Bankruptcy & Insolvency Articles

California State Court Rules That Released Parties Remain Liable For A Settlement Payment That Is Later Deemed To Be A Preferential Transfer And Is Disgorged From the Creditor

January 06, 2017

In Coles v Glaser, 2 Cal. App. 5th 384 (2016), plaintiff Kevin Coles threatened a collection action against defendant Cascade Acceptance Corporation and defendant guarantors Barney Glaser and Fred Taylor on a loan past due.  Cascade informed Coles that it could not pay and would be unlikely to pay in the foreseeable future, resulting in a lawsuit for the unpaid loan balance and other amounts.  After being served with the complaint, Cascade wired approximately $309,000 and a settlement agreement was signed where Glaser and Taylor were released on all claims "except for obligations arising under the settlement agreement."  A week after the lawsuit was dismissed, Cascade filed bankruptcy.  The bankruptcy trustee later sued Coles for the return of the settlement payment as a preferential transfer.  Eventually, the parties compromised the claim and most of the settlement paid over to the trustee.  Coles filed a claim in Cascade's bankruptcy case but only received a small dividend, leaving him with a significant shortfall.  Coles then sued Glaser and Taylor in state court for damages and, after a one-day bench trial, the trial court ruled in Coles' favor.  Glaser and Taylor appealed, claiming that the settlement agreement was fully performed because Cascade had paid the underlying obligation and that the guarantors received a release. 


The appellate court disagreed.  The court reasoned that this was a simple breach of contract matter and that Glaser and Taylor's were co‑obligors under the settlement agreement.  Even if their prior status as guarantors under the loan was still relevant, the court noted that the liability of a guarantor was exactly the same as the liability of an obligor for the purpose of pre-bankruptcy payments later clawed back into the estate as preferences (p. 389).  In any case, the court held that the settlement agreement had been breached because (1) the payment had not been made to Coles (it had been clawed back by the bankruptcy trustee) and (2) Glaser and Taylor had not paid Coles the amount of the clawback.  The court noted that "a preference payment is deemed by law to be no payment at all," so the defendants remained liable (p. 391).  Lastly, the court noted that based on the reasonable expectations of all parties, that it would be unfair if the Cascade creditors had to bear the burden to pay for the settlement. 
 
Comment 
 
Settlement payments are never "final" until at least 91 days pass (one year for situations involving insiders) after receipt of the funds. Coles is a correct decision because a party making a preferential payment should not be allowed to hide behind a release when the settlement payment is later disgorged.  Note for drafting purposes, the scope of the release was properly narrowed in the agreement to release only pre‑settlement obligations.  To further clarify the scope of the release, a prudent drafter may also want to include a springback provision that reinstates the entire obligation if it is later determined that the settlement payment constitutes a preference. This is a very helpful case for creditors when the unexpected bankruptcy occurs and ruins a multi-party settlement.  

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