A trustee may not sell claims of the estate when there is only minimal incremental benefit to unsecured creditors, according to Bankruptcy Judge Louis A. Scarcella of Central Islip, N.Y.
In his September 20 opinion, Judge Scarcella also ruled that a trustee cannot sell claims that the trustee has determined have no validity.
The outcome was a function of economics and the trivial benefit to unsecured creditors. Like the Wall Street saying goes, “Bulls make money, bears make money, but pigs get slaughtered.”
The chapter 7 debtor allegedly perpetrated a Ponzi scheme. The primary unsecured creditor accounted for about 80% of the claims.
Before bankruptcy, the primary creditor had sued the debtor and the debtor’s relatives in state court for recovery of actual and constructive fraudulent transfers. The creditor also asserted other claims under state law, like aiding and abetting and constructive trust. After bankruptcy, the trustee intervened in the suit as a co-plaintiff.
In bankruptcy court, the chapter 7 trustee filed an adversary proceeding to recover fraudulent transfers from the relatives under New York law and Section 548. The suit alleged that the relatives had received about $1.7 million in fraudulent transfers.
The trustee investigated the claims and decided that the relatives’ maximum liability was about $45,000 for being so-called net winners who took more cash out of the Ponzi scheme than they invested. Evidently, the trustee determined that the relatives were unaware of the Ponzi scheme and were thus entitled to the so-called good faith defense barring liability for the return of their principal investments.
The trustee filed a motion to settle the claims for $45,000, representing the relatives’ maximum liability. If approved, the relatives would receive general releases.
The primary creditor objected and later offered to buy all of the estate’s claims from the trustee for $70,000. The trustee filed a motion for approval, asserting that the sale would generate an additional $25,000 for the estate.
Economically speaking, here’s the rub. The primary creditor was not waiving its unsecured claim. Consequently, creditors other than the primary creditor would only receive some $5,000 from the incremental $25,000.
From the overall $70,000, other unsecured creditors would take home about $14,000, but only $5,000 more than if the court were to approve the settlement with the defendants for $45,000.
Here’s the kicker: The sale would not be the creditors’ only recovery. Judge Scarcella said the trustee had millions more to distribute.
Throughout his 31-page opinion, Judge Scarcella harps on one idea: An “overarching” principle of bankruptcy is that “the exercise of avoiding powers [must be] for the benefit of the bankruptcy estate and all creditors as opposed to benefitting but one creditor.”
Or, as Judge Scarcella also said, “bankruptcy is a collective remedy designed to maximize value for the benefit of the estate and fosters equality of distribution among similarly situated claims.”
Approving the $70,000 sale but giving other creditors only $5,000 more “is simply not an equitable result under the circumstances and contravenes the applicable law in this Circuit regarding the criterion for derivative standing or an outright sale of estate causes of action that a trustee seeks to monetize.”
Judge Scarcella therefore refused to approve the sale of the estate’s fraudulent transfer claims under state and federal law. He then turned to the question of selling other state law claims like aiding and abetting and constructive trust.
The trustee did not say he lacked the resources to pursue the other state law claims, nor did he say that the possible rewards were not worth the effort. The trustee simply said that the non-fraudulent transfer claims had no merit.
Judge Scarcella said that the sale of meritless claims is “impermissible.” He declined to approve the sale of the other state law claims, because extracting “some value by selling meritless claims would foment frivolous litigation and potentially create a cottage industry whereby a trustee will seek to monetize claims that have been carefully vetted and determined to lack merit.”
Judge Scarcella denied the motion to sell other state law claims because he would not “sanction monetizing worthless claims in such fashion.”
A trustee may not sell claims of the estate when there is only minimal incremental benefit to unsecured creditors, according to Bankruptcy Judge Louis A. Scarcella of Central Islip, New York.
In his September 20 opinion, Judge Scarcella also ruled that a trustee cannot sell claims that the trustee has determined have no validity.
The outcome was a function of economics and the trivial benefit to unsecured creditors. Like the Wall Street saying goes, “Bulls make money, bears make money, but pigs get slaughtered.”
The chapter 7 debtor allegedly perpetrated a Ponzi scheme. The primary unsecured creditor accounted for about 80% of the claims.
Before bankruptcy, the primary creditor had sued the debtor and the debtor’s relatives in state court for recovery of actual and constructive fraudulent transfers. The creditor also asserted other claims under state law, like aiding and abetting and constructive trust. After bankruptcy, the trustee intervened in the suit as a co-plaintiff.