Summary
finding that a good faith analysis should weigh both subjective good faith and the objective basis for that good faith
Summary of this case from Bayou Accredited Fund, LLC v. Redwood Growth Partners, L.P. (In re Bayou Group, LLC)Opinion
No. 98 C 5915
July 12, 2000
On Appeal from the U.S. Bankruptcy Court for the Northern District of Illinois, Hon. Ronald Barliant, Presiding Bk Case No. 93 B 16978.
MEMORANDUM OPINION AND ORDER
Background
Plaintiff Alex D. Moglia, Chapter 7 trustee of the debtor, First National Parts Exchange, Inc. ("the Debtor"), appeals from a final judgment of the bankruptcy court entered in his adversary proceeding against Universal Automotive, Inc. Universal cross-appeals from the same judgment. In the underlying proceeding, Moglia sought the recovery of allegedly fraudulent and preferential transfers that the Debtor made to Universal. This court has jurisdiction over the appeal pursuant to 28 U.S.C. § 158(a)(1).
The underlying adversary proceeding focused on the Debtor's transfer of millions of dollars worth of auto parts to Universal. Moglia alleged that the Debtor bought the parts on credit, did not pay the full purchase prices, and fraudulently sold the parts to Universal for cash at prices far below the purchase prices and reasonably equivalent value. Moglia sought $17 million in damages. Moglia also sought to recover payments the Debtor made to Universal on account of outstanding debts, arguing that the payments were preferences. Universal, in turn, sought to recover the unpaid portion of those debts. Moglia sought the equitable subordination of Universal's claim.
This court will not attempt to recount fully the facts of this dispute, which are set forth in great detail in the bankruptcy court's 70-page opinion, but will provide a brief summary of the bankruptcy court's pertinent findings. The transactions at issue involved three companies — Fort Dearborn Jobbers Supply Company, Inc., Universal, and the Debtor, Fort Dearborn was a "warehouse distributor" that purchased auto parts from manufacturers and sold them to "jobbers" who, in turn, sold them to installers. The Debtor was a small jobber and customer of Fort Dearborn. The Debtor had a retail business in which it sold product across the counter and delivered parts to mechanics and installers, The Debtor also sold parts in bulk to entities that the Debtor knew would redistribute them in bulk to other parties. Universal was the Debtor's largest such "redistribution" customer.
In 1991, Fort Dearborn and the Debtor, who had been doing business with each other for about a year, entered into a new business relationship. The terms of that relationship, which ultimately led to the demise of both companies, are disputed. What is not in dispute is that Fort Dearborn sold large quantities of auto parts to the Debtor, but received from the Debtor only a portion of the purchase prices listed on the invoices. The parties referred to these sales as "the APWA program." As the program continued, Fort Dearborn claimed that the Debtor owed the entire invoiced purchase price, while the Debtor claimed that the discount was part of the initial agreement. While the bankruptcy court found both versions of the story to be unbelievable, it found Fort Dearborn's version to be less believable than the Debtor's.
The parties devote some effort to arguing the import of the bankruptcy court's findings on this point. Whether the bankruptcy court found the Debtor's understanding of the APWA program to be accurate, and whether the Debtor's understanding was accurate, have no bearing on this court's analysis.
The Debtor's orders from Fort Dearborn under the APWA program were approximately $100,000 to $200,000 per month in the summer of 1991 and increased through the end of the year, becoming very large in 1992. As the following chart summarizes, the prices reflected on the Fort Dearborn invoices were much higher than the prices at which the Debtor sold the same products to Universal:
Invoiced Prices from Prices Universal Month Ft. Dearborn to Debtor Paid to Debtor Jan. 1992 $ 507,202 $ 394,064
Feb. 1992 412,895 43,993
Mar. 1992 439,963 200,850
Apr. 1992 1,282,392 925,262
May 1992 2,170,805 1,584,854
Jun. 1992 1,031,214 707,202
Jul. 1992 1,530,296 1,057,528
Aug. 1992 1,429,285 961,780
Sep. 1992 1,864,020 1,247,591
Oct. 1992 1,804,171 1,138,597
Nov. 1992 1,692,378 1,134,238
Dec. 1992 12,310 6,880
Universal eventually began to have questions regarding the Debtor's ability to supply the quantity, type, and variety of parts at such low prices. The Debtor explained to Universal that the Debtor bought its product from a distributor that accepted barter points in partial payment of its price. At Universal's request, the Debtor put his explanation in writing — first in a handwritten note, then in a formal letter. The explanation, however, was a lie. Later, in response to another inquiry from Universal, the Debtor informed Universal that its supplier was Fort Dearborn. Universal had been concerned that the parts may have been stolen. The Debtor reiterated its explanation that the low prices resulted from the supplier's use of barter points. Universal contacted the barter company that the Debtor said it was using, and the company confirmed that the Debtor had an account with it.
As outlined by the bankruptcy court, the financial conditions of Fort Dearborn and the Debtor rapidly deteriorated. Unable to pay its creditors, Fort Dearborn stopped supplying parts to the Debtor. Most of Fort Dearborn's debt was incurred in connection with its purchase of the goods that it sold to the Debtor under the APWA program. Fort Dearborn eventually entered into a restructuring agreement with its major creditors under which the creditors would share in any recovery by Fort Dearborn against the Debtor. Fort Dearborn ceased its business operations in August 1995 because of its financial inability to buy parts from manufacturers. As for the Debtor, it was unable to pay its bills, including its taxes, when they came due in 1991 and 1992. The bankruptcy court found that the Debtor was insolvent throughout the period from December 31, 1990 to September 25, 1992.
