In Re: RML Inc

Opinions of the United

1996 Decisions States Court of Appeals

for the Third Circuit

8-1-1996

In Re: RML Inc

Precedential or Non-Precedential:

Docket 95-7580

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UNITED STATES COURT OF APPEALS

FOR THE THIRD CIRCUIT

_______________

No. 95-7580

_______________

IN RE R.M.L., INC., previously

known as INTERSHOE, INC. Debtor

MELLON BANK, N.A., Appellant

v.

THE OFFICIAL COMMITTEE OF UNSECURED

CREDITORS OF R.M.L., INC., previously

known as INTERSHOE, INC.

_______________

On Appeal from the United States District Court

for the Middle District of Pennsylvania

(D.C. No. 95-cv-01200)

_______________

Argued June 5, 1996

Before: COWEN, NYGAARD and LEWIS, Circuit Judges

(Filed August 1, 1996)

_______________

Edward I. Swichar (ARGUED)

Earl M. Forte, III

Blank, Rome, Comisky & McCauley

1200 Four Penn Center Plaza

Philadelphia, PA 19103

COUNSEL FOR APPELLANT

Mary F. Walrath (ARGUED)

Pauline K. Morgan, Esq.

Clark, Ladner, Fortenbaugh & Young

One Commerce Square

2005 Market Street

Philadelphia, PA 19103

COUNSEL FOR APPELLEE

_______________

OPINION OF THE COURT

_______________

COWEN, Circuit Judge.

We confront in this case a difficult issue arising under

11 U.S.C. § 548(a)(2), the provision of the Bankruptcy Code (the

"Code") allowing for avoidance of constructively fraudulent

transfers. The principal question we must decide is whether a

commitment letter Mellon Bank issued in connection with a

contemplated $53-million loan conferred "reasonably equivalent

value" on Intershoe (the debtor) in exchange for $515,000 in

commitment fees that Intershoe paid to Mellon Bank. This question

is complicated by the fact that the loan, which could possibly have

saved Intershoe from bankruptcy, ultimately failed to close. We

also must decide whether Intershoe was insolvent when it

transferred the commitment fees to Mellon Bank.

After finding that Intershoe was insolvent during the

relevant period, the bankruptcy court, relying on a "totality of

the circumstances" test, concluded that Intershoe had not received

"reasonably equivalent value" in exchange for the $515,000 in fees

it had paid to Mellon. The court found that the loan commitment

was so conditional when issued that it conferred virtually no

indirect economic benefit on Intershoe. It therefore ordered

Mellon Bank to remit to the bankrupt estate all but $127,538.04 of

the commitment fees, an amount representing Mellon Bank's out-of-

pocket expenses. The district court summarily affirmed. Because

the commitment letter was so conditional that the chances of the

loan closing were minimal, we agree that Intershoe did not receive

value that was reasonably equivalent to the fees it paid Mellon

Bank. Accordingly, we, too, will affirm.

I.

A.

At all times relevant to this dispute, Intershoe was a

large-scale wholesale distributor of women's shoes. Through 1991,

its primary secured lender was Signet Bank. In the spring of 1991,

Intershoe was aware that its financing arrangement with Signet

would terminate that fall. It therefore sought to recapitalize and

refinance its operations. Intershoe wanted to attract a $15

million equity investment; it also wanted to replace Signet as its

lender with a bank group that would extend a $53 million loan

facility.

In March of 1991, Three Cities Research ("TCR") made an

initial, nonbinding proposal to make a $15 million investment in

Intershoe and began to conduct due diligence and negotiations

toward that end. Hoping that the prospect of an equity infusion

would entice potential lenders, Intershoe approached Mellon Bank,

Bank of New York ("BNY") and Citicorp to discuss potential

refinancing. Each bank made clear that an equity infusion would be

a prerequisite to any refinancing. Representatives of Mellon and

Intershoe first met in either February or March of 1991.

On June 13, 1991, Mellon issued a proposal letter

documenting its interest in extending a $53 million revolving line

of credit and a $100 million foreign exchange line of credit. The

proposal was contingent upon TCR's injection of $15 million in

cash. At first, Intershoe did not accept Mellon's offer. Instead,

it explored the possibility of obtaining financing from BNY and

Citicorp. After completing its due diligence, however, Citicorp

declined to extend credit to Intershoe. Although BNY had made a

proposal, it subsequently revised the proposal to require a large

equity infusion. Intershoe therefore declined to endorse BNY's

proposal and, instead, turned its attention back to Mellon Bank.

On August 9, 1991, Mellon Bank issued a second proposal

letter that was similar to the first in that it was conditioned

upon the injection of new capital funds of at least $15 million.

The letter also stated that Intershoe would be required to pay: (1)

a facility fee equivalent to 3/4 of one percent (.0075) of the

committed facility (half upon issuance of the commitment letter,

half at closing); (2) a collateral management fee of $10,000; (3)

all of Mellon's out-of-pocket expenses, regardless of whether the

financing occurred; and (4) a "good faith deposit" of $125,000 to

be remitted with written approval of the proposal letter. A fifth

provision in the letter was that Mellon would be permitted to

spread $28 of the $53 million loan among a group of banks. The

loan contemplated by Mellon was known as a highly leveraged

transaction ("HLT"), an asset-based loan bearing greater risk than

an ordinary loan that requires extraordinary due diligence and

monitoring of the borrower's accounts receivable, inventory and

business plan.

On August 12, 1991, Intershoe remitted to Mellon the

$125,000 "good faith deposit" in accordance with the proposal

letter. Because it had reached its borrowing limit with the Signet

Group, Intershoe could not borrow additional sums. Between August

and October of 1991, Intershoe failed to pay the majority of

invoices from its suppliers. While accounts payable increased by

$10 million, its debt to the Signet Group decreased by the same

amount; Intershoe was using what funds it had to pay down its debt.

As a result, the Signet group agreed to extend its loan facility

from September 30 to November 29, 1991, which permitted Intershoe

to continue its business operations.

In early October of 1991, Mellon Bank requested an

additional good faith deposit from Intershoe of $125,000, although

there was nothing to document this request. On October 8 or 9,

1991, Intershoe remitted the additional $125,000 to Mellon Bank by

wire transfer. On October 31, 1991, Westinghouse, to whom

Intershoe had subordinated indebtedness, agreed to restructure

Intershoe's indebtedness in order to accommodate the proposed

recapitalization.

