Nelson Mullins reported on March 25 that the Fifth Circuit Court of Appeals, in Matter of S. Coast Supply Co., 91 F.4th 376 (5th Cir. 2024), held that preference claims arising under 11 U.S.C. § 547 may be sold, reversing the dismissal of a complaint based on those claims for lack of subject matter jurisdiction. In our initial post, we noted while courts around the country are divided on the issue, the Fifth Circuit’s decision was bolstered by opinions from the Eighth and Ninth Circuits. Shortly after the initial post was published, the appellant in Matter of S. Coast Supply Co. filed a petition for a writ of certiorari to the Supreme Court on April 22. This petition could give the Supreme Court the opportunity to provide much needed guidance on a deeply divided issue amongst the court system.
As it stands, the Fifth, Eight, and Ninth Circuits have definitively held that preference claims arising under 11 U.S.C. § 547 may be sold. While other circuits have yet to directly decide the issue, caselaw from around the country reveals the potential for a large circuit split, including a pending appeal to the Eleventh Circuit from a case holding that common law claims arising under 11 U.S.C. § 544 may be sold, but claims arising under §§ 547, 548, and 549 may not. In re Teras Breakbulk Ocean Navigation Enterprises, LLC, 658 B.R. 611, 618 (S.D. Fla. 2024). For a full analysis on the decisions of the Fifth, Eight, and Ninth Circuit, please refer to my colleague’s March 25 article, “The Fifth Circuit Joins the Eighth and Ninth Circuits in Holding that Avoidance Actions are Estate Property that may be Sold Pursuant to Section 363 of the Bankruptcy Code."
This article will analyze caselaw from the Second, Sixth, and Eleventh Circuits in order to highlight the division amongst the circuits, division amongst courts in the same circuit, and preview arguments the Supreme Court could find persuasive if it decides to rule on the sale of preference claims and avoidance actions in general.
Cases in the Eleventh Circuit’s lower courts indicate that claims arising under 11 U.S.C. § 544 may be sold, but claims arising under §§ 547, 548, and 549 may not.
Lower courts across the Eleventh Circuit have concluded that preference claims and other avoidance actions may not be sold. In re McGuirk, 414 B.R. 878, 879 (Bankr. N.D. Ga. 2009) (“A trustee's avoidance powers, including those under Sections 547, 548 and 549 of the Bankruptcy Code, are unique statutory powers intended to benefit the estate, not a single creditor.”); In re Saunders, 101 B.R. 303, 305 (Bankr. N.D. Fla. 1989) (“The fraudulent transfer cause of action itself is not considered property of the estate since the avoidance of such a transfer is not a cause of action assertable by the debtor.”).
However, on March 31, 2024, the court in In re Teras Breakbulk Ocean Navigation Enterprises, LLC, ruled that while common law claims arising under 11 U.S.C. § 544 may be sold, claims arising under §§ 547, 548, and 549 may not “because those claims were uniquely created for the Trustee.” 658 B.R. at 618. On April 30, 2024, the appellant filed an appeal to the Eleventh Circuit, meaning that the Eleventh Circuit could be the next circuit court to rule on the issue. Notably, the Fifth Circuit first allowed for the sale of claims arising under § 544 before later allowing for the sale of claims arising under § 547. See In re Moore, 608 F.3d 253, 261-62 (5th Cir. 2010); Matter of S. Coast Supply Co., 91 F.4th at 385. Nelson Mullins will keep a close watch on the progress of the case.
The majority of lower courts in the Sixth Circuit rule that preference claims may not be sold.
At present, the Sixth Circuit has not directly addressed the standing of a creditor to bring avoidance actions purchased from a Chapter 7 Trustee, but the Court has cast doubt on the ability to do so. See In Hyundai Translead, Inc. v. Jackson Truck & Trailer Repair, Inc., 555 F.3d 231, 244 (6th Cir. 2009). At most, the Sixth Circuit has allowed a creditor to act on behalf of the bankruptcy estate and with the court’s approval to bring avoidance actions. Id. at 245 (“[W]e reaffirm the continued vitality after Hartford Underwriters of granting derivative standing to creditors to pursue avoidance actions on behalf of the estate and hold that this practice is available in both Chapter 11 and Chapter 7 proceedings.”).