In his seven-count complaint, Moglia sought to recover damages for intentional fraud (Counts I and III) and constructive fraud (Counts II, IV, and V) under the Bankruptcy Code, 11 U.S.C. § 548, and the Uniform Fraudulent Transfer Act, 740 ILCS 160/1, et seq., and sought to recover preferential payments made to Universal (Counts VI and VII) under 11 U.S.C. § 547. Universal brought counterclaims for balances owed it by the Debtor.
Following trial, the bankruptcy court ruled against Moglia on Counts I and III, finding that the Debtor had not acted with any actual intent to hinder or defraud creditors in transferring the auto parts at issue to Universal. The bankruptcy court also ruled that certain of the transfers were constructively fraudulent — because parts were sold for less than their reasonably equivalent value — but that Universal had acted in good faith in accepting those transfers, and so was entitled to offset the value it gave in exchange for those transfers. The bankruptcy court entered judgment in Moglia's favor on Counts II, IV, and V, awarding Moglia $195,027, plus interest. The bankruptcy court also ruled in Moglia's favor on Counts VI and VII in the amount of $196,348.16, plus interest. Universal prevailed on both of its counterclaims in the amount of $322,703.63. Both parties appeal.
ANALYSIS Moglia's Appeal
Moglia raises four issues in his appeal. First, he argues that the bankruptcy court erred in failing to apply an objective standard in determining whether Universal received goods from the Debtor in good faith under 11 U.S.C. § 548(c) and 740 ILCS 160/9(d). This is a question of law subject to de novo review by this court.
While Moglia brought claims under the Bankruptcy Act and the UFTA, the issues raised in this appeal — as framed by the parties — do not require separate analyses under the two statutes. The court has focused on the Bankruptcy Act, as the parties have not alerted the court to any aspects of the UFTA that require a distinct analysis.
Second, Moglia argues that the bankruptcy court erred in determining that Universal met its burden of proof in establishing that it acted as a good faith transferee. To the extent that Moglia challenges the legal standard adopted by the bankruptcy court, the standard is subject to de novo review; to the extent that Moglia challenges the bankruptcy court's factual findings, those findings will not be disturbed unless they are clearly erroneous.
Third, Moglia argues that the bankruptcy court erred in determining that, for purposes of assessing a damages award, "value" under 11 U.S.C. § 550(a) and 740 ILCS 160/9(b) means reasonably equivalent value, not fair market value. This is a question of law subject to de novo review.
Fourth, Moglia argues that the bankruptcy court erred in finding that the Debtor did not make any transfers to Universal with actual intent to hinder, delay or defraud any of the Debtor's creditors under 11 U.S.C. § 548(a)(1)(A) and 740 ILCS 160/5(a)(1). This issue challenges the bankruptcy court's factual findings, which will not be disturbed unless they are clearly erroneous.
Good Faith — Subjective vs. Objective Considerations
Eleven U.S.C. § 548(a) permits a bankruptcy trustee to avoid any transfer of a Debtor's interest in property, made within one year of the bankruptcy petition, on several grounds, two of which are relevant here: first, if the transfer was made with the actual intent to hinder, delay or defraud creditors; or second, if the Debtor received less than a reasonably equivalent value for the property and the Debtor was insolvent at the time of the transfer or became insolvent as a result of the transfer. Under § 548(c), a transferee who takes for value and in good faith may nevertheless enforce an otherwise voidable transfer to the extent value was given for the transfer. Moglia challenges the standard by which the bankruptcy court determined that Universal was a good faith transferee.
11 U.S.C. § 548(c) provides that:
Except to the extent that a transfer or obligation voidable under this section is voidable under section 544, 545, or 547 of this title, a transferee or obligee of such a transfer or obligation that takes for value and in good faith has a lien or may retain any interest transferred or may enforce any obligation incurred, as the case may be, to the extent that such transferee or obligee gave value to the debtor in exchange for such transfer or obligation.
The corresponding section of Moglia's state-law claim, UFTA § 9(d), is substantially the same.
"Good faith is a finding of fact, and such findings must stand unless clearly erroneous." Covey v. Commercial Nat'l Bank, 960 F.2d 657, 662 (7th Cir. 1992). However, the bankruptcy court's formulation of the legal standard by which good faith is determined is a question of law subject to de novo review. See In re Birkenstock, 87 F.3d 947, 951 (7th Cir. 1996) ("We exercise plenary review over the bankruptcy and district courts' legal interpretations of the Bankruptcy Code. . . .").
Moglia argues that the bankruptcy court used the wrong standard in determining whether Universal accepted parts from the Debtor in good faith under § 548(c). According to Moglia, the bankruptcy court erred by rejecting the objective test used by other courts, and by requiring Moglia to present evidence that Universal acted recklessly or with actual knowledge of a fraud. Moglia contends that the test for determining good faith under § 548(c) is an objective one, and that good faith "may be lacking because of facts known to the transferee that should have put the transferee on notice of other facts even though the transferee lacked actual knowledge of those facts." (Pl.'s Brief at 12)
Supplying a definition of good faith under § 548(c) is easier said than done. The Bankruptcy Code does not define good faith. "Likewise, the legislative history related to section 548(c) never defines, and scarcely addresses, good faith." In re Telesphere Communications, Inc., 179 B.R. 544, 557 n. 20 (Bankr. N.D. Ill. 1994). Courts interpreting § 548(c) "have generally refused to formulate precise definitions." Jobin v. McKay (In re ML Business Mach. Co.), 84 F.3d 1330, 1335 (10th Cir. 1996); see also Hayes v. Palm Seedlings Partners-A (In re Agricultural Research Tech. Group), 916 F.2d 528, 536 (9th Cir. 1990) ("Courts have been candid in acknowledging that good faith `is not susceptible of precise definition.'") (quoting In re Roco Corp., 701 F.2d 978, 984 (1st Cir. 1983)); In re Telesphere, 179 B.R. at 557 (noting that "there is no clear source of interpretive guidance" in construing the term). One commentator observed, in analyzing § 548(c), that "[t]he unpredictable circumstances in which the court may find its presence or absence render any definition of `good faith' inadequate, if not unwise." ML Business, 84 F.3d at 1335 (quoting 4 Collier on Bankruptcy ¶ 548.07 [2] at 548-72 (Lawrence P. King ed., 15th ed. 1996)).