On November 7, 1991, Mellon issued a formal commitment

letter (the "Letter") with terms that tracked the August 9 proposal

letter. The Letter referred to the $250,000 in good faith deposits

that Mellon had previously received and indicated that the entire

amount would be retained even if the loan did not close. These

deposits would cover Mellon's expense, time and effort in

attempting to consummate the financing. The Letter also required

the remittance of an additional $265,000, half of which represented

a nonrefundable "facility fee" for Mellon's commitment, with the

other half representing a nonrefundable agent's fee for Mellon's

syndication of the loan. The Letter also contained several

conditions: (1) Intershoe had to produce a draft audited financial

statement indicating that it had a net worth of at least $6.5

million; (2) Intershoe was required to repay or retire

Westinghouse's debt and stock warrants and retain Westinghouse as

a creditor for subordinated debt of at least $5 million; (3) $28

million of the loan commitment had to be participated out to a

group of banks; and (4) Intershoe would be required to pay a

separate collateral monitoring fee relating to administering the

loan after closing. By its terms, the commitment was set to expire

on November 29, 1991, the same day that Signet's loan facility was

due to expire.

On November 7, 1991, Intershoe accepted Mellon's

commitment and remitted the $260,000 fee as contemplated by the

Letter. That day Mellon began a "takedown examination" to update

Intershoe's financial information through the closing date. Eight

days later Mellon received a draft financial statement confirming

that Intershoe possessed a positive net worth of $6.5 million

dollars. Mellon then scheduled a meeting for November 20, 1991,

with Intershoe, the loan participants, TCR (the equity investor)

and Peat Marwick to discuss further the financial statements.

On November 17, 1991, however, TCR advised Intershoe that

it had decided not to make the $15 million equity investment and

confirmed its withdrawal from the proposed refinancing. Intershoe

informed Mellon of this development the next day, and the entire

deal collapsed. Intershoe's trade creditors continued to extend

credit even after the collapse of the Mellon financing.

On November 15, 1991, Peat Marwick issued to Intershoe an

audited financial statement for the fiscal year ending August 31,

1991. This statement indicated that as of August 31, Intershoe's

liabilities exceeded its assets by four million dollars. In

accordance with Generally Accepted Accounting Principles ("GAAP")

and Generally Accepted Accounting Standards ("GAAS"), the financial

statement took into account events subsequent to the end of the

fiscal year (e.g., the collapse of the Mellon financing) as

evidence of Intershoe's financial condition. Several questionable

items on Intershoe's balance sheet were corrected or adjusted,

resulting in an even lower net worth. The financial statement also

indicated that Intershoe would have difficulty continuing as a

going concern. On December 11, 1991, Intershoe agreed to accept

Peat Marwick's suggested changes to its financial statements.

Intershoe's financial condition continued to decline, reaching a

point where its liabilities exceeded assets by $14 million.

Intershoe sought protection under Chapter Eleven of the Code on

February 18, 1992.

B.

On May 18, 1993, the Committee filed an adversary

proceeding against Mellon Bank seeking to recover, as

constructively fraudulent transfers, the three payments that

Intershoe had made to Mellon in connection with the financing

commitment, which totaled $515,000. Under section 548(a)(2) of the

Code, the Committee bore the burden of establishing that: (1) the

debtor had an interest in the property; (2) the transfer of the

interest occurred within one year of the petition; (3) the debtor

was insolvent at the time of the transfer or became insolvent as a

result thereof; and (4) the debtor received "less than a reasonably

equivalent value in exchange for such transfer." BFP v. Resolution

Trust Corp., 511 U.S. 531, ___, 114 S. Ct. 1757, 1760 (1994)

(quoting 11 U.S.C. § 548(a)(2)(A)). The first two elements were

not disputed.

1.

On the issue of insolvency, which is defined in §

101(32)(A) of the Code as a financial condition where an entity's

debts exceed its property (at fair valuation), the bankruptcy court

focused upon August 31, 1991, the end of Intershoe's fiscal year.

It concluded that the Committee had established through the

testimony of four certified public accountants, who relied upon

Intershoe's audited (and adjusted) financials, that Intershoe was

insolvent as of that date.

Mellon attempted to argue that it was the write-offs that

rendered Intershoe insolvent, and that the write-offs were caused

by the collapse of the Mellon Bank-Intershoe deal. The bankruptcy

court disagreed:

Although events which drastically and

unexpectedly change a company's actual

financial condition (such as a fire or other

disaster) would not be the type of subsequent

event that should evidence a company's prior

financial condition, I agreed with the

testimony of the Committee's experts that the

failure of the proposed Mellon/Intershoe

transaction is exactly the type of event that

should be viewed as evidence of the company's

prior financial condition.

By all accounts, Intershoe's financial

survival was contingent upon the Mellon

refinancing and the Mellon refinancing was

contingent upon dozens of conditions, the

least certain and most important of which was

an equity infusion from TCR. TCR had made no

commitment to go through with the investment,

and, more importantly, the financial numbers

coming out of Intershoe in September, October

and November of 1991, showed a deteriorating

financial condition that would cause serious

concern to a potential equity investor.

Although there was testimony that supported

Mellon's belief that TCR still was considering

the transaction into November, 1991, the

evidence was persuasive that TCR's

participation was sufficiently uncertain that

anticipated consummation of the equity

investment and ultimately the Intershoe/Mellon

transaction should not be the basis for

upholding book entries that ultimately turned

out to have no basis in reality.

Official Comm. of Unsecured Creditors of R.M.L., Inc. v. Mellon

Bank N.A., No. 1-93-00137A, slip op. at 15-16 (Bankr. M.D. Pa. June

29, 1995). Based on these audited financials, the bankruptcy court

noted that between August and November of 1991, Intershoe suffered

"numerous materially adverse changes which resulted in $4.1 million

in losses for September and October, 1991." Id. at 6 (footnote

omitted). The court also noted that "by the end of October, 1991,

Intershoe's liabilities exceeded its assets by $8,187,903." Id.n.2. The

bankruptcy court went on to conclude that, even without

placing exclusive reliance upon the audited financial statements,

subsequent events shed sufficient light on Intershoe's financial

condition as to warrant downward adjustments in various alleged

"credits" and book entries. Id. at 18.

2.

