Delaware Bankruptcy Court clarifies broad scope of fraudulent transfer claims
The US Bankruptcy Court for the District of Delaware recently reaffirmed but limited the holding of In re DSI Renal Holdings, LLC,[1] which held that under Third Circuit law, neither debtors nor trustees could bring fraudulent conveyance actions solely for the benefit of holders of actual equity interests.
In its ruling on May 8, 2025 in In re ONH AFC CS Investors, LLC, Adv. Proc. No. 24-50085-CTG, the court held that a debtor in possession or trustee can assert causes of action for avoidance and recovery of fraudulent transfers where the beneficiaries of such causes of action would be creditors whose claims had been (1) subordinated to the level of equity pursuant to Section 510(b) of the Bankruptcy Code and (2) treated as equity interests for distribution purposes.
Factual background
Elchonon Schwartz, the Debtors’ principal, formed ONH AFC CS Investors, LLC (“ONH AFC” and, with its debtor affiliates, the “Debtors”) to raise equity to fund the purchase of the Atlanta Financial Center.
To fund the purchase, ONH AFC raised, among other funds, approximately $44 million from 654 investors through CrowdStreet, an online brokerage firm. ONH AFC represented that it would hold those funds in segregated accounts and would return those funds if the purchase failed to close.
However, the Debtors did not consummate the purchase and did not return the funds to the investors. Instead, the Debtors withdrew and dissipated those funds. Bankruptcy soon followed.
The bankruptcy case and adversary proceeding
On July 14, 2023, the Debtors filed voluntary chapter 11 cases. On December 14, 2023, the court confirmed the Debtors’ Amended Small Business Debtors’ Joint Plan of Liquidation.[2] In the plan, the Debtors subordinated investor claims, including those of the Crowdstreet investors, under Section 510(b) of the Bankruptcy Code and classified them in the same class as the Debtors’ pre-bankruptcy equity holders (the “Equity Class”).[3] Plan at 7.
The plan contemplated payment in full of all creditor classes, leaving any recovery from litigation to benefit the Equity Class. The plan went effective on December 28, 2023 and Anna Phillips was appointed post-effective date liquidating trustee with authority to pursue various estate claims and actions, including to avoid and recover fraudulent transfers.
On June 27, 2024, Phillips commenced an adversary proceeding against Josmic 2 LLC and Josmic Holdings LLC (collectively, “Josmic”) that, among other things, sought to (1) avoid and recover as fraudulent transfers prebankruptcy payments to Josmic and (2) disgorge such payments from Josmic under a theory of unjust enrichment.
Phillips specifically challenged two types of transfers: (1) a transfer of $5 million that ONH AFC used to payoff a loan from Josmic to Schwartz and (2) several other smaller transfers from ONH AFC to Josmic, supported with little additional detail.
Josmic moved to dismiss the complaint for failure to state a claim. In addition, Josmic sought a stay of the adversary proceeding to allow Josmic to file a motion for summary judgment based on the reasoning in DSI Renal. Pursuant to DSI Renal, Josmic argued that Phillips was barred from asserting a fraudulent transfer claim because the only beneficiaries of such claims would be holders in equity, not creditors.
Overview of the decision
The court denied the motion to stay
The court first addressed Josmic’s request that the action be stayed pending resolution of a to-be-filed motion for summary judgment relying on the reasoning of DSI Renal. The court denied the request.
In so doing, the court reaffirmed the “core reasoning” of DSI Renal but refused to extend it to bar fraudulent transfer claims that would benefit holders of subordinated claims, even if a plan classified those subordinated claims as equity:
“Fraudulent conveyance is a creditor’s remedy. Where the beneficiary of a bankruptcy trustee’s fraudulent conveyance action is a party that would not have been able to assert a fraudulent conveyance claim against the defendant immediately before the bankruptcy [such as an equity holder], it would make no sense (for the reasons DSI Renal explains) to permit a bankruptcy trustee to assert a fraudulent conveyance claim for the benefit of that party.” Opinion at 11.
According to the court, because equity interest holders could not bring a fraudulent transfer action outside of bankruptcy, as DSI Renal instructed, they cannot be the beneficiaries of such an action brought in a bankruptcy case.
However, the court distinguished the facts in the instant case from those in DSI Renal – unlike in DSI Renal, the beneficiaries of a fraudulent transfer claim included holders of claims subordinated under Section 510(b), not just pre-bankruptcy stockholders.
The court reasoned that while such subordinated claims are treated as equity interests for purposes of treatment of claims in bankruptcy, that treatment does not answer the fundamental question under DSI Renal: whether these beneficiaries “would have had the right to assert fraudulent conveyance claims outside of bankruptcy.” Opinion at 11–12.
According to the court, because an investor who is the victim of fraud qualifies as a creditor who may assert a state law fraudulent transfer claim outside of a bankruptcy case,[4] the court concluded that “there is no reason why a bankruptcy trustee should not be able to bring a fraudulent conveyance claim for the benefit of that investor.” Opinion at 12.
The court found Josmic’s attempt to equate subordinated claims to equity to be “quite far removed” from the reason that a bankruptcy trustee is precluded from bringing a fraudulent transfer action for the benefit of equity holders – unlike equity holders, investors who had been defrauded would be able to bring fraudulent transfer actions under state law in the absence of a bankruptcy case. Otherwise, according to the court, to deny the trustee standing to bring claims on behalf of such investors subordinated under Section 510(b) “would leave the trustee with lesser rights than the creditors enjoyed before the bankruptcy filing.” Opinion at 24.
