Pointers for Pleading Preferential and Fraudulent Transfer Claims

This article provides an overview of recent cases in which courts have considered, and ruled on, the sufficiency of factual support for the elements of preferential and fraudulent transfer claims. These cases provide a measure of guidance for practitioners who may be wondering what it takes to satisfy the heightened pleading requirement. For plaintiffs, the risk of falling short of the heightened pleading requirement is dismissal. For defendants, missing deficiencies in the complaint can mean a lost opportunity to dismiss one or more claims in a complaint early in the litigation. Accordingly, neither plaintiffs nor defendants can successfully navigate an evolving post-Twombly/Iqbal world without an understanding of how courts assess the sufficiency of these commonly pled claims.

As a general matter, the practice of filing form complaints in avoidance actions, pleading little more than bare facts and the governing statutory elements, is no longer sufficient to withstand dismissal. Accordingly, it is incumbent on plaintiffs to obtain the necessary factual support for their complaints through increased pre-litigation investigation and discovery mechanisms, such as Rule 2004 exams.

In fact, the expansive ability of plaintiff-trustees to embark on fishing expeditions through Rule 2004 has been cited by several courts as a basis for denying a relaxed pleading standard for trustees pleading fraud claims. See, e.g., Angell v. BER Care Inc. (In re Caremerica, Inc.), 409 B.R. 737, 755 (Bankr. E.D.N.C. 2009) (Caremerica I) (rejecting a relaxed pleading standard for trustee because trustee has greater access to information than the antitrust plaintiffs in Twombly or the Pakistani detainee in Iqbal, and has the full discovery powers of the court through 2004 exams and other means); Airport Boulevard Apartments, Ltd. v. NE 40 Partners, Ltd. P’ship, et al. (In re NE 40 Partners, Ltd. P’ship), 440 B.R. 124 (Bankr. N.D. Tex. Nov. 12, 2010) (same). But see Walker v. Pasteur (In re Aphton Corp.), 423 B.R. 76, 85 (Bankr. D. Del. 2010) (citing Global Link Liquidating Trust v. Avantel, S.A. (In re Global Link Telecom Corp.), 327 B.R. 711, 717 (Bankr. D. Del. 2005); Official Comm. of Unsecured Creditors of Fedders N. Am., Inc. v. Goldman Sachs Credit Partners L.P. (In re Fedders N. Am., Inc.), 405 B.R. 527, 544 (Bankr. D. Del. 2009) (allowing liberality of pleading standard for trustee because of the trustee’s “inevitable lack of knowledge concerning acts of fraud previously committed against the debtor, a third party”).

If you do find yourself at the receiving end of a motion to dismiss based on insufficiency of pleading, all is not lost. Take note that the Bankruptcy Courts have tempered Twombly/Iqbal’s more exacting pleading requirement with a willingness to grant leave to amend where the allegations appear plausible but are insufficiently pled, as discussed below.

How Did We Get Here? The Shift Away from Simple Notice Pleading
The evolution of the pleading standard has been exhaustively discussed elsewhere, but for purposes of this article, a brief overview may be helpful. Rule 8(a) of the Federal Rules of Civil Procedure, which is applicable to bankruptcy cases by Rule 7008 of the Federal Rules of Bankruptcy Procedure, provides that a pleading that states a claim for relief must contain, among other things, “a short and plain statement of the claim showing that the pleader is entitled to relief.” By contrast, Rule 9(b) of the Federal Rules of Civil Procedure, which applies to fraud claims, including constructive fraudulent transfer claims in certain circuits, is applicable to bankruptcy cases by Rule 7009 of the Federal Rules of Bankruptcy Procedure and provides that “[i]n alleging fraud or mistake, a party must state with particularity the circumstances constituting fraud or mistake. Malice, intent, knowledge, and other conditions of a person’s mind may be alleged generally.”

Until relatively recently, the long-standing pleading standard, as set forth in Conley v. Gibson, 355 U.S. 41 (1957), was that a complaint should not be dismissed for failure to state a claim unless it appeared “beyond doubt” that the plaintiff could prove “no set of facts” in support of the plaintiff’s claim that would entitle him or her to relief. Id. at 45–46.

