Funding Agreement in a Texas Two-Step Can Be Value to Counter a Fraudulent Transfer

In the six-year-old chapter 11 case of DBMP, tort claimants filed a petition for certiorari this month asking the Supreme Court to decide whether “a debtor’s pursuit of bankruptcy as part of a Texas Two-Step scheme lack[s] good faith, such that ‘cause’ exists to lift the automatic stay under 11 U.S.C. § 362(d).”

On the same day the certiorari petition was filed, Bankruptcy Judge Ashley Austin Edwards of Charlotte, N.C., wrote an opinion when creditors were attempting to set aside a two-step restructuring as a constructively fraudulent transfer. The creditors argued that the parent company’s promise to pay expenses of the chapter 11 case and to fund a trust for creditors was not “value” under Section 548(a)(1)(B), making the pre-bankruptcy restructuring a constructively fraudulent transfer.

Creditors contended that the parent’s promise was not “value” in view of Section 548d)(2)(A), which says that value “does not include an unperformed promise to furnish support to the debtor or to a relative of the debtor.”

In her September 17 opinion, Judge Edwards found disputed issues of fact requiring a trial on “value.”

The Divisional Merger Under Texas Law

Owned by a French corporate parent, CertainTeed Corp. manufactured products containing asbestos. As Judge Edwards said in her opinion, the company had already spent $2 billion before bankruptcy in defending and resolving asbestos suits. At the time of the chapter 11 filing in 2020, more than 60,000 suits remained pending, she said.

In 2019, the company underwent a so-called divisional merger under Texas corporate law, known as a two-step restructuring. CertainTeed ceased to exist. Two new companies were created. One was to become the debtor. 

Before it was dissolved, CertainTeed had assets worth about $3 billion. The soon-to-be debtor, DBMP, was given 3% of the assets reportedly worth less than $600 million. The debtor took all of the asbestos liabilities.

Another new company, which we shall refer to as New CertainTeed, took the remaining assets and undertook the obligations of a payor under a financing agreement to provide funding for expenses of the DBMP chapter 11 case and to provide funding for a Section 524(g) asbestos trust. Judge Edwards said that no payments had been made before DBMP’s chapter 11 filing, nor was the obligation secured by assets.

Three months after the two-step restructuring, DBMP filed a chapter 11 petition in North Carolina.

During the chapter 11 case, Judge Edwards said that New CertainTeed had provided $64.5 million for administrative expenses.

Having filed an adversary proceeding asserting that the pre-bankruptcy restructuring was a constructively fraudulent transfer, the official committee of tort claimants and the representative of future asbestos claimants filed a motion for partial summary judgment asking Judge Edwards to declare that the funding agreement was not “value” that would obviate a constructively fraudulent transfer under Section 548(a)(1)(B) and comparable state laws.

Excluded Promises

To avoid a transaction as a constructively fraudulent transfer, the debtor must be “insolvent,” and the debtor must have received “less than reasonably equivalent value in exchange for such transfer.”

Under Section 548(d)(2)(A), “‘value’ means property, or satisfaction or securing of a present or antecedent debt of the debtor, but does not include an unperformed promise to furnish support to the debtor or to a relative of the debtor.”

Judge Edwards wrote a detailed history of the advent of fraudulent transfer law in medieval England and its transfiguration into U.S. bankruptcy laws and state fraudulent transfer statutes. Segments of her opinion doubtless will be reproduced in law school casebooks.

Regarding the statutes’ excluded promises, as she called them, Judge Edwards said that the clauses “directly followed and were derived from over two centuries of fraudulent transfer common law decisions regarding executory consideration.” “[M]ost important,” she said, “courts never automatically applied the rule to any transaction involving executory consideration. While executory consideration was [a] necessary element for the rule’s application, it was not by itself sufficient to prove a fraudulent transfer.”