The bankruptcy court next considered whether Intershoe

had received "reasonably equivalent value" for the three separate

remittances of financing fees. Although the term "reasonably

equivalent value" is not defined in the Code, the court

acknowledged that the debtor need not receive a dollar-for-dollar

equivalent in order to receive reasonably equivalent value. The

court further acknowledged that the fair value of services rendered

in exchange for fees paid may be difficult to quantify, yet

nonetheless may constitute reasonably equivalent value. The court

applied a "totality of the circumstances" test, which considered:

(1) the good faith of the transferee (Mellon Bank); (2) the fair

market value compared to the price paid; and (3) whether the

transaction was at arm's length.

a.

The bankruptcy court's conclusions concerning the August

12, 1991, transfer of $125,000 were somewhat contradictory. This

transfer was the good-faith deposit required by the August 9, 1991,

proposal letter to cover Mellon's out-of-pocket expenses. The

court first concluded that the transfer had conferred no value on

Intershoe, observing that the loan had failed to close and that

Intershoe's financial condition had not improved. See id. at 26

("The Committee's evidence that no benefit was conferred is simple

and accessible yet is quite powerful in its simplicity.").

The bankruptcy court rejected Mellon's contention that

the existence of the proposal letter had indirect benefits, such as

encouraging Signet to extend its financing commitment or causing

trade creditors to extend unsecured credit. The court observed

that Intershoe's trade suppliers extended credit both before the

financing proposal and after the deal with Mellon had collapsed.

Thus, the prospect of financing from Mellon lacked a causal

relationship with the trade suppliers' extension of credit. The

court further noted that the existence of Mellon's financing

commitment had little or no effect on Signet's decision to extend

its loan facility.

Notwithstanding these conclusions, the bankruptcy court

determined that Mellon could retain the $125,000 transfer:

Mellon established a valid contractual basis

for retention of the $125,000.00. The August

9, 1991, proposal letter provides for a good

faith deposit in that amount and Mellon

established to my satisfaction that such

agreement was of an ordinary commercial nature

and that Mellon actually and reasonably

incurred out-of-pocket expenses through the

cessation of its takedown examination in

excess of the $125,000.00 deposit such as

warranted retention of the deposit under the

agreement. The contractual nature of this

relationship is entitled to some degree of

respect in the balancing. Additionally[] . .

. the evidence indicated that the parties were

at arm's-length at the time the proposal was

issued and accepted. Finally, a three month

period passed between the transfer of the

initial $125,000.00 and the termination of the

proposed transaction; there was adequate time

for some degree of the types of indirect

benefit alleged by Mellon to accrue with

respect to this initial transfer.

Id. at 26-27. The court also rejected the Committee's claim that

the expenses were inflated and unreasonable.

b.

The October 8, 1991, transfer of $125,000 was described

in testimony as an additional good-faith deposit. It was not

discussed in the proposal letter, however, and there was no

independent documentation of it. The bankruptcy court determined

that, if no commitment letter had issued, Intershoe would have been

entitled to a refund of this good-faith deposit (as well as the

first one). It drew this conclusion from the fact that the

proposal letter did not provide for Mellon's retention of the

"deposits." Indeed, it was not until the Letter was executed on

November 7, 1991, that Intershoe gave up its right to a refund of

the $250,000 in good-faith deposits it had paid to Mellon. Because

it was on November 7 that the second deposit became "irrevocable"

under the terms of the executed commitment letter, the bankruptcy

court chose that date--not October 8--as the date of the transfer

for "reasonably equivalent value" purposes.

The bankruptcy court concluded that Mellon had conferred

no benefit, direct or otherwise, on Intershoe between November 7

and the collapse of the deal after TCR's withdrawal on November 17,

1991. It found, first, that the short-lived commitment conferred

little or no value because it was highly conditional; i.e., it was

contingent upon a significant equity investment from TCR, which had

made no formal commitment to invest in Intershoe. The court

observed that Intershoe's deteriorating financial condition would

have deterred an equity investor from making such an investment.

The court then noted that the commitment letter conferred no

indirect value on Intershoe, such as causing trade suppliers or

Signet to extend credit.

The bankruptcy court rejected Mellon's claims that it had

conferred value to the extent its officers had expended "man-hours"

working on the deal and opportunity costs of forgoing other deals.

From the perspective of Intershoe's creditors, it reasoned,

Mellon's internal costs were irrelevant if no value had been

conferred on the debtor: "what would have been important would have

been a firm and less conditional commitment." Id. at 31. The

court further concluded, based on trial testimony, that "internal

costs are not normally factored into loan transactions exclusive of

facility-type fees; therefore there is no commercial basis

independent of the November 7th agreement for retention of" the

second good-faith deposit. Id.

Finally, the bankruptcy court pointed out that

[b]y November 7th, the arm's-length nature of

Intershoe's relationship with Mellon had

disintegrated; Intershoe's financial condition

had deteriorated and the Mellon loan appeared

to be one of few if not the only remaining

option Intershoe had to survive as a going

concern. Mellon, then, had the opportunity to

extract fees not ordinarily warranted on a

(sic) arm's length commercial basis.

Id. (footnote omitted). The court observed in a footnote that

while it was rejecting the Committee's suggestion that by November

7th Mellon was simply extracting fees for a loan commitment that it

knew would never come to fruition, "Mellon had ample reason to

believe there was a significant possibility that Intershoe could

not meet one or more of the conditions of the commitment letter,

including the TCR equity investment." Id. n.17.

With respect to the second "good-faith deposit," the

bankruptcy court held that "it is extremely difficult to conclude

that Mellon's conditional commitment had a great deal of value.

Based upon the totality of the circumstances, the Committee has

established that Mellon failed to confer reasonably equivalent

value . . . ." Id. at 31-32.

c.

The bankruptcy court then turned to the $265,000 transfer

on November 7, 1991, which represented the nonrefundable

facility/agent's fee contemplated by the commitment letter. For

essentially the same reasons that it found that no value had been

conferred in exchange for the October 8 transfer (which in reality

also occurred on November 7), the bankruptcy court concluded that

Intershoe had not received reasonably equivalent value for the

facility fee. Although recognizing that Mellon had put on credible

evidence that a $265,000 facility fee was commensurate with fees in

the industry for the size of the loan at issue, that did not alter

the analysis, the bankruptcy court said. It was unlikely that

under ordinary circumstances Intershoe would have handed over large

fees where the letter was conditioned upon an equity investment but

where there was no firm commitment from the equity investor.

