Selling the Trustees Powers

Journal Issue

Sep 2004

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s everything for sale? We
have been wondering lately how far it is legitimate to go in selling the
unique powers of the trustee in bankruptcy (TIB) to others. It's one
thing to sell to creditors or someone else the ordinary causes of action
inherited from the debtor, but something else again to permit someone other
than the TIB to use the avoiding powers, the power to assume and reject
contracts, and the other very special rights given to that collective
institution, the bankruptcy estate. The most important recent case in this
area is, of course, the Hen House decision<a href="#1" name="1a">1</a> in the Supreme Court. If it is read broadly,
it would seem to bar many of the litigation trusts found in chapter 11
plans in recent years in which actions unique to bankruptcy are included in
the package. Even if it is narrowly read, the case may have implications
for the sale of the estate's special powers.

The overall judicial response
to Hen House has
been mixed. In a fraudulent conveyance action
brought by a creditor, the Tenth Circuit BAP held that Hen House bars such an action by
anyone other than the trustee, period. In re
Fox, 305 B.R. 912 (2004). By contrast, the
Third Circuit en banc reversed the decision of its panel and found that Hen House did not foreclose
creditors' committees from bringing avoidance actions if the trustee/debtor-in-possession (DIP) unreasonably refused to do so. Cybergenics Corp. v. Chinery,
330 F.3d 548 (3d Cir. 2003). Obviously, the Fox reading would foreclose sale of the trustee's powers.
Even the Cybergenics reading may prevent such sales because its exception is based on
an unreasonable refusal by the trustee/DIP to bring the action. Does that
mean the estate can never sell the powers, because such a sale would not
fit within the "unreasonable refusal" idea? Or should Cybergenics be understood to
state just one policy ground for a Hen House exception, leaving open the possibility that a really good
result for the estate from a sale would be a second one?<a href="#2" name="2a">2</a>

Hen House was dispositive in a Judge Paskay opinion about a sale of
special powers, In re Pro Greens Inc., 297 B.R. 850 (Bankr. M.D. Fla. 2003). In this case, the TIB
had sold to a buyer the estate's claims against a transferee of
equipment. The claims included turnover, wrongful detainer and fraudulent
conveyance. The court followed a direct path of reasoning, reminiscent of
the original three-judge panel in Cybergenics. The court said that Hen House had clarified that when the statute gives a power to the
trustee, only the trustee can exercise it. These powers are given to the
trustee. Therefore, the buyer cannot exercise them.<a href="#3" name="3a">3</a>

Other recent cases have continued to approve sales of
TIB powers. In re Ames Dept. Stores Inc., 287 B.R. 112 (Bankr. S.D.N.Y. 2002). The debtors sold
to Stop and Shop their right to assume or reject 18 leases.<a href="#4" name="4a">4</a> Against a
major attack by the landlords, the court held that these rights are estate
property, consisting of the "bonus value" of the leases. The
court explained that the debtors are not selling a federal power; they
retain the sole right to assume or reject. Candidly, we are not sure what
that means, when the debtors apparently have agreed to assume or reject at
the buyer's direction, but that point is not the one that counts.

More persuasive is the court's view that this
process is really just a way of maximizing the inherent economic value of
the leases. This means that a sale is merely an acceleration of a process
that is clearly built into the Code, maximizing an asset held by the
debtor. The Ames sale of 18 leases may be nothing more than a wholesale
rather than a retail disposition. The landlord is arguably no worse off
than in the traditional case where the debtor sells one lease at a time,
assuming and assigning whenever it found a buyer, while the estate's
marketing costs will be greatly reduced and the value of the leases will be
realized and distributed to creditors much sooner.

As with so many decisions, the estate-maximization
approach may have unexpected practical consequences that create competing
policy concerns. The bulk sale of leases might tend to reduce incentives
for prompt action, leaving the landlord in limbo longer, because the debtor
and the bulk buyer may feel less pressure to resolve a given lease quickly.
Bulk sales may also generate more litigation about whether a lease assignee
will be engaged in non-conforming uses or other §365 issues. There is
also a problem of perception. The pro-estate, dividend-maximization focus
of §365 often means the TIB or DIP can speculate in a doubtful market
over a fairly substantial period of time, a painful situation for landlords
and adjacent tenants. If this "power" is sold to a third party,
is there a point where the relationship between this process and recoveries
by creditors becomes so attenuated and obscure that the public will see its
exercise as an injustice?

