When many bankruptcy practitioners think of § 546 of the Bankruptcy Code, it is in connection with the statute of limitations for avoidance actions. While these provisions may be widely known, § 546 contains several other provisions that can have a substantial impact on a party’s substantive rights in a bankruptcy case. This article highlights the various key provisions of this very important section and identifies the death traps, pitfalls and the safe harbors with respect to the same.
The Death Trap: Statute of Limitations under § 546(a)
Section 546(a) provides that an avoidance action (e.g., a preference or fraudulent transfer action) may not be commenced more than two years after the order for relief has been entered.[1] The two-year statute of limitations can be extended for an additional year from the appointment or election of the first trustee under §§ 702, 1104, 1163, 1203 or 1302 if such appointment or election takes place within the original two-year period.[2] With respect to this one-year extension, there seems to be a split among the circuits regarding whether the extension refers to the appointment/election of the permanent trustee versus the appointment of an interim trustee.[3]
A majority of courts find that the § 546(a) statute of limitations is not jurisdictional and that Bankruptcy Rule 9006 applies in calculating the statute of limitations.[4] Thus, under the right circumstances, the statute of limitations might be waived or equitably tolled.[5] If a plaintiff asserts equitable tolling, it must demonstrate that an inequitable circumstance exists and that it exercised proper diligence.[6]
Calculating an avoidance limitations period is often a routine matter and does not give rise to much controversy. When there is an extremely lengthy period of time between the petition date and the commencement date of the action, however, a party prosecuting or defending an avoidance action should pay close attention to the calculation of the limitations period. Failure to do so may result in the forfeiture of extremely valuable rights and remedies.
Pitfall #1: Notice of Continued Perfection of Mechanics’ Liens under § 546(b)
The first pitfall for an unsuspecting lawyer arises as a result of the problematic interplay between state mechanics’ lien laws and the bankruptcy provisions related to the perfection of such liens. As a starting point, certain states such as Kansas require that in order for a mechanics’ lien to be fully perfected, the lienholder must bring an action to foreclose the lien.[7] However, § 362(a)(4) and (a)(5) prevent “any act to create, perfect, or enforce any lien” against either property of the estate or property of the debtor “to the extent [that] such [a] lien secures a claim that arose before” the bankruptcy filing.
Nevertheless, § 362(b)(3) provides an exception to the automatic stay, which allows for perfection, maintenance or continuation of an interest in property “to the extent that the trustee’s rights and powers are subject to such perfection under section 546(b).” Section 546(b) provides, in the relevant part:
[T]he rights and powers of the trustee under sections 544, 545, and 549 ... are subject to any generally applicable law that permits perfection of an interest in property to be effective against an entity that acquires rights in such property before the date of the petition. If such law requires ... commencement of an action to accomplish such perfection, and ... such action has not been commenced before the date of the filing of the petition, such interest in such property shall be perfected by notice within the time fixed by such law for such ... commencement.[8]
As indicated by the statute, nonbankruptcy law will have a fundamental impact as to whether § 546(b) applies. For example, take the dramatically different outcomes in the Birdview Satellite and Trilogy Development cases.
In Birdview Satellite, the bankruptcy court found that the “generally applicable law” referred to Kansas’s mechanics’ lien law, which requires an enforcement action to be commenced for perfection.[9] The bankruptcy court found that the claimant neither commenced an action in the applicable time, nor filed the proper notice under § 546(b).[10] As a result, the bankruptcy court found that the claimant’s lien expired due to a failure to timely perfect.[11]
In Trilogy Development, the debtor’s architect filed its lien but failed to file any notice under § 546(b).[12] As a result, the bankruptcy court was required to determine under Missouri law whether “institution of a suit to enforce a mechanics’ lien under state law is part of the perfection process,” which would then require the notice to be filed.[13] After an analysis of applicable Missouri law, the bankruptcy court determined that enforcement was not part of the perfection process and that a notice was not required.[14] Further, it found that the failure to provide the notice was not fatal and that the requirement to enforce the lien was effectively tolled by § 108(c).[15]
In Trilogy Development, the architect received approximately $327,000, its pro rata portion of monies that were distributed to valid mechanics’ liens.[16] Had the subject real estate been in Kansas — just a few miles to the west — the architect would have received almost nothing for its claim as a general unsecured creditor. Thus, if there is any doubt as to whether enforcement is required to perfect under state law, a more prudent (and less costly) approach is to simply file the § 546(b) notice within the time prescribed by state law.[17]
Pitfall #2: Reclamation under § 546(c)
The second pitfall concerns a seller’s reclamation rights. Under the Uniform Commercial Code (UCC), “where the seller discovers that the buyer has received goods on credit while insolvent, he may reclaim the goods upon demand made within ten days after the receipt.”[18] The 10-day limitation does not apply if the seller received a written misrepresentation of solvency within three months before delivery.[19] Buyers in the ordinary course and good faith purchasers have priority over a seller’s reclamation right, and a seller who is successful in exercising its reclamation right has no additional remedies related to the goods.[20]
While § 546(c) was originally meant to preserve state law reclamation rights,[21] it was significantly enhanced after the passage of the Bankruptcy Abuse Prevention and Consumer Protection Act of 2005 (BAPCPA).[22] Under § 546(c), the seller has 45 days — or 20 days after commencement of the case if the 45-day period expires after the case was filed — to demand reclamation of the goods that were sold to an insolvent buyer if they were sold in the ordinary course of the seller’s business. Failure to make such a demand within the prescribed periods will result in the seller’s ability to reclaim such goods being extinguished.[23] While § 546(c) may expand the reach-back period, such rights are now expressly subordinate to prior security interests in the goods or proceeds.[24] Thus, if a large secured creditor with a blanket security interest is involved, a seller’s reclamation rights might be rendered worthless.