Again, the court noted that from the creditors' perspective, Mellon

had provided Intershoe with little, if any, value in drafting a

highly conditional commitment letter.

3.

On appeal, the District Court for the Middle District of

Pennsylvania affirmed, adopting the bankruptcy court's opinion as

its own. Mellon Bank, N.A. v. Official Comm. of Unsecured

Creditors of R.M.L., Inc., No. 1:CV-95-1200 (M.D. Pa. Oct. 13,

1995). This appeal followed.

II.

The bankruptcy court had jurisdiction over this adversary

(core) proceeding pursuant to 28 U.S.C. § 157(b)(2)(H). The

district court exercised appellate jurisdiction over Mellon's

appeal from the bankruptcy court's final order under 28 U.S.C. §

158(a)(1). We have appellate jurisdiction to review the district

court's final order pursuant to 28 U.S.C. §§ 158(d) and 1291.

Whether Intershoe was insolvent or received "less than

fair consideration" are mixed questions of law and fact. Moody v.

Security Pac. Business Credit, Inc., 971 F.2d 1056, 1063 (3d Cir.

1992). Thus, while the factual findings underlying those

determinations are reviewed only for clear error, see, e.g., Mellon

Bank, N.A. v. Metro Communications, Inc., 945 F.2d 635, 641-42 (3d

Cir. 1991), cert. denied, 503 U.S. 937, 112 S. Ct. 1476 (1992), our

review of "the trial court's choice and interpretation of legal

precepts and its application of those precepts to the historical

facts" is plenary. Id. at 642 (internal quotation marks omitted)

(quoting Universal Minerals, Inc. v. C.A. Hughes & Co., 669 F.2d

98, 103 (3d Cir. 1981)).

III.

As it did in the courts below, Mellon Bank urges reversal

on two grounds. First, Mellon Bank asserts that the commitment

letter conferred "reasonably equivalent value" on Intershoe, the

measure of which is the fair market value of the services it

rendered (i.e., the $515,000 in commitment fees Intershoe paid).

Second, Mellon Bank claims that based upon Intershoe's own balance

sheets at the time of the disputed transfers, Intershoe was not

insolvent.

A.

Reasonably Equivalent Value

Mellon Bank launches a multi-pronged attack on the

bankruptcy court's reasonably equivalent value analysis, assailing

the court's use of a totality of the circumstances test. The

gravamen of Mellon Bank's challenge is that its commitment letter

conferred "reasonably equivalent value" on Intershoe, measured by

the fair market value of the services it provided (i.e., the fees

paid by Intershoe, which were consistent with "the going rate").

Additionally, Mellon Bank contends that the bankruptcy court failed

to appreciate that commitment letters confer "value" to the extent

that they provide a financially troubled company with the "chance"

of obtaining financing that could save it from bankruptcy.

We agree that the factors underlying the totality of the

circumstances test (e.g., fair market value, arm's-length

relationship, and good faith) are simply not relevant to the

initial question whether the commitment letter in this case

conferred any value on Intershoe. We also agree that the mere

"opportunity" to receive an economic benefit in the future

constitutes "value" under the Code. As we explain more fully

below, however, fatal to Mellon Bank's position is the bankruptcy

court's record-supported factual finding that the chances of the

loan closing were negligible. The court essentially found that

Intershoe was exchanging substantial fees for an extremely remote

opportunity to receive value in the future. Because we agree that

this minimal "value" was not "reasonably equivalent," to the

lending fees Intershoe remitted to Mellon Bank, we will affirm the

bankruptcy court's determination.

1.

a.

Both parties take issue with the bankruptcy court's

totality of the circumstances test. Accordingly, we turn first to

the appropriate method of determining reasonably equivalent value.

The concept of reasonably equivalent value unfortunately has not

been defined in the Code. As the Supreme Court noted in BFP v.

Resolution Trust Corp., "[o]f the three critical terms 'reasonably

equivalent value', only the last is defined: 'value' means, for

purposes of § 548, 'property, or satisfaction or securing of a . .

. debt of the debtor' . . . ." 511 U.S. 531, ___, 114 S. Ct. 1757,

1760 (1994) (quoting 11 U.S.C. § 548(d)(2)(A)). Thus, "Congress

left to the courts the obligation of marking the scope and meaning

of [reasonably equivalent value]." In re Morris Communications NC,

Inc., 914 F.2d 458, 466 (4th Cir. 1990).

The lack of a more precise definition has led to

considerable difficulty. This definitional problem is exacerbated

in cases where, as here, the debtor exchanges cash for intangibles,

such as services or the opportunity to obtain economic value in the

future, the value of which is difficult, if not impossible, to

ascertain. Because such intangibles are technically not within §

548(d)(2)(A)'s definition of "value," courts have struggled to

develop a workable test for reasonably equivalent value. See

generally In re Young, 82 F.3d 1407 (8th Cir. 1996) (determining

whether debtors obtained "value" in exchange for charitable

contributions to church); In re Chomakos, 69 F.3d 769 (6th Cir.

1995) (examining whether debtors obtained "value" in exchange for

$7,710 in gambling losses), cert. denied, 116 S. Ct. 1568 (1996);

In re Morris Communications NC, Inc., 914 F.2d at 458 (attempting

to determine "value" of shares in corporation whose only asset was

a license application pending before the FCC that had a one in

twenty-two chance of approval); In re Fairchild Aircraft Corp., 6

F.3d 1119, 1125-26 (5th Cir. 1993) (deciding whether money debtor

spent in failed attempt to keep commuter airline afloat conferred

"value" on the debtor).

In attempting to determine whether Mellon's commitment

letter conferred any value on Intershoe, the bankruptcy court

purported to apply a totality of the circumstances test. Drawn

from other reasonably equivalent value cases, that test takes into

account the fair market value of the item received by, or services

performed for, the debtor; the existence of an arm's-length

relationship between the debtor and the transferee; and the good

faith of the transferee. These factors, however, have no bearing

on whether any "value" was actually conferred on the debtor. At

most, the fair market value and the arm's-length nature of the

relationship are relevant to the price the debtor paid. But the

price that the debtor paid, in and of itself, reveals nothing about

whether the debtor received something of actual "value." A simple

example illustrates our point:

Within one year of filing for bankruptcy, Dpays a window-washer

$1,000 to clean the

windows in an office building. The $1,000

constitutes the going rate for such a job, and

the window-washer is unaware of D's financial

condition.

