On July 22, 2010, Southern District of New York Bankruptcy Judge Robert Drain gave counsel for the Delphi reorganized debtors (the “Debtors”) an ultimatum – convince him that the debtors should be allowed to amend 130 preference-action complaints or those complaints will be dismissed on Rule 12(b)(6) grounds.  The ”new” complaints, offered up on September 7, 2010, rely on factually threadbare conclusory statements of Delphi’s insolvency during the preference period.  The Debtors’ collective prayer for relief can be paraphrased as: “Please let the Section 547(f) presumption of insolvency suffice for pleading factual grounds for insolvency!”

The Debtors may be confident that the 547(f) insolvency presumption eliminates the need to make factual allegations supporting the insolvency requirement.   But given the high stakes, why would the Debtors choose not to include allegations of the plaintiff’s asset value and amount of liabilities on the petition date and the 90 days preceding?  One possible answer to this question underscores the need to enforce the pleading standard of Ashcroft v. Iqbal, 129 S.Ct. 1937, 173 L.Ed.2d 868 (2009) even though a presumption of proof of insolvency exists.

Adversary Proceedings Cloaked in Secrecy

The Delphi administratively-consolidated bankruptcy cases were filed in 2005.  All of the preference actions were filed in 2007, but they were filed with numbers in place of defendants names, and then sealed and maintained in secrecy for over two years.  Through a series of ex parte orders obtained by the Debtors, the period for service of the 2007 complaints was extended to April 10, 2010.

The transactions at issue are now five years old.  Most defendants did not even know they had been sued until early this year.  These circumstances have led to a welter of substantive and procedural objections based on esoteric legal principles and shouts of violations of truth, justice and the American way.  (Click this link to see a report of the substantive filings made in the Delphi adversary proceedings.)

What an inglorious end it would be to this bankruptcy preference saga to have all the remaining complaints dismissed on simple grounds of insufficiency of pleading of the elements of a bankruptcy preference claim.  But while lacking glamor, a decision to require inclusion of factual allegations to support a claim of insolvency would have a far broader, practical impact on bankruptcy preference recovery actions.

Delphi’s Proffered Amendments

The reorganized Debtors have proffered amendments that they contend meet the pleading requirements of Fed. R. Civ. P. 8, made applicable by Fed. R. Bankr. P. 7008.  They contend the proposed amendments contain all the elements needed to make out preference avoidance actions under 11 U.S.C. 547(b).

The Delphi Debtors tacitly acknowledge that their new complaints are subject to the pleading standards enunciated in Ashcroft v. Iqbal and Bell Atl. Corp. v. Twombly, 550 U.S. 544, 127 S.Ct. 1955, 167 L.Ed2d 929 (2007) and that “the complaint must allege enough facts with respect to each of the… elements of section 547(b) in order to put Defendants on notice for the preference claims,” citing, In re Hydrogen, L.L.C., 2010 Bankr. LEXIS 1106, *38(Bankr.S.D.N.Y., Apr. 20, 2010).

The Debtors contend their proposed amendments meet all these requirements.

But do they?

The Iqbal/Twombly Pleading Standards

Iqbal, supra, enunciated two interrelated tests that must be applied to determine if a complaint can withstand a motion to dismiss under Fed. R. Civ. P. 12(b)(6):

First, the tenet that a court must accept as true all of the allegations contained in a complaint is inapplicable to legal conclusions.  Threadbare recitals of the elements of a cause of action, supported by mere conclusory statements, do not suffice….  Second, only a complaint that states a plausible claim for relief survives a motion to dismiss…  [W]here the well-pleaded facts do not permit the court to infer more than the mere possibility of [an actionable set of circumstances], the complaint has alleged – but has not “show[n]” – “that the pleader is entitled to relief [as required by Fed. R. Civ. Proc. 8(a)(2)]”.  Iqbal at 1949, 1950 (citations omitted)

From the foregoing, it follows that “[a] pleading that offers ‘labels and conclusions’ or ‘a formulaic recitation of the elements of a cause of action will not do.’ [citation omitted]  Nor does a complaint suffice if it tenders ‘naked assertion[s]’ devoid of ‘further factual enhancement.’”  Iqbal at 1949 quoting from Twombly, supra (citations omitted).

Delphi Automotive Systems, L.L.C. is Named the “Designated Plaintiff/Transferor”

Judge Drain specified some “minimum requirements,” including, for each alleged preferential transfer, that the Delphi Debtors identify the transferor and the named plaintiff.  It appears that the Delphi Debtors have chosen Delphi Automotive Systems, LLC (“DAS”) as the transferor/plaintiff under the rubric that DAS was a contract counterparty to all agreements with creditors and was the entity that paid all of the Delphi Debtors’ bills.  So DAS is the transferor/plaintiff.

Delphi’s Allegation of Insolvency Doesn’t Cut It Without Section 547(f) Help

One of the fundamental elements of an actionable preference is Section 547(b)(3)’s requirement that the subject transfer was “made while the debtor was insolvent.”  As to this essential element, the Delphi Debtors’ amended complaints say only:

Pursuant to Bankruptcy Code section 547(f), for purposes of this Adversary Proceeding, Plaintiff is presumed to have been, and was in fact, insolvent at the time the Transfers were made.

On its face, this “allegation” runs afoul of both of the Iqbal/Twombly tests.

First, it makes only a “formulaic recitation” of a legal conclusion about the Section 547(b)(3) insolvency element.  This is a functional nullity because, as a legal conclusion, it it is not to be taken as true.

Second, this “allegation” makes only “naked assertions” of insolvency; it does not set forth facts showing that plaintiff’s financial condition was such that the sum of its debts was greater than all of its property, at fair valuation, exclusive of property that was fraudulently transferred, as defined in Section 101(32)(A).

Plaintiff’s $2+ Billion Balance Sheet Solvency Remains Uncontradicted

Why should the insolvency pleading standard remain independent of any presumption of proof of insolvency?  Because the pleading standard affords the fundamental assurance that a complaint will not be filed unless facts exist that support each element of the preference claim.  Using Delphi as the example, should a defendant be required to rebut a presumption of insolvency when there is no factual basis for the insolvency claim to begin with?

The shortcomings of Delphi’s allegations of insolvency are underscored by the fact that DAS’s schedules, verified under penalty of perjury by an authorized officer at or near the time of filing, show convincingly that DAS had a book-value positive net worth of more than $2 billion.  This figure was first scheduled in the DAS case (05-44640) on January 20, 2006 and was confirmed in four subsequent amendments of DAS’ schedules on February 1, 2006, April 18, 2006, October 12, 2007 and October 10, 2008.

Given these repeated sworn statements proximate to the date of the petition and preference period, the Section 547(f) presumption of insolvency might already be overcome.  The amended complaints leave all to wonder:  “What facts could the Debtors have alleged in the amended complaints in support of a conclusion of book-value insolvency”?