When ownership of a corporation has been pledged, the filing of a voluntary petition for the corporation by the chapter 7 trustee of the owner can be ratified by actions taken by directors of the owner, as explained by Bankruptcy Judge John P. Mastando, III, of New York.

The facts, the corporate relationships and the financing arrangements for a company and its corporate owner were complex beyond words. At the risk of oversimplification, assume that the corporate owner had pledged ownership of another company that we shall refer to as the subsidiary.

The bankruptcy court had entered an order for relief against the owner following the filing of an involuntary petition. Naturally, a trustee was appointed for the owner.

Later, the trustee filed a voluntary petition for the subsidiary and was appointed also to serve as the chapter 7 trustee for the subsidiary. Eventually, the trustee filed a fraudulent transfer suit in the subsidiary’s case against several defendants. Evidently aiming to deprive the trustee of standing to prosecute the suit, several defendants responded by filing a motion to dismiss the subsidiary’s entire bankruptcy case, based on the idea that the trustee lacked authority to file the voluntary petition.

Judge Mastando denied the dismissal motion. His April 19 opinion is a treatise on authority to file bankruptcy petitions and on standing. His discussion of standing is all the more interesting in view of the Supreme Court’s opinion in Truck Insurance Exchange. v. Kaiser Gypsum Co., 22-1079 (Sup. Ct. June 6, 2024), regarding standing in chapter 11 cases under Section 1109(b). The Supreme Court broadly read the words “party in interest” when controversies arise over standing in bankruptcy cases. To read ABI’s report on Truck Insurance, click here.

Authority to File a Petition

The defendants argued that the voluntary petition for the subsidiary was not authorized because ownership of the subsidiary had been pledged, and the trustee did not have possession of the shares. Likewise, the directors of the subsidiary had not signed a resolution authorizing the voluntary petition.

The defendants contended that they had standing to pursue dismissal by alleging that they were creditors of the subsidiary. Judge Mastando began his discussion of authority to file a voluntary petition by saying, “Courts have generally held that creditors cannot challenge a corporate bankruptcy filing on the grounds that it was not properly authorized.” He concluded that the defendants, as creditors, could not move to dismiss the petition on the grounds that it was unauthorized.

Assuming the defendants did have standing as creditors to file the dismissal motion, Judge Mastando next considered whether the filing was authorized under the law of Florida, where the subsidiary was incorporated.

Florida law requires authorization from the board and a board resolution, and there was none. However, Judge Mastando said that a board can authorize an unauthorized act, either expressly or by implication through conduct inconsistent with repudiation of the unauthorized act.

When the petition was filed by the trustee, the subsidiary’s board had three members. Judge Mastando said that all three “have been involved in the [subsidiary’s] case essentially from its inception.” One was named as the subsidiary’s authorized representative and had signed the schedules. All three had been defendants in a lawsuit in the owner’s case, had participated in mediation, and had settled with the trustee. Furthermore, all three had objected to the motion to dismiss the subsidiary’s case. In addition, the case had been pending for three years, and none of the three had moved to dismiss.

Judge Mastando therefore found that the three board members “have implicitly ratified the Trustee’s filing of the [subsidiary’s] bankruptcy through conduct inconsistent with an intent to repudiate the filing.” As icing on the cake, he said that the trustee “clearly authorized her own filing” to the extent that shareholder authorization was required because the trustee was the sole owner of the subsidiary.

The defendants claimed that the trustee was “incapable” of voting the shares of the subsidiary because they had been pledged and were not in the trustee’s possession. As it happened, the creditor to whom the shares had been pledged had been paid in full, thus eradicating the pledge. The lack of physical possession of the shares was no bar, because the trustee had not abandoned the shares and was entitled to vote them, Judge Mastando said.

Denying the motion to dismiss the entire case, Judge Mastando said that dismissal would not be in the best interests of creditors because dismissal could deprive the trustee of standing to prosecute a suit that might benefit creditors.

Standing

The trustee had also sought denial of the motion to dismiss by alleging that the defendants lacked standing.

In tortious detail, Judge Mastando analyzed the complex facts and found that the three movants may have been creditors of the owner, but none were creditors of the subsidiary. Likewise, he decided that none were parties in interest and therefore lacked standing to file the motion to dismiss.

Observation

The defendants have filed a motion asking Judge Mastando to reconsider denial of the motion to dismiss. In the meantime, the Supreme Court handed down Truck Insurance and its apparently broad reading of who is a party in interest with standing in a bankruptcy case.

Truck Insurance involved an interpretation of Section 1109(b), which is not applicable to chapter 7 cases like the one before Judge Mastando. If Judge Mastando decides to write an opinion on the motion for reconsideration, it’ll make interesting reading and could be the first case to opine on the application of Truck Insurance outside of chapter 11.