MICHAEL B. KAPLAN, Bankruptcy Judge
This matter comes before the Court in relation to a Chapter 11 bankruptcy petition filed by the Debtor, Route 70 & Massachusetts LLC. Debtor, as Plaintiff, filed a Complaint against Defendant, The Bank ("Defendant"), seeking, inter alia, to avoid, as a fraudulent transfer, a mortgage granted from Debtor to The Bank. Presently before the Court are cross-motions, filed by Plaintiff and Defendant, seeking partial summary judgment on this claim and related claims.
The crux of Plaintiff's claim is that the grant of the mortgage was a fraudulent transfer because the proceeds of the associated loan were immediately paid by the Debtor to one of its founding members. Plaintiff's claim relies on the applicability of a doctrine known as "collapsing," whereby a court may view multiple transactions as an integrated whole for the purposes of a fraudulent conveyance analysis.
For the reasons set forth below, the Court determines that the "collapsing" doctrine does not apply on the facts of this case. As a result, Plaintiff's fraudulent conveyance claims are deficient as a matter of law. Accordingly, Plaintiff's motion for partial summary judgment is denied, and Defendant's cross-motion for partial summary judgment is granted.
Route 70 & Massachusetts LLC ("Debtor" or "Plaintiff") was formed in October 2006 by Mitchell Deutsch and Adrian Moscoguiri as a limited liability company under New Jersey Law. Debtor was intended to be a vehicle for owning and developing certain real estate ("the Property") located at the corner of Route 70 and Massachusetts Avenue in Toms River, New Jersey.
On December 22, 2006, Debtor acquired the Property from Mr. Moscoguiri and his family. The deed recording this transfer reflects a sale for the sum of $2 million. However, the parties agree that the transfer involved two other components. The first was the conveyance of a $1.8 million interest in the Property held by Mr. Moscoguiri, transferred to Debtor as part of his initial membership contribution.
On February 28, 2007, Debtor and Defendant entered into a loan agreement (the "mortgage loan") in the total amount of $6.44 million, of which only $3 million was advanced to Debtor at closing. The loan was secured by a mortgage on the Property. The $3 million advanced to Debtor was paid directly to Debtor's attorney. The funds were then disbursed to Mr. Deutsch to pay off his personal obligations incurred by him in providing his initial membership contributions — that is, to satisfy the promissory note and the Bank of America loan. This disbursement was structured as a loan (the "unsecured loan") from Debtor, as Mr. Deutsch signed a $3 million promissory note when he received the funds.
Debtor operates as a debtor-in-possession, now owned by Herkimer Investments, LLC ("Herkimer"). Herkimer became the sole member of the Debtor after acquiring Moscoguiri's interest as a result of a transfer arising from prior indebtedness.
Debtor initiated this adversary proceeding on March 31, 2009. The complaint challenges various aspects of the February 2007 loan transaction. Presently before the court is Debtor's motion for partial summary judgment on counts two, four, six and seven. Counts two and four seek to avoid the granting of the mortgage as a fraudulent transfer under either § 548 or New Jersey state law (as applied under § 544(b)). Counts six and seven seek to challenge the validity of Defendant's proof of claim and its mortgage lien; accordingly, these counts are dependent on the success of either count two or four. Defendant challenges Plaintiff's fraudulent transfer allegations and has filed a cross-motion for summary judgment with respect to counts two, four, six and seven.
Oral argument on the motions was held on August 23, 2010. At the conclusion of the hearing, the Court took the matter under advisement and reserved decision. After reviewing the parties' submissions and applicable law, the Court is prepared to rule.
The Court has jurisdiction over the underlying case under 28 U.S.C. §§ 1334(a) and 157(a) and the Standing Order of the United States District Court, dated July 10, 1984, referring all bankruptcy cases to the bankruptcy court. Venue is proper in this Court pursuant to 28 U.S.C. § 1409(a). This matter is a core proceeding within the meaning of 28 U.S.C. §§ 157(b)(2)(H) & (K). The statutory predicate for the relief sought herein is 11 U.S.C. § 548 (a)(1)(B)
Summary judgment is appropriate where "the pleadings, the discovery, and disclosure materials on file, and any affidavits show there is no genuine issue as to any material fact and the moving party is entitled to a judgment as a matter of law." Fed. R. Civ. P. 56(c).
The moving party bears the initial burden of demonstrating the absence of a genuine issue of material fact.
Once the moving party establishes the absence of a genuine issue of material fact, however, the burden shifts to the non-moving party to "do more than simply show that there is some metaphysical doubt as to the material facts."
