On Sept. 22, 2011, Charlene Milbury filed for chapter 7 bankruptcy protection in the Central District of California,[1] starting the clock on a two-year period for the commencement of avoidance actions by the trustee. The debtor was the sole owner of a materials-hauling business known as Charlene’s Transportation Inc. (CTI).[2]
During the pendency of the chapter 7 case, two creditors, Patricia and G. Cresswell Templeton III, conducted their own investigation into the activities of Milbury and certain related parties. In the days leading up to the Sept. 22, 2013, statutory deadline, the Templetons notified the trustee about a number of potentially avoidable transactions that they had uncovered. Specifically, the Templetons provided a binder to the trustee that documented “descriptions of assets and transfers that the Templetons believed might be recoverable for the benefit of the estate, as well as some supporting documentation…”[3] Unable to fully investigate the claims due to the short period of time before the statutory deadline, the trustee did not incorporate the Templetons’ findings into her claims.
In August 2014, the trustee granted the Templetons permission to pursue the additional avoidance actions on behalf of the estate. The Templetons filed an adversary complaint[4] alleging claims under both the Bankruptcy Code and California Civil Code on Sept. 17, 2014.
The defendants in the adversary proceeding, all insiders and related parties of Milby and CTI, moved to have the bankruptcy court dismiss the case under § 546(a)(1)[5], which holds:
(a) An action or proceeding under section 544, 545, 547, 548, or 553 of this title may not be commenced after the earlier of—
(1) the later of—
(A) 2 years after the entry of the order for relief; or
(B) 1 year after the appointment or election of the first trustee under section 702, 1104, 1163, 1202, or 1302 of this title if such appointment or such election occurs before the expiration of the period specified in subparagraph (A);…
The bankruptcy court agreed and dismissed the Templetons’ claims. Rather than amend their complaint, the Templetons elected to appeal to the Bankruptcy Appellate Panel (BAP) for the Ninth Circuit.
In February 2016, the BAP ruled that the bankruptcy court “erred when it dismissed the § 544(b) claims as untimely because of the trustee’s alleged lack of diligence after discovery of the fraudulent transfers”[6]
The BAP relied heavily on a previous Ninth Circuit ruling to reach its decision. In applying the “stop clock” rule created in Socop-Gonzalez v. Immigration & Naturalization Service,[7] the BAP deemed the stop-clock rule to be applicable to bankruptcy for a number of reasons. First, it protected the “certainty and sense of repose that a statute of limitations is meant to provide.”[8] Second, the rule prevents the necessity for parties to litigate the adequacy of a trustee’s diligence. Third, and perhaps most importantly, this rule would disincentivize debtors to attempt to obfuscate a trustee’s investigation in order to “run out the clock.” Finally, the rule prevents a plaintiff from being penalized for not filing suit at the earliest possible time, even if this is well in advance of the deadline.
In practice, trustees and their professionals are best served to work diligently to complete investigations within the two-year statute of limitations. However, they need not view the statutory deadline as an insurmountable obstacle; rather, they should continue to reasonably investigate and pursue potential avoidance actions whenever evidence arises.
[1] Templeton, et al. v. Milby, et al. (In re Milby), 545 B.R. 613 (B.A.P. 9th Cir. 2016).
[2] Id. at 616.
[3] Id. at 617.
[4] Id. at 618.
[6] Templeton, et al. v. Milby, et al., 545 B.R. at 619-620.
[7] Socop-Gonzales v. INS, 272 F.3d 1176 (9th Cir. 2001).
[8] Templeton, et al. v. Milby, et al., 545 B.R. at 623.