The Bottom Line

The Delaware Bankruptcy Court in Giuliano v. Schnable (In re DSI Renal Holdings LLC), Adv. Case No. 14-50356, 2020 WL 550987, (Bankr. D. Del. Feb. 4, 2020), determined any recovery obtained by the chapter 7 trustee on account of fraudulent transfer actions pursuant to section 550 of the Bankruptcy Code must be limited to the total amount of allowed creditor claims and administrative expenses in the bankruptcy case.  Almost two years after the Debtors’ bankruptcy filing, the chapter 7 trustee initiated a fraudulent transfer action against certain of the former officers and directors, among others, seeking damages in the amount of approximately $678 million, while only $166 million in claims were asserted against the Debtors.  In approving the defendant’s “capping motion”, the Court agreed, if the chapter 7 trustee were successful, the Debtors would impermissibly receive the excess after the creditors and administrative expenses were paid.

What Happened?

To set the stage, almost a year before filing for bankruptcy, non-debtor DSI Holding Company, Inc. (“DSI Parent”), Debtor DSI Renal Holdings, LLC (“DSI Renal Holdings”) and certain of its subsidiaries effectuated a complex restructuring, namely transferring out the “renal business” and other valuable assets into newly formed entities. Approximately a year later, DSI Renal Holdings, DSI Hospitals, Inc., and DSI Facility Development, LLC (collectively, the “Debtors”) filed for bankruptcy under chapter 7 of the Bankruptcy Code.  Shortly thereafter, outside of the bankruptcy process, DaVita, Inc., acquired one of the newly formed entities, non-debtor CDSI I Holding Company, Inc. (“CDSI I”), for approximately $689 million (the “DaVita Acquisition”).  As a result of the DaVita Acquisition, certain former officers and directors of entities affiliated with DSI Renal Holdings and the equity holders of DSI Parent and/or lenders under certain credit facilities of non-debtor DSI Renal, Inc. (“DSI Renal”) (The Northwestern Mutual Life Insurance Company, Apollo Investment Corp., Ares Capital Corp. and Centre Partners Management LLC and certain of its affiliates) (collectively, the “Defendants”) received approximately $440 million on account of their shares in the CDSI I and/or as repayment of outstanding debt obligations of DSI Renal.

The chapter 7 trustee (the “Trustee”) commenced a proceeding alleging the Defendants coordinated a fraudulent scheme that stripped the Debtors of substantially all of their valuable assets for little or no consideration and then turned around and sold those assets for over half a billion dollars.  The Trustee asserted claims under (i) sections 548 and 550 of the Bankruptcy Code and (ii) state law for breach of fiduciary duty, aiding and abetting fiduciary duty and corporate waste. The Trustee alleged damages in the amount of $678 million, representing the Trustee’s calculation of the proceeds received by the Defendants plus interest as a result of the DaVita Acquisition. However, according to the Official Claims Registry, the total number of claims asserted against the Debtors was only approximately $166 million. The Defendants filed a “capping motion” seeking to cap recoveries under section 550 of the Bankruptcy Code and state law.  The Court denied the Defendants’ motion for summary judgment related to the state law claims.

The Court’s opinion focused on the issue of capping the fraudulent transfer claims. First, relying upon the Third Circuit’s holdings in Cybergenics¹, Messina² and Majestic³, the Court determined it would be impermissible for the Debtors to either invoke avoidance powers or benefit from the trustee’s avoidance.  For example, in Messina, the debtors asserted the homestead exemption to claim a portion of the sale proceeds derived from the chapter 7 trustee’s avoidance of an unperfected mortgage on the debtors’ home that the debtors had no equity in. 687 F.3d at 82. The Third Circuit agreed with the trustee that the exemptions were valueless because commencement of the chapter 7 case did not confer new property rights or value in the fully encumbered property and therefore there was no value for them to exempt.  Id.

Next, the Bankruptcy Court distinguished Tronox⁴ and Trans World Airlines⁵ and similar cases where courts have refused to impose caps on avoidance recoveries and have permitted liquidation trust or reorganized debtors to receive avoidance recoveries.  The Court highlighted that in Tronox and other similar cases cited by the Trustee, courts had to determine whether creditors could recover more than their allowed claims from the avoidance recoveries, and in Trans World Airlines and other similar cases cited by the Trustee, courts were faced with the issue of whether the reorganized debtors could pursue and benefit from avoidance actions and recoveries.  In the cases that determined the reorganized debtors were entitled to recoveries, the courts identified a direct or indirect benefit for creditors as a result of the recoveries, such as a furtherance of the reorganization efforts or indirect recovery of creditor claims.  The Court concluded these cases were not applicable because (i) the chapter 7 debtors were not seeking to reorganize and therefore there was no reorganized debtor to receive avoidance recoveries and (ii) the creditors will not receive more than their allowed claims with interest.

Why This Case Is Interesting

The Delaware Bankruptcy Court’s decision in this case reinforces the notion that fraudulent transfer actions are not intended to be punitive, but rather seek to satisfy the claims of creditors who may have been injured.  While this case addresses a unique situation (and expressly distinguishes the facts of cases such as Tronox and Trans World Airlines), it is instructive for future cases where a chapter 7 trustee is considering whether to pursue valuable avoidance actions.

¹ _{226 F.3d 237, 243-47 (3d Cir. 2000).}

² _{687 F.3d 74 (3d Cir. 2002).}

³ _{716 F.3d 736 (3d Cir. 2013).}

⁴ _{Tronox Inc. v. Anadarko Petroleum Corp. (In re Tronox, Inc.), 464 B.R. 606 (Bankr. S.D.N.Y. 2012).}

⁵ _{Trans World Airlines, Inc. v. Travellers International AG (In re Trans World Airlines, Inc.), 163 B.R. 964 (Bankr. D. Del. 1994).}

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