Not So Fast Mr. Liquidating Trustee May Anyone Other Than a Bankruptcy Trustee Exercise Avoidance Powers After Confirmation

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Apr 2003

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Chapter
11 plans frequently include provisions establishing liquidating trusts or
litigation trusts, which authorize a plan trustee to litigate unresolved claims
after confirmation. This practice is expressly authorized by §1123(b)(3)
of the Bankruptcy Code, which allows a "representative of the estate"
to enforce any "claim...belonging to the debtor."

In the past, numerous
courts have construed §1123(b)(3) to authorize a plan trustee to exercise
one or more of the statutory avoidance powers granted to a bankruptcy
trustee. However, the Supreme Court's determination that the phrase
"the trustee may" in §506(c) of the Bankruptcy Code meant
"only the trustee may" in <a href="http://www.westlaw.com/find/default.wl?rs=CLWD3.0&vr=2.0&cite=1…
Underwriters Insurance Company v. Union Planters Bank N.A., 120 S. Ct. 1942, 530 U.S. 1, 147 L. Ed. 2d 1 (2000)</a>,
together with the Third Circuit's decision in <a href="http://www.westlaw.com/find/default.wl?rs=CLWD3.0&vr=2.0&cite=2…
re Cybergenics Corp., 226 F.2d 237 (3rd Cir.
2000)</a>,<a href="#1" name="1a">1</a> determining that avoidance powers are not assets owned
by a debtor, call into question the assumptions underlying the earlier
decisions allowing plan trustees to exercise avoidance powers after
confirmation.

<h3>Hartford Underwriters</h3>

Hartford
Underwriters requires that the operative
phrase "the trustee may," which is included in each of the
avoidance powers available under §§544, 547, 548, 549 and 550, be
construed as a limitation on who can exercise those powers. The same rules of statutory
construction also dictate that a court consider the framework of the Code and
the language of §1123(b)(3) before assuming that the statutory avoidance
powers available to a bankruptcy trustee are also "claims"
"belonging to the debtor" that can be retained and enforced by a
"representative of the estate" under a confirmed chapter 11 plan.

In Hartford Underwriters, the Supreme Court
explained Congress's intent in selecting the phrase "the trustee
may" in §506, as follows:

<blockquote>
Here, the statute
appears quite plain in specifying who may use §506(c)—the trustee.
It is true, however, as [the] petitioner noted, that all this actually
"says" is that the trustee may seek recovery under the section, not
that others may not. The question thus becomes whether it is a proper inference
that the trustee is the only party empowered to invoke the provisions (footnote
omitted). We have little difficulty answering yes.
</blockquote>

<a href="http://www.westlaw.com/find/default.wl?rs=CLWD3.0&vr=2.0&cite=1…
S.Ct. at 1947</a>.

The Supreme Court limited the scope of its decision<a href="#2" name="2a">2</a> to not address the validity of
the practice of "derivative standing," by which some bankruptcy
courts have permitted creditors or committees to bring avoidance actions during
bankruptcy cases on behalf of the debtor's estate. Nevertheless, the
limiting effect of the phrase "the trustee may" should apply to
each of the Code's statutory avoidance powers, because when "a
statute authorizes specific action and designates a particular party empowered
to take it, [it] is surely among the least appropriate in which to presume
nonexclusivity," and "the fact that the sole party named—the
trustee—has a unique role in bankruptcy proceedings makes it entirely
plausible that Congress would provide a power to him and not to others." <a href="http://www.westlaw.com/find/default.wl?rs=CLWD3.0&vr=2.0&cite=1…;

Drawing
a contrast to other Code sections, the Supreme Court recognized that where
Congress intended that a provision of the Bankruptcy Code could be enforced by
several persons, it made that intention clear. "Section 502(a), for
example, provides that a claim is allowed unless a party in interest objects,
and §503(b)(4) allows an entity to file a request for administrative
expense." <a href="http://www.westlaw.com/find/default.wl?rs=CLWD3.0&vr=2.0&cite=1…; at 1948</a>. The Court found that
"the broad phrasing of these sections, when contrasted with the use of
'the trustee' in §506(c), supports the conclusion that
entities other than the trustee are not entitled to use §506(c)." <a href="http://www.westlaw.com/find/default.wl?rs=CLWD3.0&vr=2.0&cite=1…; at 1948</a>.

