A bankruptcy trustee may settle or sell an estate’s “general” claim against a third party even when a creditor has a lien secured by the same claim, at least when the lien is subject to bona fide dispute, the Second Circuit held in affirming a decision by retired Bankruptcy Judge Robert D. Drain.

The August 15 opinion by Circuit Judge Robert D. Sack left open the question of whether a trustee can sell or settle a “general” claim when a creditor has a valid lien on the claim.

Note: “General” claims are sometimes referred to as “derivative” claims, meaning a claim that could be brought by the debtor. Derivative claims also include claims that a creditor could assert that are common to all creditors.

The Common Claims

Before bankruptcy, the individual debtor allegedly made himself judgment-proof by a slew of fraudulent transfers to third parties. In arbitration before bankruptcy, a creditor won an award against the debtor for almost $15 million. Also before bankruptcy, the creditor sued the debtor and third parties in state court, alleging claims including fraudulent transfer and reverse veil-piercing. The third-party defendants allegedly were recipients of fraudulent transfers.

Also before bankruptcy, the state court confirmed the debtor’s attachment of two pieces of real property allegedly owned by third parties as a result of fraudulent transfers by the debtor. After the debtor filed a chapter 7 petition, the lawsuit in state court was removed to the bankruptcy court.

The bankruptcy trustee reached a settlement with the debtor and nondebtor defendants in the suit by the creditor that had been in state court. Over the creditor’s objection, Bankruptcy Judge Drain approved the settlement and was affirmed in district court. The creditor appealed to the circuit but fared no better.

To settle, the chapter 7 trustee was utilizing the so-called strong-arm powers under Section 544(b)(1), which allow a trustee to “avoid any transfer of an interest of the debtor in property or any obligation incurred by the debtor that is voidable under applicable law by a creditor holding an [allowed] unsecured claim.”

The Claims Were Estate Property

The creditor contended in the circuit that the fraudulent transfer and reverse-veil-piercing claims were not estate property, giving the trustee no power to settle or sell.

Judge Sack said that “general” claims are property of the estate, while “personal” claims are not. A general claim is one that could be brought by any creditor. A personal claim is one that redresses injury to a particular creditor in which other creditors have no interest.

Citing In re Tronox Inc., 855 F.3d 84 (2d Cir. 2017), Judge Sack said that fraudulent transfer claims are “paradigmatic” examples of general claims, because every creditor has a similar claim for diversion of estate assets. To read ABI’s report on Tronox, click here.

In the case at hand, Judge Sack said that the injuries to the lienholder were not peculiar to the creditor who had sued in state court. He therefore held that the fraudulent transfer claims were estate property, giving the trustee the right to sell or settle.

The same held for the lienholder’s reverse-veil-piercing claims, because they resulted from the debtor’s attempt to defraud all of his creditors.

The lienholder disagreed by pointing to a decision from the highest state court in New York that could be read to say that veil-piercing is not a claim but rather a remedy. Judge Sack parsed the opinion from the New York Court of Appeals and concluded that reverse-veil-piercing and alter-ego claims are estate property.

Settlement Despite Attachment Lien

In the circuit, the holder of the attachment lien argued that the trustee could not settle and sell the claims because the creditor had a pre-bankruptcy attachment lien on the claims.

In bankruptcy court, counsel for the lienholder admitted that the attachment lien was subject to bona fide dispute. Bankruptcy Judge Drain held that the trustee could sell the claims despite the lien under Section 363(f)(4) because there was a bona fide dispute.

Beyond counsel’s admission, Judge Sack ruled that there was a dispute because the attachment lien expired in 90 days under New York Civil Practice Law and Rule (CPLR) 6214(e).

For the first time in the circuit, the lienholder argued that CPLR 6216 instead applied because it was a lien on real property, and liens under CPLR 6216 do not expire. Judge Sack dismissed the argument because it was raised for the first time on appeal.

Jevic

The creditor-lienholder argued that the sale violated the principles enunciated in Jevic, where the Supreme Court held that a so-called structured dismissal cannot distribute property in violation of the rules or priority in bankruptcy. Czyzewski v. Jevic Holding Corp., 580 U.S. 451 (2017). To read ABI’s report on Jevic, click here.

Judge Sack rejected the Jevic analogy, saying that it applies to final distributions and that the creditor-lienholder could raise the issue again “at a later stage in the bankruptcy litigation.”

Finding that Bankruptcy Judge Drain had not abused his discretion in approving the settlement under the requirements of In re Iridium Operating LLC, 478 F.3d 452 2 (2d Cir. 2007), Judge Sack affirmed the district court’s order upholding the sale and settlement of the general claims.