District of Delaware, United States Bankruptcy Judge Peter J. Walsh issues his opinion in Giuliano v. Shorenstein Company LLC (In re Sunset Aviation, Inc. ), Adv. Proc. No. 11-50965 (Bankr. D. Del.  September 7, 2011)   holding that an order for substantive consolidation is not retroactively effective when it fails to expressly provide that it is nunc pro tunc.  Based on this holding, Judge Walsh dismisses, with prejudice, the bankruptcy preference count of the complaint by Alfred T. Giuliano, Chapter 7 Trustee for the Bankruptcy Estates of Sunset Aviation (the “Trustee”). Fundamentally, Judge Walsh rejected the Trustee’s urging for the Court to perfunctorily use a substantive consolidation order to rewrite Section 547 of the Bankruptcy Code. Registered users click here to see a copy of this opinion.

The Timing of the Debtors’ Bankruptcies and the Transfer

The facts surrounding the bankruptcy preference claim made by the Trustee against defendant Shorenstein Company LLC (“Defendant”) squarely framed the issue before Judge Walsh. Three associated debtors (the “Debtors” and each a “Debtor”) filed bankruptcy on three different dates. The earliest filing date, that of Debtor Regal Jets, LLC (“Regal Jets”), was February 25, 2009. Its affiliate, JetDirect Aviation, Inc. (“JetDirect”) filed its petition 65 days later, on May 1, 2009. The cases were filed under Chapter 11 but were converted to Chapter 7 in June 2009. At the request of the Trustee, all three bankruptcy cases were substantively consolidated on August 19, 2010. The substantive consolidation order made no reference to any nunc pro tunc – i.e. retroactive  – effect.

In February, 2011, the Trustee filed a “virtual” five count complaint seeking recovery of a single $443,690 payment made by JetDirect to Defendant (the “Transfer”). Three avoidance counts alleged that the single payment was avoidable as a preferential payment under Section 547, a constructive fraudulent conveyance under Section 548(a)(1)(B) and a post petition transfer under Section 549.

The Transfer cleared on December 2, 2008 (the “Transfer Date”). This Transfer Date was 85 days prior to Regal Jets’ bankruptcy and 150 days prior to JetDirect bankruptcy. If, as Defendant contended, the JetDirect bankruptcy date is used, the Transfer plainly was outside of the 90 day preference period and not avoidable as a preference. The Trustee claimed that, due to the substantive consolidation of the Debtors’ bankruptcies, the 90 day preference period must be calculated from the Regal Jets’ bankruptcy date.  Using the Regal Jets’ filing date, the Transfer was within the preference period.

Nunc Pro Tunc Relief is Serious Business

Judge Walsh parsed through and rejected each of the Trustee’s arguments for giving the substantive consolidation order retroactive effect. The starting point for Judge Walsh’s legal analysis was “the critical fact … that neither the Trustee’s Motion for Consolidation nor the Order itself contain any language to suggest a nunc pro tunc application.” Judge Walsh then employed the analysis and holding of In re Garden Ridge Corp., 338 B.R. 627 (Bankr. D. Del. 2006), aff’d sub nom Ferguson v. Garden Ridge Corp. (In re Garden Ridge Corp.), 399 B.R. 135 (D. Del. 2008)

[T]his Court [in Garden Ridge] looked at the express language of the plan to determine whether the consolidation was meant to have retroactive effect. The plan provided, in relevant part, that “[o]n the Confirmation Date, the Chapter 11 Cases of all of the Debtors shall be substantively consolidated for all purposes related to the Plan, including, without limitation, for purposes of voting, confirmation, and distributions. . . .” Garden Ridge, 338 B.R. at 641. The Court concluded that “[t]here is no language in the Plan which would suggest that substantive consolidation should be given retroactive effect.” Id. Thus, “as stated in the Plan, substantive consolidation was for certain prospective purposes related to the Plan,” and there was no mutuality giving rise to a right of setoff. Id. (emphasis added.)

Likewise, I find in the instant case that there is no language in either the Order or the Trustee’s Motion for Consolidation that could be read to suggest a nunc pro tunc application. The Trustee attempts to distinguish Garden Ridge in his Opposition by arguing that the Order in this case “is silent as to its effective date.” (Opposition, at 16.) I disagree that it is silent. In fact, the Order contains language which is contrary to a nunc pro tunc order. Specifically, the Order states: “Further ORDERED that from the date of this Order forward, all filings in any of these cases shall be made on the docket of Case No. 09-10778.” (Order, para. 5) (emphasis added.) It is clear that the Order was meant to be applied prospectively, rather than retrospectively. The Trustee’s Motion for Consolidation is similarly devoid of retroactive language. Neither the Motion for Consolidation itself nor the proposed order attached to the Motion provide that the order be issued nunc pro tunc. On the contrary, the Trustee’s Motion for Consolidation repeatedly emphasizes that substantive consolidation is needed for ease of administration of the estates, since attempting to separate the Debtors’ affairs would be “complex and costly.” (Motion for Consolidation, ¶ 17.) This does not warrant the retroactive application of the Order, but instead favors its prospective application. As a consequence of the Trustee’s Motion for Consolidation, the Order states:

Further ORDERED that the findings with respect to the substantive consolidation, consolidation for procedural purposes and joint administration of the Debtors herein are made solely with respect to the Debtors for the purposes of facilitating the orderly liquidation of the Debtors in these proceedings.

