In LaMonica v. CEVA Group PLC, et al. (In re CIL Limited), Adversary No. 14-02442 (Bankr. S.D.N.Y June 15, 2018), the Bankruptcy Court for the Southern District of New York was tasked with deciding whether the “collapsing doctrine” could be used to determine the situs of a fraudulent transfer, which was part of an international, multi-step transaction occurring inside and outside of the United States.
If the situs of the fraudulent transfer was deemed extraterritorial (i.e., outside of the United States), then the avoidance powers under sections 544(b), 548(a) and 550 of the Bankruptcy Code would not apply. In contrast, if the fraudulent transfer was deemed a domestic transaction, then the Bankruptcy Code’s avoidance powers could clearly be invoked.
While not making a definitive ruling on the issue, Judge Garrity suggested that the collapsing doctrine could, in fact, be used to determine the situs of the fraudulent transfer. The following facts and analysis support the Bankruptcy Court’s rationale.
On April 22, 2013, an involuntary chapter 7 bankruptcy was initiated against CIL Limited (“CIL”) and shortly thereafter an order for relief was entered.
Prior to the involuntary bankruptcy, CIL owned 100% of the stock of CEVA Group Plc (“CEVA Group”), which was a holding company for a number of operating entities. CIL, in turn, was owned by funds under the control of Apollo Global Management, LLC (“Apollo”).
CIL’s debt consisted of €103 million in unsecured payment-in-kind notes, while CEVA Group’s secured and unsecured debts totaled €2.1 billion and €575 million, respectively. The holders of the CEVA Group’s debts included several investment funds, including the Apollo funds.
In April 2013, as part of a series of restructuring agreements with various parties, (a) 99.99% of the equity interests in the CEVA Group was transferred to CEVA Holdings, LLC, a newly-formed affiliate of Apollo (the “CEVA Equity Transfer”), and (b) €1.2 billion of the CEVA Group’s debt was converted into equity in CEVA Holdings (the “CEVA Debt Transfer”). Collectively, the CEVA Equity Transfer and CEVA Debt Transfer, as well as their component parts, will be referred to herein as the “CEVA Transaction.”
Less than a year later, the chapter 7 trustee in CIL’s case (the “Trustee”) filed an adversary complaint against the CEVA Group, CEVA Holdings and their directors (collectively, the “CEVA Defendants”), attacking the CEVA Equity Transfer. The Trustee claimed, among other things, that such transfer constituted a fraudulent conveyance pursuant to sections 548(a)(1)(A) and 548(a)(1)(B) of the Bankruptcy Code, because CIL received no benefit for reducing its interest in the CEVA Group to .01%.
Through several motions to dismiss, the CEVA Defendants maintained that because the CEVA Equity Transfer occurred outside of the United States, it constituted an extraterritorial transaction that was not subject to the avoidance powers under the Bankruptcy Code. The Bankruptcy Court initially agreed and dismissed the above fraudulent transfer counts with prejudice.
On motion for reconsideration filed by the Trustee, the Bankruptcy Court vacated its decision.
The “Collapsing Doctrine”
The collapsing doctrine allows a court to collapse a multi-step transaction into a single transaction for purposes of fraudulent transfer laws. This doctrine has been employed almost exclusively by several courts in the Second Circuit in evaluating whether a transferee of an alleged fraudulent transfer provided “reasonably equivalent value” to the transferor for the transferred assets. CIL Limited at 16.
One of the key cases to articulate the modern version of this doctrine is Orr v. Kinderhill Corp., 991 F.2d 31 (2nd Cir. 1993), where, as part of a tax-motivated restructuring plan, a judgment debtor transferred 10 tracts of land to newly-created, wholly-owned affiliate for nominal consideration and subsequently transferred its interests in the affiliate to the shareholders of the debtor. This multi-step transaction occurred while the debtor was being sued by a creditor.
After the creditor obtained a $1.25 million judgment, it sued to set aside the transaction on fraudulent transfer grounds. The defendants argued that the restructuring plan had to be broken down into several, distinct steps and the only step relevant to the fraudulent transfer analysis was the first step, which involved the transfer of the 10 tracts of land to the debtor’s affiliate. This initial step, in isolation, did provide equivalent value to the debtor because the debtor, at the time, owned 100% interest in the affiliate.
The Second Circuit rejected the defendant’s argument and held that the multi-step transaction had to be analyzed as a whole. Orr, 91 F.2d at 35. According to the Second Circuit:
“[w]here a transfer is only one step in a general plan, the plan ‘must be viewed as a whole with all its composite implications.’”
Id. (emphasis added) (citations omitted). Using this approach, the Second Circuit held that the entire restructuring plan, in its entirety, did not provide equivalent value because the judgment debtor eventually transferred its beneficial ownership of the tracts of land to its shareholders. Id. at 36.
After Orr, the Second Circuit decided HBE Leasing Corp. v. Frank, 48 F.3d 623 (2nd Cir. 1995), where the Court solidified the “collapsing doctrine.” According the Second Circuit, the paradigmatic scheme that invokes the doctrine occurs when
one transferee gives fair value to the debtor in exchange for the debtor’s property, and the debtor then gratuitously transfers the proceeds of the first exchange to a second transferee. The first transferee thereby receives the debtor’s property, and the second transferee receives the consideration [for such property], while the debtor retains nothing.
