Dismissal Ruling Full of Disney Allusions

Judge H. Christopher Mott of the Western District of Texas is known to fill his opinions with references to movies and pop songs.   His latest opinion in Xtreme Power Plan Trust v. Schindler, et al (In re Xtreme Power, Inc.), No. 16-1004 (Bankr. W.D. Tex. 12/22/16) continues this trend with allusions to Disney's Frozen, an ironic reference given the current warm weather in Austin.   

The opinion begins:

This type of lawsuit has become somewhat commonplace—directors of a now defunct corporation are sued for breach of fiduciary duties. Here, the parties are currently “Frozen” in battle—as the Defendants filed motions to dismiss under Rule 12(b)(6), echoing “Indina Menzel” to demand that the Plaintiff just “let it go.” For the most part, the Court agrees with the Defendants and will send all but a single claim to a wintery grave.

Opinion, pp. 1-2.

Following a lengthy opinion, the Court allowed a claim against four directors for breach of the duty of loyalty to proceed while concluding that "the remainder of the Complaint skates on such thin ice that it must be dismissed under Rule 12(b)(6)." 

While I do not have time for a lengthy analysis, click on the style of the case above to read it.   It is useful reading for those litigating director and officer liability claims.

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.

When An Argument Doesn't Turn Out As Well As Expected

Sometimes a legal argument which seems clever in the abstract can look downright silly when placed in context. That was the case with several arguments rejected by the court in Smith v. Citimortgage, Inc., et al, Adv. No. 11-5136 (Bankr. W.D. Tex. 2/21/12), which can be found here.

Argument #1:

39. None of the Plaintiffs’ first three (3) claims, which assert that the Defendants are in “breach” or “violation” of the Court’s orders entered in the Plaintiffs’ bankruptcy, come close to meeting the facial plausibility standard. The Plaintiffs have already settled and released these claims through the Court-approved Settlement. Specifically, through the Settlement, they have “release[d]” “Citimortgage . . . and [its] agents and employees . . . from all claims of any kind . . . that [the Plaintiffs’] may have with respect to the . . . [Plaintiffs’] Bankruptcy . . . or any other matters[.]”

40. The Plaintiffs’ allegations that the Defendants are in violation of the Court’s orders are claims with respect to the Plaintiffs’ bankruptcy. Even if the Plaintiffs’ factual allegations are taken as true for the moment, through the Court-approved Settlement, the Plaintiffs’ (sic) traded their rights to enforce the related orders for a contract right to enforce the Settlement pursuant to Texas-state law. They have no right to rescission of the Settlement and cannot now assert claims against any of the Defendants that they affirmatively gave up through the Settlement.

Renewed Motion to Dismiss, pp. 14-15, Dkt #17.

At first blush, the argument that the Debtors released certain claims and are now attempting to pursue them appears to be quite plausible. However, the Bankruptcy Court’s opinion adds the relevant context.

The court declines to read this provision as precluding claims for breach of the settlement agreement itself and violation of the court order approving it. The court also declines to read this provision as precluding claims for violation of the discharge injunction that arise after execution of the settlement agreement. The provision above is best understood as applying to claims that the Smiths had at the time of execution of the settlement agreement.

Opinion, p. 9.

While the argument appeared plausible on its face, it quickly turned outrageous when it became manifestly clear that the plaintiffs were suing for violation of the settlement agreement and the order approving the settlement agreement, each of which necessarily occurred after execution of the underlying agreement. While the power to compromise claims is broad, an agreement which negates its own enforcement is no agreement at all. To put it another way, a release, no matter how broad, cannot release the right to enforce the agreement in which it is contained. Also, I am not aware of any legal principal which would allow a party to release wrongs yet to occur. What is really insidious about the argument in this case is that it appears that Citimortgage was arguing that because the discharge occurred in the bankruptcy case, that the Debtors released their right to ever enforce the discharge against Citimortgage. That is an audacious claim.

Argument #2:

28. The Fifth Circuit has long recognized that in order for a bankruptcy court to have jurisdiction over a matter, “the outcome of that proceeding [must] conceivably have an[] effect on the estate being administered in bankruptcy. (citation omitted). Once administration of a case concludes and a Court closes the case, no bankruptcy case is “being administered”—the bankruptcy court’s jurisdiction over all matters therefore ends at closure of the case. (citations omitted).

29. The Court’s closure of the Plaintiffs’ bankruptcy on September 1, 2011 ended its jurisdiction over any and all related matters. Even if the Adversary were “related to” the Plaintiffs’ bankruptcy for the purposes of 28 U.S.C. Section 157 when filed (which the Defendants deny), the Court’s jurisdiction over the Adversary would have terminated on September 1.

Renewed Motion to Dismiss, p. 11.

Close, but no cigar as noted by the Bankruptcy Court:

None of the cases relied on by Citimortgage involve a debtor’s post-discharge attempt to hold a defendant in contempt for violating court orders. For this reason, Citimortgage’s argument can be easily dispensed with. Bankruptcy courts always retain jurisdiction to interpret and enforce their own orders. (lengthy list of citations omitted). (emphasis added).

Opinion, p. 7.

Never tell a judge that he lacks authority to enforce his own order. By arguing that the court lacked authority to enforce its own orders, Citimortgage struck at the court’s authority. Orders issued by a court which cannot enforce them are not worth the paper they are written on (or in the case of electronically stored data, the PDFs into which they are converted).

What of Citimortgage’s other arguments? They were on the money. Ten out of eleven statutes relied upon by the Plaintiffs for jurisdiction were either not jurisdictional at all or were inapplicable. The court found that it lacked jurisdiction over the Plaintiffs’ Fair Debt Collection Practices Act claim and its state law claims. The court dismissed the claims brought against two employees of Citimortgage. It could be said that the Plaintiffs’ claims contained several grains of wheat among an excess of chaff.

Had the defendants excluded just two arguments from their motion, they would have done a valuable service in helping the court separate the wheat from the chaff. However, by overreaching with grimace-inducing* arguments, they attacked the very integrity of the court from which they sought relief. Better to accept a strong half-victory than to generate an opinion which is equal parts rebuke to both sides.

*--Readers, can you come up with a better term? Originally, I was going to use OMG-inducing, but when I looked it up in the Urban Dictionary, it was defined as a term overused by teenage girls in chat rooms who are incapable of spelling out entire words. I tried forehead-slap, as in Homer Simpson saying "Doh!" but that didn't quite work either. I went with grimace-inducing, even though it is a bit staid, because I could not come up with something more powerful.