Articles Posted in Business Litigation

If you, or your company, is facing a claim in a bankruptcy court in Tennessee, or facing a demand letter from a bankruptcy trustee, or other party, for the return of payments made to you by a company or individual now in bankruptcy, you might be able to use what is referred to as the “subsequent new value” defense. This defense, just one defense in the Bankruptcy Code available to a creditor which is the subject of a preferential payment lawsuit, is particularly useful for creditors which maintained open accounts for now bankrupt debtors.

In concept, the defense is fairly easy to understand. In many cases, its successful application will require complex and tedious analysis of the statutory elements in light of the particular facts of the case.  Assuming that the trustee, or other party which has filed the adversary proceeding, meets his or her burden of proof that the payments to the creditor by the debtor were preferential payments under 11 U.S.C.A. §547(b), a creditor which can prove the elements of the subsequent new value defense (11 U.S.C.A § 547(c)(4)) can avoid repaying the preference payments, or some portion thereof.

To succeed under the subsequent new value defense, a creditor must, to paraphrase the statute, prove three elements: (1) That it gave new value to the creditor after a preferential transfer (a transfer with respect to which the trustee has proven all of the elements of §547(b));  (2) that the new value given was not secured by a security interest which the trustee cannot avoid; and (3) that the debtor did not repay the debt for the new value with a transfer that the trustee cannot avoid.

Like all statutes and laws, understanding the reason for it is helpful in the analysis of particular factual scenarios.  First, it is intended to promote creditors’ willingness to continue to do business with financially troubled accounts, which, ideally, will prevent bankruptcies. Second, when a creditor provides new value to a debtor, the same increases the value of the bankruptcy estate of the debtor, which increases the amount of assets available for distribution to other creditors. Thus, the defense recognizes that it is fair to allow that creditor to offset the value of the new value provided against the amount of the preferential transfers to it.

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If you are the subject of demand by a trustee or other party, whether in a pre-suit demand letter or in a filed adversary proceeding, for the return of money paid to you by an individual or business which is now in bankruptcy, you may be able to keep the money if you can prove that the payments at issue fall within the ordinary course of business exception for preference payments. This is one of the most, if not the most, widely used defense in preference cases, and defendants are successful with it with some frequency. (There are other defenses to preference actions in the Bankruptcy Code, which are not discussed in this post).

Unless the payments at issue are to an “insider,” as defined by the Bankruptcy Code, only payments made within the 90-day period before a debtor files bankruptcy can be attacked as preferences.  In addition to proving that the payments were made within the 90-day period, the trustee, or other party making the claim, has the burden of proving a few other elements in order to establish that the payments at issue were preferences.  Once that burden is met, the creditor who received the payments can avoid having to disgorge the money at issue if it carries its burden of proof that the payments, though preferences, fall within the ordinary course of business exception in the Bankruptcy Code (11 U.S.C.A. §547(c)(2)).

To help readers better understand this exception, this blog discusses two cases — one in which the defense was successful, and the other in which it was not. Before discussing those cases, it is helpful to understand some basic rules about this exception. Here they are:

1. The exception can be met by a creditor (who received a preferential payment) proving either the subjective component of the exception or the objective component of the exception.
2. The subjective component of the exception considers whether the transfer, and the debt for which it was transferred, were made in the ordinary course of business of the debtor and creditor. Like the American Camshaft case discussed below, in many cases, there will be no dispute that the debt incurred by the debtor was incurred in the ordinary course of business, but there will be a dispute about whether the payment for that debt was in the ordinary course of business of the debtor and creditor.
3. The objective component of the exception considers whether the debt was incurred in the ordinary course of the business of the debtor and creditor and whether the transfer that was the payment for the debt was made “according to ordinary business terms,” meaning ordinary business terms in the industry of the debtor and creditor.
4. The Bankruptcy Code does not define “ordinary course of business” or “ordinary business terms” and the Sixth Circuit (which is the Circuit in which Tennessee bankruptcy courts are located) has said that there is no “precise legal test” to apply to determine whether either term has been satisfied. Instead, each preference case in which the ordinary course of business defense is raised turns on its own, unique facts.
5. For the subjective component of the exception, in many cases, the most important factor that a Tennessee bankruptcy court will look at is the timing of the payments made by the debtor to the creditor that occurred within the 90-day preference period compared to the timing of the payments that occurred more than 90 days before the debtor filed bankruptcy.
6. Under the subjective component of the exception, a creditor’s chances of success will be diminished, if not foreclosed, if it engaged in collection activity during the 90-day preference window that it did not engage in prior to 90 days before the debtor filed for bankruptcy.

