On questions where the courts are split, District Judge Susan Richard Nelson of St. Paul, Minn., ruled that claims under Section 544(b) are property of the estate that a trustee has the right to sell or assign.
To recover a judgment, a judgment creditor was prosecuting a lawsuit against the judgment debtor in federal court, alleging that the debtor had fraudulently transferred his property to avoid paying the judgment. After the debtor filed bankruptcy, the trustee took over the suit, which was based on state fraudulent transfer law.
Later, the trustee settled some of the claims and assigned the remainder to the creditor. The agreement provided that the judgment creditor would turn over any surplus to the trustee if recoveries paid off the pre-bankruptcy judgment in full.
With the creditor reinstalled as plaintiff, the judgment debtor filed a motion to dismiss, contending that the creditor lacked standing, that the claims were not estate property, and that the trustee could not sell or assign the claims. Judge Nelson denied the motion in an opinion on Feb. 7.
To contend that the creditor lacked standing, the debtor argued that the trustee could not assign the claims because they were not estate property. Judge Nelson first tackled the question of whether Section 544(b) claims are estate property.
Section 544(b) provides, in substance, that a trustee may avoid a transfer that is voidable “under applicable law by a creditor holding an unsecured claim . . . .” In other words, a trustee can pursue a claim that might be brought by a creditor who actually exists.
Although not all courts are in agreement, Judge Nelson said that “a majority of courts” hold that fraudulent transfer claims under Section 544(b) are estate property. She cited the First, Fifth and Ninth Circuits as holding that fraudulent transfer claims are estate property.
On the other hand, Judge Nelson cited the Third Circuit as saying in dicta that a fraudulent transfer claim is not estate property. She also cited a Minnesota bankruptcy court as holding 22 years ago that property becomes estate property on recovery but that the right of recovery is not estate property.
She might also have said that courts have ruled that property being pursued in a fraudulent transfer suit does not become estate property until it is recovered, thus making a distinction between the claim, which might be estate property, and the property itself, which doesn’t become estate property until recovery.
Finding no explicit holding from the Eighth Circuit, Judge Nelson ruled that fraudulent transfer claims are estate property.
Next, Judge Nelson examined the ability of the trustee to sell or assign the claims. Again, there is divided authority.
The Ninth Circuit, Judge Nelson said, “has held that the trustee may transfer any avoidance claims.” The Fifth Circuit, she said, allows a trustee to sell claims inherited under Section 544(b). However, several bankruptcy courts have ruled that a trustee cannot transfer claims under the avoiding powers.
Judge Nelson said that most of the courts did not distinguish avoidance claims created by the Bankruptcy Code from pre-existing claims that a trustee inherits under Section 544(b). She said there are “only two cases holding that trustees do not have the power to transfer, specifically, Section 544(b) claims.”
There being no authority from the Eighth Circuit, Judge Nelson followed the Fifth Circuit by holding that a trustee may sell claims under Section 544(b).
Apart from the legal theories, the result makes logical sense. After all, the claim belonged to the creditor before bankruptcy, and it would be nonsensical to contend that the same creditor could not prosecute the claim if assigned by the trustee.