Is It in the Name? A Sub V Trustee’s Pursuit of Avoidance Actions

By Thomas T. McClendon

In Ghatanfard v. Zivkovic,1 the U.S. District Court for the Southern District of New York affirmed the bankruptcy court’s refusal to expand the subchapter V trustee’s powers to include bringing chapter 5 avoidance actions. The Ghatanfard court noted that the “[d]ebtor provides no authority for the proposition that a Subchapter V trustee can be empowered to pursue avoidance actions.”2 This article provides the statutory analysis for such authority.

Statutes Authorizing Avoidance Actions

Chapter 5 of the Bankruptcy Code provide authority to avoid certain transfers and obligations of the debtor. These include §§ 544 (“strong arm” powers), 545 (statutory liens), 547 (preferences), 548 (fraudulent transfers and obligations) and 549 (post-petition transfers). Proceedings under these sections are referred to in this article as “avoidance actions,” and each provide that “the trustee” may bring such action.3

The “Trustee” in Chapters 7, 11, 12 and 13

Section 101 of the Bankruptcy Code does not define “trustee.” Thus, determinating who is the “trustee” for purposes of avoidance actions depends on the particular Code chapter under which the case arises.

A chapter 7 trustee’s duties are set out in § 704. The Code incorporates certain subsections of § 704 into the other chapters’ sections on trustees, including in subchapter V.4 It is notable that this section does not explicitly authorize a chapter 7 trustee to pursue avoidance actions. The closest express duty of the trustee is § 704(a)(1)’s requirement that a chapter 7 trustee shall “collect and reduce to money the property of the estate for which such trustee serves.” This provision arguably arms the chapter 7 trustee with the right to sue on avoidance actions. However, § 704(a)(1) is not incorporated into chapters 11, 12 or 13,5 so § 704(a)(1) cannot serve as the source of authority for trustees generally to pursue avoidance actions.

In chapter 13, a standing trustee is appointed, but neither the debtor nor the chapter 13 trustee is given explicit authority by chapter 13 to bring avoidance actions.6 Courts are split on whether the debtor or the chapter 13 trustee holds the right to pursue avoidance actions. Some courts have held that the chapter 13 trustee has the exclusive authority to exercise avoidance powers.7 These courts focus on the fact that chapter 5 utilizes the phrase “the trustee” as the entity authorized to bring avoidance actions, as well as the U.S. Supreme Court’s instructions in Hartford8 that the authority provided to the trustee means that only the trustee may exercise those powers.9 Other courts have held that a debtor may bring an avoidance action by finding that debtors hold derivative standing to bring an avoidance action.10

The chapter 12 trustee is the closest parallel to the subchapter V trustee. Under § 1203, the debtor is a debtor in possession (DIP) with all of the rights of a trustee serving under chapter 11. A chapter 12 trustee is appointed, but with enumerated rights and duties.11 In general, the chapter 12 trustee does not operate the debtor’s business.12 Only if the DIP is removed is the chapter 12 trustee granted certain powers as are held by a chapter 11 trustee.

Under § 1202(b)(5), if the debtor ceases to be a DIP, a chapter 12 trustee is to perform the duties of a chapter 11 trustee under §§ 704(a)(8) and 1106(a)(1), (a)(2), (a)(6) and (a)(7). In the event of the DIP’s removal, the chapter 12 trustee also has the authority provided to the chapter 12 DIP in § 1203. However, like in chapter 13, chapter 12 has no express provision for either a DIP or a chapter 12 trustee to bring an avoidance action.

In a traditional chapter 11, a debtor, as a DIP, is given all of the rights and responsibilities of a trustee.13 Only if a DIP is removed is a trustee appointed.14 Like chapters 13 and 12, chapter 11 has no express provision for either a DIP or chapter 11 trustee to bring an avoidance action.

