard Beck, partner, and Alyssa Radovanovich, associate, are members of the Bankruptcy and Restructuring Department at Klehr Harrison.
[1] In re AmeriFirst Financial, Inc., No. 23-11240-TMH, 2024 WL 3841582 (Bankr. D. Del. Aug. 14, 2024).
[2] Id. at *5 n.54 (collecting cases).
[3] Id. at *6.
[4] Id. at *9 (footnote omitted).
[5] Id. at *20.