In In re Thermoview Indus. Inc., the U.S. Bankruptcy Court for the Western District of Kentucky had to decide whether to avoid a Chapter 11 debtor's payment of a supersedeas bond to stay enforcement of a creditor's judgment against the debtor pending appeal. The court concluded that this transfer satisfied every element of a preferential transfer and did not fall under any defenses, granting the debtor's motion for summary judgment and avoiding the transfer.

Background

On or about July 11, 2005, defendant Nelson E. Clemmens obtained a judgment in the amount of $225,000 against Thermoview Industries Inc. in Kentucky state court. Thermoview filed a notice of appeal with the Kentucky Court of Appeals, which appeal was pending as of the issuance of this opinion. On July 27, 2005, Thermoview transferred $300,000 to the Westchester Fire Insurance Company in order to obtain a supersedeas bond, the purpose of which was to stay enforcement of the judgment by Clemmens pending Thermoview's appeal.

On Sept. 26, 2005, Thermoview filed a voluntary petition for relief under Chapter 11 of Title 11 of the U.S. Bankruptcy Code, and became a debtor-in-possession at that time. On June 22, 2006, Thermoview instituted an adversary proceeding against Clemmens, alleging that the transfer of the $300,000 to obtain the bond constituted a preferential transfer under 11 U.S.C. Section 547 of the Bankruptcy Code.

Thermoview asserted the following: that this preferential transfer should be avoided; that the bond should be set aside and voided; and that the $300,000 should be returned to Thermoview. Pursuant to Fed. R. Bankr. P. 7056, incorporating Fed. R. Civ. P. 56, Thermoview filed a motion for summary judgment.

Court's Analysis

The court began by examining the standard for summary judgment under Fed. R. Bankr. P. 7056 and Fed. R. Civ. P. 56: Summary judgment is appropriate only where no genuine issue of material fact remains to be decided such that the movant is entitled to judgment as a matter of law. The burden of proof lies initially with the movant, which must demonstrate the basis of its motion for summary judgment and point out the portions of the record that demonstrate the lack of a genuine issue of material fact. Once the movant meets this burden, the nonmoving party must then point to specific facts that demonstrate the existence of a genuine issue of material fact upon which the nonmoving party will bear the burden of proof at trial.

Turning next to the substantive issue, the court looked to Section 547 of the Bankruptcy Code, which enumerates the elements of a preferential transfer, which follow. A preferential transfer is a pre-petition transfer of an interest of the debtor in property:

• to or for the benefit of a creditor;
• for or on account of an antecedent debt owed by the debtor before such transfer was made;
• made while the debtor was insolvent;
• made either on or within 90 days before the filing of the petition, or between 90 days and one year before the filing of the petition, if the transfer is made to or for the benefit of an "insider" of the debtor; and
• that enables the creditor to receive more than it would have received upon the liquidation of the debtor under Chapter 7 of the Bankruptcy Code.

The court first looked to whether an "interest of the debtor" was transferred when Thermoview paid $300,000 to Westchester to obtain the bond. Recognizing disagreement among the courts as to whether a bankruptcy estate obtains an interest in a supersedeas bond or its proceeds, the court found that because the appellate process had not been concluded, Thermoview still had an "interest" in the bond under Section 541, concerning property of the estate. Simplifying the inquiry, the court found that because the transfer of the $300,000 depleted Thermoview's estate by reducing the quantity of funds it held, the transfer to Westchester qualified as a transfer of an interest of the debtor.

Next, the court looked to whether this transfer was to or for the benefit of a creditor. The court found that while Westchester was not a creditor at the time of the transfer, the transfer of the $300,000 was made for the indirect benefit of Clemmens, as obtaining the bond assured payment in full of Clemmens's debt pursuant to the judgment should Clemmens be successful on appeal. The court then found that because the judgment preceded the date of the transfer of funds by Thermoview for purchase and placement of the bond, the transfer was on account of an antecedent debt of the debtor.

The court next looked to Section 547(f), noting the presumption of insolvency of a debtor within the 90 days immediately preceding the date of the filing of the petition. While a creditor may rebut this presumption, Clemmens introduced no evidence to do so, and the court found that Thermoview was insolvent at the time of the transfer. As to the final element of a preferential transfer (i.e., that the transfer enable the creditor to receive more than it would have received in a liquidation under Chapter 7), the court found that the transfer to Westchester had the effect of dramatically improving Clemmens's status from that of an unsecured creditor to that of a secured creditor.

As to the preferential nature of the transfer to Westchester, Clemmens asserted two defenses. First, Clemmens attempted to set forth a "new value" defense, which provides that a transfer is not preferential if: the defendant extended new value to the debtor; both the defendant and the debtor intended the new value and reciprocal transfer by the debtor to be contemporaneous; and the exchange was, in fact, contemporaneous. Clemmens argued that in exchange for the $300,000, Westchester took on a new obligation to pay Clemmens in the event Thermoview did not succeed on appeal, concluding that this resulted in new value to Thermoview given contemporaneously with Thermoview's transfer to Westchester.

The court disagreed, because while the transfer to Westchester indirectly benefited Clemmens, Clemmens did not give Thermoview anything of value in exchange for improving his status to that of a secured creditor.

Clemmens also argued for an application of the earmarking doctrine, which applies where a third party pays an antecedent debt of a debtor's creditors, and the funds used to pay the debt do not diminish the debtor's estate. Clemmens argued that Thermoview had no control over the funds, which were "earmarked" for a specific debt, relying on case law which the court ultimately found inapposite because, in those opinions: the creditors making the payments had independent obligations to pay the debtors' creditors; and the debtors had no control over the payments.

In this case, the court found that Westchester did not replace Clemmens as Thermoview's creditor, as would be the case in the typical earmarking scenario. Finding that the transfer diminished Thermoview's estate by $300,000, the court rejected Clemmens's earmarking defense.

The court concluded that the transfer of $300,000 from Thermoview to Westchester was a preferential transfer under Section 547, finding that the appropriate remedy was to avoid the transfer of the interest in the Bond to Clemmens. The court did so and granted summary judgment in favor of Thermoview.

Conclusion

The posting of a supersedeas bond is common in litigation, the policy being to protect the prevailing party that is stayed from execution on its judgment pending the outcome of the appeal. On the other hand, bankruptcy preference litigation is also common, and one policy of Section 547 of the Bankruptcy Code is the fair and equitable repayment of creditors. The facts of In re Thermoview Industries constitute a textbook example of the intersection of these policies and the tension between them. The court's opinion correctly provides that a judgment creditor, in whose favor a supersedeas bond has been issued, may still not be protected from the far-reaching effects of Section 547.

Rudolph J. Di Massa, Jr., a partner at Duane Morris, is a member of the business reorganization and financial restructuring practice group. He concentrates his practice in the areas of commercial litigation and creditors' rights. He is a member of the American Bankruptcy Institute, the American Bar Association and its business law section, the Commercial Law League of America, the Pennsylvania Bar Association and the business law section of the Philadelphia Bar Association.

Matthew E. Hoffman is an associate with the firm and practices in the area of business reorganization and financial restructuring. Hoffman is admitted to practice in Pennsylvania and New Jersey.

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