As shown in an opinion by a district judge in Arkansas, the law throughout the country is not uniform when it comes to the ability of a bankruptcy trustee to sell a debtor’s defensive appellate rights.

Procedurally and factually, the case was complicated but boils down to this: The debtor was fired by her corporate employer. Less than a month later, the employer sued the debtor, including allegations about theft of client lists and defamation. The debtor counterclaimed, alleging Medicaid fraud and violation of the False Claims Act for a retaliatory firing.

After contentious litigation, the state court judge struck the debtor’s answer and counterclaim, citing spoliation of evidence. The state court entered judgment against the debtor for more than $3.5 million.

The debtor appealed and filed a chapter 7 petition, but the appeal was frozen for years after the employer’s principal was arrested on charges of Medicaid fraud.

Years after the arrest, the state prosecutors dismissed the criminal charges, opening the door to litigation in the state appellate court and the bankruptcy court.

The chapter 7 trustee accepted the employer’s offer to purchase the debtor’s offensive and defensive appellate rights for $12,500. Were the sale to go through, the employer would pay $12,500 to ensure having a $3.5 million, nondischargeable claim.

The debtor objected to the sale of her defensive appellate rights, but not her offensive rights. The bankruptcy court approved the sale, and the debtor appealed to District Judge Paul K. Holmes, III of Fayetteville, Ark.

In his opinion on March 26, Judge Holmes recited the usual rules about estate property: (1) State law governs the nature and extent of a debtor’s interest in property, but (2) federal law governs the extent to which the interest is estate property. For him, the “federal-law component here is straightforward: to whatever extent state law recognizes a cause of action to be an interest in property, then that interest is included in the bankruptcy estate.”

The case on appeal, Judge Holmes said, was “a much more nuanced question [of] whether and to what extent Arkansas law recognizes the right of appeal to be a cause of action that is personal property.”

In Arkansas, Judge Holmes said that personal property includes “things in action,” meaning the right to bring an action or a right to recovery money. “Clearly,” he said, “defending oneself against a lawsuit brought by another party is not ‘bringing an action’ or attempting to ‘recover a debt or money.’”

“[U]nable to find any Arkansas cases disputing this common-sense notion,” Judge Holmes decided that the debtor’s right to defend herself “is not personal property” under Arkansas law, “but the causes of action she asserted in her counterclaim are personal property.” He went on to say that the debtor’s appellate rights had a “blended status,” because appellate rights were part hers but part estate property.

Addressing blended rights, Judge Holmes “found scant caselaw discussing whether blended offensive and defensive appellate rights are property of the bankruptcy estate.” The cases he did find, however, were not helpful, “because all such cases involved states under whose law defensive appellate rights are personal property,” citing decisions from Texas and California.

Sadly, Judge Holmes did not rule on whether the debtor’s defensive rights were estate property. He found other grounds to reverse and rule in favor of the debtor. Specifically, he held that the settlement was neither fair and equitable nor in the best interests of the estate.

Shortly after the bankruptcy filing, the chapter 7 trustee had hired the same lawyer who had represented the debtor. The lawyer agreed to charge the trustee only to the extent of the recovered assets. Thus, prosecuting the appeal would cost the trustee nothing.

Judge Holmes described the trustee’s choice: At no cost to the estate, the trustee could attempt to overturn a $3.5 million judgment against the estate, or, on the other hand, the trustee could sell appellate rights for $12,500 while ensuring that the estate would have a $3.5 million nondischargeable claim. He said that taking the $12,500 fell “well below” the “lowest point in the range of reasonableness.”

“No middle-income rational actor,” Judge Holmes said, “would ever accept a settlement offer of a [$3.5 million] non-dischargeable debt where the alternative is to appeal a [$3.5 million] judgment at no personal expense.” He therefore ruled that acceptance of the offer was a “clearly erroneous assessment of the evidence.”

Judge Holmes reversed the order approving the sale and remanded for further proceedings.