Ins. Co. of Pa. v. Giuliano (In re LTC Holdings, Inc.)

IN RE: LTC HOLDINGS, INC., et al., Debtors.

INSURANCE COMPANY OF THE STATE OF PENNSYLVANIA, Appellant, v. ALFRED THOMAS GIULIANO, CHAPTER 7 TRUSTEEand BMO HARRIS BANK, N.A., Appellees.

Bankr. No. 14-11111 (CSS)

Adv. No. 15-51889 (CSS)

C.A. No. 19-327 (MN)

UNITED STATES DISTRICT COURT FOR THE DISTRICT OF DELAWARE

September 17, 2020

Chapter 7

MEMORANDUM OPINION

Scott G. Wilcox, MOORE AND RUTT, P.A., Wilmington, DE; Andrew S. Kent, CHIESA SHAHINIAN & GIANTOMASI P.C., West Orange, NJ - Attorneys for Appellant Insurance Company of the State of Pennsylvania.

Richard M. Beck, KLEHR HARRISON HARVEY BRANZBURG, LLP, Wilmington, DE; David T.B. Audley, Matthew T. Benz, CHAPMAN AND CUTLER LLP, Chicago, IL - Attorneys for Appellee BMO Harris Bank, N.A.

September 17, 2020

Wilmington, Delaware

NOREIKA, U.S. District Judge

Pending before the Court is an appeal by Insurance Company of the State of Pennsylvania ("ICSP") of the Bankruptcy Court's February 4, 2019 decision, In re LTC Holdings, 597 B.R. 565 (Bankr. D. Del. 2019) ("Opinion") and accompanying Order (Adv. D.I. 114)¹ ("Summary Judgment Order") entered in the chapter 7 cases of LTC Holdings, Inc. ("LTC Holdings") and subsidiaries LTCCORP Government Services-MI, Inc., f/k/a Lakeshore Engineering Services, Inc. ("LES") and LTCCORP Government Services-OH, Inc. f/k/a Toltest, Inc. ("Toltest," and together with LTC Holdings and LES, "the Debtors"). By the Summary Judgment Order, Chief Bankruptcy Judge Christopher S. Sontchi denied ICSP's summary judgment motion and granted a summary judgment motion filed by the Debtors' secured creditor BMO Harris Bank, N.A. ("BMO"). The Summary Judgment Order resolved a dispute over the Debtors' $5.5 million tax refund and awarded the tax refund to BMO based on (1) BMO's first priority security interest in the tax refund; and (2) a determination that the competing subrogation rights of appellant ICSP derived solely from the setoff rights of the United States, which had been previously released in a court-approved settlement between the United States and the Debtors. For the reasons set forth below, the Court will affirm the Summary Judgment Order.

I. BACKGROUND

A. The Parties

Prior to the chapter 7 filing, the Debtors provided general contracting services for large construction projects, both domestic and international, with a primary focus on constructing facilities for various branches of the United States military, with arms of the United States government acting as the owner/contracting party ("the United States Contracts"). (Adv. D.I. 20 (Counterclaim) ¶ 7). For some of the United States Contracts, the Debtors were required to post performance and payment bonds, signed by a qualified surety, guaranteeing that the Debtors would perform their contracts with the United States and pay their subcontractors. (Id.). The Debtors obtained certain performance bonds and payment bonds from ICSP, as surety. (Id. ¶ 8). As the Bankruptcy Court noted, two of the United States Contracts on which ICSP acted as surety were the National Police Command Center ("NPCC") in Afghanistan and the Al Dhafra air base in the United Arab Emirates ("Al Dhafra"). LTC Holdings, 597 B.R. at 568-69.

Prior to the Petition Date, Appellee BMO extended credit to the Debtors, and the Debtors granted to BMO liens on and security interests in substantially all their personal property. (Bankr. D.I. 110, ¶ 9).

B. The Chapter 7 Cases and Claims

On May 2, 2014 ("the Petition Date"), each of the Debtors filed a voluntary petition for relief under chapter 7 of the Bankruptcy Code, and a Chapter 7 Trustee ("Trustee") was appointed. The United States Department of Defense filed a proof of claim against the Debtors, and on May 24, 2016, amended its proof of claim ("the DOD Claim"). LTC Holdings, 597 B.R. at 570. The DOD Claim included at least $68,040,956.58 in fixed, non-contingent, unbonded claims against Debtor LES and at least $893,110 in unbonded claims against the parent Debtor LTC Holdings ("the Unbonded DOD Claims"). Id. The Unbonded DOD Claims against Debtor Toltest exceeded $15 million. Id. Claims contingent upon the completion of certain contracts by the Debtors' sureties, including ICSP, amounted to $84 million ("the DOD Bonded Claims"). Id. The $84 million DOD Bonded Claims included $24,320,207.42 relating to the NPCC contract and $608,886.05 relating to the Al Dhafra contract. Id.

On July 3, 2014, the Trustee filed a motion ("the MOU Motion") seeking entry of an order approving a Memorandum of Understanding ("the MOU") between the Trustee and BMO which contained a comprehensive settlement between the Trustee and BMO. (Bankr. D.I. 110). The Bankruptcy Court granted the MOU Motion by Order entered on September 8, 2014. (Bankr. D.I. 196). In the MOU, the Trustee acknowledged that BMO had a first priority security interest in the Tax Refund (as defined below). (Id. at Ex. A, ¶ 1).

