Sharp v. Intracoastal Capital, LLC (In re Blue Earth, Inc.)

• Decision Date: 02 October 2019
• Docket Number: BAP No. NC-18-1232-BSTa,Adv. No. 3:17-ap-03063-DM
• Parties: In re: BLUE EARTH, INC., Debtor. BRADLEY D. SHARP, Chapter 11 Liquidation Trustee, Appellant, v. INTRACOASTAL CAPITAL, LLC; ANSON INVESTMENTS MASTER FUND LLP, Appellees.
• Court: U.S. Bankruptcy Appellate Panel, Ninth Circuit

In re: BLUE EARTH, INC., Debtor.

BRADLEY D. SHARP, Chapter 11 Liquidation Trustee, Appellant, v. INTRACOASTAL CAPITAL, LLC;

ANSON INVESTMENTS MASTER FUND LLP, Appellees.

BAP No. NC-18-1232-BSTa

Adv. No. 3:17-ap-03063-DM

UNITED STATES BANKRUPTCY APPELLATE PANEL OF THE NINTH CIRCUIT

Argued and Submitted: June 20, 2019

October 2, 2019

NOT FOR PUBLICATION

Bk. No. 3:16-bk-30296-DM

MEMORANDUM^*

Argued and Submitted on June 20, 2019 at Sacramento, CaliforniaAppeal from the United States Bankruptcy Court for the Northern District of California

Honorable Dennis Montali, Bankruptcy Judge, Presiding

Appearances: Howard Troy Romero of Romero Park P.S. argued for appellant Bradley D. Sharp, Chapter 11 Liquidation Trustee; Michael Benz of Chapman and Cutler LLP argued for Appellee Anson Investments Master Fund, LLP; Scott Mendeloff of Greenberg Traurig, LLP argued for Appellee Intracoastal Capital, LLC.

Before: BRAND, SPRAKER and TAYLOR, Bankruptcy Judges.

INTRODUCTION

Bradley D. Sharp appeals (1) an order granting appellees' motions to dismiss his first amended complaint to avoid and recover alleged constructive fraudulent transfers¹ to appellees, and (2) an order denying reconsideration of that decision. Although we agree that Sharp's first amended complaint failed to plead plausible claims against appellees, we believe that the bankruptcy court should have granted him leave to amend. Accordingly, we AFFIRM in part, REVERSE in part, and REMAND.

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I. FACTUAL BACKGROUND AND PROCEDURAL HISTORY

A. Background of the parties and the alleged fraudulent transfers

Blue Earth, Inc. ("BEI") was a provider of alternative and renewable energy solutions for small and medium-sized commercial facilities. BEI filed a chapter 11² bankruptcy case on March 21, 2016. Sharp ("Trustee") is the trustee of the litigation trust that was established to investigate and prosecute causes of action for the benefit of the litigation trust beneficiaries.

The following facts are as alleged by Trustee. During an expansion period for BEI, the company was in constant need of cash infusions to fund its operations and the operations of its subsidiaries until the entities could develop projects and become profitable. BEI raised the necessary capital through a combination of equity sales and loans. By October 2015, BEI's financial outlook was bleak. The company was borrowing funds from its officers and directors to meet basic obligations, such as payroll.

To raise capital to avoid a default on a secured loan that could have precipitated BEI's bankruptcy, BEI turned to one of its shareholders, Intracoastal Capital, LLC ("Intracoastal"), and a new investor, Anson Investments Master Fund, LLP ("Anson"). On October 16, 2015, BEI entered into Securities Purchase Agreements with Intracoastal and Anson (the"SPAs"). In exchange for $2,000,000 from each investor, each investor would receive 4,000,000 shares of BEI common stock, 6-month warrants to purchase an additional 4,000,000 common stock shares for $0.50 per share, and five-and-a-half year warrants to purchase an additional 4,000,000 common stock shares for $0.83 per share. Intracoastal's and Anson's respective $2,000,000 investments closed on October 20, 2015.

Just days after the SPAs closed, BEI, Intracoastal and Anson agreed to undo the transactions. On October 27, 2015, Intracoastal and Anson each executed an "Exchange Agreement" with BEI, which effectively reversed the SPAs. In exchange for the return of the 4,000,000 shares and warrants Intracoastal received, BEI paid Intracoastal $2,000,000, plus an additional $200,000, $10,000 in legal fees, and a five-year warrant to purchase 1,500,000 shares at $0.55 per share. In exchange for the return of the shares (less a small amount it had already sold) and warrants Anson received, BEI paid Anson $2,003,419, plus a five-year warrant to purchase 1,500,000 shares at $0.55 per share. These "Exchange Agreement" transfers are the basis of Trustee's claims against Intracoastal and Anson.

By the time of the Exchange Agreements, BEI had already spent the $4,000,000 it raised through the SPAs on existing debts. Thus, to finance the stock repurchase, BEI had to borrow $4,900,000 from Jackson Investment Group, LLC ("JIG"), one of BEI's largest shareholders and a senior lender. The loan was evidenced by a 9% Senior Secured Note due in two monthson December 23, 2015. BEI filed for bankruptcy five months after the Exchange Agreements.

