By: Donald L Swanson
“We need not resolve” Appellants’ arguments, but we find such arguments to be fraught with “lack of statutory support, ambiguities, anomalies” and to conflict with “purposes of the Code.”
–Second Circuit Court of Appeals, from December 19, 2019, opinion in In re Tribune Company Fraudulent Conveyance Litigation.
As a comedian says, “Now that’s funny, right there, I don’t care who you are.”
What Happens to Fraudulent Transfer Claims
In the quotation above, “Appellants’ arguments” are for the proposition that, upon expiration of bankruptcy’s two-year statute of limitations for a trustee to bring fraudulent transfer claims, all rights to bring such claims under state law revert back to debtor’s creditors.
Put another way, Appellants argue that, when bankruptcy’s statute of limitations door closes, the fraudulent transfer claims arising under state law escape—such claims are not trapped inside.
This proposition involves an unsettled question of law. Based on the quotation above, the Second Circuit Court of Appeals has a strong, but not yet final, opinion on the question.
Appellants’ Arguments Explained and Criticized
What follows is a summary of the Second Circuit’s explanation and criticism of Appellants’ arguments, from its In re Tribune opinion dated December 19, 2019.
The essence of Appellants’ theory is as follows.
- Fraudulent transfer claims are based on the idea that an insolvent debtor may not make gifts that deprive creditors of assets to pay debts. Therefore, before a bankruptcy is filed, fraudulent transfer claims belong to creditors, not to the debtor.
- But when a debtor enters bankruptcy, all debtor’s property interests vest in debtor’s bankruptcy estate. Such interests include all legal claims that could have been brought, including fraudulent transfer claims.
- The bankruptcy trustee has the exclusive responsibility to bring actions on behalf of the Debtor’s estate to marshal assets for the estate’s creditors: the trustee steps into the shoes of a creditor, under state law, to avoid any transfers that a creditor could have avoided.
- The trustee, however, is subject to a two years statute of limitations in the bankruptcy proceeding.
- If the trustee fails to enforce a fraudulent transfer claim within the two-years period, such claims revert to creditors, who may then pursue their own state law, fraudulent transfer actions.
Appellants’ theory is based on these assumptions:
- Creditors’ fraudulent transfer claims are merely stayed under § 362(a), rather than extinguished, when assumed by the bankruptcy trustee; and
- The power to bring a fraudulent transfer action returns in full flower to the creditors, once the trustee’s power to bring such actions expires;
–No Support in Statutory Language
Appellants’ theory finds no support in language of the Bankruptcy Code, the Second Circuit declares. For example:
- The automatic stay of § 362(a) applies only to actions against “the debtor”;
- Caselaw says that the trustee’s power to avoid fraudulent transfers under state law is exclusive, until the stay is lifted or the two years expire;
- The Bankruptcy Code is silent about what happens to fraudulent transfer claims upon expiration of the two years statute of limitations; and
- Statutes of limitation are intended to limit stale claims and provide peace to possible defendants—not change the identity of the authorized plaintiffs, without express language.
Appellants’ theory has other significant problems. For example:
- Avoidance powers under state law, granted to the bankruptcy trustee, are intended to simplify proceedings, reduce costs of marshaling assets, assure an equitable distribution among creditors, prevent interference with the bankruptcy estate’s responsibilities, and prevent a creditors’ race to the courthouse.
- A bankruptcy trustee’s enforcement of an intentional fraud claim under § 548 of the Bankruptcy Code is undermined, if creditors can later bring state law constructive fraud claims for the same transfers.
- Staying creditor actions on constructive fraud claims under state law, while the bankruptcy trustee deliberates, is a rational method of avoiding piecemeal litigation and ensuring equitable distribution of assets among creditors.
–Speculations and Imaginings
Appellants’ theory speculates and imagines a deliberate balancing of interests by Congress as follows:
- Avoidance defenses in § 546(e) apply only to claims by the trustee (not to claims by individual creditors), because trustee actions are a greater threat to securities markets than are actions by individual creditors; and
- That’s because trustee actions, unlike individual actions, are funded by the bankruptcy estate, are supported by national long-arm jurisdiction, and can avoid the entirety of a transfer.
Problems with such speculations and imaginings include:
- They are “ex-post”—appellants must first construct a theory and then justify the theory as rational, because the theory is essential to their claims;
- They have no support of any kind in legislative deliberations that led to § 546(e)’s enactment; and
- They understate the number of creditors who would sue, if allowed, and the corresponding danger to securities markets: e.g., creditors may assign and aggregate their claims, leading to billions of dollars of claims—as in the In re Tribune case.
The Second Circuit may not have rejected Appellants’ arguments, as a firm and final ruling. But it expresses opinions and convictions on those arguments, in In re Tribune, that are strongly held and difficult to misconstrue.
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