Even if a reclamation demand is not made, a seller can still receive a higher priority administrative claim for goods that were received by the debtor within 20 days prior to filing.[25] However, the goods must have been sold in the ordinary course of business.[26] In large chapter 11 cases, it is not uncommon for the debtor in possession to set a § 503(b)(9) bar date or to otherwise commence reclamation procedures. If a client has such claims, these procedures should be carefully reviewed and followed, including filing claims by any specified bar dates.
Safe Harbor #1: Securities and Financial Instrument-Related Transactions under § 546(e), (f), (g) and (j)
Section 546 provides several safe harbors that are connected to securities and other financial instrument-related transactions.[27] One of the most widely written about safe harbors is related to “settlement payments” and securities transactions under § 546(e). While the various intricacies of this safe harbor are beyond the scope of this article,[28] it should be recognized that the scope of this provision has been broadly interpreted.[29]
These safe harbors protect the recipients of such transactions from, among other things, preferences and constructive fraudulent transfers.[30] Further, while actual fraudulent transfers under the Bankruptcy Code are not shielded by these statutes, the same cannot necessarily be said for actual fraudulent transfers under applicable state law, specifically those under the Uniform Fraudulent Transfer Act (UFTA). While the actual fraudulent transfer provisions under the UFTA are very similar to their counterpart under the Bankruptcy Code,[31] several courts have found that such provisions are covered by the safe harbors because of their reliance on § 544.[32]
A trickier issue is whether the safe harbors protect the participants in these transactions from other common law claims that are asserted by a trustee. For example, several courts have found that § 546(e) preempts certain common law claims, such as unjust enrichment, especially when the assertion of such claims is essentially seeking the same relief as an avoidance action.[33] Conversely, several courts have rejected the use of § 546(e) to shield parties from claims for breach of fiduciary duty.[34] Nevertheless, as these safe harbors have been interpreted, they have the capacity to protect several types of transactions (that would not otherwise be protected under state law) from attack.
Safe Harbor #2: Warehousemen’s Liens under § 546(i)
Section 545(2) and (3) allows a trustee to avoid the attachment of certain statutory liens against the debtor’s property, including liens for rent.[35] Under BAPCPA, subsection (i) was added to § 546, offering greater protection to “a warehouseman’s lien for storage, transportation, or other costs incidental to the storage and handling of goods” from such avoidance.[36] However, this protection must be applied in a manner that is consistent with the state law that was in effect as of the date of BAPCPA’s enactment.[37] An example of such law is UCC § 7-209, which details the attachment and continued effectiveness of a warehousemen’s lien.[38] Accordingly, in dealing with warehousemen’s liens in the bankruptcy context, a practitioner must be cognizant of both state and federal laws.
Conclusion
Given its potential impact and reach across other Bankruptcy Code sections, § 546 is one of the key bankruptcy provisions that every practitioner should be aware. While it contains several powerful creditor defenses and remedies, it also provides several deadlines and other traps that can render certain creditor’s rights meaningless. Accordingly, for a practitioner to be ignorant of this provision is to do so at his/her own peril.
[1] 11 U.S.C. § 546(a)(1)(A).
[2] 11 U.S.C. § 546(a)(1)(B).
[3] Compare Fogel v. Shabat (In re Draiman), 714 F.3d 462, 464-66 (7th Cir. 2013) (extension runs from appointment of permanent trustee), with Avalanche Mar. Ltd. v. Seaplace Shipping Ltd. (In re Parmetex Inc.), 199 F.3d 1029, 1034 (9th Cir. 1999) (extension runs from appointment of interim trustee).
[4] See Myers v. Raynor (In re Raynor), 617 F.3d 1065, 1070 (8th Cir. 2010) (listing cases). The leading case finding that the statute of limitations was jurisdictional was Martin v. First Nat’l Bank of Louisville (In re Butcher), 829 F.2d 596 (6th Cir. 1987). However, this case has since been abrogated by Bartlik v. U.S. Dep’t of Labor, 62 F.3d 163 (6th Cir. 1995).
