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Monday, April 1, 2019

TURBULENCE: Could An Adversary Proceeding Impact Mark Noss As He Seeks To Discharge Debts Of Full Spectrum Management, LLC, His Shuttered Charter School Management Business? Part 2 of a two-part analysis


Noss heads to bankruptcy court tomorrow morning to face his creditors and a bankruptcy Trustee, but his glide path to an easy Chapter 7 discharge may have hit a rough patch.

In Chapter 7 cases, the debtor does not have an absolute right to a discharge. 

An objection to the debtor's discharge may be filed by a creditor, by the trustee in the case, or by the U.S. trustee. Creditors receive a notice shortly after the case is filed that sets forth much important information, including the deadline for objecting to the discharge. 

To object to the debtor's discharge, a creditor must file a complaint in the bankruptcy court before the deadline set out in the notice. Filing a complaint starts a lawsuit referred to in bankruptcy as an “adversary proceeding”. 

Included among the reasons for an adversary proceeding is the transfer or concealment of property with intent to hinder, delay, or defraud creditors. 

In my opinion, Independent Bank, owed $766,925 by Full Spectrum, is a likely candidate to file an adversary petition—based on “constructive fraud”. 

What is constructive fraud, and how could it apply in Full Spectrum’s bankruptcy? 

The point of an adversary proceeding is to gain money for creditors (as opposed to prosecuting a crime). 

The trustee can use an adversary proceeding to: 
• set aside fraudulent transfers (transfers for less than full value) and recover the property from the person or entity who received the transfer 

• obtain turnover of hidden or undisclosed property from whoever is in possession of the property 

• object to or revoke the discharge of a bankruptcy debtor who has hidden assets or attempted to transfer assets out of the reach of the trustee 

• recover property from employees or officers who have wrongfully taken assets of businesses in bankruptcy 

• recover property that has been wrongfully seized by creditors, and 

• determine the validity, priority, and extent (amount) of liens fraudulently placed on bankruptcy assets. 

Adversary proceedings are similar to lawsuits filed in other courts but proceed to trial much more quickly. 

The trustee can serve the initial pleadings—the summons and complaint—by first class mail. This eliminates the need to chase down someone who is avoiding service. The trustee can sue anyone in an adversary proceeding, not just debtors and creditors. 

On July 16, 2014, the Uniform Law Commission approved a series of changes to the Uniform Fraudulent Transfer Act (the “UFTA”). The UFTA had previously been adopted by most states in the country, including Michigan. The Commission’s amendments included changing the name of the law from the UFTA to the Uniform Voidable Transactions Act (the “UVTA”). 

On January 6, 2017, then-Governor Rick Snyder signed into law Public Act 552, which replaced the UFTA in Michigan with the UVTA. Throughout the UVTA, the term “fraudulent transfer” is replaced with the term “voidable transaction.” 

The use of the word “fraudulent” in the UFTA was leading to errors in which courts would apply the heightened pleading requirement for “fraud” to complaints alleging the existence of a fraudulent transfer. 

The new UVTA more clearly addresses the concept of “constructive fraud,” which allows for the avoidance (and recovery) of transfers made or of obligations incurred by an insolvent debtor in exchange for less than reasonably equivalent value. 

The words “fraud” and “fraudulent” don’t exist in the UVTA. 

The UVTA also clarifies the burden of proof required to support a claim. 

The UVTA provides that the creditor-claimant has the burden to establish its claim by a “preponderance of the evidence,” rather than the higher “clear and convincing” standard. Under federal Bankruptcy Code, the look-back period is two years. 

However, a trustee can use state law if the look back period is longer. 

The look-back period in Michigan for a potentially fraudulent transfer is 6 years, and bankruptcy Trustees may rely on Michigan's fraudulent transfer statute to avoid, or undo, a transfer of an asset. 

There are two types of fraudulent transfers in bankruptcy law. 

The first, actual fraud, involves the intent to defraud creditors, the other, sometimes called constructive fraud, involves a transfer, which is made in exchange for grossly inadequate consideration. 

Constructive fraud also requires two conditions: 1) in exchange for the transfer, the debtor received less than "reasonably equivalent value", and; 2) the debtor is unable to pay debts either at the time the transfer was made or as a result of the transfer itself. 

In this case, intent need not be proven rather the focus of the inquiry rests on whether the debtor received reasonably equivalent value. Of course, reasonably equivalent value can be in the eye of the beholder. 

When there is nothing of value exchanged for the transfer of the debtor's property, the answer is an easy one. 

Not infrequently, however, something of value is given and the question becomes whether the value was really adequate compensation for the property. 

On April 28, 2014, Noss issued a “broadcast email” to the entire Grand Traverse Academy school community touting his “financial and management experience that I have gained over 30 years” and “15 years volunteering on the board”—surely not someone who would need to secretly pay Steven Ingersoll $12,500 a month. 

But Noss did pay Ingersoll, a total of $380,863 (ostensibly for those services) between April 8, 2014 and March 1, 2016.

I'm glad I won't have to answer questions tomorrow morning, under oath, in front of a United States Bankruptcy Court judge. 

But Mark Noss will.

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