Room to Breathe: The Ninth Circuit Decides that a Trustee’s Avoidance Powers Preempt State Law Statutes of Repose

It is well settled that state law statutes of limitations do not affect a trustee’s ability to bring fraudulent transfer actions, so long as the limitations period has not expired before the petition date.[1] Assuming that the limitations period has not expired, the limitations period essentially freezes, and the bankruptcy trustee has two years of “breathing room” to investigate and bring fraudulent transfer claims.[2] But prior to In re EPD Invest. Co. LLC, it was unclear how state law statutes of repose affected a trustee’s ability to bring claims otherwise viable on the petition date.[3] Do trustees have the same room to breathe as it relates to statutes of repose? Or does the clock keep ticking, so to speak, such that the repose period continued to run until the trustee filed his or her complaint? The Ninth Circuit recently found in favor of the former view.

Background

In In re EPD Invest. Co. LLC, the chapter 7 trustee filed fraudulent transfer complaints against numerous defendants, alleging that EPD Investment Co. had operated as a Ponzi scheme.[4] Using § 544(b) of the Bankruptcy Code and the California Uniform Fraudulent Transfer Act (CUFTA),[5] the trustee sought to avoid transfers from EPD to certain defendants occurring up to seven years before the petition date of Dec. 7, 2010.[6] The trustee chose a seven-year “reach back” period because of the CUFTA’s seven-year statute of repose.

The CUFTA has both a limitations and a repose period. Cal. Civ. Code § 3439.09(a) and (b) contains the limitations period and requires a plaintiff to file fraudulent transfer actions within four years of the transfer or, for an intentional fraud, within one year after the transfer was or could reasonably have been discovered.”[7] Cal. Civ. Code § 3439.09(c) contains a seven-year statute of repose.[8]

Defendants filed a motion to dismiss, arguing that the trustee’s recovery was limited by Cal. Civ. Code § 3439.09(a) and (b) to transfers made after Feb. 9, 2007, which was four years before the order for relief.[9] Ruling upon the motion, the bankruptcy court held that California’s seven-year repose period was operative, and barred the trustee’s claims for transfers occurring more than seven years before the filing of the trustee’s complaint, even though the repose period had not yet expired at the time that the petition was filed.[10]

Interplay of the Bankruptcy Code and State Law Fraudulent Transfer Limitation Periods

The Ninth Circuit in EPD explained that many courts have provided that if the statute of limitations period governing a state-law fraudulent transfer action has not yet expired on the petition date, the trustee can bring an action under § 544(b) so long as the complaint is filed within the two-year period in § 546(a).[11] This rule applies even if the state statute of limitations expires while the bankruptcy case is pending.[12] Put another way, “so long as the state-law fraudulent transfer claim exists on the petition date, the state statutes of limitations cease to have any continued effect, and the only applicable statute of limitations for bringing the claim thereafter is within § 546(a).”[13]

Interplay of the Bankruptcy Code and State Law Fraudulent Transfer Repose Periods

As opposed to statutes of limitations (which create an affirmative defense if a party fails to initiate an action within a prescribed time), statutes of repose serve to extinguish a party’s claim after a fixed period of time, usually measured from one of the defendant’s acts.[14] Designed to be harsher than statutes of limitations, statutes of repose cut off a right of action after a specified period, regardless of “accrual or even notice that a legal right has been invaded.”[15] Whereas statutes of limitations “involve[] a party’s diligence, [statutes of repose] promote[] a defendant’s peace from litigation.”[16]

On appeal, the defendants argued that the trustee’s fraudulent transfer claims occurring more than seven years prior to the complaint date were barred by the CUFTA’s statute of repose.[17] The Ninth Circuit found only one case tending to support the defendants’ position; however, that case involved the interplay between § 546(a) of the Bankruptcy Code and an Ohio probate statute.[18]

The trustee’s position, on the other hand, was that § 546(a) makes no distinction between statutes of limitations and statutes of repose, and therefore the bankruptcy court erred when it determined that the trustee could reach back only to those transfers occurring within seven years from the filing of his complaints, rather than seven years from the petition date.[19] The trustee’s argument was that federal preemption should apply equally to state law statutes of limitations or repose. Any holding otherwise would “frustrate a trustee’s ability to recover property for the bankrupt estate’s benefit,” the goal Congress intended to accomplish through the Bankruptcy Code.[20]

Policy Considerations Support Preempting State Statutes of Repose

Agreeing with the trustee, the court in EPD held that state statutes of repose present “an obstacle to the objectives of Congress in enacting the Bankruptcy Code.”[21] It continued, “by enacting the Code, Congress has expressed an intent to regulate bankruptcy and maximize the bankruptcy estate for the benefit of creditors ... [and] Congress enacted § 544(b) and § 546(a) to foster a trustee’s ability to avoid fraudulent transfers of property under state law and to recover that property for the benefit of the estate.”[22]

The court reasoned that § 546 was created to give trustees sufficient time or “breathing room” to determine whether to assert any claim under § 544.[23] And although § 544(b) does not specifically state that it preempts state law, § 546(a) evidences Congress’s intent to do so.[24] So, to the extent that Cal. Civ. Code § 3439.09(c) — and its clear intent to extinguish all claims within seven years — conflicts with federal bankruptcy law, “[it] must yield.”[25] Finding that no substantial countervailing state interests outweighed Congress’s goal of maximizing the bankruptcy estate for the benefit of creditors (such as a state’s interest in regulating its probate matters), the court held that state law statutes of repose must give way to the Supremacy Clause.[26]

Takeaway: Trustee Gets Breathing Room

So long as a state’s applicable repose period governing the action has not expired on the petition date, the limitations and repose periods essentially freeze, and the trustee may bring an avoidance action under § 544(b) within the two-year period in § 546(a).”[27] Therefore, the “reach-back” period is established on the petition date and encompasses all transfers within the period defined by state law, which in EPD was seven years before the petition date.[28]

This holding makes practical sense. Once a petition is filed, a trustee should be permitted to have the “breathing room” necessary to assess and bring fraudulent transfer claims in order to maximize the bankruptcy estate for the benefit of creditors. If the holding were contrary, a debtor could file a bankruptcy petition knowing that the trustee might be logistically unable to file a complaint in time to defeat the repose period. Creditors and trustees are wise to use EPD to ensure that all viable claims are brought against the debtor.