Finally, in a subchapter V case, a subchapter V trustee is appointed.15 As in chapter 12, the subchapter V DIP has all of the rights (other than compensation) and powers of a chapter 11 trustee.16 The subchapter V trustee’s role is similar to a chapter 12 trustee, but notably, the subchapter V trustee is the only trustee required to “facilitate the development of a consensual plan of reorganization.”17 Again, subchapter V does not expressly authorize a DIP or subchapter V trustee to bring avoidance actions.

Section 323 Authorizes the Estate Representative to Sue and Be Sued

Notably, §§ 1106, 1183, 1202 and 1302 do not specifically authorize the relevant trustee to sue and be sued. This authority comes from a source generally applicable to all chapters: 11 U.S.C. § 323,18 which reads in full:

(a) The trustee in a case under this title is the representative of the estate.

(b) The trustee in a case under this title has capacity to sue and be sued.

Thus, a trustee’s authority to sue is common throughout the chapters. Subchapter V is no exception. Likewise, §§ 544, 545, 547, 548 and 549 all apply equally in chapter 7, 11, 12 and 13 cases.19 No distinction is drawn between a “regular” chapter 11 case and a subchapter V case. Avoidance actions are authorized to be brought by “the trustee.”

Thus, the only direct source of authority for a trustee appointed under any chapter to bring an avoidance action is (1) § 323’s authorization to sue as representative of the estate, and (2) §§ 544, 545, 547, 548 and 549’s provision that “the trustee” may bring those actions.

The “Trustee” in Subchapter V

The question thus becomes this: Can the subchapter V trustee ever be “the trustee” under § 323 and the avoidance action provisions? This article examines three procedural postures of a subchapter V in turn: (1) a typical subchapter V where the debtor is a DIP with full authority under § 1184; (2) a subchapter V case where the court has removed the DIP for cause; and (3) a subchapter V case where the court expands the powers of a subchapter V trustee.

Standard Subchapter V

At the start of every subchapter V case, the debtor has “all of the rights ... and powers ... of a trustee serving in a case under” chapter 11.20 A chapter 11 trustee is generally acknowledged to hold the right to file an avoidance action. This makes sense, because the DIP serves as the representative of the estate under § 323 and has the corresponding responsibilities, such as filing schedules and proposing a reorganization plan to treat property of the estate.21 Because § 1184 provides a subchapter V DIP with the rights and powers of a trustee, the subchapter V trustee would not be “the trustee” for purposes of the avoidance powers at the outset of the case.

Removed DIP

However, if the DIP is removed for cause under § 1185, the subchapter V trustee is required to “(A) perform the duties specified in section 704(a)(8) and paragraphs (1), (2), and (6) of section 1106(a) of this title; and (B) be authorized to operate the business of the debtor.”22 Although the subchapter V trustee does not have the right to file a reorganization plan,23 the subchapter V trustee’s status as representative of the estate and ability to operate the business should mean that the subchapter V trustee is “the trustee” for purposes of § 323 and has the corresponding right to bring avoidance actions.

“Subject to Such Limitations or Conditions as the Court May Prescribe”

In a case where a debtor remains as a DIP, can a court authorize the subchapter V trustee to pursue avoidance actions? The chapter 12 trustee is the closest parallel to a subchapter V trustee. Section 1184 is modeled after §§ 1107 and 1203. Each of these three sections condition the DIP’s authority to act as the trustee with the phrase “subject to ... such limitations or conditions as the court prescribes” (in § 1107), “subject to such limitations and conditions as the court may prescribe” (in § 1184) or “subject to such limitations as the court may prescribe” (in § 1203).