In American Camshaft Specialties, Inc. (Bankr. E.D. Mich. 2011), the creditor (“Creditor”) was able to avoid repayment of preferential payments under both the subjective and objective components of the ordinary course of business defense.  In that case, the Creditor supplied steel to the debtor (“Debtor”). The trustee for the Debtor filed suit against Creditor to recover a number of payments which had been made to the Creditor during the 90-day preference window.  The payments had been made for steel supplied to the Debtor by Creditor.  There was no dispute that the debt for the steel was incurred in the ordinary course of the business of the Debtor and Creditor.

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The “Sales” chapter of the Uniform Commercial Code (referred to as “Article 2 of the UCC”), which was adopted by Tennessee in 1963, was designed to bring uniformity and efficiency to transactions involving the sales of goods.  Article 2 is thorough, to say the least. In any breach of contract case, breach of warranty case or any other case involving goods sold, it should be reviewed carefully as it has provisions that touch on every aspect of transactions involving the sales of goods, including, contract formation, price, terms, delivery, remedies, warranties, and rejection of non-conforming goods.

There is no way, in the space for a blog such as this, to cover all of the potentially important aspects of Article 2, but the following are some observations about it that are helpful to practitioners and litigants.

The UCC – Sales Only Applies to Sales of “Goods”

Article 2 only applies to transactions involving the sales of goods. If your case involves an investment, a real estate dispute, a shareholder divorce, or some type of service, you need to look to Tennessee common law or to some other statute.  With some frequency, transactions will involve both the sales of goods and services. For example, the purchase and installation of computer software and hardware by a business will entail both the provision of goods and services (which the UCC refers to as “non-goods”).  In such cases, the UCC will apply if the predominate assets transferred were goods.  One of the leading Tennessee cases on this topic is Hudson v. Town & Country True Value Hardware, Inc., which was decided by the Supreme Court of Tennessee in 1984.

Different Rules in Article 2 May Apply If the Sale Involves a “Merchant”

A party considered a “merchant” under Article 2, in many important situations, may find that it is subject to different rules and standards under that Article.  To generalize, under Article 2, you are a “merchant” if you are a professional in a business involving the type of goods involved with the transaction. (See T.C.A. § 47-2-104 for the precise definition of “merchant”). Keep in mind that, to be considered a merchant with respect to a transaction in goods, you have to be a professional with respect to the type of goods involved. If a lighting manufacturer buys a forklift, it will not be considered a merchant with respect to that transaction. If it buys filament for the bulbs it manufactures, it will be.

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In Thompson v. Davis, an LLC dispute case, the Court of Appeals of Tennessee issued an opinion that is informative on two different fronts: (1) An LLC member’s obligation to contribute his pro rata share to repay loans taken for the benefit of the LLC, but for which all members are personally liable; and, (2)  under what circumstances a member can reduce the amount of his pro rata obligation based on alleged distributions received by the other members, but not by that member.

Before diving into the facts of, and result in, that case, it is helpful to review a couple of provisions of the Tennessee Revised Uniform Limited Liability Company Act (the “Act”) which come into play with some frequency, as well as the Tennessee statute requiring contribution by a party who is liable on a debt. First, under the Act, when an LLC is not successful, and is dissolved and liquidated, its assets must be distributed first to creditors.  (Creditors, critically, includes members who have made loans to the LLC.) If there are any assets left to distribute after creditors are fully paid, which is infrequent in my experience, they must then be distributed to members who did not receive distributions to which they were entitled. If there are assets left over after those distributions are made, they must be distributed to members first for the return of contributions, and second, for their membership interests in the LLC.  The statute that controls distributions upon liquidation is T.C.A. §48-249-620.

The Act also has its own fraudulent transfer provision embedded in it at T.C.A. §48-249-306. That statute provides that members may be liable for distributions which left the LLC unable to pay its debts as they became due in the ordinary course of business or which left it in the red, so to speak. (The preceding is a generalization, so review the statute for the details).

