Yaquinto v. Thompson St. Capital Partners

“As part of a refinancing transaction in 2014, Stone Panels Inc. (SPI) and Stone Panels Holding Corp. (Holding) jointly borrowed roughly $14 million that was immediately transferred to Thompson Street Capital Partners III, LP (Thompson Street) to partially satisfy a debt for which only Holding was obligated. Robert Yaquinto, as Chapter 7 Trustee (the Trustee) seeks avoidance of that transfer from SPI to Thompson Street.” Despite showing that the transaction was a property transfer for which SPI did not receive reasonably equivalent value, the Trustee was not able to show that SPI: (1) was insolvent on the date of the transfer or became insolvent as a result of the transfer; and (2) was engaged in a transaction for which any property remaining with SPI was unreasonably small capital or intended to incur or debts that would be beyond SPI’s ability to pay as such debts matured. The court determined that the Trustee had not met his burden of proof and granted judgment in favor of the defendant.

Factual Background 

SPI was a manufacturer of composite paneling. The Company was sold in approximately 2004 and was under the control of Metapoint Partners (Metapoint). On about Dec. 5, 2013, SPI and its shareholders, including Metapoint, retained Bigelow LLC to market SPI to potential purchasers. Nineteen indications of interest were received, averaging $30.5 million. After evaluating the four letters of intent, SPI entered into an exclusive period with Thompson Street. Even with identified risks, Thompson Street’s perceived SPI as an attractive investment. Backlog orders were high, and there were opportunities to improve operating efficiencies. Thompson Street acquired SPI for a little under $36 million. “Thompson Street agreed to purchase the stock of SPI from the SPI shareholders and option holders for approximately $34,000,000.”

On or about July 28, 2014, Holding was formed to facilitate the acquisition of SPI. Thompson Street controlled and principally owned Holding. “The general structure of the transaction was that Holding purchased the stock of SPI, but Thompson Street funded the purchase with (1) cash funded to Holding as a capital contribution of $20,300,000 and (2) a loan to Holding in the amount of $16,000,000.” Holding’s primary asset was its equity in SPI.

Transcend Valuation LLC provided an ASC 805 valuation of SPI as of July 31, 2014. Transcend’s report showed goodwill of roughly $20 million. Thompson Street intended to replace the $16 million Thompson Street note with longer-term financing from third-party lenders. This financing was finalized on Sept. 19, 2014. “The general structure of the September 2014 Transaction was that Holding and SPI would borrow $8,000,000 from PrivateBank under a secured term note, approximately $1,000,000 from PrivateBank under a secured revolving note, and $5,000,000 from Brookside under an unsecured note. The proceeds of these loans would then be used to partially satisfy the Thompson Street Note, and the remaining balance of the Thompson Street Note would be converted to equity in Holding.” Over $14 million of the loans were drawn and sent directly to Thompson Street with no proceeds received or retained by SPI. Thompson Street also exchanged $2 million in principle under the Thompson Street note for preferred and common stock in Holding. SPI and Holding granted Private Bank a security interest in substantially all their tangible and intangible personal property and assets.

SPI’s Operational Issues Following Its Acquisition 

In the years following Thompson Street’s acquisition of SPI, some operational issues arose. The cumulative effect of these problems caused SPI and Holding (together, the Debtors) to file for relief under Chapter 11 of the Bankruptcy Code, later converted to Chapter 7 in December 2016, when Robert Yaquinto was appointed as Trustee. The original complaint sought to disallow portions of Private Bank’s alleged secured claims and recover various allegedly fraudulent transfers from Private Bank. A first amended complaint added over 40 defendants, including Thompson Street and two affiliates (the Thompson Street Entities). On June 1, 2021, after settlements with various defendants, the Trustee filed a second amended complaint that only included the Thompson Street Entities. On June 7, 2021, the Thompson Street Entities filed a motion for summary judgment. On July 9, 2021, the court issued an oral ruling granting summary judgment to some of the issues but ultimately allowing Counts 2 through 5 to trial against Thompson Street only.

Legal Analysis

The Trustee argued that the Thompson Street cash transfer was a constructively fraudulent transfer as to SPI under the Bankruptcy Code and the Texas Business and Commerce Code (TBCC), which have similar requirements but are stated slightly differently. The court went on to explain the two and their nuanced differences. “The Trustee, as the party seeking to avoid the transaction, bears the burden of proof by a preponderance of the evidence on all elements of a claim for constructive fraudulent transfer.”

A Transfer of an Interest of the Debtor in Property 

The court believed it was reasonably clear that the Thompson Street cash transfer was a transfer of SPI’s property. Since Holding received the total value of cancellation of the $14 million of the Thompson Street note, it did not matter whether the total amount was transferred to Holding. “Under any set of facts, the Thompson Street Cash Transfer could not have been a constructively fraudulent transfer as to Holding because Holding did not receive less than reasonably equivalent value in exchange for the transfer.” It was relevant that both Holding and SPI were designated as borrowers under all of the loan agreements, and it was evident that SPI was the source of creditworthiness in the transaction. The court was comfortable concluding that SPI had an interest in the proceeds transferred to Thompson Street. 

