Everyone knows that chapter 7 debtors seldom have standing to object to a trustee’s initiatives in bankruptcy court because they can’t show that the outcome will affect the debtor. But how strong a showing must the debtor make about the likelihood of a surplus to establish standing to object?
That’s the subject of a March 7 opinion by Chief District Judge Waverly D. Crenshaw, Jr. of Nashville, Tenn.
The chapter 7 debtor was a law firm. The largest claim against the firm was a sanction of some $750,000 that had been entered in state court. While the bankruptcy was pending, the state appellate court set aside the sanction, finding that the trial judge had animus against the firm. The appellate court remanded the case for further proceedings before a different trial judge.
The chapter 7 trustee filed a motion to approve a settlement where the litigants seeking sanctions would have a claim for $250,000. The trustee justified the settlement by saying it would reduce the estate’s exposure and cut off the cost of ongoing litigation.
Here’s where it gets interesting. As special counsel to negotiate the settlement, the trustee had retained the lawyer who had been appointed in state court as the firm’s receiver on application of the litigants seeking sanctions.
A partner in the debtor firm objected to the settlement, contending that the trustee’s special counsel had a conflict of interest. The partner also alleged that the litigants seeking sanctions had offered to walk away with nothing after the sanction was set aside on appeal.
The bankruptcy court ruled that the partner did not have standing and approved the settlement. According to Judge Crenshaw, the bankruptcy court required the partner to produce concrete, tangible evidence showing a high likelihood of a surplus.
The partner appealed.
The trustee argued on appeal that another creditor had objected to the settlement. Although the partner was denied standing, the trustee contended that the bankruptcy court had considered the partner’s objection.
In the Sixth Circuit, Judge Crenshaw said, a party must be adversely affected pecuniarily to have standing. If the estate has a surplus for the debtor after distributions to creditors, the debtor will have standing.
How strong must the evidence be about a surplus?
According to Judge Crenshaw, there must be a reasonable possibility of a surplus, not a metaphysical possibility.
Although the bankruptcy court may have imposed too high a standard, the trustee argued that the error was harmless because the bankruptcy court had considered the partner’s objections, albeit through the objection of another creditor.
“Nevertheless,” Judge Crenshaw said, the denial of standing “may have affected [the partner’s] due process rights.”
Reversing the denial of standing and approval of the settlement, Judge Crenshaw said that the partner’s “due process deserves consideration applying the correct legal standard.” He remanded for the bankruptcy court to apply the “reasonable possibility standard” because the bankruptcy judge was “intimately familiar with the facts of this case.”
Everyone knows that chapter 7 debtors seldom have standing to object to a trustee’s initiatives in bankruptcy court because they can’t show that the outcome will affect the debtor. But how strong a showing must the debtor make about the likelihood of a surplus to establish standing to object?
That’s the subject of a March 7 opinion by Chief District Judge Waverly D. Crenshaw, Jr. of Nashville, Tenn.
The chapter 7 debtor was a law firm. The largest claim against the firm was a sanction of some $750,000 that had been entered in state court. While the bankruptcy was pending, the state appellate court set aside the sanction, finding that the trial judge had animus against the firm. The appellate court remanded the case for further proceedings before a different trial judge.