In Re Cyberco Holdings Inc.

• Citation: 431 B.R. 404
• Decision Date: 02 July 2010
• Docket Number: No. HG 04-14905,HG 05-00690.,HG 04-14905
• Parties: In re CYBERCO HOLDINGS, INC., Debtor.In re Teleservices Group, Inc., Debtor.
• Court: United States Bankruptcy Courts. Sixth Circuit. U.S. Bankruptcy Court — Western District of Michigan

431 B.R. 404

In re CYBERCO HOLDINGS, INC., Debtor.
In re Teleservices Group, Inc., Debtor.

Nos. HG 04-14905, HG 05-00690.

United States Bankruptcy Court,
W.D. Michigan.

July 2, 2010.

431 B.R. 405

COPYRIGHT MATERIAL OMITTED

431 B.R. 406

Cyberco Holdings, Inc., pro se. OPINION RE: HUNTINGTON NATIONAL BANK'S MOTIONS FOR SUBSTANTIVE CONSOLIDATIONJEFFREY R. HUGHES, Bankruptcy Judge.

The Huntington National Bank (“Huntington”) has filed separate motions to substantively consolidate the Chapter 7 cases of Cyberco Holdings, Inc. (“Cyberco”) and Teleservices Group, Inc. (“Teleservices”). Both motions are denied.

PROCEDURAL BACKGROUND

Cyberco and Teleservices are related companies because of common ownership. On December 9, 2004, creditors of Cyberco commenced an involuntary Chapter 7 proceeding against it. The involuntary petition was filed only days after a state court had ordered a receiver to take control of both entities. The receiver did not oppose the Cyberco petition and, as a consequence, an order for relief was filed the next day. Moreover, the receiver himself filed a voluntary Chapter 7 petition on behalf of Teleservices a month later.

Thomas Richardson is the trustee of the Cyberco estate and Marcia Meoli is the trustee of the Teleservices estate.¹ Both trustees are vigorously pursuing avoidance actions against Huntington under various sections of the Bankruptcy Code.² Trustee Richardson contends that Huntington received substantial preferential transfers in connection with the indebtedness

431 B.R. 407

owed to it by Cyberco.³ As for Trustee Meoli, she claims not only that Huntington itself received huge fraudulent transfers from Teleservices, but also that Huntington received even larger amounts as a subsequent transferee of other fraudulent transfers made by Teleservices to Cyberco.⁴

Part of Huntington's response to these avoidance actions has been its own request to substantively consolidate the two separate estates into a single estate. Substantive consolidation, when ordered, typically involves the combination of the affected estates' assets with all creditors then sharing equally from the common pool.⁵ However, in this instance, Huntington contends that consolidation of the two estates would also require a reassessment of the avoidance actions that have been brought against it. Specifically, it asserts that:

• For purposes of any analysis of the depletion of estate assets, the consolidated estate shall be the relevant estate.

• For purposes of determining whether Huntington gave “value” for any pre-petition transfers to it from Cyberco or Teleservices, value will be appraised in light of the post-petition effect of such transfers on the consolidated estate, and

• Pre-petition transfers between the consolidated entities will be analyzed in light of their effect post-petition on the consolidated estate.⁶

Obviously, Huntington's hope is that these reassessments will then result in a substantial reduction of what the two trustees otherwise claim must be returned to their two separate estates.

The consolidation motions were tried at the same time as certain aspects of Trustee Meoli's fraudulent transfer action against it were tried.⁷ A twelve day trial was then conducted over a three month period with closing arguments being made in January 2010. Post-hearing briefs have also been filed.⁸

431 B.R. 408

FACTS

Huntington was apparently ⁹ one of many victims of a massive fraud perpetrated by Barton Watson and others through both Cyberco and Teleservices.¹⁰ Huntington itself did not get involved with Cyberco until 2002. Watson ¹¹ had wooed Huntington to become its bank with the story that its current lender, which was in Chicago, had recently been acquired and that Cyberco was looking for a more local relationship. What Watson did not mention was that its current lender had actually asked Cyberco to leave.

Huntington immediately provided Cyberco with a new $9 million line of credit and it then increased that line to $13 million shortly thereafter. In addition, Huntington financed various equipment acquisitions and issued at least one letter of credit. All in all, Huntington's total exposure to Cyberco was in excess of $16 million by early 2004.

Cyberco had represented itself to Huntington and others as a fast growing, high-tech company on the cutting edge. This is how Huntington's own report to its shareholders described Cyberco just after Huntington landed the account:

With its world headquarters based in Grand Rapids, Michigan, CyberNET [i.e., Cyberco] is the internationally recognized front-runner in the design, deployment and operation of information technology infrastructures necessary to put mission-critical corporate data into the hands of users.

Trustee Trial Ex. 30.