As noted above, Plaintiff's motion seeks to establish a claim for avoidance of the mortgage as a fraudulent conveyance under either § 548(a)(1)(B) or under New Jersey law, as applied through § 544(b). The Bankruptcy Code authorizes a trustee to avoid transfers by the debtor in the 2 year period prior to bankruptcy where the debtor
11 U.S.C. § 548(a)(1)(B) (emphasis added). As a debtor-in-possession, Plaintiff has standing to raise this § 548 claim under 11 U.S.C. § 1107, which grants debtors-in-possession "all the rights. . . and powers . . . of a trustee serving in a case under this chapter."
Section 544(b)(1) allows the trustee to set aside transfers avoidable under applicable state law.
N.J. STAT. ANN. § 25:2-25b (emphasis added).
As debtor-in-possession, Plaintiff may have standing to raise the state law claim under § 544 (by way of § 1107), but only if there exists an "actual creditor holding an unsecured claim who could have avoided the transfer under state law."
Here, Plaintiff has not even alleged the existence of such a creditor, though the Court recognizes that Plaintiff's controlling member was formerly such a creditor. While the Court recognizes that Plaintiff's § 544(b) claims may present an issue of standing, whether or not Plaintiff has standing under § 544(b) does not affect the Court's decision at this juncture.
To successfully avoid the mortgage under a fraudulent transfer approach, Plaintiff must show that Debtor did not receive "reasonably equivalent value" in exchange for the mortgage grant. 11 U.S.C. § 548. To establish less than reasonably equivalent value, Plaintiff relies on the doctrine of "collapsing" to treat the mortgage loan and the subsequent unsecured loan of those proceeds to Mr. Deutsch as a single integrated transaction. Plaintiff's argument rests on this legal fiction because the Debtor did in fact receive the proceeds of the mortgage loan before disbursing them to Mr. Deutsch, and it cannot legitimately dispute that a $3 million loan is equivalent in value to a $3 million mortgage. Thus, Plaintiff is not entitled to relief under the text of the statutes, standing alone; rather, in order to prevail on the lack of reasonably equivalent value element of these statutory claims, Plaintiff must establish an equitable basis which supports such a finding.
As Plaintiff notes in its briefs, the Third Circuit has recognized a court's power to collapse multiple transactions into a single integrated transaction.
The "collapsing" doctrine is essentially an equitable doctrine allowing a court to dispense with the structure of a transaction or series of transactions.
Application of this equitable "collapsing" doctrine would be inappropriate in this case for at least two independent reasons. First, the Plaintiff has failed to demonstrate that creditors were harmed by the transaction, which is the equitable concern motivating the use of this doctrine. Second, the doctrine should not be applied to collapse only certain transactions within a larger scheme of related transactions; instead the doctrine requires a fully holistic approach, which here supports Defendant's position. The Court will address both points in turn.
The collapsing doctrine is most commonly applied to leveraged buyouts ("LBOs").
In the instant case, the transactions at issue are not a true LBO. However, because the transactions resulted in a "cash out" of equity, the LBO analysis is instructive. Here, any future creditor would surely have been on notice of the recorded mortgage and would therefore be unharmed if unable to look to the property for satisfaction of obligations incurred by the Debtor after the challenged transaction.
To be sure, neither § 548 nor the New Jersey fraudulent conveyance statute is limited to existing creditors, and many courts have criticized the distinction between existing and future creditors, as well as the Ninth Circuit's approach in Kupetz, as an unsupportable deviation from applicable statutes.
However, the cited decisions criticize
In the alternative, if the collapsing doctrine is germane, it should be applied holistically, in view of all related transactions. As noted above, "where a transfer is only a step in a general plan, the plan must be viewed as a whole with all its composite implications."
Plaintiff cannot on the one hand enlist equity to collapse both the mortgage loan and the unsecured loan, while at the same time insist on honoring the separate structure of the associated sale and formation transactions. Plaintiff is mistaken in arguing that the collapsing doctrine may only be applied to a narrow set of paradigmatic transactions fitting the description outlined above. "[A] paradigm is simply an example — it does not, by itself, define the exclusive elements of a claim to recover a fraudulent transfer based on a `collapsing' theory."
Debtor's formation and purchase of the property can accurately be described as initiated through a capital contribution totaling $6 million (in the form of cash, a promissory note, and interests in real property), of which $4.8 million was used to purchase the property from the Moscoguiri family. After the challenged transactions, the Debtor was left holding the property subject to a mortgage securing $3 million of enterprise indebtedness, while still holding a $1.8 million equity interest in the property (at the time of the transaction, before the property declined in value), $1.2 million of other property (Mr. Moscoguiri's other membership contribution) and a $3 million promissory note representing Mr. Deutsch's membership contribution.