While a precise definition of good faith under § 548(c) may be hard to come by, courts have followed certain parameters in applying the term. Most significantly, every circuit court that has opined on the issue has recognized an objective component to the good faith determination. In ML Business, the Tenth Circuit held that "good faith under § 548(c) should be measured objectively and . . . `if the circumstances would place a reasonable person on inquiry of a debtor's fraudulent purpose, and a diligent inquiry would have discovered the fraudulent purpose, then the transfer is fraudulent.'" 84 F.3d at 1338. And while the Eighth Circuit, in Brown v. Third Nat'l Bank (In re Sherman), 67 F.3d 1348 (8th Cir. 1995), focused on the transferee's knowledge of the debtor's insolvency rather than its knowledge of the fraud, the court still evaluated that knowledge by objective standards. The court held that "a transferee does not act in good faith when he has sufficient knowledge to place him on inquiry notice of the debtor's possible insolvency." Id. at 1355. Similarly, the Ninth Circuit recognized that "courts look to what the transferee objectively `knew or should have known' in questions of good faith, rather than examining what the transferee actually knew from a subjective standpoint." Agricultural Research, 916 F.2d at 535-36.
The majority of bankruptcy courts construing "good faith" under § 548(c) have also relied on an objective standard. See ML Business, 84 F.3d at 1336 (listing cases); Breeden v. L.I. Bridge Fund (In re The Bennett Funding Group, Inc.), 232 B.R. 565, 573 (Bankr. N.D.N Y 1999) ("A transferee's knowledge [under § 548(c)] is determined by an objective rather than a subjective standard."); Meeks v. Red River Entertainment (In re Armstrong), 231 B.R. 739, 744 (Bankr. E.D. Ark 1999) ("Good faith must be determined on a case by case basis using an objective standard of what the transferee knew or should have known."); Sanitary Ice Vending Co. v. Harris (In re Polar Chips Int'l, Inc.), 18 B.R. 480, 484 (Bankr. S.D. Fla. 1982) ("If the circumstances of a conveyance are such as to put an ordinarily prudent man on inquiry as to the fraudulent purpose of the debtor, and if a diligent inquiry would have discovered the fraudulent purpose, and the transferee fails to make such an inquiry, the transfer is fraudulent.").
The bankruptcy court's factual analysis appears to have encompassed both subjective and objective components. Much of the court's analysis focused on Universal's subjective knowledge and belief. The court observed that "[t]here is no evidence that Universal had any actual knowledge that Fort Dearborn was claiming that the Debtor owed it substantial balances for the APWA program goods, or that the Debtor was putting itself into deeper trouble with each sale." (Op. ¶ 184) The court also found the evidence insufficient to establish that "Universal knowingly participated in any fraud, whether the fraud was perpetrated by the Debtor or Fort Dearborn." ( Id. ¶ 216)
Although the bankruptcy court did not expressly indicate that it was addressing the objective reasonableness of Universal's good faith, the fact that it did so is evident from the court's factual findings. The court observed that "Universal knew it was getting very good prices, but from Universal's perspective, these were arm's length transactions, not the result of inappropriate or fraudulent motives and not intended to harm the Debtor's creditors." ( Id. ¶ 184) The court's reliance on "Universal's perspective" implies that the court looked, at least in part, to what someone in Universal's position would know, not just what Universal actually knew. The court also found that if Universal had contacted Fort Dearborn, it would not have learned what the actual invoice prices were because Fort Dearborn wanted the Debtor to generate as much cash as possible by selling to Universal. Indeed, when the principals of the companies did communicate, nothing was said by Fort Dearborn to put Universal on notice of any problem. In focusing on what Universal would have learned by investigating, the bankruptcy court looked to what Universal reasonably should have known, not just what Universal did know. Even more significantly, the bankruptcy court found that "the difference between the Debtor's prices to Universal and fair market value are not so great as to have put Universal on notice that the Debtor was divesting itself of property at prices that harmed its creditors." ( Id. ¶ 185) Again, such findings are a clear indication that the bankruptcy court looked to what Universal should have known, not just what Universal did know.
In framing the relevant legal standards, the bankruptcy court acknowledged that the majority of courts have used an objective approach in reaching good faith determinations under § 548(c). In fact, nothing in the court's analysis of those cases suggests that it rejected the legal standards set forth by those courts. Rather, the court drew factual distinctions, suggesting that it was objectively unreasonable for the transferees in those cases to proceed with the transactions. In this case, by contrast, the bankruptcy court observed that Universal "came upon an offer made by a business associate and friend, someone it had no reason to believe would act dishonestly," and that the APWA program "fit squarely into Universal's business practices of purchasing at below market prices and searching for special deals that it believed were available." ( Id. ¶ 216)
Rather than rely on the cases expressly employing an objective test for determining good faith, the bankruptcy court embraced the good faith analysis set forth in Telesphere, 179 B.R. at 557-59. The Telesphere court recognized that courts' decisions under § 548(c) "reflect a tension between a policy of protecting creditors from fraudulent transfers and a policy of promoting the ease and security of commercial transactions, with the outcome influenced substantially by the equities of the particular fact situations before the courts." Id. at 557. After discussing several Seventh Circuit cases addressing the good faith of lenders under bankruptcy law, the court concluded that "even actual knowledge of the risk involved in a proposed loan does not taint the lender's action with bad faith, as long as the lender genuinely intends the transaction to succeed." Id. at 559.
