By: Tyler Beach
St. John’s Law Student
American Bankruptcy Institute Law Review Staff
Pursuant to § 548(b)(ii) of title 11 of the United States Code (the “Bankruptcy Code”) and similar state statutes, a transfer made by an insolvent person or a transfer that renders a person insolvent may generally be avoided as a fraudulent transfer.[1]In Mukamal v. National Christian Charitable Foundation, Inc.(In re Palm Beach Finance Partners, L.P.),[2]the United States Bankruptcy Court for the Southern District of Florida held that a trial was necessary to determine the issue of insolvency despite the fact that the debtor had significant net assets at the time the transfers were made.[3]The debtor, Metro Gem, Inc. (“MGI”), was formed to raise money to invest in Petters Company, Inc. (“PCI”).[4]In 2006, MGI made four transfers to the National Christian Foundation, Inc., for approximately $9 million.[5]Two years later, after PCI was exposed as a Ponzi scheme, MGI filed for bankruptcy.[6]Palm Beach Finance Partners, L.P. and Palm Beach Finance II, L.P.were creditors of MGI that subsequently filed for Chapter 11 bankruptcy.[7]The plaintiff, the liquidating trustee for the Palm Beach Finance Liquidating Trust and the Palm Beach Finance II Liquidating Trust, sued the National Christian Foundation, Inc. in the United States Bankruptcy Court of the Southern District of Florida to avoid certain transfers made by MGI as fraudulent transfers.
Because the plaintiff’s claims were based on fraudulent transfer laws, a central issue in this litigation was the solvency of MGI at the time the transfers were made.[8]The plaintiff sought partial summary judgement on the issue of solvency, arguing that MGI was insolvent at all relevant times because a majority of MGI’s assets on the transfer dates were invested in a Ponzi scheme and had no value.[9]The defendant also filed a motion for summary judgement on the issue of solvency, arguing that MGI was solvent at the time of the transfers because MGI’s balance sheet showed significant net assets[10]and because the amounts owed to MGI by the Ponzi scheme in 2006 were actually paid.[11]The court determined that a trial was necessary to determine whether MGI was solvent at the time of the transfers.[12]
Under Georgia law, “a debtor is insolvent if, at a fair valuation, the sum of the debtor’s debts is greater than the sum of the debtor’s assets.”[13]According to the court, when assessing solvency, the determination must be made as of the date of the transfers sought to be avoided.[14]Although the Ponzi scheme existed at the time of the transfers, it was not discovered until nearly two years later.[15]However, a court does not typically consider subjective awareness when valuing assets.[16]Instead, a court will determine the fair market value of an asset by considering a hypothetical sale.[17]Under this approach, the court assumed that MGI knew about the Ponzi scheme,[18]rendering its investment valueless at the time of the transfers.[19]The court stated that even if it based the hypothetical sale on a reasonably diligent buyer rather than an omniscient buyer,[20]MGI’s investment would still be valueless because MGI could have discovered the Ponzi scheme without extraordinary effort.[21]However, this did not end the courts insolvency analysis,[22]because MGI still had a right to repayment of its principal investment.[23]Because there was no evidence regarding the value of MGI’s claim against the Ponzi scheme on the date of the transfers, the court held that neither party was entitled to summary judgement on the issue of insolvency.[24]
The Mukamal court followed the rulings of other bankruptcy courts by considering a hypothetical sale to determine the fair market value of the debtor’s assets.[25]Ultimately, the court held that a trial was necessary to determine the issue of solvency. This decision highlights the fact intensive analysis that is required to determine insolvency, which is why it will not typically by subject to summary judgement.[26]Instead, both parties will usually be given the opportunity to introduce evidence on the issue of insolvency at trial.[27]
[1]11 U.S.C. § 548(b)(ii) (2012).
[2]Mukamal v. National Christian Charitable Foundation, Inc. (In rePalm Beach Finance Partners, L.P.), No. 09-36379-EPK, 2018 Bankr. Lexis 1196 (Bankr. S.D. Fla. 2018).
