On Appeal from the United States District Court for the Middle District of Pennsylvania (D.C. No. 95-cv-01200)
Before: COWEN, NYGAARD and LEWIS, Circuit Judges
We confront in this case a difficult issue arising under 11 U.S.C. Section(s) 548(a)(2), the provision of the Bankruptcy Code (the "Code") allowing for avoidance of constructively fraudulent transfers. The principal question we must decide is whether a commitment letter Mellon Bank issued in connection with a contemplated $53-million loan conferred "reasonably equivalent value" on Intershoe (the debtor) in exchange for $515,000 in commitment fees that Intershoe paid to Mellon Bank. This question is complicated by the fact that the loan, which could possibly have saved Intershoe from bankruptcy, ultimately failed to close. We also must decide whether Intershoe was insolvent when it transferred the commitment fees to Mellon Bank.
After finding that Intershoe was insolvent during the relevant period, the bankruptcy court, relying on a "totality of the circumstances" test, concluded that Intershoe had not received "reasonably equivalent value" in exchange for the $515,000 in fees it had paid to Mellon. The court found that the loan commitment was so conditional when issued that it conferred virtually no indirect economic benefit on Intershoe. It therefore ordered Mellon Bank to remit to the bankrupt estate all but $127,538.04 of the commitment fees, an amount representing Mellon Bank's out-of-pocket expenses. The district court summarily affirmed. Because the commitment letter was so conditional that the chances of the loan closing were minimal, we agree that Intershoe did not receive value that was reasonably equivalent to the fees it paid Mellon Bank. Accordingly, we, too, will affirm.
At all times relevant to this dispute, Intershoe was a largescale wholesale distributor of women's shoes. Through 1991, its primary secured lender was Signet Bank. In the spring of 1991, Intershoe was aware that its financing arrangement with Signet would terminate that fall. It therefore sought to recapitalize and refinance its operations. Intershoe wanted to attract a $15 million equity investment; it also wanted to replace Signet as its lender with a bank group that would extend a $53 million loan facility.
In March of 1991, Three Cities Research ("TCR") made an initial, nonbinding proposal to make a $15 million investment in Intershoe and began to conduct due diligence and negotiations toward that end. Hoping that the prospect of an equity infusion would entice potential lenders, Intershoe approached Mellon Bank, Bank of New York ("BNY") and Citicorp to discuss potential refinancing. Each bank made clear that an equity infusion would be a prerequisite to any refinancing. Representatives of Mellon and Intershoe first met in either February or March of 1991.
On June 13, 1991, Mellon issued a proposal letter documenting its interest in extending a $53 million revolving line of credit and a $100 million foreign exchange line of credit. The proposal was contingent upon TCR's injection of $15 million in cash. At first, Intershoe did not accept Mellon's offer. Instead, it explored the possibility of obtaining financing from BNY and Citicorp. After completing its due diligence, however, Citicorp declined to extend credit to Intershoe. Although BNY had made a proposal, it subsequently revised the proposal to require a large equity infusion. Intershoe therefore declined to endorse BNY's proposal and, instead, turned its attention back to Mellon Bank.
On August 9, 1991, Mellon Bank issued a second proposal letter that was similar to the first in that it was conditioned upon the injection of new capital funds of at least $15 million. The letter also stated that Intershoe would be required to pay: (1) a facility fee equivalent to 3/4 of one percent (.0075) of the committed facility (half upon issuance of the commitment letter, half at closing); (2) a collateral management fee of $10,000; (3) all of Mellon's out-of-pocket expenses, regardless of whether the financing occurred; and (4) a "good faith deposit" of $125,000 to be remitted with written approval of the proposal letter. A fifth provision in the letter was that Mellon would be permitted to spread $28 of the $53 million loan among a group of banks. The loan contemplated by Mellon was known as a highly leveraged transaction ("HLT"), an asset-based loan bearing greater risk than an ordinary loan that requires extraordinary due diligence and monitoring of the borrower's accounts receivable, inventory and business plan.
On August 12, 1991, Intershoe remitted to Mellon the $125,000 "good faith deposit" in accordance with the proposal letter. Because it had reached its borrowing limit with the Signet Group, Intershoe could not borrow additional sums. Between August and October of 1991, Intershoe failed to pay the majority of invoices from its suppliers. While accounts payable increased by $10 million, its debt to the Signet Group decreased by the same amount; Intershoe was using what funds it had to pay down its debt. As a result, the Signet group agreed to extend its loan facility from September 30 to November 29, 1991, which permitted Intershoe to continue its business operations.
In early October of 1991, Mellon Bank requested an additional good faith deposit from Intershoe of $125,000, although there was nothing to document this request. On October 8 or 9, 1991, Intershoe remitted the additional $125,000 to Mellon Bank by wire transfer. On October 31, 1991, Westinghouse, to whom Intershoe had subordinated indebtedness, agreed to restructure Intershoe's indebtedness in order to accommodate the proposed recapitalization.
On November 7, 1991, Mellon issued a formal commitment letter (the "Letter") with terms that tracked the August 9 proposal letter. The Letter referred to the $250,000 in good faith deposits that Mellon had previously received and indicated that the entire amount would be retained even if the loan did not close. These deposits would cover Mellon's expense, time and effort in attempting to consummate the financing. The Letter also required the remittance of an additional $265,000, half of which represented a nonrefundable "facility fee" for Mellon's commitment, with the other half representing a nonrefundable agent's fee for Mellon's syndication of the loan. The Letter also contained several conditions: (1) Intershoe had to produce a draft audited financial statement indicating that it had a net worth of at least $6.5 million; (2) Intershoe was required to repay or retire Westinghouse's debt and stock warrants and retain Westinghouse as a creditor for subordinated debt of at least $5 million; (3) $28 million of the loan commitment had to be participated out to a group of banks; *fn1 and (4) Intershoe would be required to pay a separate collateral monitoring fee relating to administering the loan after closing. By its terms, the commitment was set to expire on November 29, 1991, the same day that Signet's loan facility was due to expire.