Id. at 635. The doctrine finds “its most frequent application to lenders who have financed leveraged buyouts of companies that subsequently become insolvent.” Id. (citations omitted).
While the earlier cases did apply the collapsing doctrine in instances where the key issue involved the fair consideration element of a fraudulent transfer, more recent lower court cases appear to find that this doctrine has a broader application. In In re Tronox Incorporated, 503 B.R. 239, 268-69 (Bankr. S.D.N.Y. 2013), Judge Gropper used the collapsing doctrine, as enunciated by Orr and HBE Leasing, to determine that steps in an integrated transaction should not be viewed in isolation in assessing whether the statute of limitations for a fraudulent transfer had already lapsed prior to the commencement of the debtor’s bankruptcy. Judge Gropper reasoned that “the law is clear that for statute of limitations purposes fraudulent conveyances examined for their substance, not their form.” Id. at 268.
In 2016, Judge Chapman in In re Sabine Oil & Gas Corporation similarly found that there was no authority limiting the collapsing doctrine to instances involving reasonably equivalent value component. 547 B.R. 503, 540. Citing to the Tronox opinion,
[T]he [Sabine] Court conclude[d] that the better view is that a proper application of the collapsing doctrine, as articulated by the Second Circuit, requires collapsing all transfers that are part of a single plan and viewing that single plan as a whole, with all its composite implications, for reasonably equivalent value and otherwise.
Id. at 540-41 (emphasis added).
Holding in CIL Limited
The Bankruptcy Court in CIL Limited was faced with the above-body of law in vacating its prior ruling on the Trustee’s fraudulent transfer claims.
Addressing the Supreme Court’s opinion prohibiting the application of US statutes to extraterritorial transactions, see Morrison v. National Australia Bank, Ltd., 561 U.S. 247 (2010), the Trustee argued that the entire CEVA Equity Transfer and CEVA Debt Transfer constituted a domestic transaction, when the Court focused on the CEVA Transaction as a whole, and not on any particular step in isolation. In this respect, the CEVA Defendants “[did] not dispute that the facts alleged in the [Trustee’s amended complaint] demonstrate that parties to the [whole] CEVA Transaction took a number of steps in the United States in furtherance of that multi-step transaction.” CIL Limited at 14.
The CEVA Defendants maintained, however, that “the Trustee’s . . . theory—that the alleged fraudulent transfer is the entire CEVA Transaction, and not merely the CEVA Equity Transfer—is inconsistent with the law of exterritoriality, which focuses on the situs of the conduct central to the statutory scheme, which, in this case, [was] the transfer of property from the debtor’s estate.” Id. at 15. In support of their argument, the CEVA Defendants cited to cases that stood for the general proposition that the purpose of the avoidance powers under the Bankruptcy Code is to preserve property that is includable within a bankruptcy estate. In re Ampal-American Israel Corp., 562 B.R. 601, 613 (Bankr. S.D.N.Y. 2017); Begier v. Internal Revenue Serv., 496 U.S. 53, 58 (1990). The CEVA Defendants further argued that no court has ever applied the collapsing doctrine in determining the situs of an alleged fraudulent transfer and such application appeared to run afoul of the Supreme Court’s decision in Morrison.
While the Bankruptcy Court acknowledged that the collapsing doctrine “has been employed almost exclusively in evaluating whether a transferee of an alleged fraudulent transfer provided ‘reasonably equivalent value,’” CIL Limited at 16, the Court found that
[I]t is clear that in directing courts analyzing fraudulent transfer claims to consider the ‘composite implications’ in collapsing a multi-step transfer, the Second Circuit did not limit that review only to the implications for assessing reasonably equivalent value.
CIL Limited at 17 (emphasis added). Accordingly, the Court allowed the Trustee to amend its fraudulent transfer claims to demonstrate facts that would establish that the integrated CEVA Transaction involved numerous steps taken in the United States, making the transaction a domestic one, which could be subject to avoidance.
It is unfortunate that the quoted language in Orr, referring to “composite implications,” was not better explained by the Second Circuit in Orr or its progeny. This ambiguous language has allowed subsequent opinions to slowly expand the collapsing doctrine to other contexts.
While the CIL Limited opinion merely vacated a prior dismissal of the Trustee’s fraudulent transfer counts and did not conclusively decide that the collapsing doctrine could be used to determine the situs of a fraudulent transfer, there is little hope that Judge Garrity will reverse course and decide that the collapsing doctrine could not be used to determine the situs of a fraudulent transfer, given the recent expansive view of the collapsing doctrine. The CEVA Defendants even appear to have moved on from their position, having recently elected to file a motion for summary judgment instead of continuing an attack the Trustee’s complaint on facial plausibility grounds.
Thus, the CIL Limited opinion should serve as another example—at least in the Second Circuit—of how the application of the collapsing doctrine will not be confined to the reasonably equivalent value element of a fraudulent transfer and can be used in other contexts; perhaps in determining the situs of a fraudulent transfer.