The Hartford Underwriters court also
considered whether the broad catch-all provision of §1109 might provide a
basis for someone other than a trustee to recover under §506(c). Although
it found §1109 inapplicable because the case had been converted to chapter
7, the court stated that "[i]n any event, we do not read
§1109(b)'s general provision of a right to be heard as broadly
allowing a creditor to pursue substantive remedies that other Code provisions
make available to other specific parties." <a href="http://www.westlaw.com/find/default.wl?rs=CLWD3.0&vr=2.0&cite=1…; at 1948</a>.

Although
decided before Hartford Underwriters, the district court for the Middle District of Florida adopted a similar
construction of "the trustee may" phrase, when it held that a
bankruptcy court may not authorize an individual creditor to pursue on behalf
of a chapter 7 estate, a fraudulent conveyance claim under §548. <a href="http://www.westlaw.com/find/default.wl?rs=CLWD3.0&vr=2.0&cite=2…
N Sun Apts. Inc. v. Dempsey, 253 B.R. 490 (M.D.
Fla. 1999)</a>:

<blockquote>
Congress's
demonstrated willingness and ability to expressly vest creditors with various
rights and powers in other Code sections compels the conclusion that
§548's silence as to creditors was intentional rather than
accidental. The plain meaning of §548 is obvious: "the chapter 7
trustee has standing to pursue the action to the exclusion of all other
affected parties, including creditors either individually or as a
group." <a href="http://www.westlaw.com/find/default.wl?rs=CLWD3.0&vr=2.0&cite=1…
re Adam Furniture Indus., 191 B.R. 249, 253 (Bankr.
S.D. Ga. 1996)</a>. In light of §548's plain and
unambiguous language, this court's sole function is to enforce it
according to its terms. Consequently, the court holds that the bankruptcy court
erred as a matter of law in granting Dempsey standing to prosecute a fraudulent
transfer action on behalf of the chapter 7 bankruptcy estate. (citation
omitted). That power belongs to the bankruptcy trustee alone.
</blockquote>

<a href="http://www.westlaw.com/find/default.wl?rs=CLWD3.0&vr=2.0&cite=1…; at 493-94</a>.

Based on this reasoning, the Surf N Sun court
held that "the bankruptcy court may not...unilaterally confer standing
upon the creditor to pursue the claim itself. If such authority is to be
granted, it must come from Congress and not the courts." <a href="http://www.westlaw.com/find/default.wl?rs=CLWD3.0&vr=2.0&cite=1…; at 494-95</a>.

<h3>The Retention of Claims by a Representative of the Estate After Confirmation</h3>

The statutory construction mandated by the Hartford Underwriters decision requires some statutory authorization for
the transfer of a trustee's avoidance power to a private party, to be
exercised after confirmation. Reorganization plans that create liquidating
trusts or litigation trusts to pursue claims on behalf of the debtor's
estate post-confirmation have successfully relied on §1123(b)(3) in the
past. In relevant part, §1123(b)(3) says that the contents of a plan may
provide for:

<blockquote>
(A) Settlement or adjustment of any claim or interest belonging to the debtor or to the
estate; or

(B) The retention and enforcement by the debtor, by the trustee, or by a representative
of the estate appointed for such purpose, of any such claim or interest.
</blockquote>

Several courts have
construed these provisions to authorize a plan to provide that a
trustee's avoidance powers will be retained and enforced by a
representative of the estate after confirmation. <a href="http://www.westlaw.com/find/default.wl?rs=CLWD3.0&vr=2.0&cite=5…
v. Leyh (In the Matter of Texas General Petroleum Corp., 52 F.3d 1330 (5th Cir. 1995)</a>. See, e.g., <a href="http://www.westlaw.com/find/default.wl?rs=CLWD3.0&vr=2.0&cite=8…
Acceptance Co. v. Robinson (In re Sweetwater),
884 F.2d 1323, 1327 (10th Cir. 1989)</a>; <a href="http://www.westlaw.com/find/default.wl?rs=CLWD3.0&vr=2.0&cite=8…
v. Sanchez (In re Chase & Sanborn Corp.),

813 F.2d 1177, 1180 (11th Cir. 1987)</a>; <a href="http://www.westlaw.com/find/default.wl?rs=CLWD3.0&vr=2.0&cite=1…
re Kroh Bros. Development Co., 101 B.R. 1000,
1005 (W.D. Mo. 1989)</a>. However, these courts did not have the
benefit of the Hartford Underwriters decision. Furthermore, the analysis of these courts focused on who would
benefit from an avoidance recovery, and whether avoidance powers may be
considered "claims," but these decisions devote little if any
attention to the question of whether avoidance powers ever "belong"
to a debtor. Upon closer examination, as discussed more fully below, it appears
that the avoidance powers are simply not claims belonging to a debtor, and
therefore no section of the Code authorizes a plan trustee to exercise such
powers after confirmation.