Applying this standard to the facts before it, the Telesphere court found no evidence that the lenders were attempting to defraud creditors, nor that the borrower was engaged in such an effort. Further, the court found that the lenders made their loans in the ordinary course of their business, and only "after performing an extensive due diligence investigation into numerous aspects of the . . . transaction, including the financial condition of Telesphere and the value to be received by Telesphere as a result of the . . . transaction." Id. The lenders' investigation "disclosed a reasonable prospect of success of the . . . transaction and the eventual repayment of the Lenders' loan." Id.
Judging by the Telesphere court's factual analysis, there is nothing inconsistent between its approach and the pronouncements of courts employing an objective test under § 548(c). Although the Telesphere court rejected the notion that "a transferee acts in good faith only to the extent that it does not know of facts that would put a reasonable person on inquiry notice about the precarious financial condition of the transferor or, alternatively, the voidability of the transfer," id, at 559 n. 23, that rejection was followed by a factual inquiry into the objective reasonableness of the lenders' good faith. Only after discussing the scope and findings of the lenders' due diligence investigation did the Telesphere court find that the lenders "made their loans in a good faith expectation of being repaid from a successful transaction." Id. at 559.
The Telesphere court's rejection of a purely objective test for determining good faith was proper — the mere fact that a transferee is on notice of the precarious financial condition of the transferor does not preclude a finding of good faith under all circumstances. If, as in Telesphere, the transferee proceeds after reasonably accounting for those warning signs, and in full awareness and acknowledgment of the corresponding risks, the court may be justified in finding good faith. Conversely, a transferee cannot stick its head in the sand, clinging to its subjective belief while purporting to ignore signs of fraud or insolvency on the part of the transferor. While the Telesphere court's discussion of case law shows that the § 548(c) inquiry cannot be based solely on a "reasonable person" standard, the court's factual analysis suggests that a transferee's purely subjective good faith does not end the inquiry. The court must also account for the objective reasonableness of the transferee's belief. See generally Quinn v. Ingham (In re GIBCO, Inc.), 185 F.R.D. 296, 300 (D. Col. 1997) (recognizing that good faith under § 548(c) "includes both objective and subjective components").
Finding good faith by the transferee in spite of the transferor's known financial difficulties may be more likely where the transferee is a lender, as in Telesphere. As Moglia points out, lenders may be attempting to help an insolvent or distressed debtor overcome its difficulties.
This court believes that the bankruptcy court implicitly acknowledged these dual subjective/objective components in its § 548(c) analysis. As noted above, rather than reject the circuits courts' reliance on objective tests in cases like ML Business, Agricultural Research, and Sherman, the bankruptcy court factually distinguished those cases. Further, much of the court's factual analysis went beyond the question of Universal's subjective belief, instead addressing the reasonableness of that belief in light of Universal's role in the transaction and relationship to the other parties.
Despite the comprehensive scope of the bankruptcy court's substantive analysis, its framing of the standard was overly narrow. The court held that "[b]ecause the evidence does not establish that Universal acted with knowledge of any fraud or out of any improper motive or recklessly, this Court has found that it took the goods in good faith and for value." (Op. ¶ 219) Only the word "recklessly" suggests that the court's inquiry included an objective component. The court did not indicate its basis for choosing recklessness as the relevant standard of conduct, nor how that standard would be applied. This court does not believe — nor does it find any support for the belief — that a transferee's subjective good faith must be reckless in order to be objectively unreasonable.
The holding's reference to "knowledge" of fraud apparently refers to subjective knowledge in light of the bankruptcy court's reasoning that "the draconian effect of a finding that the transferee did not take in good faith weighs in favor of requiring evidence that the transferee had actual knowledge of a fraud or at least acted recklessly." (Op. ¶ 218)
As discussed above, this court believes that the bankruptcy court engaged in the proper § 548(c) inquiry — weighing both the subjective good faith of Universal and the objective basis for that good faith. However, the language used by the bankruptcy court in framing the inquiry suggests that the objective component played little or no role in its ruling. Based solely on the language of the holding, the bankruptcy court's approach would appear to conflict with the approach taken by most courts in making § 548(c) determinations. In this court's view, nothing in Telesphere or Seventh Circuit case law gives rise to such a conflict. While other courts have emphasized the objective nature of the inquiry, such emphases stem from the facts of the particular case, not from the blanket irrelevance of subjective considerations.
Indeed, the closest the Seventh Circuit has come to a pronouncement on the issue suggests that objective considerations are relevant. In addressing good faith under § 550(b)(1), the court recognized that "the recipient of a voidable transfer may lack good faith if he possessed enough knowledge of the events to induce a reasonable person to investigate." Bonded Financial Servs., Inc. v. European American Bank, 838 F.2d 890, 897-98 (7th Cir. 1988). While this court does not find the Telesphere court's disregard of this holding — on the ground that it arose in the context of § 550(b), not § 548(c) — wholly convincing, the resolution of Moglia's argument is not based on the Bonded Financial holding or its applicability to this case.
The court understands the bankruptcy court's reluctance to formulate a substantive good faith standard, given the lack of guidance from Congress. However, the fact that good faith escapes precise definition does not mean that courts should shun interpretative guidelines altogether. Covey, 960 F.2d 657, relied on by the bankruptcy court, does not suggest otherwise. In that case, the Seventh Circuit recognized that good faith is a question of fact to be decided by the trial court, but did not address — much less call into question — the notion that the good faith inquiry should have an objective component. As noted above, the majority of courts that have wrestled with the § 548(c) problem have concluded that the good faith determination should be governed, at least in part, by objective considerations.
