The powers of a Subchapter V trustee cannot be expanded to authorize the trustee to pursue avoidance actions belonging to the trustee, according to an opinion by District Judge Cathy Seibel of White Plains, N.Y.

The statements by Judge Seibel in her November 7 opinion about the expansion of a Subchapter V trustee’s powers may not be holding, because the decision in that regard arguably was not necessary to affirming the bankruptcy court.

The Conflicted Debtor

The debtor was an individual who owned and operated several restaurants. In a class action, he was sued by former employees for violation of state and federal labor laws. A jury awarded the class a judgment for more than $5 million.

The debtor was appealing the judgment when he filed a petition for himself to reorganize under Subchapter V of chapter 11. In attempting to collect the judgment, the class plaintiff had discovered that the debtor allegedly made millions of dollars in fraudulent transfers to his “life partner.”

The class plaintiff filed a motion in bankruptcy court to convert the case to chapter 7 under Section 1112(b)(1). To fend off the motion, the debtor offered to have the court expand the Subchapter V trustee’s power to pursue fraudulent transfers.

Bankruptcy Judge Sean H. Lane concluded that the debtor had a “huge conflict of interest” and doubted whether he could authorize a Subchapter V trustee to pursue avoidance actions. He also decided that authorizing the trustee to investigate would result in needless delay.

Concluding that conversion to chapter 7 was the “remaining option,” Judge Lane converted the case, allowing that a chapter 7 trustee could file fraudulent transfer suits.

Standing to Appeal

When the debtor appealed, the class plaintiff argued that the appeal should be dismissed because the debtor was not a “person aggrieved” and lacked standing to appeal.

Judge Seibel cited Second Circuit authority for the idea that an appeal may be taken in a bankruptcy case only by a “person aggrieved,” that is, someone who was directly, adversely and pecuniarily affected by the order.

On conversion from chapter 11 to chapter 7, Judge Seibel said there is no question of Article III standing. Citing the Second Circuit, she said the question is whether the chapter 7 trustee supplanted the debtor.

Unlike creditors, Judge Seibel said that chapter 7 debtors, as a general rule, lack standing to appeal, because liquidation extinguishes the debtor’s pecuniary interest. There is an exception that gives the debtor standing when there is a “reasonable possibility” of a surplus after payment of creditors’ claims in full.

Judge Seibel decided that the debtor had standing, because she was willing to assume that he was “pecuniarily affected by the conversion.” However, she said the debtor would not have standing were he challenging the chapter 7 trustee’s administration of the estate.

The debtor’s victory was short-lived, because Judge Seibel affirmed on the merits.

Cause Found for Conversion

Section 1112(b)(1) permits the bankruptcy court to dismiss or convert a case to chapter 7 “for cause.” Section 1112(b)(1) prevents the court from converting or dismissing “if the court finds and specifically identifies unusual circumstances establishing that converting or dismissing the case is not in the best interests of creditors and the estate.”

On appeal, conversions are reviewed for abuse of discretion. Judge Seibel said that Judge Lane had “adequately articulated” grounds for conversion and that there were no “unusual circumstances” to foreclose conversion.

Expanding a Sub V Trustee’s Powers

The debtor contended that Judge Lane abused his discretion by converting when he should have given expanded powers to the Subchapter V trustee. Pertinent to the appeal, Section 1183(b)(2) allows the court to expand the powers of a Subchapter V trustee to “perform the duties specified in paragraphs (3) [and] (4) of section 1106(a).” Those duties are the conduct of an investigation and the filing of a report.

Judge Seibel explained how “Judge Lane concluded that to empower a Subchapter V trustee to pursue matters not authorized by statute, over the objection of a creditor, would inject uncertainty and risk complications later on.”

Judge Seibel saw no abuse of discretion in declining to expand the powers of the Subchapter V trustee, because the “Debtor provide[d] no authority for the proposition that a Subchapter V trustee can be empowered to pursue avoidance actions.” Indeed, she said, “the only case to which any party points holds to the contrary.”

Judge Seibel affirmed conversion to chapter 7.

Observation

Once again, we ask: Is “person aggrieved” no longer good law after Truck Insurance Exchange v. Kaiser Gypsum Co., 602 U.S. 268 (2024)? To read ABI’s report, click here.