That the $1,000 D paid represents the fair market value of the

window-washer's services and that the transaction was at arm's

length say absolutely nothing about whether the debtor received

"value;" "value" was conferred because D obtained a palpable

benefit from the service performed--i.e., clean windows.

The bankruptcy court, therefore, conflated two inquiries

that should remain separate and distinct: before determining

whether the value was "reasonably equivalent" to what the debtor

gave up, the court must make an express factual determination as to

whether the debtor received any value at all. The bankruptcy court

seemed to recognize this as it attempted to reconcile the totality

of the circumstances test with our analysis in Metro

Communications, Inc., 945 F.2d at 635.

b.

Metro Communications, Inc. involved a loan that Mellon

Bank provided to the acquiror in a leveraged buy-out ("LBO"). As

collateral for the LBO loan, Metro, the target of the LBO, gave

Mellon Bank a security interest and guarantee in substantially all

of its assets. With the LBO loan, Mellon also provided a credit

facility to Metro, also secured by Metro's assets. Less than one

year later, Metro sought protection under the Code. A committee of

unsecured creditors brought an adversary proceeding alleging, inter

alia, that the granting of the security interests were

constructively fraudulent transfers under § 548(a)(2) of the Code.

The bankruptcy and district courts concluded that Metro had not

received reasonably equivalent value in exchange for the security

interests it provided to Mellon Bank.

In reversing, we observed that "[b]ecause Metro did not

receive the proceeds of the acquisition loan, it did not receive

any direct benefits from extending the guaranty and security

interest collateralizing that guaranty." Id. at 646.

Nevertheless, we stressed that

indirect benefits may also be evaluated. . . .

These indirect economic benefits must be

measured and then compared to the obligations

the bankrupt incurred. . . . The touchstone is

whether the transaction conferred realizable

commercial value on the debtor reasonably

equivalent to the realizable commercial value

of the assets transferred.

Id. at 646-47 (emphasis added) (citations omitted). We went on to

discover two indirect benefits that conferred "value" on Metro.

The first was Mellon Bank's extension of a credit facility to

Metro: "[t]he ability to borrow money has considerable value in the

commercial world. To quantify that value, however, is difficult.

Quantification depends upon the business opportunities the

additional credit makes available to the borrowing corporation and

on other imponderables in the operation or expansion of its

business." Id. at 647. The second indirect benefit created by

Metro's granting of a security interest in its assets, which

allowed the LBO to close, was a "legitimate and reasonableexpectation that

the affiliation of these two corporations . . .

would produce a strong synergy." Id. (emphasis added).

Significantly, we found that the expected synergy created "value,"

even though an unforseen change in the law prevented it from

becoming a reality.

c.

In spite of the plain requirement that the debtor

actually receive something of value, Mellon Bank continues to

insist that the fair market value of services rendered is

conclusively determinative of reasonably equivalent value. To

support this contention it relies on the Supreme Court's recent

decision in BFP v. Resolution Trust Corp., 511 U.S. at 531, 114 S.

Ct. at 1757. BFP, of course, stands for no such proposition. The

Court there held that the proceeds of a mortgage foreclosure sale

conducted in accordance with state law constitute "reasonably

equivalent value" as a matter of law, even where those proceeds are

substantially below the fair market value of the real estate sold.

The BFP Court noted in passing that "the 'reasonably equivalent

value' criterion will continue to have independent meaning

(ordinarily a meaning similar to fair market value) outside the

foreclosure context." 511 U.S. at ___, 114 S. Ct. at 1765.

The dictum in BFP does not help Mellon Bank, however,

because in the real estate context there is no doubt that the

debtor is receiving something of "value" (i.e., cash) in exchange

for real property, which also has a measurable value. Thus, the

real issue in BFP was not whether any value was exchanged, but

rather whether the value obtained was "reasonably equivalent" to

what was given up. Thus, BFP in no way alters the requirement that

when the debtor transfers property--whether it be real estate or

cash--it must receive something of "value" in return.

This is fully consistent with our decision in Metro

Communications, Inc., 945 F.2d at 646, which noted that the

fraudulent conveyance laws are intended to protect the debtor's

creditors. Rejecting Mellon Bank's contention that the debtor had

received "value" simply because the bank had parted with value by

loaning funds, we said that "[t]he purpose of the laws is estate

preservation; thus, the question whether the debtor receivedreasonable

value must be determined from the standpoint of the

creditors." Id. Mellon Bank's assertion in this case that it has

conferred value simply because the fees it charged Intershoe

represent the fair market value of Mellon Bank's services similarly

misses the mark.

In sum, in light of our decision in Metro Communications,

Inc., the bankruptcy court committed legal error to the extent that

it applied a totality of the circumstances test to the initial

question whether the commitment letter at issue conferred any value

on Intershoe. To determine whether this threshold requirement was

satisfied, the court should have examined whether Intershoe

received any benefit from the commitment letter, whether direct or

indirect, without regard to the cost of Mellon Bank's services, the

contractual and arm's-length nature of the relationship, and the

good faith of the transferee.

2.

Its application of the totality of the circumstances test

notwithstanding, the bankruptcy court announced two conclusions

essential to the resolution of the question whether Intershoe had

received any value in exchange for the commitment fees it had

remitted to Mellon Bank. The court first determined that Mellon

Bank's commitment letter did not confer any tangible, indirect

benefits on Intershoe. For instance, the court found that Signet's

extension of its credit facility beyond the original expiration

date and the trade suppliers' decision to extend credit to

Intershoe were not the direct result of Mellon Bank's willingness

to lend funds to Intershoe. The court then determined that the

loan commitment failed to confer any significant intangiblebenefits on

Intershoe. Specifically, the court determined that the

commitment letter essentially offered only a very slim "chance" of

obtaining a substantial economic benefit in the future because it

contained numerous conditions that, in all likelihood, could not

have been satisfied.

With this latter determination the bankruptcy court

implicitly held that money spent on an investment bearing a certain

degree of risk can generate cognizable value within the meaning of

§ 548(a)(2) of the Code, even where the investment ultimately fails

to generate a positive return. The Committee disputes this legal

conclusion, arguing that money spent on a losing investment fails

to confer "value" as a matter of law. If the Committee is correct,

then we would be compelled to affirm since it is undisputed that

Intershoe exchanged $515,000 in fees for a loan that never closed.