In 2007, the Supreme Court articulated a new heightened pleading standard in Twombly, 550 U.S. 544, dismissing Conley’s “no set of facts” language as an “incomplete, negative gloss on an accepted pleading standard.” Id. at 570. Instead, the Supreme Court held that to withstand dismissal, a complaint must contain “enough facts to state a claim to relief that is plausible on its face,” not mere “labels and conclusions” or “formulaic recitation of the elements of a cause of action.”Id. at 555, 570.

Two years after deciding Twombly, the Supreme Court confirmed that its heightened pleading standard extended to all civil suits in the federal courts. Thus, “threadbare recitals of the elements of a cause of action, supported by mere conclusory statements” cannot survive a motion to dismiss. Iqbal, 129 S. Ct. at 1949. Rather, “all complaints must now set out sufficient factual matter to show that the claim is facially plausible.” Id. at 1950. The Supreme Court further explained that a claim is facially plausible “when the plaintiff pleads factual content that allows the court to draw the reasonable inference that the defendant is liable for the misconduct alleged.” Id. at 1949. Determining whether a complaint is “facially plausible” is “a context-specific task that requires the reviewing court to draw on its judicial experience and common sense.” Id. at 1950.

Preferential Transfer and Fraudulent Transfer
To plead a cause of action for preferential transfer under the Bankruptcy Code, a complaint must provide sufficient facts to support each of the five conditions enumerated in section 547(b). Specifically, the trustee (or a party who has stepped into the trustee’s shoes) may avoid any transfer of an interest of the debtor in property (1) to or for the benefit of a creditor; (2) for or on account of an antecedent debt owed by the debtor before such transfer was made; (3) made while the debtor was insolvent; (4) made (A) on or within 90 days before the date of the filing of the petition; or (B) between 90 days and one year before the date of the filing of the petition, if such creditor at the time of such transfer was an insider; and (5) that enables such creditor to receive more than such creditor would receive if (A) the case were a case under Chapter 7 of this title; (B) the transfer had not been made; and (C) such creditor received payment of such debt to the extent provided by the provisions of this title. 11 U.S.C. § 547(b).

To plead a cause of action for constructive fraudulent transfer under the Bankruptcy Code, a complaint must provide sufficient facts to support each of the following three elements: that within two years of the petition date, (1) the debtor transferred an interest in property, (2) the debtor was insolvent at the time of the transfer or became insolvent as a result of the transfer, was engaged in business or was about to engage in business for which the debtor’s remaining property constituted unreasonably small capital, or intended to incur or believed that it would incur debts beyond its ability to pay as they matured, and (3) the debtor received less than reasonably equivalent value in exchange for such transfer. 11 U.S.C. § 548(a)(1)(B).

Although these statutory elements may seem straightforward, a developing line of cases has provided particularly useful assessments of the manner and quality of factual support that is sufficient to satisfy the elements of preferential and fraudulent transfer claims.

Notable Cases
In the series of Caremerica decisions, the Bankruptcy Court considered several adversary complaints seeking to recover preferential and fraudulent transfers to various defendants and ruled on the sufficiency of pleading for the elements of a preferential transfer and fraudulent transfer.

In Angell v. BER Care, Inc., et al. (In re Caremerica, Inc.), 409 B.R. 737 (Bankr. E.D.N.C. July 23, 2009) (Caremerica I), the Chapter 7 trustee brought adversary proceeding to avoid and recover alleged preferential and fraudulent transfers. In applying the analysis of Twombly/Iqbal, the court dismissed the preferential transfer and constructive fraudulent transfer counts because the trustee failed to allege sufficient factual support regarding (1) the identification of the transferors, particularly where multiple debtors and nondebtors shared similar names; (2) the nature and amount of the antecedent debt; (3) the insolvency of the debtor at the time of the transfers (which the court noted could be satisfied by alleging specific dates and amounts of each alleged transfer and, for those transferees alleged to be insiders, facts addressing why a particular defendant qualifies as an insider); and (4) the constructive fraudulent transfer under section 548(a)(1)(B) (which the court noted could be satisfied through facts describing the consideration received by each transferor and the debtors’ insolvency at the time of transfer). Id. at 750–56. The court further found the trustee sufficiently pled the allegation that the transfer enabled the creditor to receive more than it would under Chapter 7 because the debtors’ summary of schedules reflected liabilities far greater than assets. Id. at 754.