[5] See Draiman, 714 F.3d at 466.
[6] See In re Redden, 2013 WL 5436368, at *4 (Bankr. D. Del. Sept. 30, 2013); Lee v. Nat’l Home Ctrs. Inc. (In re Bodenstein), 253 B.R. 46, 50 (B.A.P. 8th Cir. 2000).
[7] See In re Birdview Satellite Communications Inc., 90 B.R. 465, 470 (Bankr. D. Kan. 1988).
[8] Id. at 466-67 (summarizing relevant parts of 11 U.S.C. § 546(b)) (internal quotations omitted).
[9] Birdview Satellite, 90 B.R. at 467.
[10] Id. at 470.
[11] Id.
[12] Trilogy Dev. Co. LLC v. BB Syndication Servs. Inc., 468 B.R. 854, 876 (Bankr. W.D. Mo. 2011).
[13] Id. at 877.
[14] Id. at 880.
[15] Id.
[16] Amended Order Granting Agreed Motion for Approval of Settlement of Pending Appeals and for Authority to Distribute Lien Proceeds, 7, No. 09-42219-drd11 (Bankr. W.D. Mo. June 6, 2012).
[17] For additional analysis related to mechanics’ liens and bankruptcy, see Paul R. Hage and Patrick R. Mohan, “If You Build It: What You Should Know about Mechanic’s Liens in Bankruptcy,” XXX ABI Journal 8, 14, 80-81, October 2011.
[18] U.C.C. § 2-702(2).
[19] Id.
[20] U.C.C. § 2-702(3).
[21] Similar to reclamation, § 546(h) provides for a process in chapter 11 cases whereby upon motion of the trustee (or debtor in possession), pre-petition goods can be returned to the creditor for a reduction of the creditor’s pre-petition claim.
[22] For additional analysis related to reclamation and the BAPCPA changes to the same, see David L. Woods, “Reclamation under BAPCPA: Model for Uniformity?,” XXVI ABI Journal 6, 40-41,78-79, July/August 2007. However, notwithstanding the BAPCPA changes, several courts have found that such changes did not create a new “federal right of reclamation.” See, e.g., In re Dana Corp., 367 B.R. 409, 418 (Bankr. S.D.N.Y. 2007).
[23] Section 546(d) provides additional requirements with respect to reclamation if a grain storage or fish processing facility is involved. See 11 U.S.C. § 546(d).
[24] 11 U.S.C. § 546(c)(1).
[25] 11 U.S.C. §§ 503(b)(9) and 546(c)(2).
[26] 11 U.S.C. § 503(b)(9).
[27] See 11 U.S.C. § 546(e) (margin and settlement payments), (f) (repo agreements), (g) (swap agreements) and (j) (master netting agreements).
[28] For recent analysis related to § 546(e), see Brian L. Shaw and David R. Doyle, “Seventh Circuit Gives More Shelter to Investors under § 546(e),” XXXIII ABI Journal 6, 14, 90-91, June 2014.
[29] See, e.g., Grede v. FCStone LLC, 746 F.3d 244, 252-54 (7th Cir. 2014); Enron Creditors Recovery Corp. v. Alfa, S.A.B. de C.V., 651 F.3d 329, 334-35 (2d Cir. 2011); Contemporary Indus. Corp. v. Frost, 564 F.3d 981, 985 (8th Cir. 2009); In re Resorts, Int’l Inc., 181 F.3d 505, 515 (3d Cir. 1999); and Kaiser Steel Corp. v. Charles Schawb & Co., 913 F.2d 846 (10th Cir. 1990); but see also Munford v. Valuation Research Corp. (In re Munford Inc.), 98 F.3d 604, 609-10 (11th Cir. 1996).
[30] These safe harbors only impact “transfers” and would not seemingly have an impact on the avoidance of obligations. See Geltzer v. Mooney (In re MacMenamin’s Grill Ltd.), 450 B.R. 414, 428-29 (Bankr. S.D.N.Y 2011).
[31] Compare 11 U.S.C. § 548(a)(1)(A) with UFTA § 4.
[32] See, e.g., Official Comm. of Unsecured Creditors of Nat’l Forge Co. v. Clark (In re Nat’l Forge Co.), 344 B.R. 340, 370-71 (W.D. Pa. 2006).
[33] See Official Comm. of Unsecured Creditors of Hechinger Inv. Co. of Del. Inc. v. Fleet Retail Fin. Group (In re Hechinger Inv. Co. of Del.), 274 B.R. 71, 96-97 (D. Del. 2002).
[34] See, e.g., AP Servs. LLP v. Silva, 483 B.R. 63, 72 (S.D.N.Y. 2012).
[35] 11 U.S.C. § 545(2) and (3).
[36] 11 U.S.C. § 546(i)(1).
[37] 11 U.S.C. § 546(i)(2).
[38] U.C.C. § 7-209.