Because the language of the bankruptcy court's holding suggests a possible disregard for the objective component of the good faith inquiry under § 548(c), that portion of the judgment is reversed, and this case is remanded. Given that the bankruptcy court appears to have considered the objective reasonableness of Universal's good faith — without expressly acknowledging as much — the bankruptcy court may reach the identical conclusion on remand. Nevertheless, the bankruptcy court is in a much better position than this court to determine whether, in fact, Universal's good faith was objectively reasonable. Specifically, on remand the bankruptcy court should determine whether, in light of all of the facts, Universal accepted the auto parts in question from the Debtor in good faith, and whether that good faith was objectively reasonable. The court sees no reason why further briefing or evidentiary proceedings on remand would be necessary — unless, of course, the bankruptcy court believes otherwise. In all likelihood, this determination can be made based on the factual record already established, and may simply require the bankruptcy court to clarify its holding.
Good Faith — The Factual Finding
Moglia next challenges the bankruptcy court's conclusion that Universal was a good faith transferee, arguing that the court's factual findings preclude a finding of good faith. According to Moglia, "Any reasonably diligent inquiry by Universal would quickly have confirmed that there wasno commercially reasonable explanation for the terms of sale the Debtor was giving Universal." (Pl.'s Brief at 25-26) The bankruptcy court's findings, Moglia argues, "leave no room for finding that Universal established its good faith, which was its burden." ( Id. at 28)
Moglia couches this argument as a mixed question of law and fact. As a legal question, to the extent that Moglia is arguing that the bankruptcy court reached the wrong conclusion because it failed to weigh its factual findings against an objective standard, the court has already addressed this concern, as discussed above. The bankruptcy court will clarify its holding accordingly on remand.
As a factual question, to the extent that Moglia is challenging the bankruptcy court's finding of good faith, that challenge fails. As Universal points out, the bankruptcy court conducted a four and a half week trial, heard twenty-eight witnesses, and presided over a factual record consisting of over 200 exhibits and 500 transaction files. Its findings of fact comprise 199 paragraphs and fill over 54 pages. The bankruptcy court's findings are well-reasoned and reflect a deep knowledge of the case. Moglia has not pointed to any evidence overlooked by the bankruptcy court that would preclude a finding of good faith. On remand, the bankruptcy court may conclude — as a factual matter — that Universal's subjective good faith was objectively unreasonable. At this stage, however, this court does not find that the opposite conclusion would be clearly erroneous.
Reasonably Equivalent Value vs. Fair Market Value Under § 550(a)
Because the bankruptcy court found that "the sales by the Debtor to Universal of AC Delco resistor spark plugs at prices less than 85¢ each were for less than reasonably equivalent value," and were thus voidable under § 548(a)(1)(B), (Op. ¶ 209), Moglia was entitled to recover the value of those spark plugs from Universal under § 550(a). In determining the recoverable value of the spark plugs, the bankruptcy court looked to their "reasonably equivalent value," rather than their fair market value. ( Id. ¶ 221) The bankruptcy court found the reasonably equivalent value of the plugs to be 85¢ each, and based the damages awarded to Moglia on that price. ( Id. ¶ 222)
Moglia now contends that the bankruptcy court was wrong not to base the § 550(a) recovery on the spark plugs' fair market value, which, according to Moglia, was found by the bankruptcy court to be 94¢. For its part, Universal also challenges the bankruptcy court's valuation of the spark plugs. Universal argues that, under the bankruptcy court's analysis, 85¢ actually represents the fair market value of the spark plugs in the Debtor's hands, not the reasonably equivalent value of the spark plugs. According to Universal, 94¢ represents the fair market value of the spark plugs only in the hands of Universal, and so is irrelevant to the § 550(a) inquiry.
As with the good faith inquiry, the statutory provision itself sheds little light on the dispute. Section 550(a) provides that:
(a) . . . to the extent that a transfer is avoided under section . . . 548 . . . of this title, the trustee may recover, for the benefit of the estate, the property transferred, or, if the court so orders, the value of such property, from —
(1) the initial transferee of such transfer or the entity for whose benefit such transfer was made; or
(2) any immediate or mediate transferee of such initial transferee.11 U.S.C. § 550(a).
"Section 550(a) is intended to restore the estate to the financial condition it would have enjoyed if the transfer had not occurred." Hirsch v. Gersten (In re Centennial Textiles, Inc.), 220 B.R. 165, 176 (Bankr. S.D.N.Y. 1998) (listing cases holding same). While the statute does not define "value," "[c]ourts generally agree that the market value of the property at the time of transfer, less the consideration received, is the proper measure of recovery under § 550." Hirsch v. Steinberg (In re Colonial Realty Co.), 226 B.R. 513, 525 (Bankr. D. Conn. 1998) (listing cases holding same). The fair market value approach is followed in this district as well. See McCullough-Cartwright Pharm. Corp. v. Chemical Packaging Corp. (In re McCullough., Cartwright Pharm. Corp.), Nos. 88 B 2600, 90 A 317, 1991 WL 242985, at *13 (Bankr. N.D. Ill. Sep. 19, 1991) (recognizing that estate "is entitled under § 550 to recover the market value of the transfer, which is what it would have received if the property had not been improperly transferred"); James B. Downing Co. v. Agri Dairy Products, Inc. (In re James B. Downing Co.), 74 B.R. 906, 911 (Bankr. N.D. Ill. 1987) ("The market price at the time of transfer is the proper measure of damages because that is what the debtor would have been able to get for its [product] had it not been improperly transferred.").
