Dev. Specialists, Inc. v. Kaplan

• Decision Date: 26 April 2017
• Docket Number: Civil No. 1:16–cv–421–DBH
• Citation: 574 B.R. 1
• Parties: DEVELOPMENT SPECIALISTS, INC., Appellant v. Michael W. KAPLAN, et al., Appellees
• Court: U.S. District Court — District of Maine

574 B.R. 1

DEVELOPMENT SPECIALISTS, INC., Appellant

v.Michael W. KAPLAN, et al., Appellees

Civil No. 1:16–cv–421–DBH

United States District Court, D. Maine.

Signed April 26, 2017

Paul McDonald, Robert J. Keach, Bernstein Shur Sawyer & Nelson, Portland, ME, Timothy J. McKeon, Seyfarth Shaw LLP, Boston, MA, for Appellant.

Christian T. Chandler, Rebecca G. Klotzle, Curtis, Thaxter, Stevens, Broder & Micoleau, Portland, ME, Lawrence G. Green, Burns & Levinson LLP, Boston, MA, for Appellees.

DECISION AND ORDER ON BANKRUPTCY APPEAL

D. Brock Hornby, United States District Judge

This is an appeal under 28 U.S.C. § 158(a)(1) from the bankruptcy court's final judgment in an adversary proceeding. That court found no fraudulent debtor transfers and no breach of corporate directors' duties. After oral argument on April 12, 2017, I now AFFIRM the bankruptcy court, although my reasoning differs somewhat.

STANDARD OF REVIEW

The parties agree on the standard of review. Appellant's Br. 6 (ECF No. 11); Appellees' Br. 2 (ECF No. 15). I accept the bankruptcy court's factual findings unless they are clearly erroneous. I review the bankruptcy court's conclusions of law de novo. Fed. R. Bankr. P. 7052 ; Fed. R. Civ. P. 52 ; In re Furlong, 660 F.3d 81, 86 (1st Cir. 2011).

FACTUAL AND PROCEDURAL BACKGROUND ¹

The plaintiff/appellant Development Specialists, Inc. is the liquidating trustee for six related debtors in the leather business that entered chapter 11.² The trustee seeks to avoid certain transfers by some of the debtors and to recover damages from the former shareholders³ and directors⁴ of one of those debtors, Prime Maine.⁵ The trustee's focus is a complex transaction that closed on November 20, 2007 and a later 2010 release related to that transaction.

In 2007, like other U.S. companies in the leather tanning and finishing industry, Prime Maine experienced profitability challenges. Memorandum of Decision (Mem. of Dec.) 4 [App. 1329]. Meriturn Partners, LLC (Meriturn), a private equity firm that specializes in restructurings and that had recently acquired Irving Tanning, expressed an interested in Prime Maine, seeing an opportunity to merge Prime Maine with Irving Tanning and gain access to additional customers and markets. Id. at 6 [App. 1331]. Meriturn and Prime Maine began negotiations and exchanged multiple letters of interest, culminating in a May 31, 2007 letter that outlined a series of steps whereby Irving Tanning and Prime Maine would come under the common ownership of a new holding company, Prime Delaware.⁶ Am. Joint Stipulation of Undisputed Facts ¶¶ 27–29 [App. 1143]. Prime Maine, Irving Tanning, and Prime Delaware then entered into an August 15, 2007 Contribution Agreement, which was subsequently amended on the closing date, November 20, 2007. Id.¶¶ 30–34 [App. 1143–44]. In the end Meriturn contributed about $3 million while Irving Tanning, Prime Delaware, Prime Maine, Prime Missouri, and Cudahy entered into substantial lien-secured loan agreements with Wells Fargo, N.A. (Wells Fargo) to complete the financing.⁷ At the closing, Irving Tanning, Prime Maine, and Cudahy all came under the common ownership of Prime Delaware, and Prime Missouri remained a wholly owned subsidiary of Prime Maine.⁸

At the closing, (1) Irving Tanning, Prime Delaware, Cudahy, Prime Maine, and Prime Missouri executed a $1,860,000 term note, a $40,000,000 revolving note, and a $25,000,000 revolving note, all payable to Wells Fargo,⁹ Mem. of Dec. 10 [App. 1335]; (2) the debtors actually borrowed from Wells Fargo $1,656,785 under the term note and $28,165,000 under the revolving notes, Am. Joint Stipulation of Undisputed Facts ¶¶ 35–36 [App. 1141]; (3) Irving Tanning, Prime Delaware, Prime Maine, Cudahy, and Prime Missouri directed Wells Fargo to pay $10,629,459 in cash proceeds to Prime Maine's shareholders (the shareholder defendants) and $4 million in non-competition payments to Michael and Stephen Kaplan¹⁰ (previously co-chairs of the Prime Maine and Prime Missouri boards); (4) Prime Delaware delivered a $3,817,000 promissory note to the Prime Maine shareholders; (5) Prime Delaware issued 40% of its shares to the Prime Maine shareholders; (6) Prime Maine delivered the $9 million cash value of life insurance policies to certain Prime Maine shareholders; and (7) Prime Delaware entered into employment and non-competition agreements with Michael and Stephen Kaplan. Mem. of Dec. 10–11 [App. 1335–36]; see supra note 10. Prime Maine's shareholders transferred all their shares, i.e. , complete ownership of Prime Maine and its subsidiary Prime Missouri, to Prime Delaware. Mem. of Dec. 8–9 [App. 1333–34]; Am. Joint Stipulation of Undisputed Facts ¶ 51 [App. 1147].