Accordingly, we address this preliminary question before reviewing

the propriety of the bankruptcy court's factual findings.

a.

Relying on the following language from our decision in

Metro Communications, Inc., the Committee argues that where the

debtor's financial condition either continues to deteriorate or

fails to stabilize, money spent on a losing investment cannot

confer "value" as a matter of law:

The touchstone is whether the transaction

conferred realizable commercial value on the

debtor reasonably equivalent to the realizable

commercial value of the assets transferred.

Thus, when the debtor is a going concern and

its realizable going concern value after the

transaction is equal to or exceeds its going

concern value before the transaction,

reasonably equivalent value has been received.

945 F.2d at 647 (emphasis added). We disagree. The Committee's

argument depends for its validity on the contention that the

highlighted sentence is part and parcel of the Metro

Communications, Inc. court's holding. If that were true, then our

Internal Operating Procedures would mandate an affirmance here,

since it is clear that Intershoe's going concern value declined at

the time of the disputed transfers to Mellon Bank. Kirk v. Raymark

Indus., Inc., 61 F.3d 147, 168 (3d Cir. 1995) ("The holding of a

panel in a reported opinion is binding on subsequent panels.")

(internal quotation marks and alteration omitted) (quoting I.O.P.

Rule 9.1). But we view the highlighted passage as providing an

example of how a court can determine that a debtor received directbenefits

and, thus, "value" from a transaction. Significantly, the

court in Metro Communications, Inc. went on to discover several

potential, intangible benefits that, although incapable of precise

measurement, conferred value on Metro despite their failure to

materialize. That should dispel any suggestion that Metro

Communications, Inc. stands for the proposition that a debtor must

receive a direct, tangible economic benefit in order to receive

"value" for purposes of § 548(a)(2) of the Code.

Furthermore, were we literally to apply the highlighted

statement from Metro Communications, Inc. as the categorical test

for value under § 548(a)(2), we would announce a rule for this

Circuit that only successful investments can confer value on a

debtor. This would permit a court viewing the events with the

benefit of hindsight to conclude that any transfer that did not

bring in the actual, economic equivalent of what was given up fails

to confer reasonably equivalent value as a matter of law. Such an

unduly restrictive approach to reasonably equivalent value has been

soundly rejected by other courts, Chomakos, 69 F.3d at 771

(gambling losses conferred value on debtor); Fairchild Aircraft

Corp., 6 F.3d at 1119 (money spent in failed attempt to keep

commuter airline afloat conferred value on debtor), and with good

reason. Presumably the creditors whom § 548 was designed to

protect want a debtor to take some risks that could generate value

and, thus, allow it to meet its obligations without resort to

protection under the Bankruptcy Code:

According to [appellant], the only value that

can be considered is property actually

received. Under this view the value of an

investment--no matter how large and how

probable the potential return--cannot be

considered unless it actually pays off, and

only to the extent that it does so. . . . The

narrow "realized property" approach to value

advanced by [appellant] finds no approbation

in the law.

Fairchild Aircraft Corp., 6 F.3d at 1126-27. Accordingly, we hold

that money spent on investments that fail to stabilize or improve

the debtor's condition (i.e., "losing" investments) can confer

value within the meaning of § 548(a)(2) of the Code.

The question, then, is how to determine whether an

investment that failed to generate a positive return nevertheless

conferred value on the debtor. We think our decision in Metro

Communications, Inc. answers this question implicitly. We held

there that the mere expectation that the fusion of two companies

would produce a strong synergy (an expectation that turned out to

be inaccurate in hindsight) would suffice to confer "value" so long

as the expectation was "legitimate and reasonable." Id. at 647

(emphasis added). See id. ("The touchstone is whether the

transaction conferred realizable commercial value on the debtor .

. . .") (emphasis added). Thus, so long as there is some chance

that a contemplated investment will generate a positive return at

the time of the disputed transfer, we will find that value has been

conferred. Accord Chomakos, 69 F.3d at 771 (because legalized

gambling provides fair chance for significant pay-off, $7,710 in

gambling losses conferred value on debtor); Fairchild Aircraft

Corp., 6 F.3d at 1126 ($432,380.91 spent in failed attempt to keep

commuter airline viable conferred value because "the likelihood

that a sale would occur was also demonstrably high"); cf. Morris

Communications NC, Inc., 914 F.2d at 458 (shares in a corporation

whose only asset was a licensing application pending before the FCC

with a one in twenty-two chance of approval had value).

We think our analysis appropriately balances a creditor's

interest in estate preservation against a debtor's legitimate, pre-

bankruptcy efforts to take risks that, if successful, could

generate significant value and, possibly, avoid the need for

protection under the Code altogether. As we noted above, requiring

that all investments yield a positive return in order to find that

they conferred value on the debtor would be unduly restrictive.

But so, too, would a rule insulating from § 548's coverage

investments that, when made, have zero probability of success. The

best solution, therefore, is to determine, based on the

circumstances that existed at the time the investment was

contemplated, whether there was any chance that the investment

would generate a positive return. In this way creditors will be

protected when an irresponsible debtor invests in a venture that is

obviously doomed from the outset.

b.

With these legal principles in mind, our review of the

bankruptcy court's conclusion that Intershoe did not receive

reasonably equivalent value proceeds in two, discrete steps: first,

we determine whether the commitment letter conferred any value on

Intershoe; second, we consider the bankruptcy court's finding that

whatever value was conferred was not "reasonably equivalent" to the

two transfers of lending fees totaling $390,000 is clearly

erroneous.

Although the bankruptcy court did not announce an

explicit finding on the question whether Mellon Bank's commitment

letter conferred any value on Intershoe, it is clear that the court

implicitly answered that question in the affirmative. The

bankruptcy court stated that "all parties should have known there

was a substantial probability that the loan would not close[.]"