In deciding to measure Moglia's recovery by the reasonably equivalent value of the spark plugs, the bankruptcy court stated that Moglia's "contention that `value' for purposes of recovery under Bankruptcy Code § 550 be fair market value is based on one line of dicta in an inapposite preference case, Slutsky v. Michel Tire Co. (In re Vann), 26 B.R. 148 (Bankr. S.D. Ohio 1983)." (Op. ¶ 221) This characterization gives short shrift to a wealth of case law that is not limited to preference cases. See, e.g., Colonial Realty Co., 226 B.R. at 525 (awarding market value for fraudulent transfer). As shown above, the accepted approach under § 550 is to measure value by the fair market value of the property at the time of transfer.
The bankruptcy court went on to reason that "[i]t makes no sense to find, on the one hand, that a sale for 85¢ would not have been a fraud on creditors, but then, on the other hand, require a good faith buyer to pay 94¢." (Op. ¶ 221) Concerned that a recovery based on fair market value would give the estate a windfall, the bankruptcy court observed that the "estate would not have been harmed if it had sold all the goods at reasonably equivalent value, and that should be the measure of damages." ( Id.) This court agrees that the fair market value as measured by the price that Universal was able to charge for the spark plugs would overcompensate the estate and unfairly penalize Universal. However, the fair market value as measured by the price that the Debtor would have been able to charge is warranted because it restores the estate to the position it would have occupied absent the improper transfer.
In suggesting that 94¢ is the proper fair market value for purposes of § 550(a), Moglia correctly points out that the bankruptcy court's estimation of 94¢ was not based strictly on Universal's pricing. (Pl.'s Reply at 12) Because Universal "failed to provide convincing evidence of the terms of its transactions" (Op. ¶ 172), the court looked to evidence of "comparable sales." ( Id. ¶ 173) In adjusting the 94¢ figure downward, however, the court looked to indications "that the Debtor could not have sold the products for the same price as Universal." ( Id. ¶ 176) This suggests, contrary to Moglia's argument, that 94¢ does not represent the value of the spark plugs to the Debtor at the time they were transferred to Universal. In keeping with the restorative purpose of § 550(a), fair market value is to be determined from the estate's perspective. See, e.g., Adashek v. Newspapers, Inc. (In re Milwaukee Cty. Conserv. and Public Serv. Corp.), 47 B.R. 846, 847 (E.D. Wis. 1985) ("The `value' of the preference that is recoverable [under § 550(a)] is determined from the viewpoint of the trustee and estate.").
Judging by the bankruptcy court's analysis, this dispute may boil down to a mere matter of semantics. The bankruptcy court set forth a detailed and well-grounded explanation as to why the Debtor would not have been able to sell the spark plugs at the same prices at which Universal was able to sell them. The discrepancy was based on several factors, including the parties' different positions and roles in the market, the Debtor's inability to extend credit to purchasers, and Universal's transportation and storage costs. To the extent that 85¢ represents the bankruptcy court's estimation of the price at which the Debtor could have sold the spark plugs at the time they were transferred to Universal, the conclusion is not incompatible with the fair market value approach used by courts under § 550(a).
However, to the extent that 85¢ represents some other measure of the spark plugs' value, the bankruptcy court's determination is inconsistent with the purpose of § 550(a). Because the bankruptcy court labeled 85¢ as the "reasonably equivalent value," this court cannot discern with any certainty what 85¢ represents. As the bankruptcy court recognized, reasonably equivalent value is not the same as fair market value. (Op. ¶ 205) Accordingly, this portion of the bankruptcy court's judgment is reversed and remanded. As with the good faith determination, the bankruptcy court may need merely to clarify its holding on remand.
Actual Intent to Hinder, Delay, or Defraud Creditors
Moglia contends that the bankruptcy court committed clear error in finding that the Debtor's sales to Universal were not made with actual intent to hinder, delay, or defraud creditors within the meaning of § 548(a)(1)(A). Moglia correctly points out that it is sufficient to establish the requisite intent "by showing that a debtor made transfers knowing that their effect would be detrimental to creditors." (Pl.'s Reply at 14 (citing Martino v. Edison Worldwide Capital (In re Randy), 189 B.R. 425, 438 (Bankr. N.D. Ill. 1995))) The bankruptcy court, according to Moglia, satisfied this standard by finding that the Debtor knew it was incurring liabilities that it would not be able to meet. In support of this characterization, Moglia points to two findings of the bankruptcy court:
59. Singerman [the Debtor's president and sole shareholder] knew he was in trouble because Fort Dearborn was claiming the Debtor owed more money tha[n] he thought it owed. Nevertheless, he never confronted Adelman [Fort Dearborn's principal] or explicitly denied liability. Singerman was concerned that if it got out on the street that the Debtor supposedly owed that kind of money, it would have ruined his business because he would not have been able to get credit anywhere. Singerman testified that he had not called Adelman about the amounts claimed on the Fort Dearborn statements because he did not want to "draw a line in the sand."
62. There is no direct evidence of Adelman's state of mind, but the inference is unavoidable. Neither Adelman nor Singerman was prepared to deal with the consequences of honestly confronting the problem and stopping the conduct that was making it worse with every sale. By the spring of 1992, both men were desperately trying to save their businesses, and both decided that the way to do that was to raise cash as fast as possible. The best way to do that was to sell even more APWA program merchandise.