B. Trustee's original complaint and the motions to dismiss

In his original complaint against Intracoastal and Anson (together, "Defendants"), Trustee alleged that the Exchange Agreements constituted constructive fraudulent transfers under § 548(a)(1)(B). He sought to avoid the transfers and recover $2,210,000 from Intracoastal and $2,003,419 from Anson, the amounts Defendants received from BEI under the Exchange Agreements, plus pre- and post-judgment interest.

Defendants moved to dismiss Trustee's original complaint, arguing that Trustee's insolvency allegations were conclusory and contradicted public information and BEI's own statements concerning its solvency at the time of the Exchange Agreements. Specifically, BEI had represented in the Exchange Agreements that it was financially healthy, and BEI's Form 10-Q dated September 30, 2015, just weeks before the Exchange Agreements, reflected that BEI had nearly $80,000,000 in assets over liabilities (e.g., assets of nearly $100,000,000 versus liabilities of just over $21,000,000). Lastly, Defendants argued that Trustee conceded BEI was solvent at the time, because he alleged that BEI was able to secure a loan from JIG for the purpose of funding the transfers.

In opposition, Trustee argued that even if he could not establish insolvency under § 548(a)(1)(B)(ii)(I), he could still prevail on his claim ifBEI was (a) engaged in business or a transaction for which any property remaining with it was unreasonably small, or (b) if BEI intended to incur or believed that it would incur debts beyond its ability to pay as they matured. § 548(a)(1)(B)(ii)(II), (III). Trustee requested leave to amend the complaint if additional facts were necessary.

The bankruptcy court held two hearings on the motions to dismiss the original complaint. At the first hearing, the court indicated that Trustee had sufficiently pled BEI's insolvency. By the second hearing, the court had reconsidered and told him that ¶¶ 41-43 of the complaint were insufficient for pleading the three alternative grounds for establishing insolvency under § 548(a)(1)(B)(ii)(I)-(III); they simply parroted the statutory language. Ultimately, the court granted the motions to dismiss with leave to amend:

THE COURT: Mr. Powell, I'm going to stick with that [ruling]. I think with my thinking that insolvent, do you mean balance sheet insolvent? Do you mean cash flow insolvency? You know, were they -- were their revenues such that they couldn't pay their debts as they become due and, again, just state it. You can't just restate the definition. I do think for you to file the complaint and state that BEI was insolvent, you have to have some basis, and I don't think it's a high bar here. . . . .

Hr'g Tr. (Mar. 26, 2018) 8:1-9.

C. Trustee's first amended complaint and the motions to dismiss

Trustee then filed his first amended complaint ("FAC"). To bolster his allegation that BEI was insolvent at the time of the Exchange Agreements,Trustee added the following:

¶ 38. At the time of the Transfers, BEI suffered from unmanageable indebtedness. But for the funds it received pursuant to the October 16 SPAs, it would have defaulted on a secured loan that would have necessitated it immediately filing for bankruptcy protection;

¶ 39. BEI did not have sufficient funds to continue developing its works in progress. Such projects were needed to finally generate income streams for the company;

¶ 40. On October 15, the day before the SPAs were finalized, BEI had a monthly 'burn rate' of $900,000, an amount that had to be raised monthly to meet its debts. This was a 50% increase in the 'burn rate' since September;

¶ 42. As a result of the Transfers, BEI was left without meaningful cash reserves to pay its debts as they became due, and the Exchange Agreements ultimately contributed significantly to BEI declaring bankruptcy;

¶ 43. Apart from being cash-flow insolvent, BEI was also balance sheet insolvent at the time of the Transfers or became insolvent as a result thereof. Despite the company's disclosures during the relevant timeframe, its financial statements contained various accounting errors that resulted in a grossly overstated value of the company's assets. For example, BEI accounted for non-binding letters of intent on unfunded renewable energy projects as assets worth millions of dollars;

¶ 44. BEI proceeded with the Exchange Agreements with knowledge of the company's serious financial problems and of theprejudice to creditors caused by trading $4 million in cash for over $5 million in debt;

¶ 53. As noted above, BEI was insolvent at the time of the Transfers or became insolvent as a result thereof. It no longer had the ability to pay debts as they came due and the value of its liabilities exceeded its actual assets;

¶ 54. The Transfers also left BEI with an unreasonably small amount of capital with which to engage in its business. It had to turn to its existing shareholders and creditors for funds to keep the company on life support. After a few unsuccessful months without capital needed to engage in business BEI filed for bankruptcy;

¶ 55. At the time of the Transfers, BEI was engaged in business or was about to engage in business for which any property remaining with BEI was an unreasonably small amount of capital. Indeed, one of its primary investment models was to fund capital-intensive renewable energy systems. Such projects required significant sources of construction and project financing, and BEI had an unreasonably small amount of property to engage in its business;

¶ 56. At the time of

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