Apart from the Act, and also at issue in the Thompson v. Davis case, was the Tennessee contribution statute related to instruments, T.C.A. §47-3-116.  That statute provides that a party who pays an obligation on an instrument, such as a bank note, is entitled to seek contribution from others who were also liable for the payment of the note. The statute provides that those others must contribute their pro rata share. For example, if A, B, and C borrow $750,000, interest free, and agree to be jointly and severally liable to the lender for the obligation, and A pays off the obligation, A is entitled to file suit against B and C and collect $250,000 apiece from B and C. A does not have to sue both for contribution, but A cannot collect more than $250,000 from either.

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In cases involving non-competition agreements, the battle is almost always fought, and won or lost, at the preliminary injunction stage.  Once the court rules on whether the former employer (or other party which has obtained a non-compete agreement) is, or is not, entitled to a preliminary injunction, in my experience, a trial rarely occurs. Thus, the importance of prevailing, or not, at the preliminary injunction stage cannot be overstated.

Broadly speaking, one of the main types of relief typically sought in a motion for a preliminary injunction arising out of an employment agreement is that the court enter an order prohibiting the former employee from competing with his or her former employer. The exact terms of an order obtained at the preliminary injunction stage will vary according to the terms of the non-compete agreement at issue and the court’s modification of those terms, if it modifies them (which it is empowered to do).

In deciding whether to grant a motion for a preliminary injunction, a court will consider the following factors:  (1) Whether the former employer is likely to prevail on the merits at trial; (2) whether, without an injunction, the former employer will suffer irreparable harm; (3) whether the preliminary injunction will cause substantial harm to the former employee or others; and (4) the public interest. In my experience, the most important factor is (1), followed by (3).

Our firm has handled many of these cases over the years and factors (2) and (4) have mostly been inconsequential. With respect to factor (2), irreparable harm means harm which has occurred, but for which a court cannot calculate damages, and thus, for which it cannot award damages. There is a large body of case law that supports the conclusion that a former employer will suffer irreparable harm from unfair competition by a former employee.  This is so because it is almost always impossible for a former employer to prove, with any degree of specificity, the damages it will incur from lost business and lost opportunities resulting from the former employee, even when they will most assuredly occur without an injunction.  Thus, in our experience, once a court determines that the former employer is likely to prevail on the merits, it is infrequent that a preliminary injunction is not granted on the basis that the former employer did not prove irreparable harm.

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Most construction contracts, including those based on the American Institute of Architects (“AIA”) forms, contain terms requiring that any change orders be in writing and signed. Tennessee courts have, with some frequency, not enforced those provisions. Usually, the legal theory used by those courts is waiver.

Two Tennessee construction cases involving construction contracts with change order requirements, and in which the courts reached different outcomes, provide a good view of the legal landscape in which a contractor which has not strictly complied with a written change order provision will find itself.  The first case is Moore Construction Company, Inc. v. Clarksville Department of Electricity (Tenn. Ct. App. 1985).  Here are the key facts in that case:

• The project was for the construction of a new office building
• The owner contracted with two prime contractors, Moore and Kennon
• Moore was to perform the site work and other exterior work
• Kennon was to construct the building
• All parties understood that Moore would be able to complete only part of its work before Kennon finished constructing the building, and that, it would not be able to complete its work until Kennon had finished constructing the building
• Moore completed its initial work timely
• Once Kennon started, it fell behind schedule due to its subcontractors
• In September of 1981, Moore began to complain that it could not complete its work due to the delays by Kennon
• A meeting was held among the owner, Moore and Kennon at which meeting it was agreed that the parties would have to adjust their schedules
• No written change order was prepared after this meeting, but the owner prepared a job site memo stating that the parties had agreed to extend the time for Moore to complete its work
• When Moore went back to work, the owner directed it to perform extra work and it did
• The extra work was done without a change order and the owner ultimately paid Moore for that extra work without protest
• Moore requested that the owner pay it an additional $22,000 in delay damages above the contract price which resulted to Moore from the delays caused by Kennon

The owner refused to pay Moore the delay damages. It argued that it had no obligation to do so because it had not signed a change order for an increased contract price. The construction contract in the Moore case incorporated the AIA General Conditions which provided: “If the Contractor wishes to make a claim for an increase in the Contract Sum, he shall give the Architect written notice thereof within twenty days after the occurrence of the event giving rise to such claim.”  Article 12.1 of the General Conditions also required that the contractor obtain a written change order to enlarge the scope of work.