Under New Jersey law, the parties could have properly formed Debtor to achieve this result more directly. That is, Mr. Deutsch could have initially contributed his promissory note
Where, as here, the series of separate transactions achieved a result that could have been properly achieved by a simpler transaction, equity would require this Court to view all the transactions as an integrated whole. That these transactions occurred so closely in time supports aggregating them together in an equitable framework.
Alternatively, if Mr. Deutsch's promissory note is ignored as a worthless sham, the disbursement of proceeds from the mortgage loan may still have been proper, or at least of sufficient legitimacy to preclude a finding of fraud on the part of Defendant. Specifically, in the context of Mr. Deutsch's $3 million contribution to Debtor, the disbursement of mortgage loan proceeds may be characterized as a cash distribution. Under N.J. STAT. ANN. § 42:2B-42a, members of an LLC may receive distributions:
Here, the proceeds of the mortgage loan were disbursed to Mr. Deutsch in his capacity as a founding member of the Debtor, on account of his initial membership contribution. The disbursement was properly documented and consented to by Mr. Moscoguiri, the other controlling member of the Debtor. Accordingly, even if the promissory note is ignored, the disbursement may properly be characterized as a distribution. There is no fraudulent conveyance where "the debtor retains the proceeds from the first exchange, [and] reconveys them for fair consideration, or uses them for some other legitimate purpose, including the preferential repayment of pre-existing debts."
Having determined that the collapsing doctrine is either inapplicable or insufficient to support Plaintiff's claims in counts two, four, six and seven, the Court concludes that Plaintiff cannot prevail on these claims as a matter of law and is thus prepared to grant Defendant's cross-motion for summary judgment. To the extent a subsequent reviewing court should be at variance with this Court's decision against recourse to the collapsing doctrine, the Court is compelled to note that there remain several critical areas of inquiry where the record does not support a finding by the Court as to the absence of genuine issues of material facts:
As noted above, in order for the collapsing doctrine to bear upon this matter, the transferee in the transaction sought to be avoided must have had knowledge of the fraudulent scheme. That is, Defendant's mortgage lien may only be avoided if it had "actual or constructive knowledge of the entire scheme that renders [the] exchange with the debtor fraudulent."
While the former is essentially undisputed, the latter remains a genuine issue of material fact insufficiently established by Plaintiff. Indeed, the arguments presented above all support the contention that Defendant had no reason to suspect fraud. That is, Defendant's intent may well have been innocent, given the potential absence of other creditors at the time of the transaction, as well as the reasonableness of the Debtor's and Defendant's apparent treatment of the challenged transaction as part of the LLC formation and asset acquisition transactions.
Next, it remains unclear whether Defendant had reason to believe that the scheme would leave the Debtor insolvent, insufficiently capitalized, or in a position to incur debts beyond its ability to pay, as required by the cited fraudulent conveyance statutes. Pointedly, Plaintiff has not alleged any facts to suggest that Debtor did not have the ability to use the remainder of the property's equity — representing by the $1.8 million equity interest contributed by Mr. Moscoguiri — or the $1.2 million of other assets contributed by Mr. Moscoguiri, towards short-term operating expenses. For a land development venture such as contemplated by the Debtor, with little overhead or operating costs apart from professional fees, these assets or additional capital contributions may have been sufficient going forward.
Finally, Plaintiff's own brief indicates that Mr. Deutsch's $1 million promissory note to the Moscoguiri family was secured by an unrecorded mortgage on the property. As New Jersey is a race-notice state, see N.J. STAT. ANN. § 46:22-1, Defendant would have been subordinated to an unrecorded mortgage if it had notice thereof. To the extent that the disbursement of loan proceeds to Mr. Deutsch allowed the Debtor to satisfy an existing encumbrance that would take priority over Defendant's mortgage lien, reasonably equivalent value was given. The extent of Defendant's knowledge of the Moscoguiri family's unrecorded mortgage presents another issue of material fact, both as to reasonably equivalent value and as to Defendant's knowledge that the scheme was fraudulent. Accordingly, Plaintiff has failed to establish the absence of a genuine issue of material fact as to Defendant's knowledge of the fraudulent nature of the scheme, even if it were "collapsed."
For the foregoing reasons, the Court finds that Plaintiff has failed to demonstrate both the absence of a genuine issue of material fact and entitlement to judgment as a matter of law. Accordingly, Plaintiff's motion for summary judgment is denied. Defendant's cross motion for summary judgment is granted, limited to counts two, four, six, and seven. Defendant is directed to submit a form of order.