(Op. ¶¶ 59, 62)
Contrary to Moglia's characterization, neither of these paragraphs indicate that the bankruptcy court found that the Debtor incurred liabilities that it knew it would be unable to meet. Paragraph 59 focuses on the parties' dispute as to the amounts owed, noting that Fort Dearborn claimed that the Debtor owed more money, and that Singerman was concerned over potential rumors that the Debtor supposedly owed large sums of money. As the bankruptcy court found elsewhere, "Considering [Singerman's] testimony as a whole . . . it is very clear that he never wavered from his original understanding of the APWA program." ( Id. at 19 n. 5)
Moglia seizes on paragraph 62's reference to "the problem" as signifying "the Debtor's mounting insolvency," and argues that the bankruptcy court therefore found that the Debtor knew of, but refused to confront, the fact that the APWA program was rendering it insolvent. (Pl.'s Brief at 37) Moglia offers no support for its assertion that "the problem" referred to by the bankruptcy court is the Debtor's insolvency. Judging by the context, it is more likely that "the problem" meant the parties' dispute as to the terms of the program, and the fact that Fort Dearborn was demanding more money from the Debtor. There is no finding that Singerman conceded the validity of Fort Dearborn's claims, or that he knew that the Debtor's continuation of the program would lead, in fact, to insolvency. Paragraph 62 does not suggest that the bankruptcy court committed clear error in finding that the Debtor did not intend to delay, hinder, or defraud its creditors.
The snippet of Singerman's testimony cited by Moglia as evidence of the bankruptcy court's error also misses the mark. On cross-examination of Singerman, the following exchange occurred:
Q: Sir, as you continued to buy the product from Fort Dearborn you knew that you couldn't possibly pay for it, correct?
A: That's correct.
(Pl.'s Brief at 36 (quoting Tr. 12/12/97 at 26))
As Universal points out, Singerman subsequently clarified this testimony, stating:
I want to clarify the owing to Fort Dearborn. As I understand the program, I was not to owe Fort Dearborn at any time any residual. When someone says to me could I have the ability to pay for it, it is based upon the assumption that they wanted that money, not my understanding that I owed it. I want to be very clear about that, okay.
(Resp. at 40 (quoting Tr. 12/12/97 at 28))
Notwithstanding Singerman's clarification, Moglia insists that the testimony shows that "Singerman admitted he knew he `couldn't possibly pay' what Fort Dearborn was claiming the Debtor owed for the product." (Reply at 17) Even under Moglia's characterization, the testimony is not evidence that Singerman knowingly incurred obligations that the Debtor could not meet. Singerman admitted that he could not pay what Fort Dearborn was claiming to be owed, not what was actually owed. Moglia's argument that "[i]t is no defense that the debtor purportedly entertains an ill-founded belief that he doesn't `owe' the money" mischaracterizes the findings below. ( Id.) The bankruptcy court found Singerman to be a credible witness, and found that he never wavered from his original understanding of the APWA program. (Op. at 19 n. 5) Regardless of whether Singerman's understanding was correct, he cannot be said to have intended to hinder, delay, or defraud creditors by continuing in the program. His admission under cross-examination does not suggest that the bankruptcy court committed clear error in reaching the same conclusion.
Based apparently on Singerman's admission, Moglia argues that the bankruptcy court also committed clear error in finding that Singerman never wavered from his original understanding of the program. (Pl's Brief at 36 n. 18) Because the admission — especially when viewed along with Singerman's subsequent clarification — does not indicate that Singerman stopped believing that his understanding of the program was correct, this court rejects Moglia's argument.
Universal's Cross-Appeal
In its cross-appeal, Universal challenges two aspects of the bankruptcy court's ruling. First, Universal argues that the bankruptcy court erred in concluding that Universal paid less than reasonably equivalent value to the Debtor for spark plugs. Second, Universal argues that the bankruptcy court abused its discretion in its award of prejudgment interest.
Reasonably Equivalent Value Under § 550(a)
The court has already addressed many of the arguments proffered by Universal in support of its assertion that it paid reasonably equivalent value for the spark plugs. Universal contends that, in finding that the reasonably equivalent value of the spark plugs was 85cent, the bankruptcy court actually meant that 85¢ was the fair market "value of the spark plugs from the Debtor's perspective. As discussed above, there is some merit to Universal's reading of the bankruptcy court's analysis. It is up to the bankruptcy court, on remand, to clarify exactly what 85¢ represents. If 85¢ does not represent the fair market value from the Debtor's perspective, then the bankruptcy court will need to generate a new figure for purposes of compensation under § 550(a).
As a factual matter, however, this court does not find that the bankruptcy court committed clear error in finding that Universal paid less than reasonably equivalent value for the spark plugs — regardless of whether 85¢ is viewed as the spark plugs' reasonably equivalent value or fair market value. From what this court can discern, Universal's argument to the contrary is based primarily on another court's factual determination that 87% of a product's fair market value was reasonably equivalent value. See First Trust Nat'l Ass'n v. American Nat'l Bank and Trust Co. (In re Adventist Living Centers, Inc.), 174 B.R. 505, 517 (Bankr. N.D. Ill. 1994). The fact that another court made a different factual determination does not render the bankruptcy court's determination clearly erroneous. Prejudgment Interest
of course, if any facet of the above analysis leads the bankruptcy court to revisit its factual findings, it is free to do so.
Universal challenges the bankruptcy court's award of prejudgment interest on three grounds. First, Universal argues that prejudgment interest should not be awarded where, as here, the amount of the transferee's liability was undetermined prior to judgment. Second, Universal argues that prejudgment interest should begin on the date the claim was filed, not on the date of the avoided transfer. Third, Universal argues that interest should be calculated at the applicable federal judgment rate, not the prime rate.