[3]See id. at *19.
[4]See Mukamal v. Nat’l Christian Foundation, Inc., No. 09-36379-BKC-PGH, 2014 Bankr. Lexis 5418 (Bankr. S.D. Fla. 2014). Starting in 1995 and continuing through September 2008 MGI’s primary business was obtaining funds from third parties to invest in PCI notes. Id. at *2–3.
[5]See Mukamal v. Nat’l Christian Charitable Foundation, Inc., No. 09-36379-EPK, 2018 Bankr. Lexis 1196, at *5 (Bankr. S.D. Fla. 2018).
[6]See id. at *2–3.
[7]See id. at *4. The plaintiff filed a separate adversary proceeding against MGI that settled for approximately $96 million. See id.
[8]See id. at *8. Solvency was required for the plaintiff to succeed under O.C.G.A. § 18-2-75 and also supported the plaintiff’s claim under O.C.G.A. § 18-2-74. See O.C.G.A. § 18-2-74 (2015); O.C.G.A. § 18-2-75 (2015).
[9]See id. at *6. The parties’ dispute focused on MGI’s finance receivables, more than 80% of which were attributable to MGI’s investment in a Ponzi scheme. See id. at *9.
[10]See id. at *9(“During the period of the transfers . . . MGI’s balance sheet showed significant net assets.”).
[11]See id. at *12. (“MGI actually received funds equal to the finance receivables on its books in 2006.”).
[12]See id. at *19. The court determined that the plaintiff’s claims under O.C.G.A. § 18-2-74 were sufficient to survive summary judgement. See id. at *20. However, because the plaintiff failed to produce evidence that it had pre-transfer claims against MGI, the court granted summary judgement for the defendant on the issue of O.C.G.A. § 18-2-75. See id.at *25.
[13]O.C.G.A. § 18-2-72 (2015).
[14]See Mukamal v. Nat’l Christian Charitable Foundation, Inc., No. 09-36379-EPK, 2018 Bankr. Lexis 1196, at *10 (Bankr. S.D. Fla. 2018). A court typically will not consider facts that arise after the date of the transfers. See id.
[15]See id. at *12.
[16]See id.
[17]See id. at *13. (“When valuing an asset or an entity, it is common to consider a hypothetical sale.”).
[18]See Coated Sales, Inc. v. First Eastern Bank, 144 B.R. 663 (Bankr. S.D.N.Y. 1992) (stating that fair market value presumes that all relevant information is known by seller and buyer).
[19]See Mukamal v. Nat’l Christian Charitable Foundation, Inc., No. 09-36379-EPK, 2018 Bankr. Lexis 1196, at *14 (Bankr. S.D. Fla. 2018). The court also stated that it was irrelevant that MGI later received payment from the Ponzi scheme, because there was never a legitimate business with the legal ability to pay MGI. See id.
[20]See id.at *17. Some argue for an alternative approach to a hypothetical sale that assumes a reasonable buyer. See id. at *15.
[21]See id. at *16.
[22]See id. at *17. The court concluded that 80% of the finance receivables had no value on the relevant transfer dates but said that this did not end the solvency analysis. See id.
[23]See id.
[24]Seeid. at *19.
[25]See Coated Sales, Inc. v. First Eastern Bank, 144 B.R. 663, 668 (Bankr. S.D.N.Y. 1992) (“[F]air market valuation entails a hypothetical sale[.]”).
[26]See Lawson v. Ford Motor Co., 78 F.3d 30, 38 (2d. Cir. 1996)(“Whenever possible, a determination of insolvency should be based on seasonable appraisals or expert testimony.”).
[27]See Coated Sales, Inc. v. First Eastern Bank, 144 B.R. 663. The court considered proposed adjustments to the book value by both parties before deciding the issue of solvency. See id. at 670.