Notably, the court rejected the trustee’s contention that a relaxed standard of pleading fraudulent claims should apply for trustees, finding that a trustee should have greater access to information than the antitrust plaintiffs in Twombly or the Pakistani detainee in Iqbal: “After all, the trustee has theoretically had all of the books and records of the debtors for up to two years prior to bringing these causes of action, with the full discovery powers of the court through 2004 exams and other means available during that time.” Id. at 754. By contrast, the court denied the defendant’s motion to dismiss the actual fraudulent transfer claim because the trustee made particularized factual allegations and provided an exhibit to the complaint reflecting the dates, amounts, and names of transferees with respect to each alleged fraudulent transfer. Id. at 755. The court granted the trustee leave to amend his complaint to address the pleading deficiencies identified by the court.

In Angell v. Haveri (In re Caremerica, Inc.), 409 B.R. 346 (Bankr. E.D.N.C. July 28, 2009) (Caremerica II), the Chapter 7 trustee sought to avoid and recover alleged preferential and fraudulent transfers. Referring back to its opinion in Caremerica I, the Bankruptcy Court dismissed the complaint on the basis that the trustee had failed to plead sufficient factual support regarding (1) a transfer of an interest of the debtor in property, including the identify of which of the multiple debtors had made the alleged transfers; (2) the dates, amounts, and number of transfers; (3) the nature and amount of the antecedent debt; (4) the occurrence of the transfers within the 90 day preference period; (5) a particularized showing of the circumstances of the actual fraudulent transfer under section 548(a)(1)(A); and (6) constructive fraudulent transfer under section 548(a)(1)(B) (which the court noted could be satisfied through facts describing the consideration received by each transferor and the debtors’ insolvency at the time of transfer). Id. at 350–54. As in Caremerica I, the court permitted the trustee leave to replead his claims.

In Angell v. Burrell (In re Caremerica, Inc.), 2009 WL 2253225 (Bankr. E.D.N.C. July 28, 2009) (Caremerica III), the trustee brought an adversary proceeding to avoid and recover allegedly preferential transfers and fraudulent transfers. The court dismissed the preferential transfer claim as to all elements (except that the transfer enabled the creditor to receive more than it would under Chapter 7 which the court found was satisfied for the reasons set forth in its opinion in Caremerica I) because the trustee failed to allege sufficient factual support regarding (1) the identification of the transferors, particularly where multiple debtors and nondebtors shared similar names; (2) the dates, amounts, and number of transfers; (3) the nature and amount of the antecedent debt; (4) the insolvency of the debtor at the time of the transfers where the transfers were alleged to have been made prior to the 90-day period preceding the petition (which the court noted could be satisfied by alleging specific dates and amounts of each alleged transfer and, for those transferees alleged to be insiders, facts addressing why a defendant qualified as an insider where the alleged relationship between the defendants and the debtors failed to rise to the control and involvement characteristic of insiders under section 101(31)); (5) a particularized showing of the circumstances of the actual fraudulent transfer under section 548(a)(1)(A); and (6) constructive fraudulent transfer under section 548(a)(1)(B) (which the court noted could be satisfied through facts describing the consideration received by each transferor and the debtors’ insolvency at the time of transfer). Id. at *2–6. As in Caremerica I and II, the court permitted the trustee leave to amend his complaint.

In Angell v. First Eastern, LLC (In re Caremerica, Inc.), 2010 WL 428059 (Bankr. E.D.N.C. Jan. 5, 2010) (Caremerica IV), following the dismissal of his complaint by the court in Angell v. First Eastern, LLC (In re Caremerica, Inc.), 2009 WL 2253241 (Bankr. E.D.N.C. July 28, 2009), the trustee filed an amended complaint seeking to avoid and recover alleged preferential and fraudulent transfers. This time, the court denied defendant’s motion to dismiss the preferential transfer claim because the trustee sufficiently alleged the existence of an antecedent debt by attaching as an exhibit to the complaint a running account of the rents due, the payments made, and the accumulating arrearage over time. Id. at *1. With respect to the trustee’s alternative argument that the transfers constituted constructive fraudulent transfers, the court denied the motion to dismiss because of the uncertainty regarding whether the defendant gave any consideration to the debtors, which would require discovery to resolve, given that the “trustee does not have sufficient information.” Id. at *2.

