The Fifth Circuit held severance payments to be fraudulent transfers under Section 548.

John R. Stanley vs US Bank National Association ( February 10, 2010)

The U.S. Court of Appeals for the Fifth Circuit affirmed a district court ruling and held that under Section 548, it was enough that the officer was an insider when the debtor incurred the obligation. Plaintiff bankruptcy trustee sued defendant former officer of the debtor to recover severance payments as fraudulent transfers under 11 U.S.C.S. § 548. The United States District Court for the Southern District of Texas granted judgment in favor of the trustee. The officer appealed. In a declaratory action by plaintiff executive liability insurer, the court held the judgment against the officer was not a "Loss" under the policy. The trustee appealed.

TransTexas Gas Corporation (“TransTexas”) was engaged in exploration, production, and transmission of oil and natural gas. In April 1999, TransTexas filed for Chapter 11 bankruptcy protection. The reorganization plan provided that the company would enter a three-year Employment Agreement with John Stanley, Sr., the company's founder. The Agreement was effective March 17, 2000 and provided that Stanley could be terminated beginning two years after its execution and at termination, Stanley would be entitled to severance pay. If he was dismissed for reasons other than cause, he would receive three million dollars. If he was terminated for cause, his payment would be one and a half million dollars. If he voluntarily resigned, he would be paid no severance.

Despite its reorganization, TransTexas struggled financially. In March, Stanley and TransTexas agreed that Stanley would resign and the Board executed a "Separation Agreement” in March 2002. It explicitly superseded his Employment Agreement. He was to be paid three million dollars in instalments. Stanley had received $ 2,270,794.90 before the payments ceased. In April 2002, TransTexas purchased an executive and organization liability insurance policy ("the Policy") from National Union. Stanley was an insured for any covered claims that were made during the policy period, regardless of when the incidents giving rise to the claims occurred.

Subsequently, as a result of its financial deterioration, TransTexas in November 2002 filed a second Chapter 11 proceeding in the bankruptcy court for the Southern District of Texas. The bankruptcy court confirmed the creditors' plan for reorganization in August 2003 and a liquidating trust was established with U.S. Bank as the liquidating trustee.

U.S. Bank filed an adversary proceeding against Stanley, seeking to avoid the severance payments. It alleged that the payments violated Section 547(b) and 548, and the Texas Uniform Fraudulent Transfer Act ("TUFTA"). Tex. Bus. & Com. Code § 24.005 (West 2002). After a two-day trial, the bankruptcy court held that the severance payments constituted both unlawful preferences under Section 547(b) and fraudulent transfers pursuant to Section 548 and TUFTA. Stanley was ordered to repay the over two million dollars he had received, plus attorneys' fees and costs.

On appeal, the district court agreed in most respects. There are two different district courts that entered rulings that were reviewed in this case. In the first decision - Chief Judge Hayden Head held that Stanley's severance payments were avoidable as fraudulent transfers pursuant to Section 548 and TUFTA, but not as preferential transfers under Section 547(b). Stanley's repayment obligation was unaffected by the partial disagreement with the bankruptcy court.

On appeal, both parties asserted error. U.S. Bank seeks reversal of the district court's holding that the transfers were not preferential under Section 547(b). Stanley argues for reversal of the holding that the severance payments were fraudulent transfers under Section 548 and TUFTA. Prior to the issuance of Chief Judge Head's opinion, the insurer, National Union, had filed for a declaratory judgment against Stanley and U.S. Bank in the United States District Court for the Southern District of Texas. The Court held that the insurer was not liable under the Policy for the judgment entered against Stanley and judgment against Stanley was not a "Loss" under the Policy, and even if it were, it fell within the "profit or advantage" exclusion. U.S. Bank appealed.

The Court examined the two issues: Whether the payments amounting to more than two million dollars were fraudulent transfers ;Whether coverage to U.S. Bank under the Policy was properly denied

Fraudulent Transfers Under 11 U.S.C. § 548.

The Court noted both the bankruptcy court and the district court held that TransTexas's severance payments to Stanley were avoidable fraudulent transfers pursuant to Section 548. This provision of the Bankruptcy Code protects creditors of insolvent debtors from unlawful pre-filing transfers to company insiders. The Court held that the two elements of Sec. 548 are clearly satisfied. The severance payments made to Stanley after his dismissal was obligations incurred by TransTexas within two years of its petition date. With regard to the third element, the Court held that under Section 548, it was enough that Stanley was an insider either at the time of the transfer of the funds or at the time the company incurred such obligation. Therefore, Stanley was indisputably an insider at the time he entered into the relevant obligation. That is enough for Section 548.

With regard to the fourth and the fifth element, the Court stated that there was no clear error in finding that the payments were made either with the intent to hinder, delay, or defraud a creditor, or that the debtor received less than reasonably equivalent value in exchange for the obligation while the debtor was insolvent.

The Court held that the severance payments removed over $ 2 million dollars from the estate. For reasonably equivalent value, the issue was not the validity of the original Employment Agreement (EA) but what rights he had under it when the Separation Agreement (SA) was later reached. For a year before termination, there was evidence of good cause for termination, which would have reduced by half the severance payment. The officer actually resigned, which under the EA would have entitled him to nothing. The debtor agreed to payment under the SA anyway. It was thus not reasonable equivalence. Under § 548(a)(1)(B)(ii)(IV), a transfer was fraudulent when the obligation was incurred to an insider under an employment contract not in the ordinary course of business. The payments were fraudulent transfers

National Union's Policy Coverage for a "Loss”

The Court concluded that "Loss" under the policy excluded matters uninsurable under Texas law and under Texas law fraudulent transfer payments that had to be repaid due to a bankruptcy order was a disgorgement of ill-gotten gains, or restitution. Thus, the judgment against the officer was not a "Loss" under the policy.

The Court of Appeals affirmed the judgment of district courts.