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In a recent breach of contract case, In re Estate of John E. Mayfield, the Court of Appeals of Tennessee reversed the decision of the trial court which had held that a contract for the sale of a storage facility was unenforceable because there was no mutual assent of the parties.  This opinion is a very helpful reminder to practitioners of how fundamental contract law principles can determine the outcome of a substantial transaction, and of how easy it can be to lose sight of the importance of paying attention to basic contract law principles, as the trial court did.

Here are the key facts:

• Clayton worked for Mr. Mayfield as a housekeeper and manager of his rental storage facility
• At some point, she heard Mr. Mayfield say that someone had offered him $1 million for the facility
• Realizing that Mr. Mayfield might be interested in selling the facility, Ms. Clayton contacted Mr. Saltsman, whom she thought might be interested in purchasing it
• Saltsman was interested in the facility and wanted to see it
• The day that Mr. Saltsman was scheduled to visit the facility, Mr. Mayfield could not make it because he had been moved to Alive Hospice, so Ms. Clayton met Mr. Saltsman at the facility
• The day of the visit to the storage facility, Mr. Saltsman told Ms. Clayton that he would like to buy the property and that he would start with an offer “around” $900,000
• Clayton did not make an offer of $900,000 to Mr. Mayfield on behalf of Mr. Salstman, but instead, she made an offer on his behalf of $950,000
• Clayton explained that she made the offer of $950,000, instead of $900,000, because she knew that Mr. Mayfield already, as he had told her, had received an offer of $1 million. So, she decided to make an offer in the middle.
• When Ms. Clayton informed Mr. Mayfield that Mr. Saltsman would buy the property for $950,000, he said “I’ll take it.”
• Saltsman testified that, when Ms. Clayton came back to him and told him that Mr. Mayfield was willing to sell the property for $950,000, he said: “Sounds good to me. Send me a contract.”
• Mayfield asked Ms. Clayton to go to his lawyer’s office to have a contract prepared
• Clayton testified that, before those instructions, Mr. Mayfield had accepted Mr. Saltsman’s offer
• Once Ms. Mayfield had the written contract from Mr. Mayfield’s lawyer, she went to Alive Hospice where Mr. Mayfield was
• Mayfield signed the contract
• Since Mr. Saltsman was traveling, he told Ms. Clayton to take the signed contract to his house and told her that he would sign it when he returned home
• After Ms. Clayton dropped off the signed contract at Mr. Saltsman’s house, Mr. Mayfield’s lawyer’s assistant called and told her that it was the “wrong” contract, was “invalid,” and would need to be re-written
• Clayton informed Mr. Saltsman of the conversation she had had with Mr. Mayfield’s lawyer’s office. Mr. Saltsman said “okay” and that the name of the buyer would need to be changed to another entity than was on the current contract
• Before a new contract could be drawn up, Mr. Mayfield died
• Saltsman did not return to town and see the contract Mr. Mayfield had signed until after Mr. Mayfield had died

Mr. Saltsman filed a claim with the estate of Mr. Mayfield. To support the claim, he attached the contract signed by Mr. Mayfield, but it was not signed by Mr. Saltsman. Several months after filing his initial claim, Mr. Saltsman signed the contract and filed an amended claim with a copy of the contract bearing his signature and Mr. Mayfield’s.

Mr. Mayfield’s estate took the position that no enforceable contract existed. The trial court held that no enforceable contract existed because there was no mutual assent.  The trial court held that there was no mutual assent because, first, Ms. Clayton had testified that someone from Mr. Mayfield’s lawyer’s office had told her the contract was not valid and would have to be redrafted. Second, the trial court found that there was no mutual assent because Mr. Saltsman had not signed the contract until seven months after Mr. Mayfield had signed it.