On November 7, 1991, Intershoe accepted Mellon's commitment and remitted the $260,000 fee as contemplated by the Letter. That day Mellon began a "takedown examination" to update Intershoe's financial information through the closing date. Eight days later Mellon received a draft financial statement confirming that Intershoe possessed a positive net worth of $6.5 million dollars. Mellon then scheduled a meeting for November 20, 1991, with Intershoe, the loan participants, TCR (the equity investor) and Peat Marwick to discuss further the financial statements.
On November 17, 1991, however, TCR advised Intershoe that it had decided not to make the $15 million equity investment and confirmed its withdrawal from the proposed refinancing. Intershoe informed Mellon of this development the next day, and the entire deal collapsed. Intershoe's trade creditors continued to extend credit even after the collapse of the Mellon financing.
On November 15, 1991, Peat Marwick issued to Intershoe an audited financial statement for the fiscal year ending August 31, 1991. This statement indicated that as of August 31, Intershoe's liabilities exceeded its assets by four million dollars. In accordance with Generally Accepted Accounting Principles ("GAAP") and Generally Accepted Accounting Standards ("GAAS"), the financial statement took into account events subsequent to the end of the fiscal year (e.g., the collapse of the Mellon financing) as evidence of Intershoe's financial condition. Several questionable items on Intershoe's balance sheet were corrected or adjusted, resulting in an even lower net worth. The financial statement also indicated that Intershoe would have difficulty continuing as a going concern. On December 11, 1991, Intershoe agreed to accept Peat Marwick's suggested changes to its financial statements. Intershoe's financial condition continued to decline, reaching a point where its liabilities exceeded assets by $14 million. Intershoe sought protection under Chapter Eleven of the Code on February 18, 1992.
On May 18, 1993, the Committee filed an adversary proceeding against Mellon Bank seeking to recover, as constructively fraudulent transfers, the three payments that Intershoe had made to Mellon in connection with the financing commitment, which totaled $515,000. Under section 548(a)(2) of the Code, the Committee bore the burden of establishing that: (1) the debtor had an interest in the property; (2) the transfer of the interest occurred within one year of the petition; (3) the debtor was insolvent at the time of the transfer or became insolvent as a result thereof; and (4) the debtor received "less than a reasonably equivalent value in exchange for such transfer." BFP v. Resolution Trust Corp., 511 U.S. 531, ___, 114 S. Ct. 1757, 1760 (1994) (quoting 11 U.S.C. Section(s) 548(a)(2)(A)). The first two elements were not disputed.
On the issue of insolvency, which is defined in Section(s) 101(32)(A) of the Code as a financial condition where an entity's debts exceed its property (at fair valuation), the bankruptcy court focused upon August 31, 1991, the end of Intershoe's fiscal year. It concluded that the Committee had established through the testimony of four certified public accountants, who relied upon Intershoe's audited (and adjusted) financials, that Intershoe was insolvent as of that date.
Mellon attempted to argue that it was the write-offs that rendered Intershoe insolvent, and that the write-offs were caused by the collapse of the Mellon Bank-Intershoe deal. The bankruptcy court disagreed: Although events which drastically and unexpectedly change a company's actual financial condition (such as a fire or other disaster) would not be the type of subsequent event that should evidence a company's prior financial condition, I agreed with the testimony of the Committee's experts that the failure of the proposed Mellon/Intershoe transaction is exactly the type of event that should be viewed as evidence of the company's prior financial condition.
By all accounts, Intershoe's financial survival was contingent upon the Mellon refinancing and the Mellon refinancing was contingent upon dozens of conditions, the least certain and most important of which was an equity infusion from TCR. TCR had made no commitment to go through with the investment, and, more importantly, the financial numbers coming out of Intershoe in September, October and November of 1991, showed a deteriorating financial condition that would cause serious concern to a potential equity investor. Although there was testimony that supported Mellon's belief that TCR still was considering the transaction into November, 1991, the evidence was persuasive that TCR's participation was sufficiently uncertain that anticipated consummation of the equity investment and ultimately the Intershoe/Mellon transaction should not be the basis for upholding book entries that ultimately turned out to have no basis in reality.
Official Comm. of Unsecured Creditors of R.M.L., Inc. v. Mellon Bank N.A., No. 1-93-00137A, slip op. at 15-16 (Bankr. M.D. Pa. June 29, 1995). Based on these audited financials, the bankruptcy court noted that between August and November of 1991, Intershoe suffered "numerous materially adverse changes which resulted in $4.1 million in losses for September and October, 1991." Id. at 6 (footnote omitted). The court also noted that "by the end of October, 1991, Intershoe's liabilities exceeded its assets by $8,187,903." Id. n.2. The bankruptcy court went on to conclude that, even without placing exclusive reliance upon the audited financial statements, subsequent events shed sufficient light on Intershoe's financial condition as to warrant downward adjustments in various alleged "credits" and book entries. Id. at 18.
The bankruptcy court next considered whether Intershoe had received "reasonably equivalent value" for the three separate remittances of financing fees. Although the term "reasonably equivalent value" is not defined in the Code, the court acknowledged that the debtor need not receive a dollar-for-dollar equivalent in order to receive reasonably equivalent value. The court further acknowledged that the fair value of services rendered in exchange for fees paid may be difficult to quantify, yet nonetheless may constitute reasonably equivalent value. The court applied a "totality of the circumstances" test, which considered: ...