A Bankruptcy Court’s Analysis of a Motion to Dismiss Annulment Actions: The Analytical Framework | Patterson Belknap Webb & Tyler LLP

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A federal judge recently allowed a trustee preferential transfer request against a law firm to sue, but rejected a constructive fraudulent transfer request. The decision highlights the pleading standards and analytical framework for motions to dismiss such claims. Insys Liquidation Trust v. Urquhart (In re Insys Therapeutics Inc.), Case No. 19-11292, Adv. No. 21-50359, 21 Bankr. LEXIS 2965 (JTD) (Bankr. D. Del. 28 Oct. 2021).

The debtors had paid the law firm $90,000 within 90 days of the Chapter 11 filing. The liquidation trustee sued the company to reverse the transfers and recover the costs. The company filed for dismissal, alleging that the complaint did not indicate a claim upon which relief could be granted under Federal Bankruptcy Rules 7008 and 7012.

In the context of a motion to dismiss, a “complaint must contain sufficient factual elements, accepted as true ‘to set forth a prima facie plausible claim for relief’.” In re Insys Therapeutics Inc., 2021 Banking. LEXIS 2965, at *4 (citing Bell Atl. Corp. vs. Twombly, 550 US 544, 570 (2007)). The court “must make all reasonable inferences in favor of the plaintiff” and the defendant bears the burden of showing that a plaintiff’s claims “are implausible”. Identifier. (quote omitted).

The bankruptcy court first considered the company’s arguments to reject the preferential transfer request. The five elements of this claim under Section 547(b) of the Bankruptcy Code are:

  • a transfer has been made to or for the benefit of a creditor;
  • for or in respect of a prior debt owed by the debtor before such transfer was made;
  • when the debtor was insolvent;
  • within 90 days of filing for bankruptcy (or between 90 days and one year for insiders of the debtor); and
  • which allowed the creditor to receive more than they would in a Chapter 7 liquidation.

Before filing a lien claim, a debtor must also perform “due diligence” on the circumstances of the case and any affirmative defenses. 11 USC § 547(b).

The law firm argued that the complaint failed to demonstrate that he had received a previous debt, that he was a creditor, or that he had received more than he would have in a case under the chapter 7. The firm also said that before the case was filed, there was no evidence that the debtors had exercised “due diligence”.

Specifically, the company claimed that the complaint contained too few facts to satisfy the elements of Section 547. But the court noted that – as is often seen in preference lawsuits – the key facts were contained in a appendix attached to the complaint. The schedule identified the payor and payee, payment amount, payment date, check number, and the date, number and amount of the law firm’s invoices. The schedule also revealed that the debtor had made payments on these invoices. According to the court, these details constituted sufficient facts to demonstrate that the law firm had received payments for previous debts and was a creditor.

The court also found that the complaint satisfied the fifth element of section 547(b): the complaint alleged that if the company had not received the transfers, it would have had an unsecured debt in a hypothetical case of the chapter 7, and therefore would have received less than full payment of the bills. In addition, the court concluded that the trustee exercised due diligence before filing the lawsuit. Accordingly, the court rejected all of the law firm’s arguments and allowed the trustee to proceed with the preferential transfer claim.

The court then considered the implied fraudulent conveyance claim. To successfully assert such a claim, a plaintiff must demonstrate that the debtor (i) received less than reasonably equivalent value for the transfers at issue and, (ii) was insolvent when the transfers were made, ended up with unreasonably small capital, or was unable to pay debts as they came due. 11 USC § 548(a).

The court concluded that the allegations in the complaint “repeat only the elements of the law and contain no factual allegations” regarding the specific prongs of the Section 548 test. In re Insys Therapeutics Inc., 2021 Banking. LEXIS 2965, at *11. The trustee argued that it was sufficient for the complaint to allege a lack of reasonably equivalent value because the matter was to be resolved by way of discovery, not on a motion to dismiss. Although the court agreed that the issue “cannot be resolved at the motion to dismiss stage,” the trustee “still must allege certain facts that would ultimately support a finding of no reasonably equivalent value.” Identifier. But, the court pointed out that the complaint did not state any facts to support the allegation.

Similarly, the trustee’s claims of insolvency were flawed. The court noted that the complaint does not “plausibly allege insolvency” when the transfers took place. Merely reciting the language of the law “is not enough.” Identifier. to *13. Consequently, the court dismissed the trustee’s claim for fraudulent transfer by construction.

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