Reasonably Equivalent Value

There were two parts to this question: first, whether the debtor received value and, second, whether that value was reasonably equivalent. “Reasonably equivalent” means substantially comparable to the worth of the property transferred. It does not have to be dollar for dollar. It was clear that whatever the value of benefits from Thompson Street to Holding might have been, it was not reasonably equivalent to the value of the jointly borrowed proceeds transferred to Thompson Street.

Fragile Financial Conditions 

The bankruptcy law provided three ways to satisfy the financial condition required for a constructively fraudulent transfer. Those three overlapped substantially with the Texas Law: (1) to show that the debtor was insolvent on the date of the transfer or made insolvent by the transfer; (2) that the debtor was engaged in a business or transaction (or was about to be so) for which any property remaining was “an unreasonably small capital”; and (3) that the debtor incurred, or believed they would incur, debts that would be beyond the debtor’s ability to pay as such debts matured.

Insolvency

The Bankruptcy Code defined insolvency as a “financial condition such that the sum of such entity’s debts is greater than all of such entity’s property, at a fair valuation”—the balance sheet test. The fair value was not determined by the book values of the assets and liabilities but by their FMV on a going-concern basis. The court may choose the values of one side or the other or use its fair valuation. The Trustee’s expert, Quinn, did not perform a balance sheet insolvency test for SPI but did provide some commentary on the subject, noting that, after the Transaction, goodwill was listed on the books at $29 million, and total SPI assets were listed as roughly $19.6 million greater than liabilities. While Quinn did not believe this provided a straightforward narrative of solvency, he pointed out that the bulk of the assets was goodwill and likely significantly overstated.

Thompson Street’s expert, Deetz, did perform a balance sheet test to measure the solvency of SPI and opined that SPI was solvent at the date of the Transaction. Deetz relied on a report produced by Transcend Valuation LLC for the July 2014 Transaction. He valued the business as a going concern, including goodwill on the balance sheet. “Following the Fifth Circuit’s instructions to estimate what the debtor’s assets would realize if sold prudently in current market conditions, the Court believes that under the circumstances, goodwill and other intangible assets were properly considered in determining the solvency of SPI.”

Deetz also offered credible evidence on the goodwill increase following the July 2014 Transaction, noting that the $20 million represents the results of a competitive market transaction. The court concluded that the Trustee had not shown that SPI was insolvent at the date of the Thompson Street Cash Transfer, and it did not become insolvent as a result of that Transaction.

Unreasonably Small Capital or Knowingly iIncurring Debt Beyond the Ability to Repay. 

The adequate capital test examines whether the debtor was engaged or about to be engaged in a business transaction that would leave the debtor with unreasonably small capital. The cash flow test examines whether the debtor would incur or intend to incur debts that would be beyond the debtor’s ability to pay as the debts matured. Unreasonably small was not defined. A third circuit case observed that “unreasonably small capital” refers to “the inability to generate sufficient profits to sustain operations.” (Moody v. Sec. Pac. Bus. Credit, Inc.) The courts should compare the debtor’s projected cash flow with the debtor’s cash needs for a reasonable time following the Transfer. The court had to look at circumstances as they existed at the September 2014 transaction. What was reasonably foreseeable and what was not? The court benefited from two experts, one from each side, who analyzed the circumstances at the date of the transaction.

In support of the argument that the conditions were foreseeable, the Trustee argued that all parties knew there might be immigration documentation issues. But, shortly after the Transaction, SPI began using E-Verify and parted with 10 to 12 highly skilled employees. Their departure resulted in mounting problems for the plant. “The evidence does not support a conclusion that this was a problem that could have been solved with increased access to capital.” 

The Trustee also argued that it was reasonably foreseeable that SPI could not survive unless it expanded and that the funding for the capital expenditures was insufficient. However, the evidence did not show that it was unreasonable to rely on SPI’s cash flows even with the additional debt burden.

Thompson Street did significant due diligence before the acquisition and used less leverage because of the perceived risks. After the acquisition, SPI had access to capital through its cash on hand and its revolving line of credit.

The actual problems that did arise tended to support the position that SPI did not decline because of inadequate capitalization. In addition to product mix issues and customer delays, the new VP of operations had a significant negative impact on SPI’s operations. These problems were not foreseeable at the date of the Transaction.

Based on the record, SPI had sufficient cash access to operate and pay its debts as they matured. Experts Quinn and Deetz testified about the adequate capital issues, and the court found Deetz’s testimony more persuasive. Quinn’s testimony contained errors and flawed assumptions, while Deetz considered all available information.

“It is true that SPI did not receive reasonably equivalent value in exchange for the Thompson Street Cash Transfer, but the requirement of fragile financial conditions has not been met.” The Trustee has not satisfied the burden of proof in meeting the elements of a fraudulent transfer.