Bankruptcy Courts have begun to apply the Supreme Court’s heightened pleading standards enunciated in Bell Atlantic Corp. v. Twombly, 550 U.S. 544 (2007) (“Twombly”) and Ashcroft v. Iqbal, 129 S.Ct. 1937 (2009) (“Iqbal”) to preference actions.  The latest court to do so is the Bankruptcy Court for the Southern District of New York in the bankruptcy case of In re DPH Holdings Corp. et al (“Delphi”); Case No. 05-44481(RDD).

On October 8, 2005, Delphi Corporation, a global technology manufacturer, filed for bankruptcy under chapter 11 of the Bankruptcy Code.  In August of 2007, right before the two year statute of limitations for filing avoidance actions was to expire, the Debtor filed an ex parte motion to file several hundred avoidance action complaints under Bankruptcy Code Section 547 under seal, which the Court granted.  The Debtor argued that it was necessary to file the complaints under seal to preserve its ability to avoid the transfers if and when necessary without harming the Debtor’s current business relationships with the Defendants.  The Debtor then filed over 700 avoidance actions unbeknownst to the Defendants.  The Debtor also obtained 4 extensions of time to serve the complaints beyond the 120 day deadline for serving complaints provided by Bankruptcy Rule 7004 (which incorporates Rule 4(m) of the Federal Rules of Civil Procedure).  The motion to approve filing the complaints under seal and requests for extensions were ex parte to the majority of the Defendants.

Bankruptcy Code Section 547 states: “the trustee 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–

(A) on or within 90 days before the date of the filing of the petition; or

(B) between ninety days and one year before the date of the filing of the petition, if such creditor at the time of such transfer was an insider; 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 2 years after the complaints were filed under seal, the Debtor served the complaints upon the Defendants.  Eighty-three of the Defendants filed motions to dismiss the complaints asserting, among other things, that the complaints were defective and were not sufficiently pled under the heightened pleading standards of Twombly and Iqbal, which set forth what claims for relief must include under Rule 8 of the Federal Rules of Civil Procedure (which is applied to bankruptcy adversary proceedings under Bankruptcy Rule 7008).

Rule 8 states that a complaint must contain, among other things, “a short and plain statement of the claim showing that a pleader is entitled to relief.”  Prior to Twombly and Iqbal, courts held this to mean that a complaint should not be dismissed for failure to state a claim unless it appeared “beyond doubt that the plaintiff can prove no set of facts in support of his claim which would entitle him to relief.” Conley v. Gibson, 355 U.S. 41, 45-46 (1957).  

In Twombly, an antitrust case, the United States Supreme Court stated that while factual allegations need not be detailed to survive a motion to dismiss for failure to state a claim under Rule 8, they require more than “labels and conclusions, and a formulaic recitation of the elements of a cause of action.”  The Supreme Court further stated that allegations contained in the complaint must be sufficient to raise a right to relief beyond mere speculation, and must state enough factual matter to make a claim “plausible.”  In Iqbal, the Supreme Court held that the heightened pleading standards set forth in Twombly apply to all civil suits in federal courts, not just antitrust cases.

At the July 22, 2010 Delphi omnibus hearing, the Court analyzed whether the preference actions were sufficiently pled under Twombly and Iqbal (the Court entertained the notion that Twombly and Iqbal may not apply to the preference actions because they were filed prior to Twombly and Iqbal, but concluded that the heightened pleading standards applied).

Applying Twombly and Iqbal to the complaints, the Court held that the complaints were not sufficiently pled under Rule 8 for three reasons: (1) the complaints did not identify which of approximately 40 debtors were the transferors; (2) the complaints did not allege the particular antecedent debts on account of which the transfers were made; and (3) some of the complaints listed multiple defendants in the same action, but did not assert which defendants were initial transferees and which were subsequent transferees (Bankruptcy Code Section 550 provides limitations on avoiding transfers received by subsequent transferees).

Notwithstanding, the Court did not dismiss the complaints outright, but afforded the Debtor 45 days to file motions to amend the complaints and instructed the Debtor to file a separate motion for each complaint with a copy of the amended complaint attached to each motion.  In September 2010, the Debtor filed motions for leave to file amended complaints, with hearings scheduled for December 16, 2010.

Delphi follows recent bankruptcy courts applying Twombly and Iqbal to preference actions, including the following:

In re Caremerica, Inc., 409 B.R. 737 (Bankr. E.D. N.C. 2009).  In In re Caremerica, Inc., the Plaintiff sued the Defendants under Bankruptcy Code Sections 547 and 548 seeking to recover preferential and fraudulent transfers.  The Defendants filed motions to dismiss alleging that the complaints were not sufficiently pled under Rule 8.  The Court, applying the heightened pleading standards of Twombly and Iqbal, granted the Defendants’ motions to dismiss.  The Court reasoned: (1) the complaint failed to meet the “plausibility” standard because it did not indicate which debtor entity initiated the transfers in question; (2) the complaint’s allegation that the preferential transfers were made for or on account of an antecedent debt was conclusory; and (3) the complaint failed to factually demonstrate that the Debtor was insolvent.

In re Troll Communications, LLC, 385 B.R. 110 (Bankr. D. Del. 2008).  In In re Troll Communications, LLC, the Plaintiff sued the Defendant under Bankruptcy Code Sections 547 and 548 seeking to avoid and recover preferential and fraudulent transfers.   The Defendant filed a motion to dismiss asserting that the Plaintiff did not sufficiently plead “insolvency” because certain facts that the Debtor pled relating to insolvency were inconsistent with facts contained elsewhere in the complaint.  The Court held that notwithstanding the apparent inconsistencies in the complaint, the Plaintiff sufficiently pled the allegation of insolvency because the allegation was supported by specific factual statements and not mere conclusory allegations.  The Court noted that a plaintiff is only required to plead sufficient facts, not prove them, to survive a motion to dismiss.

Commentary

Delphi and the other recent cases exemplify that preference actions have become subject to the heightened pleading requirements set forth in Twombly and Iqbal.   Form complaints with bare recitations of elements that may have survived motions to dismiss under Rule 8 prior to Twombly and Iqbal, may now be subject to dismissal.  Notwithstanding, courts have been pragmatic and liberal in allowing plaintiffs leave to amend complaints.  Practitioners prosecuting avoidance actions should seek to provide as much factual support for each cause of action.  Practitioners defending avoidance actions should scrutinize complaints to see if they could be dismissed on the basis that they are not sufficiently pled under Rule 8, Twombly and Iqbal.  For a copy of the July 27, 2010 Delphi hearing please email info@neigerllp.com.