Whether to grant prejudgment interest and the rate of interest are matters within the bankruptcy court's discretion. Gorenstein Enterprises, Inc. v. Quality Care-USA, Inc., 874 F.2d 431, 439 (7th Cir. 1989). Although the Bankruptcy Code does not specify whether a court may award prejudgment interest to a prevailing trustee, Carmel v. River Bank America (In re FBN Food Services, Inc), 175 B.R. 671, 690 (Bankr. N.D. Ill. 1994), aff'd, 185 B.R. 265 (N.D. Ill. 1995), aff'd and remanded, 82 F.3d 1387 (7th Cir. 1996), courts do so frequently, although not automatically. Energy Cooperative, Inc. v. Cities Service Co. (In re Energy Cooperative, Inc.), 130 B.R. 781, 792 (Bankr. N.D. Ill. 1991). As bankruptcy courts have recognized, prejudgment interest is essential to compensate the prevailing party for the lost time value of money. FBN Food Services, Inc., 175 B.R. at 690 (citing NLRB v. International Measurement and Control Co., 978 F.2d 334, 336-37 (7th Cir. 1992)).
In Turner v. Davis, Gillenwater Lynch (In re Investment Bankers, Inc.), 4 F.3d 1556 (10th Cir. 1993) — the case primarily relied on by Universal in asserting that prejudgment interest should not have been awarded in this case — the Tenth Circuit observed that "courts have traditionally awarded prejudgment interest to a trustee who successfully avoids a preferential or fraudulent transfer from the time demand is made or an adversary proceeding is instituted unless the amount of the contested payment was undetermined prior to the bankruptcy court's judgment." Id. at 1566 (emphasis added). This language strikes the court more as an observation by the Tenth Circuit of courts' general practice, rather than as a blanket prohibition of any prejudgment interest award where the contested amount is undetermined prior to judgment. Similarly, in Barber v. Lebo (In re Industrial Municipal Engineering, Inc.), 127 B.R. 848, 851 (Bankr. C.D. Ill. 1990), the court observed that "[a] prevailing standard, though not uniformly accepted, is whether the amount of the transfer could have been ascertained without a judicial determination." This language does not suggest a hard-and-fast legal rule, but rather a commonly followed approach to prejudgment interest. See also Colonial Realty Co., 226 B.R. at 526 ("Some courts refuse to award prejudgment interest where the amount of the contested payment was unliquidated before judgment.").
This court's interpretation is supported by Gray v. Travelers Ins. Co. (In re Neponset River Paper Co.), 219 B.R. 918 (Bankr. D. Mass. 1998), aff'd, 232 B.R. 829 (B.A.P. 1st Cir. 1999), in which the court rejected "the argument that prejudgment interest must be denied where the amount was neither liquidated nor reasonably ascertainable before trial." Id. at 920. The Neponset River court found that "a prevailing plaintiff on a claim whose amount was neither liquidated nor reasonably ascertainable before trial is entitled to prejudgment [interest] not as a matter of right but only in the discretion of the jury — or of the judge, as the case may be." Id. "The prejudgment status of the claim is a factor in the court's equitable balancing, but not necessarily a controlling one." Id. Even where the disputed amount is not ascertainable before judgment, the estate cannot be made whole without the award of prejudgment interest. See id. at 921.
This court recognizes that, under some circumstances, the award of prejudgment interest may be inequitable where the disputed amount is not ascertainable before judgment. Universal has not convinced the court that such an award was inequitable here. In any event, this is a matter within the discretion of the bankruptcy court. This court discerns no basis on which to find that the award of prejudgment interest was an abuse of the bankruptcy court's discretion under these circumstances.
As for the date on which prejudgment interest should begin to accrue, courts have taken different approaches. Where a transfer is found to be constructively fraudulent, some courts have awarded prejudgment interest beginning from the time demand is made or an adversary proceeding initiated, see, e.g., Murray v. Louisiana State Univ. Foundation (In re Zohdi), 234 B.R. 371, 385 (Bankr. M.D. La. 1999); Floyd v. Dunson (In re Ramirez Rodriguez), 209 B.R. 424, 434 (Bankr. S.D. Tex. 1997); Pereira v. Private Brands, Inc. (In re Harvard Knitwear, Inc.), 193 B.R. 389, 399 (Bankr. E.D.N.Y. 1996); Shape, Inc. v. Midwest Engineering, Inc. (In re Shape, Inc.), 176 B.R. 1, 3 (Bankr. D. Me. 1994), while other courts have awarded prejudgment interest from the date of the transfer. See, e.g, Kendall v. Sorani (In re Richmond Produce Co., Inc.), 151 B.R. 1012, 1022 (Bankr. N.D. Cal. 1993), aff'd, 195 B.R. 455 (N.D. Cal. 1996); Bucki v. Singleton (In re Cardon Realty Corp.), 146 B.R. 72, 81 (Bankr. W.D.N.Y. 1992). Other than its overly narrow portrayal of case law, Universal has offered no reason why the bankruptcy court abused its discretion in awarding prejudgment interest from the date of the constructively fraudulent transfers in this case.
Finally, the court summarily rejects Universal's contention that the bankruptcy court abused its discretion by basing its prejudgment interest award on the prime rate. See Gorenstein Enterprises, Inc., 874 F.2d at 436-37.
Conclusion
The judgment below is reversed to the extent that the bankruptcy court failed to consider the objective reasonableness of Universal's good faith under § 548(c), and to the extent that the bankruptcy court failed under § 550(a) to award Moglia the fair market value — as considered from the Debtor's perspective — of the spark plugs transferred to Universal. As explained above, these aspects of the bankruptcy court's holding may merely need to be clarified on remand. However, to the extent that the current language of the bankruptcy court's opinion reflects substantive inconsistencies with this court's analysis in these areas, the bankruptcy court may need to alter its corresponding conclusions. The bankruptcy court's judgment is affirmed in all other respects, This case is remanded for further proceedings consistent with this opinion.