Opinion ID: 77754
Heading Depth: 2
Heading Rank: 2

Heading: ATN Was Insolvent at the Time of the Transfer

Text: 20 Finding that ATN's petition was timely does not end our inquiry, however. We turn next to the merits, and consider whether ATN has met both prongs of the fraudulent transfer test set out in N.J. Stat. Ann. § 25:2-27.a. 9 21 The first prong of the fraudulent transfer inquiry asks whether the debtor making the challenged transfer was insolvent at the time the transfer was made. New Jersey law recognizes both presumptive and conclusive insolvency. Under New Jersey law, [a] debtor who is generally not paying his debts as they become due is presumed to be insolvent. N.J. Stat. Ann. § 25:2-23.b. A debtor is conclusively insolvent if its debts exceed the fair value of his assets. N.J. Stat. Ann. § 25:2-23.a. 22 Here, there is no question that the bankruptcy court was right in finding that ATN meets the test of presumptive insolvency. The bankruptcy court found that [i]n order to accumulate the cash [to pay the Allens and their attorneys], ATN delayed paying some of its regular bills for a short period of time. Bankr.Ct. Order at 12, 321 B.R. at 321-22. The company was thus clearly unable to meet its debts as they came due and must be considered presumptively insolvent. Id. at 30, 321 B.R. at 332 (As such, under New Jersey law, ATN is presumptively insolvent during this approximately five month time period between December 23, 1998, and June 1, 1999, when the transfers were made). The parties do not dispute this point, and our independent review of the record confirms the company's dire financial straits. On May 17, 1999, just two weeks before the transfer, ATN Chief Financial Officer Phil Krieger noted in an e-mail to Carpenter: FYI ... will need to cut back on payments for next two weeks ... money for Dan is going to be awfully tight. Three days later, Krieger e-mailed several ATN employees, including Carpenter, saying: We will need a substantial portion if not all of the funds that ATN currently has in order to meet the 6/1 payment. We hopefully will have a line of credit in place by that time, but it will not cover the full 6 million. As soon as ATN knows the status of the line and what cash will be available, then I can make a decision on what needs to be done. This of course will be done in conjunction with Gary [Carpenter]. If this thing goes down to the last minute, which we should all expect it will, then that is reality and we will have to deal with it. 23 By that time, ATN's landlord and insurance carrier were threatening to terminate their agreements with the company, and other vendors were threatening to withhold services. Carpenter himself estimated that on June 1, 1999, the day ATN transferred $6 million to the Allens, the company had only $453 in its checking account. On June 2, the day after the $6 million transfer, ATN actually owed $5 million dollars to AT&T. Although ATN received hundreds of thousands of dollars in the weeks following the transfer, its debts still far exceeded its assets. 24 The bankruptcy court's finding of presumptive insolvency finding shifted the burden to the Allens to show that ATN was conclusively solvent under a balance sheet test: That is, that the fair value of ATN's assets exceeded the fair value of its debts, notwithstanding the fact that it had not paid its debts as they come due. N.J. Stat. Ann. § 25:2-23.a. Applying this balance sheet test, and apparently relying solely on evidence presented by ATN to prove its in solvency, the bankruptcy court found that ATN was actually solvent at the time of the transfer. The bankruptcy court's reasoning on this point was erroneous. 10 25 The bankruptcy court calculated three adjustments to ATN's bottom line, which began with a net value of negative $216,144. 11 The parties do not dispute the first of these adjustments, by which the court added between $4,655,000 and $7,430,000 12 to the company's assets to reflect the value of its customer list. However, the court's calculation of the second and third adjustments — or, rather, its refusal to do so — requires closer examination. If made, these adjustments would have lowered ATN's net worth by more than $15 million, thus demonstrating clear balance sheet insolvency. 26 The second adjustment turned on the disputed value of the shareholder loans which Carpenter pledged to ATN following ATN's $6.25 million transfer to the Allens. The bankruptcy court upwardly adjusted ATN's assets to reflect the value of these outstanding loans, thus increasing the company's value by $4,520,902. Although the loans were back-dated to appear contemporaneous with the transfer, Carpenter's loans arose after the $6.25 million transfer from ATN to the Allens. Because Carpenter had no ability to repay the loans — a fact which was knowable at the time the loans were made — this upward adjustment was erroneous as a matter of law. 27 As the bankruptcy court recognized, Carpenter's ability to repay the loans was entirely dependent on ATN's financial performance: Of course, Carpenter's ability to repay the loans was directly tied to his ability to improve ATN's profitability. If the company succeeded, Carpenter prospered. Conversely, if ATN failed, so did he. Carpenter certainly had no independent income or assets available to repay the substantial shareholders loans. Bankr.Ct. Order at 12, 321 B.R. at 321 (emphasis added). Effectively, Carpenter pledged the company's dwindling value against itself, knowing that he personally had no funds to make the payments. 13 At the time of the ATN-WATS settlement in October 2000, Carpenter produced an affidavit indicating that he had a negative net worth of $9,471,781, most of it — $8,976,460 — due to the promissory notes he gave ATN under the Allen settlement and which he had obviously not been able to repay. 14 In an ironic twist, the bankruptcy court erroneously considered this a reason to discount ATN 's argument that the loans were worthless, saying that it is irreconcilably circular — ATN is insolvent because Carpenter cannot repay his shareholder loans, and Carpenter cannot repay his shareholder loans because ATN is insolvent. The court was correct about the circularity of the situation, but erred in holding that this circularity favored the Allens. In truth, it simply demonstrated that there was no value underlying Carpenter's promise. 