On August 8, 2014, BMO filed a proof of claim against each of the Debtors in the amount of no less than $39,153,909.92 ("the BMO Claim"). See LTC Holdings, 597 B.R. at 568.

C. The Tax Refund

Shortly before the Petition Date, the Debtors filed a consolidated tax return for tax year 2013, showing a net operating loss of $28 million for the 2013 tax year ("2013 NOL"). By separate application to the IRS ("the Tax Refund Application"), the Debtors sought to "carryback" the 2013 NOL to 2011 and obtain a refund of $5,628,542 in income taxes previously paid for tax year 2011 ("Tax Refund"). LTC Holdings, 597 B.R. at 569. In response to the Tax Refund Application, the United States claimed setoffs against the Tax Refund based on damages that the United States asserted were due from the Debtors under certain United States Contracts. The United States therefore placed an administrative hold on the Tax Refund. Id. at 569-70.

D. Tax Refund Settlement and Order

The Trustee negotiated a settlement with the United States, memorialized in a stipulation dated January 12, 2016 between the Trustee and the United States (BMO Appx. Ex. 3, "the Tax Refund Stipulation"), under which (among other terms) the United States would release the Tax Refund to the Trustee in exchange for the Trustee releasing the Debtors' contract claims against the United States (referred to as "REAs" - Requests for Equitable Adjustment). (BMO Appx. Ex. 3, ¶¶ G, H, 7). In testimony given in support of the Tax Refund Settlement Motion (as defined below), the Trustee testified that the REAs being released had a face value of approximately $51 million. (Bankr. D.I. 917, 6/9/2016 Hr'g Tr. at 109). As part of the settlement, the Trustee also agreed to the allowance of the United States' amended proof of claim. (BMO Appx. Ex. 3, ¶ 5).

Paragraph 4 of the Tax Refund Stipulation, representing the waiver by the United States of its setoff claims against the Tax Refund, states:

4. Except as provided by paragraph 5, effective as of the Effective Date and in consideration of the obligations under this Stipulation, the Contracting Activities shall be deemed to expressly waive any setoff rights arising out of the DOD Claim or the Government Contracts they may have or ever had pursuant to 11 U.S.C. § 553, and shall be estopped from claiming any such setoff rights it may have or ever had pursuant to 11 U.S.C. § 553, against any of the Debtors in the Tax Refund. Nothing in this paragraph shall waive, estop, or otherwise limit any right of setoff by the Internal Revenue Service.

(BMO Appx. Ex. 3, ¶ 4). Paragraph 10 of the Tax Refund Stipulation, representing the release by the United States of its claims against the Debtors, including its setoff claims against the Tax Refund, states:

10. Except with respect to the obligations set forth herein, upon the Effective Date, the Contracting Activities hereby remise, release, discharge and acquit the Trustee and the Debtors' estates from any and all claims, action, liabilities, debts and causes of action whatsoever, however incurred or arising, now existing or hereafter arising, known or unknown, actually brought or that could have been brought relating or pertaining to the Government Contracts, the Government Projects, the Tax Refund, the Rocco Contract, and the Rocco Payment. Nothing in this Agreement shall be construed to release or waive liability arising under federal tax, criminal, or environmental law or liability for fraud (including, but not limited to, securities and pension benefit fraud and claims arising under the False Claims, Act, 31 U.S.C. § 3729, et seq.). The Contracting Activities waive any right that they, or the assigns and successors, may have to file a proof of claim under Section 502(h) of the Bankruptcy Code, or otherwise receive payment from the Debtors' estates. Except as limited by the preceding sentence, nothing in this paragraph affects or limits a distribution to the United States by the Trustee on account of the Allowed DOD Claim.

(BMO Appx. Ex. 3, ¶10).

On January 14, 2016, the Trustee filed a motion seeking approval of the Tax Refund Stipulation pursuant to Rule 9019 of the Federal Rules of Bankruptcy Procedure ("the Tax Refund Settlement Motion"). (Bankr. D.I. 662; Adv. D.I. 20 ¶ 22). On February 11, 2016, ICSP filed a limited objection to the Tax Refund Settlement Motion ("the ICSP Objection"). (Bankr. D.I. 681). The Bankruptcy Court held an initial hearing on the Tax Refund Settlement Motion on March 7, 2016. (Bankr. D.I. 766). Following the initial hearing, the Trustee and ICSP reached an agreement on proposed language approving the Tax Refund Settlement Motion. The agreement on proposed language was reported to the Bankruptcy Court at the next hearing on June 9, 2016, and, in light of that agreement, ICSP withdrew the ICSP Objection. (Bankr. D.I. 917, 6/9/2016 Hr'g Tr. at 5-6). On June 28, 2016, following closing arguments, the Bankruptcy Court entered an Order approving the Tax Refund Stipulation (BMO Appx. Ex. 4) ("Tax Refund Settlement Order").

Paragraph 3 of the Tax Refund Settlement Order...