Cyberco had in fact started as a legitimate business in the early 1990s and Cyberco still had some actual customers in 2002. However, by that time Watson was resorting more and more to fraud to generate Cyberco's revenues. Indeed, virtually all of Cyberco's revenue was attributable to fraud when it finally collapsed in late 2004.

Watson's scheme was as simple as it was brazen. He sought out banks, leasing companies, and other similar institutions on the pretext that Cyberco needed more computer equipment for its rapidly growing global business. However, Cyberco never acquired any of the equipment for which it had received funding. Rather, Watson would represent that Teleservices was Cyberco's source for the desired equipment and, as a consequence, the finance companies would forward the necessary funds to Teleservices on the mistaken belief that Teleservices had something to

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sell.¹² Watson would then have Teleservices issue false invoices and other documents to evidence the supposed transaction. As for Cyberco, Watson packed its computer room with fake servers and he then swapped serial numbers among those servers in order to deceive the victims whenever they attempted an audit of their collateral.¹³

Teleservices, of course, did not keep its ill-gotten gains. Rather, it funneled them back to Cyberco and Cyberco in turn used what it received (1) to perpetuate the fraud by making payments on the many promissory notes and leases Cyberco had signed in connection with prior nonexistent purchases; and (2) to pay Cyberco's other operating expenses, including the handsome salaries and expense accounts of Watson and his fellow cheats. Those payments, though, were made for the most part through Huntington accounts that Cyberco had opened and Huntington otherwise facilitated these payments through various cash management services it provided. Consequently, millions and millions of dollars passed through Huntington even though Cyberco's actual indebtedness to Huntington was considerably less.¹⁴

431 B.R. 410

Huntington's relationship with Cyberco deteriorated as time progressed, and in fact, by January 2004, Huntington had followed its predecessor's suit by also asking Cyberco to leave. Six months passed, though, before Cyberco actually began to pay down its debt. Moreover, virtually all of Cyberco's legitimate business had disappeared by then. Consequently, Watson funded the loan paydown to Huntington by generating even more funds through the Teleservices scam. Indeed, it was Teleservices that made most of the paydown even though Teleservices itself had no banking relationship with Huntington. All told, Huntington was able to reduce its exposure from $12,600,000 in June 2004 to only about $600,000 just weeks before the FBI raided Cyberco in November of that same year. Trustee Trial Ex. 231-K, 153.

DISCUSSION

Many courts have recognized substantive consolidation as an available remedy under the Bankruptcy Code.¹⁵ In its broadest sense, it:

treats separate legal entities as if they were merged into a single survivor left with all the cumulative assets and liabilities (save for inter-entity liabilities, which are erased).
Genesis Health Ventures, Inc. v. Stapleton (In re Genesis Health Ventures, Inc.), 402 F.3d 416, 423 (3rd Cir.2005).

However, pinning down the exact authority that empowers a bankruptcy court to impose such a remedy has proven illusive. The Bankruptcy Code itself makes no reference to “substantive consolidation” and the term “consolidate” or “consolidation,” standing alone, appears in only two places.¹⁶

Nonetheless, modern courts are wont to say that substantive consolidation is permitted under the Bankruptcy Code through Section 105(a), which, in pertinent part, provides that:

The court may issue any order, process, or judgment that is necessary or appropriate to carry out the provisions of this title.

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See, e.g., Walter E. Heller & Co. v. Langenkamp (In re Tureaud), 59 B.R. 973, 975 (N.D.Okla.1986); In re DRW Prop. Co. 82, 54 B.R. 489, 494-95 (Bankr.N.D.Tex.1985); Gold v. Winget (In re NM Holdings Co.), 407 B.R. 232, 274 (Bankr.E.D.Mich.2009). But it is just as often said that substantive consolidation is to be viewed as “a product of judicial gloss.” Union Savings Bank v. Augie/Restivo Baking Co., Ltd. (In re Augie/Restivo Baking Co., Ltd.), 860 F.2d 515, 518 (2nd Cir.1988).¹⁷ Indeed, courts regularly regard their ability to order substantive consolidation as deriving from an equitable power that predates the Code.

Substantive consolidation traces its roots to the Bankruptcy Act of 1898. The Act then contained no express statutory authorization for consolidation, either generally or in the case of spouses. Instead, the authority to order substantive consolidation was implied from the bankruptcy court's general equitable powers.
Reider v. FDIC (In re Reider), 31 F.3d 1102, 1105 (11th Cir.1994) (footnotes and citations omitted).¹⁸

Sampsell v. Imperial Paper & Color Corp., 313 U.S. 215, 61 S.Ct. 904, 85 L.Ed. 1293 (1941) is, in turn, frequently cited as the seminal Act case from which this equitable remedy evolved.¹⁹

It would seem, then, that a thorough understanding of both Sampsell and the many other...