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The economic loss doctrine prohibits a party, which is seeking only damages for economic loss, from recovering those damages pursuant to a tort cause of action.  Under the doctrine, economic losses are the damages suffered by a party, other than damages for personal injury or property damage to “other” property.  Here is an example of the application of the economic loss doctrine:

• Plaintiff bought 1,000 widgets from Defendant
• The widgets all malfunctioned and were virtually useless because Defendant defectively manufactured them
• Plaintiff’s losses include the cost of the widgets and profits it lost from the anticipated resell of the widgets
• Under the economic loss doctrine, the Plaintiff can recover under breach of contract and breach of warranty causes of action, but cannot recover under tort causes of action for misrepresentation or products liability

If, in the above example, one of the widgets, because of a defect, had caused personal injury to a warehouse worker of Plaintiff or had burned down Plaintiff’s warehouse, Plaintiff could recover, under tort theories, for the damages caused by that widget because they were for personal injuries or to “other property” (property other than the widgets).

The purpose of the doctrine is to preserve the boundaries between tort and contract law, or, as it has been put: To keep contract law from drowning in a sea of tort law.  Another principle underpinning the doctrine was stated as follows by a Tennessee court: “Courts should be particularly skeptical of business plaintiffs who – having negotiated an elaborate contract or having signed a form when they wish they had not – claim to have a right in tort.”

The economic loss doctrine, as it exists in Tennessee, took a new twist based on a recent decision of the Court of Appeals of Tennessee in the case of Milan Supply Chain Solutions, Inc. v. Navistar, Inc.  In that case, the trial court held that Tennessee’s economic loss doctrine did not apply to fraud claims.  The court of appeals, at least on the facts before it, disagreed and reversed.  The case is a very significant case dealing with a very significant defense that is sure to become even more litigated in commercial disputes in Tennessee courts in the coming years.

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The United States District Court for the Northern District of Tennessee decided against a former employee in a breach of contract case for failure to pay sales commissions on the grounds that he was required to do more than just connect the new customer with his employer (“Employer”). It should be noted, at the outset, that this case turned largely on the specific language of the former employee’s employment contract, and should not be taken as establishing a general rule that independent sales representatives and employees cannot collect commissions for just initiating the contact with the new customer. In some cases, they can.

Even though the case, Jackson v. Maine Pointe, LLC, 2018 WL 1371488, was decided largely on its unique facts, valuable lessons for commissioned sales representatives and employees can be derived from an understanding of what happened in the case.  Perhaps the most important lesson is how important it is for employees and representatives to pay attention to the terms of their written commission agreements and, where possible, to bargain for terms that leave no doubt about when they are entitled to be paid commissions.

Here are the key facts of the case:

• Jackson was an at-will employee of a company which specialized in operations consulting
• Jackson’s position was Vice-President of Food and Beverage
• Jackson’s offer letter provided that Employer would pay him commissions of 7% for “sales of $0 to $6,000,000” and 8% for “sales of $6,000,001 and above” for “New Name Client Work Developed by you”
• The specific language about commissions, which became critical, provided: “You will be eligible to earn sales commissions on collected engagement revenue (not analysis, nor reimbursed T&E Revenue … All commissions are paid monthly as project revenue is collected . . . “
• While employed, Jackson identified Colony Brands as a potential customer for Employer
• Jackson agreed to pay a referral fee of 1.5% to another employee of Employer who had a relationship with Colony Brands for helping Jackson connect with Colony Brands
• Just days prior to his termination from employment with Employer, Jackson sent an email to, and left a voicemail with, a contact at Colony Brands
• After Jackson was terminated, another employee of Employer resent Jackson’s email to the contact at Colony Brands, a Mr. Hughes
• Mr. Hughes responded to the email and even referenced Mr. Jackson’s name in his response
• Thereafter, other employees of Employer met with Mr. Hughes, and Colony Brands ultimately paid $6.3 million to Employer
• The employees who met with Colony Brands and brought the contract with it to fruition were paid commissions and the employee to whom Jackson had promised a 1.5% commission as a referral fee was paid that amount
• Jackson received no commission whatsoever

Jackson filed a breach of contract lawsuit against Employer. He argued that he was entitled to the agreed commission from the Colony Brands’ business because he had procured the business.  His former Employer argued that, under the terms of the written employment/commission agreement, to be entitled to a commission, Jackson had to do more than just “procure” the business — he had to “develop” it.

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