Vendors are often confronted with the classic dilemma when a customer becomes financially distressed and falls behind. Do they continue to do business with the customer and attempt to obtain credit support, which may be the better way to get paid—or “cut the cord,” terminate the relationship, and initiate collection? When the decision is to continue the relationship and demand security or other credit support, such agreements and future payments could be scrutinized later if the customer or affiliates who provided guarantees or security file a bankruptcy case. To a vendor, a customer with a number of affiliates may appear as one business to the vendor, but in a bankruptcy case this will be examined, and each will be viewed separately to determine if the pre-bankruptcy agreements and transactions should be avoided as fraudulent transactions. The situation was recently reviewed by Judge Mary F. Walrath of the U.S. Bankruptcy Court for the District of Delaware in Giuliano v. World Fuel Services (In re Evergreen International Aviation), case no. 13-13364 (adv. No. 15-51918) (MFW) (Aug. 22, 2018).

Guarantee and Payment of Debt Fuels Future Litigation

According to the opinion, the debtors were in the business of providing air cargo transportation and aviation support. The defendant, World Fuel Services, Inc. sold fuel to the debtors for over a decade prior to the bankruptcy. One of the debtors, Evergreen International Airlines, Inc. (Airlines), was the primary purchaser, and fell behind in invoice payments prior to 2012. As a result, World Fuel and Airlines, together with Airlines' affiliate, Evergreen Helicopters, Inc., entered into a repayment agreement. A few months later, several affiliates guaranteed the debt, including the corporate parent, Evergreen International Aviation, Inc. (Aviation). The agreement acknowledged the default and $6.9 million debt. In addition to the guarantees, two other Evergreen affiliates granted World Fuel a security interest in collateral valued at $6 million.

In 2013, Aviation sought to enter into an agreement to sell the stock of Helicopters for $190 million. Aviation leased an aircraft from General Electric at the time. GE demanded additional security before it would agree to the sale. The proposed collateral was an aircraft, valued at $4.2 million, that was part of the collateral package already pledged to World Fuel. To address this problem, Aviation, Airlines and World Fuel agreed that Aviation would pay $5.2 million to World Fuel in exchange for World Fuel's release of its security interest in the aircraft.

Within months of the transaction, the debtors filed petitions under Chapter 7 of the Bankruptcy Code. The Chapter 7 trustee filed a complaint against World Fuel (and a nondebtor Evergreen affiliate), which sought to avoid Aviation's guarantee of Airlines' debt and the $5.2 million payment to World Fuel in exchange for the release of its lien against the aircraft. The trustee and World Fuel each filed motions for summary judgment. The issue was whether Aviation received “reasonably equivalent value” for each of the two transfers.

Court Finds Value Was Received

The court began its analysis by describing how “Section 548(a) of the Bankruptcy Code permits a trustee to avoid either a transfer of the debtor's property or an obligation incurred by the debtor if it occurred within two years of the petition date, the debtor was insolvent at the time of the transfer or became insolvent as a result of it, and the debtor received less than reasonably equivalent value in exchange for the property or obligation,” see 11 U.S.C. Section 548. The term “value” means “property, or satisfaction of or securing a present or antecedent debt of the debtor.”

Courts in the U.S. Court of Appeals for the Third Circuit apply a two-step approach to determine whether a debtor received reasonably equivalent value in exchange for a transfer or obligation. First, the court considers whether, based on the circumstances that existed at the time of the transfer, it was legitimate and reasonable to expect the debtor would receive some value. Second, if the debtor received any value, the court must compare the value and the transfer to determine whether the debtor received roughly the value it delivered. Courts engage in a fact driven analysis of the totality of the circumstances including the parties' good faith, the market value compared the amount transferred, and whether the transaction was at arm's length.

Turning to these transactions, the court first analyzed Aviation's guaranty of Airlines' debt to World Fuel. The trustee contended that Aviation received no value when it gave the guaranty because the debt was owed by Airline, not Aviation. World Fuel argued that Aviation received value because all of its subsidiaries were able to continue to purchase fuel on credit. In addition, Aviation and its subsidiaries shared the same line of credit. Without the guaranty, World Fuel argued, neither Airlines nor Helicopters would have been able to continue to operate. Finally, World Fuel argued that its forbearance from executing on other Evergreen guarantor affiliates constituted value.

The court noted a debtor that incurs an obligation on behalf of a third party does not usually receive value. A debtor can receive indirect value if the debtor and the third party are so related that they share an identity of interests. “A common example,” the court wrote, “is when a parent corporation makes a transfer to, or incurs an obligations on behalf of, its subsidiary.” However, courts are reluctant to find indirect value when the subsidiary is insolvent. In this case, the trustee argued that Airlines was already insolvent when Aviation gave the guaranty. The court reasoned that Airlines' debt was jointly and severally guaranteed by both debtor and nondebtor affiliates, and the trustee had failed to provide any evidence of the other affiliates' insolvency, only that the affiliates combined were insolvent. As a result, the court denied the trustee's request for summary judgment with respect to the guaranty.

The trustee argued that the $5.2 million payment was avoidable because it was made pursuant to the guaranty, which was itself avoidable. World Fuel argued that the payment was made pursuant to a separate repayment agreement, and facilitated the sale of Helicopters' stock in exchange for World Fuel's release of its lien in the aircraft. Further, consummation of the sale provided Aviation with reasonably equivalent value. The court agreed, and granted World Fuel's motion for summary judgment with respect to the payment.

Conclusion

Most vendors (and other creditors) who confront significant customer payment delinquencies know that in bankruptcy cases payments received within 90 days of the bankruptcy filing will be examined to determine if they can be avoided as preferences. However, transactions entered into, and payments received more than 90 days before the filing, are often reviewed under fraudulent transfer law. Creditors are advised to plan for such a possibility when considering any transaction with a distressed company, including examining the impact on each corporate entity involved in the transaction. What may be viewed by the creditor as appropriate and fair debt management might later be attacked. Given that “reasonably equivalent value” requires a factual analysis on a case-by-case basis, outcomes cannot be assured.

Andrew C. Kassner is the chairman and chief executive officer of Drinker Biddle & Reath, a national law firm with more than 635 lawyers in 12 offices. He chaired the corporate restructuring group for almost 20 years. He can be reached at [email protected] or 215-988-2554.

Joseph N. Argentina Jr. is an associate in the firm's corporate restructuring practice group in the Philadelphia and Wilmington, Delaware, offices. He can be reached at [email protected] or 215-988-2541.