28 In any case, the shareholder debt was clearly not a liquid asset — the bankruptcy court recognized that neither Daniel [Allen] nor Carpenter had liquid assets — and thus had no immediate value to ATN. As such, Carpenter's promise to repay money to the company over time (the loans had a ten-year term) should not have been considered — certainly not at full value — as among the company's assets. See In the Matter of Taylor, 228 B.R. 491, 502 (Bankr.M.D.Ga.1998) (In calculating the debtor's balance sheet, the court should consider only those assets `readily susceptible to liquidation and the payment of debts.' (internal quotation and citation omitted)). 29 The third adjustment involved ATN's obligation (if any), at the time of the transfer, to WATS in the then-ongoing litigation between those two entities. WATS' suit claimed $39 million in damages, a claim which the parties eventually settled for $10.5 million. ATN argued that the full amount of the settlement should be a downward adjustment to ATN's assets at the time of the transfer because it was a plainly foreseeable liability. The Allens argued, and the bankruptcy court found, that ATN's obligation to WATS did not arise until after the transfer at issue in this case, could not have been reasonably foreseen, and thus no downward adjustment was necessary. 15 We reject both extreme positions, and find that the proper approach would have simply discounted the expected value of the judgment by the probability of its ever occurring. Although it may be true, as the bankruptcy court put it, that no one could have predicted this result with any reasonable certainty, such a precise prediction was not required. The court was instead required to calculate the present value of the liability — the expected cost of the liability times the estimated chance of it ever occurring. Unless either the expected cost or the chances of it occurring are equal to zero (that is, the liability is costless, or the chances of it happening are negligible), the estimated value should be more than zero. 30 New Jersey law requires a bankruptcy court conducting an insolvency analysis to include the value of claims against the debtor. Under New Jersey law, a claim means a right to payment, whether or not the right is reduced to judgment, liquidated, unliquidated, fixed, contingent, matured, unmatured, disputed, undisputed, legal, equitable, secured, or unsecured. N.J. Stat. Ann. § 25:2-21. By its plain terms, this includes WATS' pending claim against ATN — a prototypical contingent liability. 31 The fair value of a contingent liability, of course, should be discounted according to the possibility of its ever becoming real. Thus in this case the bankruptcy court should have estimated the expected value of a judgment against ATN (ATN's own lawyers had already placed it in the millions well before the case actually settled for $10.5 million), and then multiplied that value by the chance that ATN would face such a judgment (thus, for example, halving the judgment's value if ATN faced only a fifty percent chance of an adverse judgment). The Seventh Circuit Court of Appeals set forth the leading statement of this approach in In re Xonics Photochemical: 32 [A] contingent liability is not certain — and often is highly unlikely — ever to become an actual liability. To value the contingent liability it is necessary to discount it by the probability that the contingency will occur and the liability will become real. 33 841 F.2d 198, 200 (7th Cir.1988). Thus, [t]he asset or liability must be reduced to its present, or expected, value before a determination can be made whether the firm's assets exceed its liabilities. Id. (citations omitted) (emphasis added). 34 The bankruptcy court should have calculated a discounted value for this liability, especially in light of its willingness to include the value of contingent assets in its balance sheet calculations. The court in fact acknowledged that both contingent liabilities and contingent assets are appropriately considered, Bankr.Ct. Order at 34, 321 B.R. at 335 (internal citation omitted), but failed to apply that reasoning to the WATS debt. Had the court done so, it is difficult to imagine that it would have come up with a fair value of zero dollars. While that might be an appropriate valuation for some exceedingly remote or unlikely liabilities, the record evidence shows that, at the time of the transfer, ATN faced a very real prospect of a multi-million dollar obligation to WATS. In January, 1998, almost a year before ATN settled its lawsuit with the Allens, the company had a pending settlement offer from WATS in the amount of $2 million. ATN's counsel advised ATN at that time that the company had significant exposure, and that [d]iscovery to date indicates that there is a substantial risk that the plaintiff could be successful on all, or part of this claim at the time of trial. Since plaintiff had asserted claims for fraud there is also the possibility, while remote, of punitive damages. 35 Rather than calculate an appropriately discounted value for this eminently foreseeable liability, however, the bankruptcy court simply said that certainly no one could have reasonably estimated the amount of the settlement 18 months earlier. Absolute precision, however, is not required. But since ATN's own lawyers had advised it — more than a year prior to the settlement — that the company faced millions of dollars in liability, the bankruptcy court was not justified in simply assigning a dollar value of zero to the liability (the equivalent of saying that there was no chance whatsoever any liability would be incurred). The bankruptcy court implicitly recognized this fact when it noted that [p]erhaps, upon a thorough review, ATN, in 1999, should have anticipated a contingent liability to ATN in some amount, but exactly $10.5 million seems far fetched. It is of course correct to say that $10.5 million — the amount of the settlement — probably could not have been predicted with any accuracy in 1999. But the court erred by using this uncertainty to completely discount the value of the liability: Accordingly, the court concludes that no downward adjustment to add a $10.5 million contingent liability payable to WATS is merited. Bankr.Ct. Order at 36, 321 B.R. at 336 (emphasis added). 36 Thus the bankruptcy court erred by failing to downwardly adjust ATN's assets according to the (discounted) value of ATN's obligation to WATS. The bankruptcy court effectively gave full positive value to ATN's contingent assets, and no negative value to its contingent debts. As a result, it substantially overvalued the company. 16 37