District of Delaware Bankruptcy Judge Mary F. Walrath grants motion of Mitsubishi Digital Electronics America, Inc (“Mitsubishi”) to dismiss a bankruptcy preference avoidance complaint for failure to state a claim for relief. In her May 1, 2012 opinion, Judge Walrath holds that the Chapter 7 trustee’s Section 547 preferential transfer count fails to sufficiently identify which of the two associated debtors was the transferor.  Judge Walrath further concludes that the Trustee can not maintain a Section 502(d) count for disallowance of Mitsubishi’s claims until the trustee has obtained “any judicial determination of Mitsubishi’s liability”.  Giuliano v. Mitsubishi Digital Electronics America, Inc., Adv. Proc. No. 11-52663 Dkt No. 24 (Bankr.D. Del. May 1, 2012)

Not “Plead Thin and Win” Complaints

On January 26, 2011, Ultimate Acquisition Partners, LP (“UAP”) and a single co-debtor CC Retail (“CC”) filed Chapter 11 petitions. On May 3, 2011, the Court converted the Debtors’ cases to Chapter 7 and Alfred T. Giuliano was appointed Chapter 7 trustee. Between July 19 and July 21, 2011, Trustee Giuliano filed 72 preference actions.

This was one of the the first Delaware bankruptcy mass preference actions arising out of a case filed and converted after the Delaware Bankruptcy Court made unequivocally clear that the days of “virtual, mail merge” preference complaints were over. Trustee Giuliano apparently took note. The complaints included a heavy dose of relationship pleading and each payment was identified by reference to the invoice it paid.

The care of pleading the other elements of the Section 547 avoidance actions caused one deficiency to stand out. As we remarked in our July 20, 2011 comment: “Why isn’t the debtor (there are two debtors) that made the transfer identified.” The complaints seem to provide a clue if not the explanation for Trustee Giuliano’s apparent pleading omission:

The Debtors operated specialty stores primarily in the mid-west and western United States. Of the 46 stores, 35 were operated by [UAP] and 11 were operated by [CC]. All operated under the name “Ultimate Electronics” (“Operating Name”). The Debtors maintained a single bank account, … from which all payments were made, including the transfers at issue in this action. Each payment bore the Debtors’ Operating Name on its face. [Emphasis added]

One Debtor Too Many

Judge Walrath in her opinion cited a critical admission by Trustee Giuliano:

The Trustee admits that if [Valley Media, Inc. v. Borders, Inc. (In re Valley   Media, Inc.), 288 B.R. 189, 192 (Bankr. D. Del. 2003)] and [Miller v. Mitsubishi Digital Elecs.   Am. Inc. (In re Tweeter Opco), 452 B.R. 150, 154-55 (Bankr. D. Del. 2011)] are read to “absolutely require such identification, the Complaint is deficient.” However, the Trustee contends that the transferor was sufficiently identified in the Complaint to eliminate the possibility of confusion on the part of Mitsubishi as to the source of the payments sought to be avoided, and thus his claim should not be dismissed.

In this two debtor bankruptcy case, Judge Walrath holds that there is one debtor too many to excuse the Trustee’s failure to identify the transferor of each transfer:

This Court has previously held that to survive a motion to dismiss, a preference complaint must specify which debtor made the transfer. See Gellert v. The   Lenick Co. (In re Crucible Materials Corp.), No. 09-11582, 2011 WL 2669113, at *2 (holding that a preference complaint must allege “the name of the debtor/transferor”); In re Tweeter Opco, 452 B.R. at 154-55 (same); OHC Liquidation Trust v. Credit Suisse   First Bos. (In re Oakwood Homes Corp.), 340 B.R. 510, 522 (Bankr. D. Del. 2006) (same); In re Valley Media, Inc., 288 B.R. at 192 (same). No reason has been given as to why this same rule should not be applied in the instant case, and therefore, the Court will dismiss the Trustee’s preference claims.

Are All 502(d) Counts in Preference Complaints Subject to Dismissal?

Trustee Giuliano’s complaint also sought to disallow, pursuant to section 502(d) of the Bankruptcy Code, Mitsubishi’s claim and 503(b)(9) administrative expense request. Section 502(d) requires a bankruptcy court to disallow any claim of an entity from which a preferential transfer is recoverable until transfer is repaid. With few exceptions, those prosecuting mass preference recovery actions in Delaware as well as other jurisdictions have tacked on a Section 502(d) count to the preference complaint.

Mitsubishi contended that the 502(d) claim should be dismissed “because as of yet, there has been no judicial determination that Mitsubishi received a preference, and thus, Mitsubishi has not been found “liable” for any amount.”

Judge Walrath agreed with Defendant Mitsubishi and also dismissed the 502(d) count, holding:

The Court finds that the Trustee’s 502(d) claim should be dismissed. A debtor or trustee “wishing to avail itself of the benefits of section 502(d) must first obtain a judicial determination on the preference complaint.” In re Lids Corp., 260 B.R. at 684. See also In re Mountaineer Coal Co., Inc., 247 B.R. 633, 647 (Bankr. W.D. Va. 2000) (holding that section 502(d) “would not appear applicable unless and until a finding under one of the cited sections had been made and then the claimant had failed to comply with such ruling”). The Trustee has not obtained any judicial determination of Mitsubishi’s liability, and therefore, has no basis for a section 502(d) claim. As to the Trustee’s concern about Mitsubishi possibly asserting a new value defense to the preference claims, the Court is not persuaded that this is an appropriate consideration at this stage.

Practice Notes

Judge Walrath’s dismissal of the Section 547 preference count is reassuring.  Even were there were only two debtors, the name of the transferor must be pleaded in connection with each transfer. However, debtors and trustee have a countermeasure. In the future, Chapter 7 trustees increasingly may seek to have multiple debtors bankruptcy cases substantively consolidated when there is a challenge in isolating transfers to a specific debtor.

Judge Walrath’s holding on Section 502(d) is sound but nevertheless surprising due to the near uniform practice of including 502(d) counts in preference complaints. Only time will tell if the holding will produce any change in practice by either preference plaintiffs or defendants.