Since the Caremerica line of cases, more recent cases have largely followed the same analysis undertaken therein with respect to preference and fraudulent transfer claims.

For example, in Walker v. Pasteur (In re Aphton), 423 B.R. 76 (Bankr. D. Del. Jan. 27, 2010), the Chapter 11 trustee sued two creditors seeking, inter alia, to avoid and recover certain constructively fraudulent transfers to the creditors pursuant to section 548(a)(1)(B). The court held that the trustee’s factual allegations were sufficient under Federal Rule of Civil Procedure 9(b) to make his claims plausible because he identified the assets transferred by the debtor by date and transferee, further assigned reasonable values to the assets exchanged, and described the debtor’s insolvency (by attaching a copy of the debtor’s Securities and Exchange Commission (SEC) Form 10-K, which reflected the debtor’s negative net worth). Id. at 83, 88.

In Official Committee of Unsecured Creditors of Hydrogen, L.L.C. v. Blomen (In re Hydrogen, L.L.C.), 431 B.R. 337 (Bankr. S.D.N.Y. Apr. 20, 2010), the Bankruptcy Court found that the unsecured creditors committee’s claims for preferential and constructive fraudulent transfers were inadequately pled. In considering the committee’s preferential transfer claims, the Bankruptcy Court concluded that the absence of factual information such as the dates, amounts, and types of transfers; the identifiable antecedent debts owed by the debtor for which the transfers were made; or facts regarding the debtor’s insolvency warranted the dismissal of the claims. Id. at 355–56.

Similarly, with respect to the constructive fraudulent transfer claims, the Bankruptcy Court determined that the complaint’s “‘formulaic recitation of the elements’” of the claims, together with the “complete absence of facts supporting the allegation that the [d]ebtor received less than reasonably equivalent value” in exchange for payments made, was insufficient to withstand dismissal under Twombly/Iqbal. Id. at 352–53 (quoting Iqbal, 129 S. Ct. at 1949). However, the court granted the plaintiff leave to replead the dismissed claims (with the exception of the deepening insolvency claim, which the court held was not recognized in New York). Id. at 363.

In Charys Liquidating Trust v. Hades Advisors, LLC (In re Charys Holding Co.), 2010 WL 2788152 (Bankr. D. Del. July 14, 2010), the Bankruptcy Court considered the sufficiency of a Chapter 11 trustee’s allegations of preferential transfer and constructive fraudulent transfer. Applying Iqbal and Twombly, the court concluded that the trustee adequately pled the identification of the allegedly preferential transfer, including the date, identify of the transferor and transferee, and amount of transfer. Id. at *5. However, the court dismissed the preference claim because the trustee failed to allege that the defendant provided services to the debtors or owed any other preexisting debt, thereby failing to sufficiently allege facts from which the court “could infer that Transfer was made on account of antecedent debt.”

By contrast, the court found that the trustee had adequately pled a constructive fraudulent transfer claim by alleging that the defendant, a restructuring consultant who was retained by a board member on the eve of the debtors’ bankruptcy filings, did not provide meaningful services to the debtors because the board had already retained a different company to provide restructuring advice. Id. at *7.

Notably, the Bankruptcy Court acknowledged that while the complaint was “not a model of detailed pleading, reasonably equivalent value is a fact-intensive determination that typically requires testing through the discovery process.” Id. Accordingly, the court “could infer that the [d]ebtors did not receive services commensurate with the [] transfer.” Id.

In Farinash v. Bensusan (In re Prebul Jeep, Inc.), 2010 WL 3304608 (Bankr. E.D. Tenn. Aug. 20, 2010), the trustee sought to file a second amended complaint clarifying the factual basis of certain preference claims asserted in the first amended complaint. The defendants argued that the motion should be denied based on futility grounds because the allegations in the proposed second amended complaint were insufficient to state a claim upon which relief could be granted and therefore would not survive a motion to dismiss (or, as in this case, a motion for judgment on the pleadings). The court held that the trustee adequately alleged (1) which specific debtor had an interest in the property transferred by stating that debtor Prebul Jeep, Inc., made the alleged transfers that originated from an account it owned; (2) the nature and amount of the antecedent debt, by alleging that “defendant…was fraudulently induced…to transfer approximately $15,497,925.00 into a checking account owned by the debtor, Prebul Jeep, Inc.,” together with the characterization of this liability as a potential restitutionary obligation satisfied the antecedent debt element of section 547; (3) the debtor’s insolvency at the time of the transfers, by attaching copies of the debtor’s financial statements; and (4) that the transfer enabled the defendants to receive more than under a Chapter 7 liquidation, by pointing to the debtors’ schedules which showed assets of $995,784.41 and liabilities of $23,078,120.40, together with allegations that the creditors have filed priority claims of $620,000, unsecured claims of over $39,000,000, and unclassified claims of $12,000,000. Id. at *4–5.