Official Comm. of Unsecured Creditors of R.M.L., Inc. v. Mellon

Bank, N.A., No. 1-93-00137A, slip op. at 32 (Bankr. M.D. Pa. June

29, 1995) (emphasis added). Put another way, the court concluded

that by November 7, 1991, there was a slight chance that the loan

would close. This finding is amply supported by the record and,

hence, cannot be disturbed on appeal. First, although TCR had not

formally committed to participate in the deal, there is no evidence

in the record that TCR had made known its intention to withdraw

before November 17, 1991. Thus, as of November 7, 1991, when the

commitment letter was executed and the disputed fees remitted,

there was at least some chance that the most important condition in

the letter could be fulfilled. With respect to the other

conditions in the letter, which pertained mainly to Intershoe's

financial condition, record evidence reveals that, despite

Intershoe's deteriorating condition, Mellon was willing to waive or

modify many of these conditions. Since we review the transaction

at the time the transfer was made, In re Chomakos, 69 F.3d 770-71,

the bankruptcy's court's implicit determination that the letter

provided Intershoe with at least some chance of receiving a future

economic benefit and, therefore, "value" is not clearly erroneous.

We next consider the bankruptcy court's determination

that whatever value was conferred by the letter, it was not

"reasonably equivalent" to the $390,000 in lending fees Intershoe

paid to Mellon Bank. We conclude that in assessing the reasonable

equivalence issue, the bankruptcy court appropriately relied on the

totality of the circumstances test. See Barrett v. Commonwealth

Fed. Sav. and Loan Ass'n, 939 F.2d 20, 22 (3d Cir. 1991); see alsoIn re

Chomakos, 170 B.R. 585, 592 (Bankr. E.D. Mich. 1993), aff'd,

69 F.3d at 769 (both considering a variety of factors, including

the fair market value compared to the actual price paid and the

arm's-length nature of the transaction).

Mellon Bank insists that the court's findings that: (1)

the fees Intershoe paid were in line with market rates; (2) Mellon

Bank acted in good faith; and (3) for the most part, the parties

dealt at arm's length, render clearly erroneous its conclusion that

Intershoe did not receive value that was "reasonably equivalent."

We disagree. As our discussion of "value" should have made clear,

supra III.A.2.a, while the chance of receiving an economic benefit

is sufficient to constitute "value," the size of the chance is

directly correlated with the amount of "value" conferred. Thus,

essential to a proper application of the totality of the

circumstances test in this case is a comparison between the value

that was conferred and fees Intershoe paid. Metro Communications,

Inc., 945 F.2d at 646 ("indirect economic benefits must be measured

and then compared to the obligations that the bankrupt incurred").

So understood, the bankruptcy court's conclusion that the

chance of receiving value represented by the commitment letter was

so small that it was not reasonably equivalent to the $390,000 in

fees Intershoe paid in no way conflicts with the court's

observation that the commitment fees were in line with market

rates. The bankruptcy court concluded that while a debtor

reasonably might pay $390,000 in fees for a real chance to obtain

a $53 million credit facility, the commitment letter at issue in

this case was so conditional that it provided Intershoe with little

chance, if any, to obtain the loan it sought. Accordingly, as long

as there is support in the record for the bankruptcy court's

conclusion that the commitment letter was highly conditional (and,

thus, of little "value"), we must affirm.

That the loan was highly conditional cannot seriously be

disputed. The bankruptcy court concluded that "both transfers were

made in exchange for a highly conditional loan commitment, and all

parties should have known there was a substantial probability that

the loan would not close." Official Comm. of Unsecured Creditors

of R.M.L., Inc., No. 1-93-00137A, slip op. at 32. Significantly,

the court found that "TCR had made no commitment to participate in

the transaction and Intershoe's deteriorating financial condition

was a deterrent to an equity investor." Id. at 30. The court

further stated that "there was a significant possibility that

Intershoe could not meet one or more of the conditions of the

commitment letter, including the TCR equity investment." Id. at 31

n.17. Finally, the court noted that "Intershoe's financial

survival was contingent upon the Mellon refinancing and the Mellon

refinancing was contingent upon dozens of conditions, the least

certain and most important of which was an equity infusion from

TCR." Id. at 16. Since all of these findings have ample support in

the record, the bankruptcy court's conclusion that the commitment

letter conferred minimal value--value that was not reasonably

equivalent to the fees Intershoe paid--is not clearly erroneous.

We acknowledge that the measurement and comparison called

for by Metro Communications, Inc. is no easy task. Indeed, we

noted in that case that "[t]he ability to borrow money has

considerable value in the commercial world. To quantify that

value, however, is difficult." 945 F.2d at 647. Yet we expressed

no reservations about the bankruptcy courts' ability to analyze

such potential, intangible benefits. We also acknowledge that

whether a contemplated investment provided a significant "chance"

to receive value more often than not will be bound up in the

bankruptcy court's factual determinations and, thus, largely immune

from attack on appeal. But this is as it should be; the bankruptcy

court, with its unique expertise, is in far better position than

either the district courts, sitting as appellate tribunals, or the

courts of appeals to make such determinations. See generally In re

Fairchild Aircraft Corp., 6 F.3d at 1125 n.5 (noting that fairness

of consideration received is a "fact-laden" inquiry that ought to

be reviewed deferentially).

In sum, because Intershoe expended $390,000 in commitment

fees for a loan that had little chance of closing, we agree that

the Committee met its burden of establishing that Intershoe failed

to receive reasonably equivalent value.

B.

Insolvency

Mellon Bank next contends that the Committee failed to

establish that Intershoe was "insolvent," see 11 U.S.C. §

548(a)(2)(B)(i), on the dates of the disputed transfers. Section

101(32)(A) of the Code defines insolvency as a "financial condition

such that the sum of such entity's debts is greater than all of

such entity's property, at a fair valuation . . . ." 11 U.S.C. §

101(32)(A). For purposes of § 548, solvency is measured at the

time the debtor transferred value, not at some later or earlier

time. Metro Communications, Inc., 945 F.2d at 648. This is known

as the "balance sheet" test: "assets and liabilities are tallied at

fair valuation to determine whether the corporation's debts exceed

its assets." Id. (emphasis added).

Mellon Bank's principal argument is that the bankruptcy

court inappropriately relied on an audited, year-end financial

statement indicating that Intershoe had a net worth of negative $4

million as of August 31, 1991. That financial statement was

prepared several months after the disputed transfers were made and,

according to Mellon Bank, reflected "substantial adjustments" that

were "precipitated by the collapse of the Mellon-TCR transaction .