<h3>Do Avoidance Powers Belong to the Debtor?</h3>

Recent
decisions in slightly different contexts have cast some light on these
questions. For example, in <a href="http://www.westlaw.com/find/default.wl?rs=CLWD3.0&vr=2.0&cite=2…
v. United States, 219 F.3d 498 (5th Cir. 2000)</a>,
the Fifth Circuit applied the Hartford Underwriters analysis of the phrase "the trustee may"
to a chapter 13 debtor's attempt to avoid a tax lien under §545. The
court determined that only the trustee in a chapter 13 case had standing to
exercise this power. The court had no difficulty reaching this conclusion,
noting that the only avoidance power granted a debtor is the power under
§522 to avoid certain transfers related to exempt property, and that the
catchall provisions of §1303, which authorize a chapter 13 debtor to
exercise certain powers of the trustee, did not include authority to assert any
other avoidance powers.

<blockquote><blockquote>
<hr>
<big><center>
...Congress
gave only limited avoidance powers to debtors—the ability to avoid liens
impairing exempt property under §522.
</center></big>
<hr>
</blockquote></blockquote>

Looking
at this issue from a different perspective, in Cybergenics I, the Third Circuit considered whether statutory
avoidance powers are assets owned by a debtor. There, the bankruptcy court had
authorized the sale of substantially all of the debtor's assets to a
third party prior to confirmation of a plan. After the sale, the creditors'
committee demanded that the debtor-in-possession (DIP) bring a fraudulent
transfer action against participants of a pre-petition leveraged buyout. After
the DIP refused, the bankruptcy court authorized the committee to prosecute the
action. In an appeal of that decision to the district court, the defendants
successfully argued that the DIP no longer owned the claim because it had been
included in the "all assets" sale. To resolve the appeal of the
district court's decision, the Third Circuit explained that it had to decide
whether "fraudulent transfer claims...[were] assets of Cybergenics." <a href="http://www.westlaw.com/find/default.wl?rs=CLWD3.0&vr=2.0&cite=2…
F.2d at 240</a>.

The
Third Circuit described §548 as a "legal fiction" that enables
a trustee or DIP to bring certain causes of action that actually belong to its
creditors in order to recover property on behalf of the bankruptcy estate:

<blockquote>
The fact that
§544(b) authorizes a DIP, such as Cybergenics, to avoid a transfer using a creditor's
fraudulent transfer action does not mean that the fraudulent action is actually
an asset of the DIP, nor should it be confused with the separate authority of a
trustee or a DIP to pursue the pre-petition debtor's causes of action
that became property of the estate upon the filing of the bankruptcy petition.
(citation omitted). Rather, it simply enables a DIP to carry out its
trustee-related duties.
</blockquote>

<a href="http://www.westlaw.com/find/default.wl?rs=CLWD3.0&vr=2.0&cite=2…; at 243</a>. Based on this analysis, the
court concluded that the prior sale of all of the debtor's assets had not
included a sale of the power to avoid fraudulent transfers because that was
never an asset of the debtor or its estate, and reversed the dismissal of the
committee's complaint. <a href="http://www.westlaw.com/find/default.wl?rs=CLWD3.0&vr=2.0&cite=2…; at 245</a>.

Nothing
in the Code suggests that the authority granted to a DIP to exercise the
"powers" of the trustee under §1107(a) transforms those powers
into the equivalent of a "claim...belonging to the debtor or
estate," so that a "representative of the estate...[may enforce]
such claim" under §1123(b)(3). Congress's careful selection of
different terms in each of the applicable Code sections suggests otherwise.

Tellingly,
the broad definition of "claim" in §101(5) does not include a
reference to the statutory avoidance powers of the Code, although as noted
above, some courts have held otherwise. See <a href="http://www.westlaw.com/find/default.wl?rs=CLWD3.0&vr=2.0&cite=8…
re Sweetwater, 884 F.2d 1323, 1327 (10th Cir.
1989)</a> (broad definition of claim includes the estate's
right to payment under §§547, 549, 553 and 544). While the definition
of "property of the estate" does include all "legal or
equitable interests of the debtor in property as of the commencement
date," this should not, as the Cybergenics I court concluded, include the avoidance powers
granted to a trustee. This conclusion is also supported by §541(a)(3),
which further defines "property of the estate" to include
"any interest in property that the trustee recovers under §329(b),
363(n), 543, 550, 553 or 723 of this title." The omission of a reference
to the trustee's statutory avoidance powers in this subsection indicates
that those powers are not property of the estate.

