453 B.R. 352
Bankr. E.D. Ark.2011Background
- Debtors Jerry and Amelia Frankum filed Chapter 7; Heartland Community Bank and Ruffin & Jarrett Funeral Home had security interests in Newport Hospital stock as part of pre-petition settlements.
- Creditors entered into Consent to Sale and Asset Purchase Agreement with CHS to sell Newport Hospital assets for $10.25M plus covenant-not-to-compete payments of $250k to each debtor.
- Closing disbursed $11M, with Heartland receiving $613,500 and a $500k covenant-not-to-compete payment plus $113,500; Debtors directed processing via Land Services under Wiring Instructions.
- Debtors petition filed Oct 14, 2005; liens on Newport Hospital stock had previously been found preferential transfers in/for other proceedings.
- Trustee seeks avoidance under 11 U.S.C. §547 to recover the $500k covenant-not-to-compete payment as a preferential transfer; court had previously resolved related issues in an Order on First Motion for Summary Judgment.
- Court grants Trustee’s motion, finding Debtors possessed a property interest in the covenant-not-to-compete payments and that the transfer satisfied the hypothetical Chapter 7 test for preference.
Issues
| Issue | Plaintiff's Argument | Defendant's Argument | Held |
|---|---|---|---|
| Whether Debtors had a property interest in the covenant-not-to-compete payments. | Trustee: contractual rights in payments constitute property of the estate. | Heartland: payments held for benefit of creditors; no Debtor control. | Yes; Debtors had a contractual right and controlled payment. |
| Whether the covenant-not-to-compete payment was a preferential transfer under §547(b)(5). | Real liquidation vs. hypothetical liquidation shows preference. | Heartland: comparison misapplied; payments not to Debtors’ estate. | Yes; transfer enabled Heartland to receive more than under hypothetical Chapter 7. |
| Whether the hypothetical Chapter 7 test is satisfied under the correct framework. | Using real vs hypothetical liquidation, including secured/unsecured mix, favors Trustee. | Heartland contends a narrower, post-petition comparison. | Satisfied; real liquidation exceeds hypothetical, supporting preference. |
| Whether Heartland released its security interest upon receipt of the $500k payment. | No release occurred; unsecured/partially unsecured claim status persists. | Heartland argues claim valuation discounts matter. | Undisputed no release; preference remains. |
| What is the governing effect of law-of-the-case from the First Motion for Summary Judgment? | Law-of-the-case supports Heartland will receive more under Chapter 7. | Law-of-the-case applies to certain findings; overall analysis remains necessary. | Law-of-the-case controls only to the extent consistent with current analysis; preference established. |
Key Cases Cited
- Begier v. I.R.S., 496 U.S. 53 (1990) (definition of property of the estate and breadth of §541(a))
- In re Auto-Train Corp., 49 B.R. 605 (D.C. 1985) (test for comparing real vs hypothetical liquidation under §547(b)(5))
- Barash v. Public Finance Corp., 658 F.2d 504 (7th Cir. 1981) (hypothetical Chapter 7 test framework and unsecured vs secured effects)
- T & B Scottdale Contractors, Inc. v. U.S., 866 F.2d 1372 (11th Cir. 1989) (earmarking-like scenarios; funds held for third party do not necessarily become estate property)
- In re Inca Materials, Inc., 880 F.2d 1307 (11th Cir. 1989) (constructive trust-like treatment; funds designated to pay creditors affect estate status)