. . ." Mellon Bank's Br. at 41. But for that unexpected collapse,

Mellon Bank argues, several alleged "credits" Intershoe was

carrying on its books rendered it solvent, at least on paper, at

the time it remitted the disputed commitment fees to Mellon Bank.

In short, Mellon bank accuses the bankruptcy court of relying on

hindsight to conclude that Intershoe was insolvent in October

through November of 1991. This argument need not detain us long.

The use of hindsight to evaluate a debtor's financial

condition for purposes of the Code's "insolvency" element has been

criticized by courts and commentators alike. See, e.g., Credit

Managers Ass'n of S. California v. Federal Co., 629 F. Supp. 175,

186 (C.D. Cal. 1985) (looking at whether projected cash flows were

reasonable when made, not whether they ultimately panned out); Ohio

Corrugating Co. v. DPAC, Inc., 91 B.R. 430, 438 (Bankr. N.D. Ohio

1988) ("The court feels that participants in an LBO must be

protected from the perfect hindsight often evidenced in creditors'

subsequent attacks on the corporate buyout."); Raymond J.

Blackwood, Note, Applying Fraudulent Conveyance Law to Leveraged

Buyouts, 42 Duke L.J. 340, 381 (1992) ("[C]ourts should take care

not to indulge in hindsight."); Kenneth C. Kettering, The

Pennsylvania Uniform Fraudulent Transfer Act, 65 Pa. B.A. Q. 67, 75

(1994) ("The debtor should not be responsible as a matter of

hindsight for developments that could not reasonably have been

foreseen at the time of the transfer.").

Hindsight, however, is not what prompted the bankruptcy

court to ignore certain alleged "credits" and, thus, conclude that

Intershoe was insolvent. On the contrary, and as Mellon Bank

acknowledges, at least two alleged "credits," which together

totaled $4.3 million, depended for their validity on Intershoe's

belief that the loan would close. As we have already discussed,

the bankruptcy court found, as a matter of fact, that Intershoe

knew or should have known that its deteriorating financial

condition would preclude it from meeting one or more of the

conditions in the commitment letter:

By all accounts, Intershoe's financial

survival was contingent upon the Mellon

refinancing and the Mellon refinancing was

contingent upon dozens of conditions, the

least certain and most important of which was

an equity infusion from TCR. TCR had made no

commitment to go through with the investment,

and, more importantly, the financial numbers

coming out of Intershoe in September, October

and November of 1991, showed a deteriorating

financial condition that would cause serious

concern to a potential equity investor. . . .

[T]he evidence was persuasive that TCR's

participation was sufficiently uncertain that

anticipated consummation of the equity

investment and ultimately the Intershoe/Mellon

transaction should not be the basis for

upholding book entries that ultimately turned

out to have no basis in reality.

Official Comm. of Unsecured Creditors of R.M.L., Inc., No. 1-93-

00137A, slip op. at 16 (emphasis added). This conclusion is fatal

to Mellon Bank's position. The bankruptcy court correctly

determined that a debtor's creative accounting practices, which

have the effect of grossly overstating its financial condition,

cannot be the basis of a court's solvency analysis.

Furthermore, if a debtor's treatment of an item as an

"asset" depends for its propriety on the occurrence of a contingent

event, a court must take into consideration the likelihood of that

event occurring from an objective standpoint. See, e.g., In Re

Xonics Photochemical, Inc., 841 F.2d 198 (7th Cir. 1988) ("the

asset or liability must be reduced to its present, or expected,

value before a determination can be made whether the firm's assets

exceed its liabilities"). Such an analysis is by no means unknown

to the law. See generally Basic, Inc. v. Levinson, 485 U.S. 224,

108 S. Ct. 978 (1988) (adopting test from SEC v. Texas Gulf

Sulphur, 401 F.2d 833 (2d Cir. 1968) (en banc), cert. denied, 394

U.S. 976, 89 S. Ct. 1454 (1969), that materiality of contingent

corporate event is determined by balancing probability of event

occurring against its anticipated magnitude). Far from "hindsight"

or "post-hoc" analysis, a court looks at the circumstances as they

appeared to the debtor and determines whether the debtor's belief

that a future event would occur was reasonable. The less

reasonable a debtor's belief, the more a court is justified in

reducing the assets (or raising liabilities) to reflect the

debtor's true financial condition at the time of the alleged

transfers.

In this case, moreover, Daniel Coffey, a certified public

accountant who served as the Committee's insolvency expert,

revealed that in the course of performing an audit, accountants

abide by a far more stringent rule. Mr. Coffey testified that "in

reality, if an auditor didn't think there was a real 99 percent

chance that this loan is going to close, they wouldn't leave [the

"credits"] on the balance sheet. Everybody would say let's sit and

wait and see what happens." App. at 1610. Since the bankruptcy

court found that the probability of the loan closing was

essentially zero, a finding we have already determined is amply

supported by the record, the court properly discounted (to zero)

the $4.3 million Intershoe had carried on its balance sheet as

alleged "assets." Thus, by November of 1991, Intershoe's actual

assets were $4.3 million lower than its balance sheet had

reflected.

Apart from properly refusing to consider $4.3 million as

assets, the bankruptcy court also reversed a $4.5 million "asset"

that Intershoe had carried on its books as a credit due from

factory suppliers related to defective merchandise:

there was no credible evidence offered to

substantiate the book-entry for alleged

credits from Intershoe's suppliers. Even in

absence of the testimony that adjustments were

warranted by GAAP and GAAS, based upon the

evidence, I find it entirely appropriate to

make downward adjustments to Intershoe's then-

value to write off [this] alleged asset[].

Official Comm. of Unsecured Creditors of R.M.L., Inc., No. 1-93-

00137A, slip op. at 18. Far from relying upon hindsight, the court

concluded that this entry had no basis in fact when it was made.

As Intershoe was unable to produce any documentation to support

this alleged "credit," the bankruptcy court's decision to ignore

the credit is amply supported by the record and, hence, not clearly

erroneous.

In sum, Intershoe was found to have a net worth of

negative $4 million on August 31, 1991, and negative $8 million on

November 15, 1991. The bankruptcy court properly refused to

consider various items totaling $8.8 million that Intershoe had

attempted to portray as assets. Since the transfers at issue here

occurred on November 7, 1991, the bankruptcy court's insolvency

determination will be affirmed.

IV.

The judgment of the district court affirming the order of

the bankruptcy court will be affirmed in all respects.