On March 20, 2012, in an adversary proceeding stemming from the Mirant bankruptcy, the U.S. Court of Appeals for the Fifth Circuit (i) affirmed the U.S. District Court for the Northern District of Texas’ ruling that Mirant’s recovery trust had standing to pursue a fraudulent transfer action even though Mirant’s unsecured creditors arguably received a full recovery under Mirant’s confirmed plan, and (ii) overturned the District Court’s determination that Georgia’s, rather than New York’s fraudulent transfer law, applied to the action. Because the District Court had dismissed the fraudulent transfer action based on Georgia law, which the Fifth Circuit now deemed inapplicable, the Fifth Circuit remanded the case for adjudication under New York law. MC Asset Recovery LLC v. Commerzbank A.G. et al., 2012 WL 919620 (5th Cir. (Tex.)). The Fifth Circuit’s rulings resurrected Mirant’s seven-year-old fraudulent transfer action, and are important, pro-creditor precedents that could impact numerous pending and future fraudulent transfer actions.
In 2000, Mirant Corp., an energy company headquartered in Georgia, sought to expand its European operations through a substantial order of power generation equipment from General Electric. Commerzbank A.G. provided financing for Mirant to acquire the equipment though a European subsidiary of Mirant, and Mirant acted as guarantor of the subsidiary’s obligations. However, in 2003, the Mirant subsidiary canceled the purchase before GE had completed construction of the equipment, and Mirant was forced to make payments under the guaranty.
Mirant subsequently filed for chapter 11 protection and in 2005 commenced an adversary proceeding to recover the amounts paid to Commerzbank and other lenders under Bankruptcy Code section 544(b), which provides a bankruptcy trustee certain avoidance powers under applicable non-bankruptcy law. Prior to the resolution of the suit, Mirant confirmed a plan of reorganization pursuant to which a special litigation entity named MC Asset Recovery, LLC was created to take Mirant’s place in the litigation and act as debtor in possession.
In 2007, the lenders moved to dismiss the fraudulent transfer action, alleging, among other things, that the Debtors’ post-bankruptcy recovery trust lacked standing because under Mirant’s chapter 11 plan, Mirant’s creditors received stock in the reorganized Mirant that was equal to the value of their allowed claims, and thus the creditors were paid in full on the effective date of the plan. The lenders’ argument comported with the reasoning of Adelphia Recovery Trust v. Bank of America, N.A., 390 B.R. 80 (S.D.N.Y. 2008).
In that case, the U.S. District Court for the Southern District of New York held that Adelphia’s recovery trust lacked standing to pursue an avoidance action because Adelphia’s creditors were paid in full on the effective date of Adelphia’s chapter 11 plan, and thus no “actual injury” existed as required under Article III of the U.S. Constitution. Other courts, however, have held that the full satisfaction of creditor claims does not bar the continuation of an avoidance action because equity holders and other interest holders in the estate may still stand to benefit from a recovery, and because standing is to be evaluated at the time the bankruptcy case is commenced, and not based on creditor recoveries on the plan effective date. See Stalnaker v. DLC, Ltd., 376 F.3d 819 (8th Cir. 2004); In re Acequia, 34 F.3d 800 (9th Cir. 1994).
In the instant case, the Bankruptcy Court focused heavily on Adelphia’s Constitutional analysis and explored whether Mirant’s creditors had an “actual injury” that the fraudulent transfer action sought to redress. Because Mirant’s plan provided for payment in stock rather than in cash, and distributions were made following the effective date, the Bankruptcy Court found that not all creditors were paid in full on the effective date. Accordingly, the Bankruptcy Court held that an “actual injury” existed, and thus the recovery trust had standing to pursue the avoidance action.
The District Court reached the same conclusion as the Bankruptcy Court, though for different reasons. The District Court indicated that standing should be determined as of the commencement of the bankruptcy case, and thus standing is appropriate even if unsecured creditors have been satisfied in full. Further, because Mirant’s unsecured creditors were paid in stock, the avoidance action indirectly benefited the unsecured creditors by promoting “a more financially sound estate.” MC Asset Recovery, LLC v. Commerzbank A.G., et al., 441 B.R. 791, 803 (N.D. Tex. 2010).
The Fifth Circuit, considering the reasoning of the lower courts and the split between federal courts on this issue, affirmed the District Court’s holding that standing is to be determined as of the commencement of a bankruptcy case. The Fifth Circuit thus concurred with the reasoning of the Eighth Circuit in Stalnaker and the Ninth Circuit in Acequia, and stated that “[o]nce a trustee’s avoidance rights are triggered at the time of filing, they persist until avoidance will no longer benefit the estate under § 550,” regardless of whether unsecured claims have been satisfied in full. Accordingly, the Fifth Circuit held that the recovery trust had standing to prosecute the fraudulent transfer action as long as avoidance of the fraudulent transfer would benefit the estate as a whole.
