What Happens to Fraudulent Transfer Claims When Barred by Bankruptcy’s Two-Year Statute of Limitations?

Are the claims dead and buried?

By Donald L. Swanson

Two Hypotheticals and a Question:

First Hypothetical: Debtor makes a fraudulent transfer shortly before filing Chapter 7 bankruptcy. The Chapter 7 Trustee refuses to pursue the fraudulent transfer claim, and the Bankruptcy Code’s two-year statute of limitations expires.

Second Hypothetical: Debtor makes a fraudulent transfer shortly before filing Chapter 11 bankruptcy. The Chapter 11 debtor continues in possession, without appointment of an official committee. The Bankruptcy Code’s two-year statute of limitations expires, without any effort to pursue the fraudulent transfer claim.

A Question: What happens to the fraudulent transfer claims in these hypotheticals after expiration of the two-year statute of limitations?

U.S. District Court’s Answer

The answer from one U.S. District Court is this: the fraudulent transfer claims “automatically revert” to creditors, who may then pursue those claims in state court. Here’s the District Court’s analysis:

“Because creditors’ avoidance claims are not property of the estate, the trustee has a limited time in which to bring them,” and “when the two-year limitation on trustee avoidance claims expires, the claims automatically revert” to creditors.

In re Tribune Company Fraudulent Conveyance Litigation, Multidistrict Litigation No. 11 MD 2296, 499 B.R. 310  (S.D.N.Y. 2013).

The District Court cites three cases to support its answer.

First case – A farm equipment dealership:

In re Integrated Agri, Inc., 313 B.R. 419, 427-28 (Bankr. C.D.Ill. 2004).  In this Chapter 7 case the trustee files a fraudulent transfer action after expiration of the Bankruptcy Code’s two-year statute of limitations. The court rules that, once the trustee’s claim is prohibited by expiration of the statute of limitations, a creditor “regains standing to pursue a state law fraudulent conveyance action, in its own name and for its own benefits.”

Second case – An embezzler:

Klingman v. Levinson, 158 B.R. 109, 113 (N.D. Ill. 1993). The Defendant embezzeles money, and Plaintiff sues. Levinson files bankruptcy but does not receive a discharge of Plaintiff’s claim. Levinson’s bankruptcy trustee does not pursue any fraudulent conveyance claim. Accordingly, the court rules: “The trustee’s exclusive right to maintain a fraudulent conveyance action expires and creditors may step in (or resume actions) when the trustee no longer has a viable cause of action.”

Third case – A murderer:

In re Tessmer, 329 B.R. 776, 779 (Bankr. M.D. Ga. 2005). Ethel Tessmer kills her husband. After her conviction for felony murder, she transfers her interest in real estate to her parents. Then the former mother-in-law sues her for wrongful death, and the murderer files Chapter 7 bankruptcy. The bankruptcy case then follows “a somewhat tortured path,” involving a court-approved settlement of the fraudulent transfer claim, the grant of a discharge to debtor, and considerable litigation over the legal effects of such events, which result “in a great deal of confusion.” However, the Court determines that the trustee’s settlement prevents further action by the mother-in-law: “[C]reditors do not regain the right to sue unless the trustee abandons the claim or he no longer has a viable cause of action because, for example, the statute of limitations has run.”

Appeal to Second Circuit

On appeal, the Second Circuit Court of Appeals rejects the District Court’s answer above in a § 546(e) defense context. Here is what the Second Circuit says:

–The inference is that, if the two-year statute of limitations is not met by the bankruptcy estate, the fraudulent transfer claims “revert” to creditors “in full flower,” who may then pursue their own state law fraudulent transfer actions.

–This inference “finds no support in the language of the [Bankruptcy] Code” or its “purposes” and is a ”glaring anomaly.”

However, the Second Circuit limits its ruling on this “revert to creditors” issue to the § 546(e) context before it:

–“We resolve no issues regarding the rights of creditors to bring state law, fraudulent conveyance claims” outside the § 546(e) context.

Appeal to U.S. Supreme Court

The Second Circuit’s ruling in this case is, currently, the subject of a Petition for a Writ of Certiorari to the U.S. Supreme Court in the case of Deutsche Bank Trust Company America v. Robert R. McCormick Foundation, Supreme Court Case No. 16-317. The Supreme Court has yet to rule on this Petition.

It will be interesting to see if, and how, the U.S. Supreme Court addresses this fraudulent transfer issue.

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