When bankruptcy fiduciaries are appointed, one of their many duties is to identify and monetize property of the debtor’s estate. Frequently, such property may include a corporate debtor’s causes of action against its officers and directors, and related causes of action against the debtor’s professionals whose negligence may have driven the debtor into bankruptcy. In that context, disputes often arise as to whether a particular cause of action belongs to the debtor’s estate, or to certain, or all, of the debtor’s creditors.
Although most courts agree that whether an action may be maintained by the bankruptcy estate depends on whether the debtor could have brought the action prior to filing for bankruptcy, courts have not been consistent in their interpretation of the applicable state laws that underlie these causes of action.
A state-law claim is property of a bankruptcy estate when (1) under applicable state law, the debtor could have raised the claim as of the commencement of the case; and (2) the “cause of action alleges only indirect harm to a creditor (i.e. an injury which derives from harm to the debtor) and the debtor could have raised a claim for its direct injury under the applicable law.”[1]
However, “[w]hen creditors . . . have a claim for injury that is particularized as to them, they are exclusively entitled to pursue that claim, and the bankruptcy trustee is precluded from doing so.”[2]
The fact that creditors can “assert,” “bring,” or “prosecute” a cause of action, does not mean that the action “belongs” to them. In fact, certain actions (like a denuding claim) can most properly be thought of as “belonging” to the corporation though they are virtually always “asserted” by creditors.[3]
It is entirely possible for bankruptcy estate and a creditor to each have separate claims against a third party arising out of same general series of events and broad course of conduct, and thus the existence of common parties and shared facts between the debtor’s bankruptcy and the creditor’s cause of action does not necessarily mean that the claims asserted by the creditor are property of the estate.[4] However, the creditor must be able to state an independent state law claim against a third party.[5] By contrast, the mere fact that a successful outcome may increase the amount available for distribution to creditors does not transform a claim that otherwise belongs to the corporation into one that can be separately maintained by each creditor.[6]
If the claims pled by creditor are in fact derivative claims in disguise, they fall within the scope of the automatic stay.[7]
In sum, bankruptcy fiduciaries should never assume that every cause of action they identify belongs to the debtor’s estate. Instead, the proper cause of action is to evaluate the law on competing creditor claims in the debtor’s jurisdiction and, if there is no clear cut answer, be prepared to litigate the issue and/or negotiate a settlement with potentially adverse creditors.
[1] In re Mortgage America Corp., 714 F.2d 1266 (5th Cir. 1983); In re S.I. Acquisition, Inc., 817 F.2d 1142 (5th Cir. 1987); In re Educators Group Health Trust, 25 F.3d 1281 (5th Cir. 1994); and In re Seven Seas Petroleum, Inc., 522 F.3d 577 (5th Cir. 2008); Board of Trustees of Teamsters Local 863 Pension Fund v. Foodtown, Inc., 296 F.3d 164 (3d Cir. 2002); In re Icarus Holding, LLC, 391 F.3d 1315, 1321 (11th Cir. 2004); Lumpkin v. Envirodyne Indus., Inc., 933 F.2d 449, 463 (7th Cir. 1991).
[2] In re Bernard L. Madoff Inv. Securities LLC, 740 F.3d 81, 88 (2d Cir. 2014) citing Hirsch v. Arthur Andersen & Co., 72 F.3d 1085, 1093 (2d Cir. 1995); In re Emoral, Inc., 740 F.3d 875 (3d Cir. 2014); Harrison v. Soroof International, Inc., 320 F.Supp.3d 602 (D. Del. 2018); Steinberg v. Buczynski, 40 F.3d 890, 893 (7th Cir. 1994); In re Bane, 426 B.R. 152, 158-59 (Bankr. W.D. Pa. 2010).
[3] In re Mortgage America, 714 F.2d at 1276 and 1276 n. 9.
[4] In re FoodServiceWarehouse.com, LLC, 601 B.R. 396 (E.D. La. 2019); see also In re Seven Seas, 522 F.3d at 587.
[5] See In re Phar-Mor, Inc., Securities Litigation, 166 B.R. 57, 62 (W.D. Pa. 1994)
[6] In re Bruno, 553 B.R. 280, 286 (Bankr. W.D. Pa. 2016).
[7] See Picard v. Fairfield Greenwich Ltd., 762 F.3d 199, 208 (5th Cir. 2014); Marshall v. Picard (In re Bernard L. Madoff Inv. Sec. LLC), 740 F.3d 81, 94 (2d Cir. 2014) citing Johns-Manville Corp. v. Chubb Indem. Ins. Co. (In re Johns-Manville Corp.), 517 F.3d 52, 67 (2d Cir. 2008); Fox v. Picard (In re Madoff), 848 F.Supp.2d 469, 482 (S.D.N.Y 2012), aff’d, 74 F.3d 81 (2d Cir. 2014); In re Buccaneer Resources, LLC, 912 F.3d 219 (5th Cir. 2019); citing In re Dexterity Surgical, Inc., 365 B.R. 690, 702 (Bankr. S.D. Tex. 2007); In re Emoral, Inc., 740 F.3d at 879; but see Cumberland Oil Corp. v. Thropp, 791 F.2d 1037 (2d Cir.), cert. denied, 479 U.S. 950, 107 S.Ct. 436, 93 L.Ed.2d 385 (1986) (one complaint is not duplicative of another solely because it recites some or all of the same facts).