A debtor’s shareholders do not have standing to object to the retention of a chapter 7 trustee’s professionals, for reasons explained by Bankruptcy Judge Craig T. Goldblatt of Delaware.
Judge Goldblatt’s February 1 opinion touches on some of the issues raised in the third bankruptcy case to be heard this term in the Supreme Court. See Truck Insurance Exchange v. Kaiser Gypsum Co. (In re Kaiser Gypsum Co.), 60 F.4th 73 (4th Cir. Feb. 14, 2023). cert. granted sub nom. Truck Ins. Exch. v. Kaiser Gypsum Co., No. 22-1079, 2023 WL 6780372 (Oct. 13, 2023). To read ABI’s reports on the Fourth Circuit’s decision and the grant of certiorari, click here and here.
To be argued in the Supreme Court on March 19, Truck Insurance will explore the role that Article III of the Constitution plays in deciding who has standing in bankruptcy cases.
Shareholders Sued for Receipt of Fraudulent Transfers
The trustee for a corporate debtor in chapter 7 had sued some of the debtor’s shareholders for receipt of fraudulent transfers. More specifically, the trustee alleged that the shareholders had received transfers of the debtor’s property for no consideration. The shareholders defended by alleging that the debtor was solvent when they received dividends.
Later, the trustee filed an application to approve retention of a firm to be substituted as the trustee’s general counsel. The shareholders objected to the retention application.
To address the objection, Judge Goldblatt began “with the presumption that the objecting defendants, who hold equity in the debtor, are parties-in-interest in the bankruptcy case and have standing to appear and be heard on any dispute that might affect the value of their equity interests in the debtor.”
Despite the broadest view of standing, Judge Goldblatt said that Section 327(c) “addresses who may object to the retention of counsel on account of that counsel’s representation of a creditor.”
Section 327(c)
In cases under chapters 7, 11 and 12, Section 327(c) says that “a person is not disqualified for employment under this section solely because of such person’s employment by or representation of a creditor, unless there is objection by another creditor or the United States trustee, in which case the court shall disapprove such employment if there is an actual conflict of interest.” [Emphasis added.]
Judge Goldblatt said that the statute “expressly and unambiguously limits standing to object to a retention in these circumstances to other creditors or the United States trustee.” He went on to say that the objectors “hold equity in the debtor but are not creditors. They therefore lack standing to raise this objection.”
To salvage their status as creditors, the defendant shareholders relied on Section 502(h), which provides:
A claim arising from the recovery of [a preference or a fraudulent transfer] shall be determined, and shall be allowed . . . or disallowed . . . the same as if such claim had arisen before the date of the filing of the petition.
Judge Goldblatt said that Section 502(h) “does not create a claim, it merely addresses when a claim that might come into being as a result of the trustee’s recovery of property would arise.” [Emphasis in original.]
Section 502(h) would benefit preference defendants and make them creditors, because payment of a preference would give rise to a claim in the amount of the recovered preference. However, the objecting defendants were not being sued for a preference.
Because the defendants were being sued for recovery of a fraudulent transfer, they would have no claim even if the trustee were to make a recovery, because the defendants paid nothing for the property they received.
Judge Goldblatt was careful to say that Section 502(h) “might have some application” to a fraudulent transfer if the defendants had paid something for transferred property that was worth more than they paid. But that was not the case before him.
“[D]espite being given every opportunity to offer a theory,” Judge Goldblatt said that the “objecting defendants . . . have made no suggestion that there is any circumstance in which they would hold a claim against the debtor.”
“Under the plain language of § 327(c),” Judge Goldblatt overruled the objection to the retention application because the objecting defendants “are not creditors” and “may not object to the trustee’s motion.”
Observations
Assume that Judge Goldblatt had made a finding that the debtor would be insolvent no matter what the trustee might recover. Depending on what the Supreme Court says in Truck Insurance, shareholder-defendants might have no standing even if Section 327(c) wasn’t on the books.
Why’s that?
Article III of the Constitution limits federal courts’ subject matter jurisdiction to circumstances in which there is a case or controversy. If shareholders are “out of the money,” can they be a party to a controversy that does not affect them? If shareholders couldn’t advance a controversy to which they were parties, they might lack constitutional standing even without Section 327(c).
Conversely, assume that Judge Goldblatt had found the debtor to be solvent. Could shareholders object to a retention application despite Section 327(c)?
Given solvency, shareholders would appear to be parties to a controversy because the outcome might affect their recoveries. In such a circumstance, could Section 327(c) be unconstitutional as applied, given that shareholders would be taking sides on a controversy that affects them?
Truck Insurance may tell us whether Congress has the right to bestow standing on parties who wouldn’t have constitutional standing (e.g., Section 1109(b)) or deprive parties of standing when they have constitutional standing.
A debtor’s shareholders do not have standing to object to the retention of a chapter 7 trustee’s professionals, for reasons explained by Bankruptcy Judge Craig T. Goldblatt of Delaware.
Judge Goldblatt’s February 1 opinion touches on some of the issues raised in the third bankruptcy case to be heard this term in the Supreme Court. See Truck Insurance Exchange v. Kaiser Gypsum Co. (In re Kaiser Gypsum Co.), 60 F.4th 73 (4th Cir. Feb. 14, 2023). cert. granted sub nom. Truck Ins. Exch. v. Kaiser Gypsum Co., No. 22-1079, 2023 WL 6780372 (Oct. 13, 2023).