Choice of Law
Early in the fraudulent transfer action, Commerzbank and the other lenders that received guaranty payments from Mirant argued that Georgia’s fraudulent transfer law should govern the payments, while the recovery trust argued that New York’s fraudulent transfer law should apply. Throughout the litigation, each court looked closely at the similarity of the two potentially applicable laws to the Uniform Fraudulent Transfer Act, a model law that has been adopted by 43 states. New York is one of seven states that has not explicitly adopted the UFTA.
New York’s fraudulent transfer law mirrors certain aspects of the UFTA, including the treatment of guaranty payments as transfers subject to avoidance. Georgia’s fraudulent transfer law has been based on the UFTA since 2002. However, because Mirant’s guaranty was executed and delivered prior to 2002, the Bankruptcy Court’s choice of law analysis focused on Georgia’s preceding fraudulent transfer statute (section 18-2-22 of the Official Code of Georgia), which did not provide for the avoidance of guaranty payments.
The Bankruptcy Court held that New York law should apply and that the fraudulent transfer action should proceed, while the District Court disagreed and held that Georgia’s former fraudulent transfer law should apply, thus absolving the lenders from liability as guaranty payments could not constitute fraudulent transfers under Georgia’s former law.
The Fifth Circuit analyzed the choice of law issue by applying the “most significant relationship” test as stated in sections 6 and 145 of the Restatement (Second) of Conflict of Laws. This test provides that the rights and liabilities of parties to tortious conduct are to be decided by the local law of the state with the most significant relationship to the event and the parties involved. The application of this test is to be guided by, among other things, the needs of the interstate and international systems, the basic policies underlying the particular field of law, and certainty, predictability and uniformity of result. In evaluating these principles, the Restatement recommends that courts consider: the place where the injury occurred or where the conduct causing the injury occurred, the domicile, residence, nationality, place of incorporation and place of business of the parties, and the place where the relationship between the parties is centered.
The Fifth Circuit concluded that the intangible nature of the creditors’ injury (and corresponding difficulty in terms of assigning a meaningful location to the injury), as well as the fact that both New York and Georgia had significant contacts to the alleged offense, did not favor application of one state’s law over the other. The Fifth Circuit ultimately determined that a desire to encourage uniformity of results among varying jurisdictions, strongly favored application of New York law due to its similarity to the UFTA.
The Fifth Circuit found that “the basic policy at issue is the protection of creditors from fraudulent transfers,” and New York law provided creditors with a potential remedy, whereas Georgia’s former law did not. Further, because of the widespread adoption of the UFTA and New York’s similarity to the UFTA with respect to the treatment of guaranty payments, the Fifth Circuit found that application of New York law promoted the needs of the interstate system in encouraging harmonious relations and uniform results among jurisdictions.
Additionally, although the Fifth Circuit recognized that application of Georgia law would benefit the lenders, none of the lenders were citizens of Georgia, which significantly diminished the state’s interest in seeing Georgia law govern the dispute. Further, as Georgia replaced section 18-2-22 of its Code with a statute modeled on the UFTA, and thus now recognizes guaranty payments as avoidable transfers, Georgia had little interest in seeing 18-2-22 govern the dispute.
The Fifth Circuit’s holdings in Mirant strongly support the rights of unsecured creditors in fraudulent transfer actions. Despite the apparent full satisfaction of Mirant’s unsecured creditors under the confirmed plan of reorganization, the Fifth Circuit provided Mirant’s unsecured creditors with a further opportunity to benefit based on their status as equity holders in the reorganized debtor entity. This makes sense as the essence of equity ownership is the right to share in profits, whether these arise through litigation or otherwise.
Further, although the Fifth Circuit in Mirant favored the application of New York fraudulent transfer law, which is not based on the UFTA, the UFTA’s underlying principles of expansive creditor protection and uniformity across jurisdictions played a pivotal role in the Fifth Circuit’s reasoning. Mirant suggests that state fraudulent transfer regimes differing from the UFTA may be marginalized in the years to come. With this decision and the adoption of the UFTA by an increasing number of jurisdictions over the last few decades, the UFTA is now tantalizingly close to its original goal of uniform application. This development brings greater certainty and uniformity to a complex area of law, and is no doubt welcome news to unsecured creditors.