Synthesizing the common law and the evolution of corporate laws, Judge Edwards said, 

[W]hile some courts made performance to date a central part of their analysis, all courts consider as critical the promise’s enforceability, assignability, likelihood of performance, present economic value, and capacity to confer a direct or indirect benefit on the debtor at the time of the transfer . . . . Importantly, the decisions in which courts denied finding value generally involved more than the mere postponement of performance but instead involved promises that were unperformed, speculative, unenforceable, unsupported by present rights, ineffective as to their attestations, or directed toward someone other than the debtor. Lastly and most importantly, of the cases that did apply the excluded promise clause to executory consideration, only a few outlier courts did so on summary judgement and without a trial. Most other cases applied the clause after a trial and based on significant evidence.

Critical for her ultimate conclusion, Judge Edwards said that a decision as to whether the funding agreement falls within the excluded promise clause is “at most, a mixed question of law and fact.” In the case before her, however, she said that the debtor’s assets other than the funding agreement had “no possibility” of equaling the debtor’s liabilities.

Caselaw on Excluded Promises

Regarding the funding agreement’s capacity to represent value, Judge Edwards concluded that “some commercial contracts are not encompassed by the excluded promise clause . . . , whereas other commercial contracts may be encompassed by the excluded promise clause.” From caselaw, she concluded:

‘An unperformed promise of support’ is not a generic statutory phrase, but rather a legal term of art deriving its meaning from two hundred years of common law that [preceded] the modern excluded promise clauses.

“On the whole,” Judge Edwards understood the caselaw to mean that a funding agreement, “if sufficiently enforceable and likely to be performed, [is] not automatically excluded from value as a matter of law . . . . If there is a sufficient expectation of realization of the value purported to be forthcoming, the excluded promise clauses cannot apply, at least as a matter of law.”

“In this case,” Judge Edwards found “sufficient basis to hold that the excluded promise clause does not apply as a matter of law.” She read the funding agreement to mean that it “presumptively gives [the debtor] rights to enforce New CertainTeed’s obligations under the same.”

“Similarly,” Judge Edwards saw “some factual bases to assume that New CertainTeed will performs its obligations, given the facts that (1) New CertainTeed has performed in part by paying $64.5 million in legal fees . . . and (2) the dire consequences that would follow if New CertainTeed did not perform.”

Referring to courts that “have frequently turned to the specific facts involved in order to make their determinations,” Judge Edwards decided that “such an approach [is] appropriate here where the application of the excluded promise clauses lean towards a mixed question of law and fact.” She observed that “few courts have historically applied the excluded promise clause as a matter of law and usually do so only after a trial.”

Judge Edwards concluded that the funding agreement’s value “may instead depend on facts concerning confirmation, including the terms and likelihood of a confirmable plan. Further development of the record is therefore warranted before the Court resolves this issue,” given “the Fourth Circuit’s expressed expectation that these proceedings advance toward confirmation.”

Ruling that the financing agreement was not excluded from “value” as a matter of law, Judge Edwards denied the motion for partial summary judgment because “the interpretation of ‘promise of support’ in the excluded promise clause is a mixed question of fact and law and warrants further fact-finding.”

Commentary

Prof. Bruce A. Markell provided ABI with the following commentary:

The opinion rightly traces pre-Code support cases to actual-fraud suspicion (badges, presumptions, private exemptions), with a drift toward constructive fraud. It then recasts the issue in constructive fraud cases as a value-uncertainty test. 

While arguably technically accurate, that conclusion sits uneasily with the court’s concession that courts have voided transfers despite recognizing real value, and with the importation of common law history as part of plain-meaning textualism.

In this case, denying summary judgment rewards two-step sponsors: unsecured, non-assignable, affiliate-controlled funding promises remain litigable “value,” prolonging delay while claimants die. 

Planned two-steps gain a template; pending debtors gain leverage.

Prof. Markell is the Professor of Bankruptcy Law and Practice at the Northwestern University Pritzker School of Law.