Two chapter 12 cases have addressed the chapter 12 trustee’s pursuit of avoidance actions. In Teigen,24 the court held that the chapter 12 trustee has no inherent statutory authority to pursue an avoidance action. The court held that avoidance actions were vested in the DIP, but the chapter 12 trustee could gain the authority to pursue an avoidance action in two ways.25 First, if the chapter 12 debtor were removed from possession, the chapter 12 trustee’s duties would be expanded under § 1202(b)(5) to include the rights and obligations of the chapter 12 DIP under § 1203, including the right to bring avoidance actions.26 Second, the Teigen court observed that the authority of the chapter 12 debtor was modified in § 1203 by the clause “[s]ubject to such limitations as the court may prescribe.” The Teigen court reasoned that this clause was sufficient authority to reduce the powers of the chapter 12 DIP to pursue avoidance actions and place such power in the chapter 12 trustee. The Teigen court also stated that it would only grant such a motion “where the facts indicate the Debtor is not performing his duties in the best interest of the creditors.”27

The other case is Viegelahn.28 The Viegelahn court reviewed Teigen and followed its reasoning, but it dismissed the chapter 12 trustee’s complaint for failure to obtain an order from the court authorizing the trustee to pursue the avoidance action, and because the debtor had exempted the property such that the estate would not benefit from the avoidance.29

The same analysis applies to subchapter V trustees, who have nearly identical duties as chapter 12 trustees. These duties do not include prosecuting avoidance actions at the outset of the case. However, virtually identical language allowing the court to proscribe limitations on a DIP (and corresponding authority to the trustee) applies in subchapter V and chapter 12.30

As previously noted, the Ghatanfard court held that the Bankruptcy Code did not authorize a subchapter V trustee to file avoidance actions. One other case, Turkey Leg Hut,31 has addressed the issue in a subchapter V case. The Turkey Leg Hut court found that the subchapter V trustee lacked standing to bring an avoidance action because none of the subchapter V trustee’s statutory duties in § 1183 provided for prosecuting avoidance actions.32 The court did not consider the ability of a court to limit the debtor’s authority under § 1184.

The Turkey Leg Hut court also observed that the subchapter V trustee occupies a unique role with a duty to “facilitate the development of a consensual plan of reorganization.”33 This is perhaps the strongest argument against authorizing the subchapter V trustee to pursue avoidance actions.

A subchapter V trustee’s pursuit of an avoidance action prior to confirmation might impede the trustee from fulfilling his or her statutory obligation to facilitate the confirmation of a consensual plan. In this event, the subchapter V trustee should not be authorized to pursue an action that runs counter to their statutory obligation.

In the course of negotiating a plan, potential avoidance actions might form a significant roadblock to confirmation of a consensual plan. Such avoidance actions are often against insiders or vendors with longstanding relationships with debtor’s management. In such a case, the court’s authorization of the subchapter V trustee to bring such an avoidance action as a “condition” under § 1184 might aid — not hinder — the subchapter V trustee’s effort to facilitate a consensual plan. This would be especially true if the parties needed the avoidance action filed before confirmation of the plan.

Derivative Standing Under § 1123(b)(3)(B)

If the avoidance action can be filed after plan confirmation, the subchapter V trustee might also be authorized to pursue avoidance actions under a confirmed plan. Under § 1123(b)(3)(B), a reorganization plan might provide for “the retention and enforcement by the debtor, by the trustee, or by a representative of the estate appointed for such purpose, of any such claim or interest.” There is no reason why the subchapter V trustee, as an individual familiar with the case, could not serve as such an estate representative.34 Courts routinely authorize liquidating trustees and creditors’ committees to do so.

Conclusion

No meaningful statutory difference exists between a chapter 12 trustee and a subchapter V trustee with respect to avoidance powers. When authorized by court order, both may be “trustees” who serve as representatives of the estate under § 323 and the avoidance action statutes. Thus, in appropriate cases, bankruptcy courts should authorize the subchapter V trustee to pursue avoidance actions when the debtor is unwilling or unable to do so.

Tom McClendon is a partner with Jones & Walden LLC in Atlanta and represents all parties in bankruptcy cases and bankruptcy litigation, with an emphasis on chapter 11 and subchapter V.