For Sale: Avoidance Actions (Or Are They?)
This article was authored for and originally published in the November 2023 issue of the Turnaround Times, a newsletter for the Northern Ohio Chapter of the Turnaround Management Association.
Can a bankruptcy trustee sell or assign causes of action that arise from the trustee’s avoidance powers under section 544(b) of the Bankruptcy Code? While the practice has become more common in bankruptcy proceedings, the law surrounding the practice is not entirely settled, particularly in the Sixth Circuit.
Bankruptcy Trustee’s Avoidance Powers
Avoidance actions are used by debtors in possession and trustees to undo transfers of money or property made during a certain period of time leading up to the filing of the debtor’s petition. The most common avoidance actions include preferential transfers (“preferences”) and fraudulent transfers. Section 547 of the Bankruptcy Code provides the trustee with the ability to set aside preferences, which are transfers made by an insolvent debtor to a creditor for payment of a preexisting debt within 90 days before the filing of the petition (or if the creditor is an insider, within one year of filing). Section 548 of the Bankruptcy Code gives the trustee the ability to set aside fraudulent transfers, which are transfers of a debtor’s property made within two years before the filing of the petition (or other time limit set by state law pursuant to section 544(b) of the Bankruptcy Code) for which the debtor received little to no consideration while the debtor was insolvent. This allows the trustee to recapture the transferred property and bring it back into the bankruptcy estate for equitable distribution to all creditors. Increasingly, debtors and trustees have sought to sell avoidance actions in order to maximize available funds for creditor distributions.
Circuit Court Views
While several circuit courts, including the First1, Third2, Fifth3, Eighth4, and Ninth5 have found that avoidance actions are subject to sale or assignment, decisions in the Sixth Circuit reveal a split as to whether the Bankruptcy Code permits such sales.
In 2016, a bankruptcy court in the Eastern District of Michigan in In re Clements Mfg. Liquidation Co., LLC held that a chapter 7 trustee may not assign avoidance actions as part of a settlement6. In so ruling, the court noted that the trustee’s avoidance power under section 544 of the Bankruptcy Code is not estate property, but is simply a power that facilitates the carrying out of trustee-related duties for the benefit of all creditors. Later that year, that court reaffirmed that fraudulent transfer claims may not be assigned by a chapter 7 trustee as part of a settlement, sale, or otherwise7. However, in 2021, a bankruptcy court in the Southern District of Ohio in In re Murray Metallurgical Coal Holdings, LLC found that avoidance actions constitute property of a debtor’s estate because what constitutes a debtor’s estate is construed generously under the Bankruptcy Code and “every conceivable interest of the debtor, future, nonpossessory, contingent, speculative, and derivative, is within reach8.” Because the chapter 11 debtors’ contingent interests in proceeds of avoidance actions constituted estate property, the Murray court held such actions were subject to sale.
Recent Circuit Precedent
More recently, in August 2023, the Eighth Circuit concluded that avoidance actions are estate property9. In Simply Essentials, the estate lacked the funds to pursue avoidance actions against certain creditors, leading the trustee to sell the actions in a section 363 sale10. Subsequently, a losing bidder appealed the sale, questioning whether the actions were estate property that the debtor was permitted to sell11. On appeal, the Eighth Circuit concluded that such actions constituted property of the estate12. Citing to Supreme Court precedent, the court first noted that there are no requirements in the Bankruptcy Code that a debtor must hold a possessory interest in estate property at the commencement of a reorganization proceeding13. Next, the court observed that property of a debtor seized by a creditor prior to filing a bankruptcy petition is still a part of the bankruptcy estate14. Accordingly, the court held the right to file an avoidance action is an inchoate or contingent interest of the estate and, therefore, must be considered property of the estate that can be subject to a sale or an assignment.
Conclusion
With this most recent decision, whether a debtor in possession or trustee may sell or assign avoidance actions to creditors is becoming a less nuanced question for many courts. While there is not direct Sixth Circuit precedent on the matter and the lower courts have offered differing opinions, it seems that the Murray decision, in conjunction with other circuit court precedent, suggests that future Sixth Circuit precedent would continue the positive direction toward a sale of avoidance actions fitting squarely within the ambit of Bankruptcy Code.
1 In re TelexFree, LLC, 941 F.3d 576, 587, 67 Bankr. Ct. Dec. (CRR) 235 (1st Cir. 2019) (suggesting such actions can be sold by the trustee in finding that avoidance actions under 11 USC §§ 547 and 548 constitute property of the estate.).
2 See Official Committee of Unsecured Creditors of Cybergenics Corp. ex rel. Cybergenics Corp. v. Chinery, 330 F.3d 548, 566, 568, 41 Bankr. Ct. Dec. (CRR) 98, Bankr. L. Rep. (CCH) P 78861 (3d Cir. 2003) (generally
holding that creditors can be granted derivative standing if the trustee/debtor in possession refuses to act or consents); In re Pursuit Capital Management, LLC, 595 B.R. 631, 658 (Bankr. D. Del. 2018) (extending the power to Chapter 7 cases so that “individual creditors may be permitted to assert avoidance actions in appropriate circumstances with court approval.”); See also In re Wilton Armetale, Inc., 968 F.3d 273, 285, 69 Bankr. Ct. Dec. (CRR) 38 (3d Cir. 2020) (making it clear that the Third Circuit’s prior holding “does not … [mean] that trustees cannot transfer causes of action” and allowing an effective transfer by upholding the trustee’s abandonment of claim that reverted to a creditor.).
3 See Cadle Co. v. Mims (In re Moore), 608 F.3d 253 (5th Cir. 2010) (finding that a fraudulent transfer claim under state law could be sold to creditors and that such claim was estate property under § 541(a) or § 544(b), but the court noted that it “do[es] not address the broader question whether a trustee may sell all chapter 5 avoidance powers, such as the power to avoid preferences under § 547 or to avoid fraudulent transfers under § 548.”
4 See In re Simply Essentials, LLC, 78 F.4th 1006, 1008 (8th Cir. 2023).
5 See Duckor Spradling & Metzger v. Baum Trust (In re P.R.T.C., Inc.), 177 F.3d 774, 781 (9th Cir. 1999)); In re Lahijani, 325 B.R. 282, 288, 44 Bankr. Ct. Dec. (CRR) 247 (B.A.P. 9th Cir. 2005) (avoidance claims owned by the bankruptcy estate may be sold and need not be “sold to a creditor who agrees to pursue those avoidance powers for the benefit of all creditors”).
6 In re Clements Mfg. Liquidation Co., LLC, 558 B.R. 187 (Bankr. E.D. Mich. 2016).
7 In re Dinoto, 562 B.R. 679, 682 (Bankr. E.D. Mich. 2016).
8 See In re Murray Metallurgical Coal Holdings, LLC, 623 B.R. 444, 516 (Bankr. S.D. Ohio 2021).
9 Simply Essentials, 78 F.4 1008 (finding “avoidance actions are property of the estate”).
10 Id. at 1007-08.
11 Id.
12 Id. at 1008.
13 Id. at 1008-09 (citing United States v. Whiting Pools Inc., 462 U.S. 198, 206 (1983)).
14 Id. at 1009 (citing Whiting Pools, 462 U.S. at 208).
