The Bankruptcy Code contains a safe harbor for transactions that a debtor enters into after an involuntary petition is filed against it, but before an order for relief on the petition is entered. See 11 U.S.C. §§ 549(b) and 303(f). This safe harbor protects post-petition transactions, which are otherwise subject to avoidance, from being unwound by the trustee in bankruptcy. The policy for this safe harbor is that before an order for relief enters, the debtor must be able to operate its business; the mere filing of an involuntary petition shouldn’t be allowed to cripple the debtor’s affairs.
A bankruptcy court recently held that, under the equities of the particular case, the same policy may have broader application and prevent the trustee from avoiding other transfers. Specifically, where a non-debtor sells personal property in an arms-length transaction for value, and the non-debtor is later retroactively placed into bankruptcy through substantive consolidation, the sale may not be an avoidable post-petition transfer.
In In re Clark, Case No. 12-00649-TLM, 2015 WL 8603098 (Bankr. D. Idaho Dec. 11, 2015), Clark managed a ranch called Crystal Springs Ranch, LLC (the Ranch). Clark filed a chapter 12 case under his own name with the Ranch listed as a d/b/a. The Ranch was not put into bankruptcy. While Clark’s bankruptcy case was pending, Kerslake bought a tractor from the Ranch in good faith, for value, without knowledge of Clark’s bankruptcy case. Eventually a chapter 7 trustee was appointed for Clark’s bankruptcy case, and the trustee successfully moved to have the Ranch substantively consolidated with Clark’s bankruptcy estate. Notably, though the trustee apparently anticipated that he would bring certain avoidance actions if the substantive consolidation was successful, he did not provide notice of the substantive consolidation action to the anticipated targets of those actions, including Kerslake.
The court granted substantive consolidation “nunc pro tunc,” in other words, it was deemed to be effective as of Clark’s petition date. Thus, Kerslake’s purchase of the tractor was technically a post-petition transfer because it occurred after the deemed effective date of the substantive consolidation. The trustee moved to avoid the transfer as an unauthorized post-petition transfer under Bankruptcy Code § 549.
The court granted summary judgment to Kerslake and held that the trustee could not avoid the purchase of the tractor. Though the transaction didn’t fit neatly within the language of the “gap period” safe harbor in § 549(b), similar policies applied. Specifically, there was no dispute that Kerslake purchased the tractor in good faith from the Ranch at a time when the Ranch was not in bankruptcy. Only later, when the trustee obtained retroactive bankruptcy relief relating to the Ranch, without notice to Kerslake, did the purchase become a “post”-petition transaction avoidable under § 549(b). Moreover, the substantive consolidation ruling itself was a form of equitable relief to the trustee, and the trustee could not use equitable relief to work an unequitable result on Kerslake. As a result, under its Bankruptcy Code § 105 equitable powers, the court held that Kerslake’s purchase of the tractor was not an avoidable post-petition transfer.