Accordingly, the court denied Josmic’s motion to stay for purposes of considering a motion for summary judgment on DSI Renal grounds.
The court granted in part and denied in part the motion to dismiss
The court also granted in part and denied in part Josmic’s motion to dismiss.
- Actual fraudulent conveyance claims:[5] The court denied the motion to dismiss claims for actual fraudulent transfers in part because the trustee alleged sufficient facts to support an inference that they were made with the intent to hinder, delay, or defraud creditors. The most significant challenged transfer was $5 million paid to Josmic to satisfy a debt owed by Schwartz, and the court found that the allegations regarding misappropriation of these funds were sufficient to survive motion to dismiss. With respect to the remaining challenged transfers, however, the court held that “alleg[ing] in conclusory fashion that the transfers were fraudulent” does not “permit a reader to draw a commonsense inference that the transfers were made with the intent to hinder, delay, or defraud creditors,” and granted the motion to dismiss with respect to these transfers. Opinion at 28.
- Constructive fraudulent conveyance claims:[6] The court dismissed claims for constructive fraudulent conveyance because Phillips failed to allege insolvency at the time of the transfers, a necessary element for a constructive fraudulent conveyance claim.
- Unjust enrichment:[7] The court dismissed the cause of action for unjust enrichment because the complaint failed to allege that Josmic received more that the repayment of a valid loan (albeit, a loan to Schwartz). The court also found that, under New York law, unjust enrichment is not viable where a contract (the loan agreement with Schwartz) governs the relationship.
Key takeaways of ONH AFC
There are two key takeaways from ONH AFC.
First, the court restated and adopted the holding in DSI Renal that a trustee cannot bring a fraudulent transfer claim solely for the benefit of equity holders.
Second, the court clarified that the DSI Renal holding did not apply to holders of subordinated claims classified as equity in a plan. According to the court, Section 510(b) subordination does not fundamentally change the pre-bankruptcy legal rights of the subordinated claimants: While under Section 510(b) such subordinated claims are treated as “equity” for purposes of distributions under a plan, Section 510(b) does not limit rights that such claimants would have outside of bankruptcy and, by extension, does not limit the exercise of those rights by a debtor or trustee.
For more information
If you have any questions about this ruling or any restructuring-related matter, please reach out to the authors, Robert Klyman and David M. Riley, or your usual DLA Piper contact.
[1] Case No. 14-50356, 2020 WL 550987 (Bankr. D. Del. Feb. 4, 2020).
[2] In re ONH AFC CS Investors, LLC, et al., Case No. 23-10931-CTG, ECF No. 202.
[3] Section 510(b) provides that “[f]or the purpose of distribution under this title, a claim arising from rescission of a purchase or sale of a security of the debtor or of an affiliate of the debtor, for damages arising from the purchase or sale of such a security, or for reimbursement or contribution allowed under Section 502 on account of such a claim, shall be subordinated to all claims or interests that are senior to or equal the claim or interest represented by such security, except that if such security is common stock, such claim has the same priority as common stock.
[4] See also Opinion at 24 n. 57 (citing Dillon v. Axxsys Int’l, Inc., 185 F.App’x 823, 830 (11th Cir. 2006) (finding that parties who had been fraudulently induced into investing were creditors of the corporation by virtue of having rights to payment against the corporation); In re Bayou Group, LLC, 372 B.R. 661, 665 (Bankr. S.D.N.Y. 2007) (reaching same conclusion and collecting cases so holding); Drivetrain, LLC v. X. Commerce, Inc., No. 22-50448 (CTG), 2023 WL 1804627, at *6 & n.58 (Bankr. D. Del. Feb. 7, 2023) (noting that when “an investor is fraudulently induced into making an investment based on a company’s material misrepresentations, the investor immediately becomes a creditor – holding a tort claim against the company for having been defrauded into making those investments,” but noting that § 510(b) may subject such a claim to subordination in bankruptcy)).
[5] To plead a claim for intentional (actual) fraudulent conveyance under § 548(a)(1)(A), the trustee must allege (1) that the transfer was made within two years of the petition date, and (2) the debtor made the transfer “with actual intent to hinder, delay, or defraud any entity to which the debtor was or became, on or after the date that such transfer was made or such obligation was incurred, indebted.” Opinion at 26 (quoting 11 U.S.C. § 548(a)(1)(A)).
[6] To plead a claim for constructive fraudulent conveyance under 11 U.S.C. § 548(a)(1)(B), the trustee must allege that (1) the debtor received less than reasonably equivalent value in exchange for the challenged transfer and (2) the debtor either (a) was insolvent at the date of the transfer or became insolvent as a result of the transfer, (b) was left with “unreasonably small capital” immediately after the transfer, (c) “intended to incur, or believed that the debtor would incur, debts that would be beyond the debtor’s ability to pay as such debts matured,” or (d) “made such transfer to or for the benefit of an insider, or incurred such obligation to or for the benefit of an insider, under an employment contract and not in the ordinary course of business.” Opinion at 28 (quoting 11 U.S.C. § 548(a)(1)(B)(i)-(ii)).
[7] To assert a claim for unjust enrichment, New York state law requires facts alleging “(1) that the defendant was benefitted; (2) at plaintiff’s expense; and (3) that equity and good conscience require restitution.” Opinion at 29 (quoting Beth Isr. Med. Ctr. v. Horizon Blue Cross & Blue Shield of N.J., 448 F.3d 573, 586–587 (2d Cir. 2006)).
