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Defeating Settling Party’s Effort to Use Preference Law to Void a Bankruptcy Court Settlement

June 18, 2018

Tarter Krinsky & Drogin’s Bankruptcy & Corporate Restructuring Group recently completed its successful representation on behalf of The Brown Publishing Company Liquidating Trust, which was created several years ago in connection with the confirmed bankruptcy plan of The Brown Publishing Company and its affiliated debtors in the Bankruptcy Court for the Eastern District of New York (E.D.N.Y.).

Among other things, the plan called for the Liquidating Trust to pursue causes of action belonging to the debtors’ estates. One of those causes of action related to a breach of a Chapter 11 asset purchase agreement between the debtors (as sellers) and the proposed purchaser, Brown Media Corporation, an entity created by one of the debtors’ shareholders to buy the debtors’ assets out of the bankruptcy case. In connection with its initial bid, the proposed purchaser had deposited $765,000 with an escrow agent as a good faith deposit. After the purchaser breached that contract, the debtors entered into a new purchase agreement with the second-highest bidder, but continued to assert that they were entitled to keep the good faith deposit – and to seek additional damages related to the purchaser’s default.

Years later, the Liquidating Trust, on behalf of the debtors’ estates, commenced an adversary proceeding in the Bankruptcy Court against Brown Media. After a trial on damages but before the E.D.N.Y. Court issued an opinion, the Liquidating Trust and Brown Media agreed to resolve the adversary proceeding by entering into a signed Settlement Stipulation and Order approved by the E.D.N.Y. Court.

In accordance with the Settlement Stipulation, mutual releases were exchanged, including Brown Media’s agreement that it would release to the debtors’ estates any rights it may have maintained in the $765,000 good faith deposit being held in escrow.

Within 90 days of the E.D.N.Y. Court’s settlement stipulation, Brown Media filed a chapter 7 bankruptcy case in the Southern District of Ohio, and a trustee was appointed to oversee the case’s administration in the Ohio Court.

During that case, two creditors of Brown Media obtained derivative standing from the Chapter 7 trustee in the Ohio Court in order to commence a cause of action against the Liquidating Trust for a return of the $765,000 good faith deposit that had been released under the Settlement Stipulation as a preferential transfer under the U.S. Bankruptcy Code. As set forth in section 547(b) of the Bankruptcy Code, subject to certain defenses that may exist, a debtor “may avoid any transfer of an interest of the debtor in property:

1. to or for the benefit of a creditor;
2. for or on account of an antecedent debt owed by the debtor before such transfer was made;
3. made while the debtor was insolvent;
4. made on or within 90 days before the date of the filing of the petition…and
5. that enables such creditor to receive more than such creditor would receive if

a. the case were a case under chapter 7 of this title;
b. the transfer had not been made; and
c. such creditor received payment of such debt to the extent provided by the provisions of this title.

Over a century ago, the Supreme Court decided in Barton v. Barbour, 104 U.S. 126 (1881) that leave of the bankruptcy court is required before a third party could institute an action against a bankruptcy trustee in the trustee’s official capacity. This has since been called the Barton Doctrine. In recognition of this doctrine, the Brown Media creditors filed a motion with the E.D.N.Y. Court presiding over the Liquidation Trust’s case seeking leave to commence a preference action against the Liquidation Trust, which is an estate representative with powers similar to those of a bankruptcy trustee.

After the Brown Media creditors filed their Barton Motion, the Liquidation Trust hired Tarter Krinsky & Drogin LLP as co-counsel (joining co-counsel McLaughlin & Stern LLP). Our role was to help respond to the Barton Motion in order to prevent the Brown Media creditors from obtaining relief under the Barton Doctrine and thereafter commencing a preference action against the Liquidation Trust.

In the objection that Tarter Krinsky and co-counsel prepared, the Liquidation Trust raised a number of arguments in response to the Barton Motion. The three primary arguments raised in the response follow. First, we argued that the Settlement Stipulation entered by the E.D.N.Y. Court was a final non-appealable order, one which could not be attacked years later by a preference action commenced by a counterparty to the Settlement Stipulation. Second, we argued that Brown Media had released any claims it could have asserted against the Liquidating Trust under the Settlement Stipulation. Lastly, we argued that Brown Media creditors could not establish a prima facie case that they would ultimately succeed if they were granted leave to commence a preference action against the Liquidation Trust.

After hearing oral argument, the E.D.N.Y. Court ruled in favor of the Liquidating Trust by order dated October 26, 2017. Thereafter, the Brown Media creditors filed an appeal of the E.D.N.Y. Court’s order. To avoid the risks and costs associated with the appeal, the Liquidating Trust reached a settlement with the Brown Media creditors through which the Liquidating Trust agreed to pay a modest sum equal to approximately 3 percent of the good faith deposit to the Brown Media creditors. In April 2018, the Ohio Court presiding over the Brown Media Corporation case and the E.D.N.Y. Court presiding over the Brown Publishing Company bankruptcy case, by separate orders, approved the settlement between the parties.

Tarter Krinsky & Drogin partners Rocco Cavaliere and Deborah Piazza represented the Liquidating Trust in connection with the successful prosecution of the objection and ultimate resolution of the matter. Our Bankruptcy & Corporate Restructuring Group regularly represents litigants in contested matters and adversary proceedings pending in bankruptcy courts in New York, New Jersey and elsewhere.

Note: The information contained in this client alert is not confidential and publicly available on the Bankruptcy Court’s website at www.nyeb.uscourts.gov.

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