Southern District of Florida Affirms Trustee’s Sale of State Law Avoidance Claims

There is a split among federal courts as to whether a Chapter 7 Trustee may sell avoidance claims and to what degree such claims may be sold.

The filing of a bankruptcy case creates as estate comprised of all of a debtor’s legal and equitable interests in property, including causes of action, under Section 541 of the Bankruptcy Code.

As of the date of filing, a debtor may hold claims to avoid and recover transfers under applicable state fraudulent transfer law. Chapter 5 of the Bankruptcy Code provides for numerous causes of action by which transfers of property made by a debtor may be set aside and recovered. For example, a trustee in bankruptcy may avoid a preferential transfer made to a creditor with 90-days of the petition date or to an insider within one-year of the petition date under Section 547. Under Section 549, a trustee may avoid a post-petition transfer of property upon satisfaction of the elements provided for therein. Section 548 allows for the avoidance of actual and constructive fraudulent transfers made within two-years of the filing of a bankruptcy petition. Section 544 allows a trustee to rely upon state avoidance law to recover property, which law typically has a longer look back period.

The dispute among the courts can be boiled down as to whether the trustee holds claims for relief that can be sold or whether he or she is conferred with the power to bring these claims, which authority cannot be assigned or sold to a third party.

In the Teras bankruptcy cases, on August 19, 2022 the United States Bankruptcy Court for the Southern District of New York (Hon. Robert Mark) approved the sale of the avoidance claims held by the Chapter 7 trustee on behalf of their bankruptcy estates to a third-party and extended the time in which to bring such claims.

The Teras debtors moved for reconsideration of the sale orders and the extension arguing that the avoidance actions are not property of the Teras estates, but instead are powers only entrusted to the trustee that cannot be sold or transferred. [D.E. No. 73 (Case No. 20-18841-RAM)]; [D.E. No. 119 (Case No. 20-18843-RAM)].

The Bankruptcy Court held a hearing on the motion for reconsideration on October 18, 2022. Judge Mark first determined that the sale reflected the proper exercise of the trustee’s business judgment, noted that the trustee had been unable to find counsel to prosecute the prospective claims, and concluded that the sale would confer a benefit on the bankruptcy estates.

Judge Mark then turned to the question of whether the claims could be sold by the trustee, noting

[t]here is no binding authority on the 11th Circuit on this issue of whether avoidance actions are property of the estate. A good summary of the cases on both sides is contained in two fairly lengthy opinions, one very lengthy because it dealt with multiple issues and then complex facts. One of the decisions, Murray Metallurgical Coal Holdings, LLC, 623 B.R. 444, and the discussion of property of the estate starts at Page 506 and carries on at least through Page 512. It’s [a] Bankruptcy, Southern District of Ohio, 2021 decision by Judge Hoffman.

After finding that avoidance actions are property of a Chapter 7 bankruptcy estate, Judge Mark focused on whether avoidance actions brought under state common law claims can be sold versus avoidance actions brought under bankruptcy created claims. The Bankruptcy Court agreed with the finding in Cedar Rapids that “Section 544(b) claims are unique among the trustee’s avoidance powers because they do not create a cause of action to allow the trustee to step into the shoes of a creditor with an existing claim,” and that such “causes of action [ ] exist independent of the bankruptcy proceeding,” [ECF No. 25 at 13] (October 18, 2022 Bench Ruling Transcript at 13:23–14:7). Thus, the Bankruptcy Court concluded that the trustee had the authority to sell the avoidance actions that arose under Section 544, i.e. state law, but not those created by Chapter 5 of the Bankruptcy Code. [ECF No. 25 at 15] (October 18, 2022 Bench Ruling Transcript at 15:17–20).

The Teras debtors appealed from the order granting reconsideration and approving the narrower sale of the state law avoidance actions to the District Court for the Southern District of Florida.

The District Court reviewed the Bankruptcy Court’s findings of fact for clear error and its conclusions of law de novo. In an order enter entered on March 31, 2024, it affirmed the Bankruptcy Court’s sale order, as amended on reconsideration, and the extension. The District Court concluded that the Bankruptcy Court’s opinion authorizing the sale, as modified on reconsideration, was sound. A copy of the order can be found here.

The Teras debtors have filed a notice of appeal to the United States Court of Appeals for the 11th Circuit. Stay tuned to this blog to see how the 11th Circuit decides the appeal.

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