Perhaps
more important, §1123(b)(3) allows the retention of claims or interests
"belonging to the debtor." Congress granted several avoidance
powers to the bankruptcy trustee and authorized a DIP to exercise such powers
under §1107(a). But as noted above, Congress gave only limited avoidance
powers to debtors—the ability to avoid liens impairing exempt property
under §522.

<h3>Only a Trustee or DIP May Bring Avoidance Actions</h3>

Under
the analysis required by Hartford Underwriters, where Congress has identified a specific party authorized to assert
specific powers in one section of the Code and not in others, it must be
presumed that Congress intended a different meaning. Thus, the phrase that
allows the retention of any "claim or interest belonging to the debtor or
the estate" to be enforced by a representative of the estate in
§1123(b)(3) should not be treated as the equivalent of a grant of the
statutory avoidance powers otherwise available only to the trustee and a DIP.
Having consistently granted these avoidance and recovery powers only to the
trustee in all but one section of the Bankruptcy Code, it may become much more
difficult to persuade a court that Congress also intended that these avoidance
powers be lumped into the catch-all phrase "claim or interest belonging
to the debtor or the estate" under §1123(b)(3). In fact, such a
result may be particularly difficult for a plan that purports to transfer these
statutory avoidance powers to an essentially private liquidation trust, created
by private parties and subject to few if any of the limitations Congress
imposes on a real bankruptcy trustee during a case. Accordingly, if the ability
to exercise avoidance powers post-confirmation is a crucial element of a
chapter 11 plan, practitioners had better think twice about the impact of Hartford
Underwriters before assuming a plan
liquidating trustee can do the job.

<hr>
<h3>Footnotes</h3>

<a name="1">1</a> <a href="http://www.westlaw.com/find/default.wl?rs=CLWD3.0&vr=2.0&cite=2…
re Cybergenics Corp., 226 F. 2d 237 (3rd Cir.
2000)</a>, is not the vacated decision. The subsequent decision in
this adversary after remand <a href="http://www.westlaw.com/find/default.wl?rs=CLWD3.0&vr=2.0&cite=3…
re Cybergenics Corp., 304 F.2d 316 (3rd Cir.
2002)</a>, has been vacated pending review en banc. To avoid confusion, the earlier decision will be
referred to as Cybergenics I, and
the later vacated decision, which dealt with the issue of a committee's
"derivative standing" to prosecute avoidance actions, will be
referred to as Cybergenics II).
The argument advanced here does not depend on the outcome of the review of Cybergenics
II. <a href="#1a">Return to article</a>

<a name="2">2</a> "We
do not address whether a bankruptcy court can allow other interested parties to
act in the trustee's stead in pursuing recovery under §506(c). Amici
American Insurance Association and National Union Fire Insurance Co. draw our
attention to the practice of some courts of allowing creditors or
creditors' committees a derivative right to bring avoidance actions when
the trustee refuses to do so, even though the applicable Code provisions (see <a href="http://www.westlaw.com/find/default.wl?rs=CLWD3.0&vr=2.0&cite=1…
U.S.C. §§544, 545, 547(b), 548(a)</a> and 549(a)) mention only
the trustee. See, e.g., <a href="http://www.westlaw.com/find/default.wl?rs=CLWD3.0&vr=2.0&cite=6…
re Gibson Group Inc., 66 F.3d 1436, 1438 (6th
Cir. 1995)</a>. Whatever the validity of that practice, it has no
analogous application here, since the petitioner did not ask the trustee to
pursue payment under §506(c) and did not seek permission from the
bankruptcy court to take such action in the trustee's stead. The petitioner
asserted an independent right to use §506(c), which is what we reject
today. Cf. <a href="http://www.westlaw.com/find/default.wl?rs=CLWD3.0&vr=2.0&cite=8…
re Xonics Photochemical Inc., 841 F.2d 198,
202-03 (C.A. 7 1988)</a> (holding that creditor had no right to
bring avoidance action independently, but noting that it might have been able
to seek to bring derivative suit)." <a href="http://www.westlaw.com/find/default.wl?rs=CLWD3.0&vr=2.0&cite=1…; at 1951 n.5</a>. <a href="#2a">Return to article</a>

Journal Authors

Robert M. Quinn

Journal Date

Tuesday, April 1, 2003 - 12:00

Bankruptcy Rule

2003