Although there are a number of cases that follow the same analysis set forth in the Caremerica line of cases, there are a handful that have declined to apply its pleading standard on the basis that it exceeds the Twombly/Iqbal standard.

For example, in Tousa Homes, Inc. v. Palm Beach Newspapers, Inc. (In re Tousa, Inc.), 2010 WL 5300921 (Bankr. S.D. Fla. Dec. 27, 2010), the Bankruptcy Court declined to follow the Caremerica line of cases regarding the sufficiency of pleading a preferential transfer claim, insofar as “the pleading requirements of Caremerica require more than the standard promulgated in Twombly and Iqbal and the liberal pleading policy underlying the civil rules.” Id. at *2. In considering Caremerica, the court examined Valley Media Inc. v. Borders, Inc. (In re Valley Media, Inc.) 288 B.R. 189 (Bankr. D. Del. 2003), which held that a plaintiff bringing a preference claim had to plead certain facts to survive a Rule 12(b)(6) motion to dismiss, including (a) an identification of the nature and amount of each antecedent debt; (b) an identification of each alleged preference transfer by (i) date, (ii) name of debtor/transferor, (iii) name of transferee, and (iv) the amount of the transfer. Valley Media, 288 B.R. at 192. Valley Media reflected Delaware’s more stringent pleading standard for preference claims, even prior to Twombly and Iqbal. The court in In re Tousa went on to hold that as long as a preference complaint makes clear who transferred what, to whom, and when, a preference defendant will have enough information to mount whatever defenses may be available and the complaint should not be dismissed for failure to state a claim under the Twombly/Iqbal standard. Id. at *1–3. Accordingly, while the court adopted the portion of Caremerica’s holding regarding the “amorphous payer problem” where a complaint fails to identify the source of an allegedly preferential transfer, it declined to adopt in toto Caremerica’s interpretation of preference adversary pleading requirements (which largely mirrored what was required under Valley Media).

Similarly, in Butler v. Anderson (In re C.R. Stone Concrete Contractors, Inc.), 434 B.R. 208 (Bankr. E.D. Mass. June 9, 2010), the Bankruptcy Court declined to apply Valley Media and held, inter alia, that to state a preferential transfer claim, a Chapter 7 trustee did not have to satisfy a heightened pleading standard by specifically identifying in his complaint the nature and amount of each antecedent debt; nor did he need to identify each alleged preferential transfer by date, name of debtor/transferor, name of transferee, and amount of transfer. It was enough if the complaint provided fair notice of the trustee’s claim and of the grounds on which it was based. Id. at 220.

Post-Twombly/Iqbal Factual Support Checklists
The charts below distill the courts’ findings in the cases discussed in this article and provide checklists of examples and sources of factual support that Bankruptcy Courts have held are sufficient to pass the Twombly/Iqbal pleading standard.

Conclusion
The foregoing cases reveal that a careful plaintiff can avoid a Twombly/Iqbal challenge to the sufficiency of his or her complaint by taking particular care in offering specifics to the Bankruptcy Court in pleading his or her claims and by doing pre-litigation legwork to obtain the necessary evidence to support those claims, if necessary. While the Bankruptcy Courts do not yet have a uniform interpretation of the pleading requirements under Twombly/Iqbal in the context of preference claims or fraudulent transfer, providing as much information as possible to bolster one’s claims is only prudent. In fact, failing to do so may risk dismissal, notwithstanding the Bankruptcy Courts’ permissive leave to replead where the allegations appear plausible but are inadequately pled.

Keywords: preference, preferential transfer, Twombly, Iqbal, Caremerica

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