By: Donald L Swanson
The general rule is that claims of the bankruptcy estate against third parties (e.g., preference claims and tort claims) can be sold to third parties in a § 363 sale.[Fn. 1]
However, a recent opinion from the U.S. Fifth Circuit Court of Appeals discusses whether a state’s champerty law impairs a § 363 sale.[Fn. 2]
- The opinion is Crabtree v. Allstate Property & Casualty Insurance Co., Case No. 23-60537, issued July 18, 2024.
Champerty Laws
Here are observations about champerty laws from the Fifth Circuit opinion:
- “champerty” is a bargain between a stranger and a party to a lawsuit by which the stranger pursues the party’s claim in consideration of receiving part of any judgment proceeds;
- entering a champertous agreement in Mississippi is a crime and creates a void contract; but
- champerty is not a defense to a civil action—the fact that a contract is champertous “in no wise affects the obligation of defendant to plaintiff.”
Fact Context
Here is the fact context from the Fifth Circuit’s opinion:
- Debtor rear-ends Claimant, causing extensive injuries;
- Debtor is insured, but Claimant’s injuries exceed policy limits;
- Insurer refuses to settle with Claimant, without informing Debtor of the settlement negotiations or of Debtor’s potential personal liability; and
- Such failures give Debtor a bad-faith claim against the insurer.
Claimant sues Debtor.
Bankruptcy & Claim Financing
After the lawsuit is filed, Debtor files bankruptcy. The Bankruptcy Court allows the personal-injury action to proceed to trial. Claimant is awarded $4 million against Debtor, which amount substantially exceeds the insurance policy limits.
Debtor’s bad-faith claim against Insurer is an asset of Debtor’s bankruptcy estate.
As part of a settlement between Claimant and Debtor of the personal injury judgment, the Bankruptcy Court allows Claimant to purchase Debtor’s bad-faith claim against Insurer for $10,000.
Claimant cannot pay the $10,000 up-front. So Claimant gets financing from Lender:
- Lender pays the bankruptcy estate $10,000 to acquire the bad-faith claim; and
- Then, Lender assigns such claim to Claimant in exchange for Claimant’s promise to repay Lender $10,000 plus interest at 8%, with repayment contingent on a recovery from Insurer;
Lawsuit Against Insurer
Claimant sues Insurer in federal District Court, asserting Debtor’s bad-faith claim.
The District Court dismisses Claimant’s lawsuit for lack of subject matter jurisdiction because:
- the assignment of Debtor’s claim to Lender and Lender’s assignment thereof to Claimant are champertous and void under Mississippi law; and
- so, Claimant lacks Article III standing to pursue the claim.
Claimant appeals to the Fifth Circuit Court of Appeals, averring that champerty is not available to Insurer as a defense.
Fifth Circuit Ruling
Here’s how the Fifth Circuit rules on the champerty issue: “we CERTIFY the following question [on Champerty] to the Supreme Court of Mississippi:”
- “Does MISS. CODE ANN. § 97-9-11 (rev. 2013) allow a creditor in bankruptcy to engage a disinterested third party to purchase a cause of action from a debtor?”
The Fifth Circuit adds:
- “We disclaim any intention or desire that the Court confine its reply to the precise form or scope of the question certified”; and
- “This panel retains cognizance of this appeal pending response from the Supreme Court of Mississippi.”
Fifth Circuit Rationale
And here is the Fifth Circuit’s rationale for its certification ruling:
- Lender’s actions appear to violate Mississippi’s champerty statute because Lender, (i) bought Debtor’s bad-faith claim solely to assign it to Claimant, and (ii) did not have a “real and legitimate” stake in the bad-faith claim or the bankruptcy proceeding;
- the issue becomes murkier because Lender purchased the claim as Claimant’s designee, and Claimant has a real and legitimate interest in that claim as a creditor in Debtor’s bankruptcy;
- had Claimant purchased the bad-faith claim directly, the assignment would not be champertous—so, if Claimant could purchase the cause of action directly, does Mississippi law truly prohibit the indirect purchase?; and
- we face a difficult and unsettled question of state law.
Conclusion
Some states have laws of champerty. How champerty laws affect § 363 sales can be uncertain, as demonstrated by the Fifth Circuit opinion discussed above.
Here’s hoping the opinion to follow, from the Supreme Court of the State of Mississippi, will shed further light on the subject and create clarity.
——————–
Footnote 1. See, e.g., Matter of S. Coast Supply Co., 91 F.4th 376 (5th Cir. 2024); In re Simply Essentials, LLC, 78 F.4th (8th Cir. 2023); and In re Lahijani, 325 B.R. 282, 288 (9th Cir. BAP 2005).
Foontote 2. There is a division among states on the recognition of champerty laws: (i) many states, by common law or statute, reject champerty, but (ii) other states, including Delaware, Pennsylvania and New York, have and apply champerty laws. See, e.g., Fenwick & West LLP, “A Strategic Look at Champerty and Third-Party Litigation Financing” (2019).
** If you find this article of value, please feel free to share. If you’d like to discuss, let me know.
Feed Original Url