(Order, para. 4.)

Judge Walsh fundamentally disagreed with the Trustee’s premise that nunc pro tunc relief can be granted as a perfunctory matter.   Judge Walsh explained that nunc pro tunc relief  is serious business:

As I noted in a previous decision, “nunc pro tunc relief is a form of extraordinary relief.” In re Valley Media, Inc., 2003 WL 21956410, at *3 (Bankr. D. Del. Aug. 14, 2003). Collier provides that “[s]uch nunc pro tunc orders are permissible so long as they are ‘necessary or appropriate to carry out the provisions of . . . title [11].’” COLLIER, ¶ 105.02[6][a] (citations omitted.) I do not think it appropriate to use a nunc pro tunc order to rewrite § 547, which is what the Trustee is seeking to do here by extending the preference period beyond 90 days. While the Bankruptcy Court has the equitable power under § 105 to issue orders nunc pro tunc, “[s]ection 105 must in all cases be carefully construed so as to implement and fit the specific provisions of the Bankruptcy Code.” In re Hoffman Bros. Packing Co., Inc., 173 B.R. 177, 186 (B.A.P. 9th Cir. 1994).

Sixth Circuit Authority is also Distinguishable

The Trustee had urged Judge Walsh to adopt the analysis of the Sixth Circuit Court of Appeals in First Nat’l Bank of Barnesville v. Rafoth (In re Baker & Getty Fin. Serv., Inc.), 974 F.2d 712 (6th Cir. 1992). After declining to follow the Sixth Circuit decision in any event, Judge Walsh went on to explain that Baker & Getty was factually distinguishable. First, in Baker & Getty the transfer was actually made by the entity that was first to file on behalf of another associated debtor. Judge Walsh noted that “[h]ere, Shorenstein is a creditor only of JetDirect and received the transfer from JetDirect.”

Second, in Baker & Getty, the Sixth Circuit had found evidence that “the Bank did treat the debtors as one entity . . . .” Baker & Getty, 974 F.2d at 715. Judge Walsh contrasted the facts before him stating:

there is no evidence that Shorenstein, or any particular creditor, treated Regal Jets and JetDirect as one entity. While the Trustee alleged in his Motion for Consolidation that the Debtors’ creditors were led to “believe that they were dealing with what was effectively one single entity” because of the Debtors’ lack of internal controls, he has not alleged specific facts with regard to any particular creditor that support this assertion.

Judge Walsh similarly distinguished the decision of the Bankruptcy Court for the Northern District of Ohio in Evans Temple Church of God in Christ and Comm. Ctr., Inc. v. The Carnegie Body Co. (In re Evans Temple Church of Christ and Comm. Ctr., Inc.), 55 B.R. 976 (Bankr. N.D. Ohio 1986). Judge Walsh noted that in Evans Temple Church, “there was evidence that the creditor in that case treated the debtors as one entity.”

The Trustee’s Secondary Arguments

The Trustee had also made a res judicata argument, which Judge Walsh summarily rejected: “I find that the doctrine is inapplicable here, as the parties are arguing over what the Order itself says. Furthermore, as the Trustee did not request retroactive effect in his Motion for Consolidation, creditors were not put on notice that a retroactive application was even being contemplated.”

Finally, the Trustee requested that the Plaintiff now be allowed to request nunc pro tunc application of the Consolidation Order. Judge Walsh noted that “numerous” motions to dismiss similar avoidance actions were pending. Accordingly, he concluded “[t]his adversary proceeding is not the proper proceeding to reconsider the Order.”

Back to the Future Part II – the Bankruptcy Version

Avoidance actions are all about timing and that timing is all tied to the date a debtor filed its petition. The whole notion that what was once pre-petition becomes post-petition is like the plot of the movie Back to the Future Part II.

Consider pre-petition payments that would qualify for non-avoidance as a preference under Section 547 by reason of application of the contemporaneous exchange defense or the subsequent new value defense.  Upon entry of a nunc pro tunc substantive consolidation order, those payments become post-petition payments avoidable under Section 549, which lacks either of those preference defenses. Section 549 has its own protections, including a transfer authorized under the Bankruptcy Code or by bankruptcy court order authorizing a payment. However, the Bankruptcy Code does not apply to and no bankruptcy court order is possible for an entity that has not filed bankruptcy.

Judge Walsh appropriately characterizes nunc pro tunc relief as serious business. For those in the Sixth Circuit, continued dealings with a non-debtor affiliate of entities in bankruptcy entails unquantifiable, if not incomprehensible, risks.