That brings us to the broader question. Bankruptcy
law gives the TIB extraordinary powers, but when the TIB passes them along
to someone else, have the policies that support those powers been
substantively changed? The TIB is visibly the court-appointed
representative of creditors, but a buyer is just another self-interested
party.<a href="#5" name="5a">5</a> Consistent with that concern, the Delaware bankruptcy court held
that a sale of avoiding powers cannot be sustained if the recoveries would
not flow through to the creditors.<a href="#6" name="6a">6</a> But the obvious response is that a
lump-sum payment up front may be better for the creditors, so why draw this
distinction? That point may suggest that the underlying problem is not so
much "who benefits" as "who controls."

Some reaction to these concerns is beginning to echo
through the courts. One recent decision refused approval of sale of an
avoiding power claim. In re Metropolitan
Electric Manu. Co., 295 B.R. 7 (Bankr. E.D.N.Y.
2003). The court found that the claims being sold were likely worthless,
good only as devices to harass the defendants. The TIB in that case was
reluctant to certify the merits of these claims. The court held that unless
a TIB agrees to "bless" the merits of the claims to be sold and
to be involved in deciding whether they should be brought, the sale will
not be approved, even if some cash would thereby become available to
creditors. The obvious premise is that TIBs will not bring unjustified
suits and will be accountable if they do.<a href="#7" name="7a">7</a> An estate should not profit
by encouraging others to engage in such shenanigans.

The court in Metropolitan emphasized that the TIB is a fiduciary to every creditor,
even one that might be sued. As a court-appointed and supervised officer,
the TIB is likely to be responsible and balanced in taking legal action and
can be held responsible as well. The logic of Hen
House may ultimately bar all these sorts
of sales. If not, it is probably a good thing that the courts are starting
to insist that the trustee remain a central figure in the assertion of any
of the estate's unique powers, although perhaps allowed to partner
with others who might provide funding and other assistance.

On the other hand, if the sale of the special powers
is widely condoned, perhaps we'll see a sale of a contempt action
under §362. Or maybe an auction of a chance to take a 2004 deposition.
Or, let's see now....

<hr>
<h3>Footnotes</h3>

<a name="1">1</a> Underwriters Insurance Company v. Union Planters Bank N.A., 530 U.S. 1 (2000) (Hen House). <a href="#1a">Return to article</a>

<a name="2">2</a> In the
Second Circuit, Hen House has apparently no relevance to these issues, a situation that
leaves us more confused than usual. See, e.g.,
In re Housecraft Indus. USA Inc., 310
F.3d 64 (2d Cir. 2002). <a href="#2a">Return to article</a>

<a name="3">3</a> The case
had a stunning twist: Judge Paskay himself had approved the sale just a
short time before. "A-ha," says the judge, "I made very
sure that the sale was 'AS IS' and with no reps or
warranties!" Yes, judge, but.... <a href="#3a">Return to article</a>

<a name="4">4</a> The
interests transferred are called "designation rights." The
court says they have been described as "the right to direct the
debtors to assume and assign...unexpired leases...to third parties
qualifying under the Bankruptcy Code, after such non-end users locate
ultimate purchasers of the unexpired leases...." Ultimately, it
appears, the debtors hope to sell hundreds of leases. See, also, In re Ernst Home Center Inc., 221 B.R. 243 (BAP 9th Cir. 1998) (appeal of bankruptcy
court approval of a similar scheme dismissed as moot). <a href="#4a">Return to article</a>

<a name="5">5</a> Of course,
the same argument can be made to some extent about a DIP, which is one of
the difficulties of perception modern U.S. bankruptcy law faces in a number
of areas. <a href="#5a">Return to article</a>

<a name="6">6</a> In re Burlington Motor Holdings Inc., 231 B.R. 874 (Bankr. D. Del. 1999). <a href="#6a">Return to article</a>

<a name="7">7</a> The Second
Circuit has permitted sale of a fraudulent conveyance action to a secured
creditor, but explicitly rested its approval on the fact that the TIB would
remain as a plaintiff and would exercise some control in the case. In re Housecraft Indus. USA Inc., 310 F.3d 64 (2d Cir. 2002). <a href="#7a">Return to article</a>

Journal Authors

Elizabeth Warren

Jay L. Westbrook

Journal Date

Wednesday, September 1, 2004 - 12:00

Bankruptcy Rule

2004