As a result, the Prime Maine shareholders collectively received in excess of $23.6 million in exchange for their stock and agreements. Mem. of Dec. 14 [App. 1339]. The trustee claims that the November 20 transaction amounted to a leveraged buyout (LBO), that the Prime Maine shareholders are responsible for fraudulent transfers by Prime Delaware, Prime Maine, and Prime Missouri, and that the directors of Prime Maine¹¹ breached duties of loyalty and care to that corporation. ¹²

The shareholders and directors dispute the LBO characterization, preferring to call the transaction a merger or roll-up,¹³ and assert that there were no fraudulent transfers and no breaches of directors' duties. After a 5–day bench trial, the bankruptcy court filed a written opinion in favor of the shareholders and directors, finding that the trustee had not met its burden on any of the claims,¹⁴ and entered final judgment accordingly. The trustee has appealed.¹⁵

ANALYSIS

Fraudulent Transfers

Maine has adopted the Uniform Fraudulent Transfer Act (UFTA), 14 M.R.S.A. § 3571.¹⁶ It permits a creditor to challenge transfers where there was either actual or constructive intent to defraud. 14 M.R.S.A. § 3575.

Actual Fraud in November 2007 Transaction¹⁷

The trustee asserts actual fraud in the transfers made by Prime Maine and Prime Missouri on November 20, 2007.¹⁸ According to Maine's UFTA, a transfer is fraudulent if the debtor "made the transfer or incurred the obligation ... [w]ith actual intent to ... defraud any creditor of the debtor." 14 M.R.S.A. § 3575(1)(A). The statute also lists eleven factors that "may be given" consideration (along with other unidentified factors) in determining actual intent. Id.§ 3575(2).¹⁹ Maine's Law Court has stated: "The court may consider factors other than the [listed factors], and any combination of factors may support a determination of actual intent." FDIC v. Proia, 663 A.2d 1252, 1254 (Me. 1995).

The bankruptcy court in this case found that the shareholder defendants did not engage in actual fraud. Mem. of Dec. 13–18 [App. 1338–43]. The trustee correctly observes that the UFTA focuses not on the shareholders but on the debtors, the corporations that made the transfers. But it was the trustee that, in the relevant counts of the adversary complaint, focused on the noncorporate defendants to make the case for actual fraud.²⁰ That is understandable, because the individuals' intent could be attributed to the corporations. It would be a pointless exercise to send the case back to the bankruptcy court now to ask for findings about these two debtors (Prime Maine and Prime Missouri) as distinct from the shareholders on this issue.²¹ And certainly on this record, an appellate court is not in a position to find the contrary, i.e. , actual intent on the part of the debtors: that is for the factfinder.

According to Maine law, actual fraud under the UFTA must be proven by clear and convincing evidence. Proia, 663 A.2d at 1254 n.2. I have read the trial transcript and the relevant exhibits. Although there is room for a difference of opinion over whose version of value in the transaction to believe, the bankruptcy court's factual findings that there was no actual fraud are not clearly erroneous. Therefore its conclusions on those counts must stand.

Constructive Fraud in November 2007 Transaction²²

The trustee asserts constructive fraud in the November 20 transfers made by Prime Delaware, Prime Maine, and Prime Missouri. According to the statute, a transfer is fraudulent under this prong of the UFTA if the debtor:

made the transfer or incurred the obligation ... [w]ithout receiving a reasonably equivalent value in exchange for the transfer or obligation and the debtor:

(1) Was engaged or was about to engage in a business or a transaction for which the remaining assets of the debtor were unreasonably small in relation to the business or transaction; or

(2) Intended to incur, or believed or reasonably should have believed that he would incur, debts beyond his ability to pay as the debts became due.

Id. § 3575(1)(B). The cases and the commentators call this constructive fraud.

Applying a preponderance of the evidence standard,²³ the bankruptcy court found that the trustee did not satisfy the first, underlying, element ("without receiving a reasonably equivalent value in exchange for the transfer") because Prime Delaware did receive reasonably equivalent value in exchange for the transaction with Prime Maine's shareholders.²⁴ This finding lies at the heart of the LBO labelling controversy. The trustee demands and the shareholders/directors resist the LBO label because it generally intensifies the scrutiny of a transaction.²⁵ The trustee argues that once the LBO label is applied, the "reasonably equivalent value in exchange" element of the fraudulent transfer statute can almost never be satisfied.²⁶ In its decision, the bankruptcy court did not refer to the 2007 transaction as an LBO, calling it a "merger" and calling Prime Delaware "the resulting business" in light of testimony from Stephen Kaplan, Michael Kaplan, Moore, Goldberg, and Pombo. Mem. of Dec. 17 [App. 1342]. I respect the bankruptcy court's decision not to accept or reject the LBO label. Labelling too often is a substitute for analysis.²⁷ In the end, ...