Stating a Cause of Action on an Avoidance Action After Iqbal

Pleading a claim to recover a preferential transfer is one of the most basic bankruptcy causes of action. Merely by establishing the date, amount and recipient of the transfer, the plaintiff can establish that a transfer was made, within 90 days before bankruptcy while the debtor was presumed to be insolvent. Most preference complaints include this basic information and then the conclusions that the payment was made on account of an antecedent debt and that the transferee received more than it would have received in a hypothetical chapter 7. Anyone who has practiced bankruptcy law for any period of time has seen (or drafted) the form complaint with an exhibit A describing the transfer. Preference complaints are sometimes paired with fraudulent conveyance claims making skeletal allegations.

After Ashcroft v. Iqbal, 129 S.Ct. 1937 (2009) and Bell Atlantic Corp. v. Twombly, 550 U.S. 544 (2007), the Supreme Court signaled that a higher standard would be required for pleading, one of plausibility. Instead of pleading the bare elements of a cause of action, the pleading must contain sufficient facts to make the claim plausible.

How does that apply to common avoidance actions? Judge Craig Gargotta addressed that question in Crescent Resources Litigation Trust v. Nexen Pruet, LLC, Adv. No. 11-1082 (Bankr. W.D. Tex. 1/23/12), which can be found here.

In Nexen Pruet, the Litigation Trust filed a complaint which alleged two causes of action: a preference claim and a fraudulent transfer claim. The complaint included the following:

*A description of the debtors’ cash management system;

*A statement that the debtors’ schedules, statement of financial affairs, disclosure statement and a declaration of the debtors’ CFO (none of which were attached) indicated that the debtors were insolvent at all relevant times;

*An exhibit describing the transfers by date, amount, invoice number and date the check cleared; and

*A statement of each cause of action.

The defendant filed a motion to dismiss for failure to state a cause of action, alleging that the claims were based on “naked assertions devoid of further factual enhancement.” The Court found that both claims should be dismissed without prejudice.

The Court relied extensively upon In re Careamerica, Inc., 409 B.R. 737 (Bankr. E.D. N.C. 2009).

In the case of the preference claim, the Court found that the plaintiff had failed to allege sufficient facts to show that the transfer was made on account of an antecedent debt:

Notwithstanding the Court’s finding that the Trust has sufficiently pleaded the majority of the elements of a preferential transfer action, the Court finds that the Trust has not sufficiently pleaded the existence of an antecedent debt. By contrast to the cases cited above, including those which espouse even the most lenient of pleading standards, the Trust’s Complaint contains no description whatsoever of the Defendant, Nexen Pruet, much less a description of the nature of the relationship between Nexsen Pruet and the Debtors. The Complaint merely contains the conclusory allegation that “[t]he Transfers were made . . . for or on account of an antecedent debt owed by the particular Debtor to the Defendant before such Transfers were made,” with no factual allegations to support this contention (id. at 6). Without more, the Court is unable to infer the existence of an antecedent debt based on the conclusory allegations presented under Count I of the Complaint.

Opinion, p. 12.

With respect to the fraudulent conveyance claim, the Court found that the pleadings with regard to both insolvency and lack of reasonably equivalent had not been adequately pled, concluding:

In this case, like in Caremerica, the Trust’s allegations with respect to the fraudulent transfer claim contained in Count Two of the Complaint do no more than mirror the elements of § 548(a)(1)(B) (see docket no. 1, at 7). The Trust argues that the Complaint, read in its entirety, contains a “detailed pleading of insolvency” and a “clear pleading of reasonably equivalent value.” (Docket no 1 at 9.) Like in Caremerica, however, “other than dates, amounts, and names of transferees included in Exhibit B,” along with general conclusory allegations of insolvency and reasonably equivalent value, the Trust fails to support its allegations with factual assertions. (citation omitted).

First, with regard to insolvency, the Trust alleges that the Debtors’ Schedules, Statements of Financial Affairs, and Disclosure Statement, along with the declaration of the Debtors’ chief financial officer, reflect that the Debtors were “deeply insolvent at all times relevant to the complaint.” (Docket no. 1 at 5.) The Trust did not attach any of these documents to its Complaint nor did it refer the Court to any specific facts provided in these documents that would allow the Court to draw a reasonable inference of insolvency. The Trust further alleges that the Debtors were insolvent “under a number of tests” and then proceeds to describe each test, without providing the applicable facts to support a finding of insolvency under any of them (id.). Second, with regard to reasonably equivalent value, the Complaint contains only one sentence, which states, “The Debtor or Debtors identified on Exhibit B received less than the reasonably equivalent value in exchange for the Transfer(s).” (Docket no. 1, at 7.) In light of Iqbal and Twombly, this Court will not accept such “threadbare recitals of a cause of action’s elements, supported by mere conclusory statements.” (citation omitted).

Opinion, pp. 14-15.

The Nexen Pruet opinion has much different implications for the two causes of actions involved. With regard to preference claims, the opinion imposes only a minor burden. In performing its due diligence before filing suit, the plaintiff should have investigated the relationship between the debtor and the creditor and, in particular, should have reviewed the invoices submitted by the creditor. Thus, pleading facts with regard to an antecedent debt should not impose a significant burden. By the same token, it does not provide that much more information to the defendant, who presumably would know this information as well.

The fraudulent conveyance claim is another matter. A preference is a preference primarily because of timing. On the other hand, a fraudulent conveyance could be based on any number of scenarios from a payment made on the debt of another to a payment made to an insider based on made-up invoices. In this regard, the heightened pleading requirements provide useful information to the defendant, as well as requiring the plaintiff to have a theory which would survive scrutiny under Rule 9011. In many cases, a preference claim and a fraudulent conveyance claim will be mutually exclusive. Generally, an antecedent debt implies value. Thus, only an antecedent debt in a transaction for less than reasonably equivalent value could be actionable under both statutes. By requiring a higher standard for pleading fraudulent conveyance claims, the Court protects defendants from having to respond to potentially spurious claims.