Overall, the majority of lower court cases in the Sixth Circuit have held that preference actions, and avoidance actions in general, may not be sold. See In re Clements Mfg. Liquidation Co., LLC, 558 B.R. 187, 189 (Bankr. E.D. Mich. 2016) (“Chapter 7 Trustee in this case may not assign any of the avoidance actions/powers” to a group of creditors who could then pursue the claims on their own behalf.); In re Dinoto, 562 B.R. 679, 682 (Bankr. E.D. Mich. 2016) (“[F]raudulent transfer claims may not be assigned by the Chapter 7 Trustee, as part of a settlement or a sale, or otherwise.”); Lawrence v. Jahn, 219 B.R. 786, 801 (E.D. Tenn. 1998) (The Chapter 7 Trustee “has the exclusive standing and capacity to sue and be sued on behalf of the bankruptcy estate under 11 U.S.C. § 323(b).”); Fed. Ins. Co. v. Morris, Bankr. No. 11-60657, Adv. No. 11-6049, 2011 WL 4544057, at *3 (Bankr. N.D. Ohio Sept. 29, 2011) (“The chapter 7 trustee has exclusive standing to prosecute or settle avoidance actions for the purpose of orderly administration of the bankruptcy estate.”); In re Salas, No. 318-02662, 2020 WL 9172379, at *4 (Bankr. M.D. Tenn. Dec. 7, 2020) (holding that creditor lacked standing to pursue avoidance actions purchased from the trustee).
Interestingly, in In re Murray Metallurgical Coal Holdings, LLC, the court broke from other lower courts in the Sixth Circuit and held that avoidance actions were property of the estate subject to sale. 623 B.R. 444, 508 (Bankr. S.D. Ohio 2021). This opinion indicates a divide within the Sixth Circuit, and perhaps illustrates a trend that more recent caselaw tends to favor allowing the sale of preference claims and avoidance actions in general.
Lower Courts in the Second Circuit remain divided.
The Second Circuit is divided specifically over whether an avoidance action may be sold to a creditor and pursued for the sole benefit of the creditor. The relevant test in the Second Circuit is that a creditor may acquire standing to pursue the debtor's claims if
(1) the committee has the consent of the debtor in possession or trustee, and
(2) the court finds that suit by the committee is
(a) in the best interest of the bankruptcy estate, and
(b) is “necessary and beneficial” to the fair and efficient resolution of the bankruptcy proceedings.
In re Commodore Int'l Ltd., 262 F.3d 96, 100 (2d Cir. 2001); see in Glinka v. Murad, 310 F.3d 64 (2d Cir. 2002) (expanding the test to apply to individual creditors.).
Lower courts are split on whether this test allows for a creditor to purchase an avoidance action and pursue it for the creditor’s sole benefit. Some lower courts interpreting this test have refused to allow the sale of state fraudulent conveyance claims, calling them “as important a tool to a chapter 7 trustee as claims under §§ 547 and 548,” unless the creditor pursues the actions “on behalf of the estate, with any recovery inuring to and distributed among all creditors.” In re Barkany, No. 8-14-72941-LAS, 2021 WL 4272589, at *9 (Bankr. E.D.N.Y. Sept. 20, 2021) (emphasis in original); Republic Credit Corp. v. Boyer, 372 B.R. 102, 105 (D. Conn. 2007) (“The sale or assignment of avoidance claims to an objecting creditor is not permitted if the creditor intends to pursue the claims on its own behalf.”); see In re Greenberg, 266 B.R. 45, 47 (Bankr. E.D.N.Y. 2001) (holding that a creditor with 99% of the estate’s claims could only purchase state fraudulent conveyance actions from a trustee if the creditor pursued the claims on behalf of the state, not just for its own benefit.).
Other lower courts have come to a different conclusion. In Knoll, Inc., the court determined that the sale of an avoidance action satisfied the test set forth in In re Commodore Int'l Ltd when the trustee received the bankruptcy court’s approval of the sale and the trustee concluded that the pursuit of the claims would not be a beneficial use of the estate’s funds. Knoll, Inc. v. Zelinsky, No. 05-CV-1499 (GLS/DRH), 2008 WL 11504632, at *7 (N.D.N.Y. Apr. 8, 2008). The court noted that the trustee, by “obtaining at least some monetary benefit for the estate where otherwise there would have been none,” satisfied the In re Commodore Int’l ltd test. Id. The Knoll court’s finding mirror those in Matter of S. Coast Supply Co., where the Fifth Circuit ruled that allowing the sale of the preference claims “will grant bankruptcy courts more flexibility in distributing assets, maximize the value of the bankruptcy estate, and in turn, allow for more equitable distribution of assets.” Matter of S. Coast Supply Co., 91 F.4th 376, 384 (5th Cir. 2024)
Conclusion
While the Fifth, Eighth, and Ninth Circuits have provided an answer on whether preference claims may be sold, other courts remain either mired in uncertainty or at direct odds with the Fifth, Eighth, and Ninth Circuit’s conclusions. As described in more detail in our initial post, the ability to sell avoidance actions is likely beneficial to both debtors and creditors, but may have some drawbacks. As a positive, it could allow a debtor or trustee with insufficient funds to pursue an avoidance action to sell such claims and generate immediate cash. However, this ability to sell avoidance actions may also “open[] the door for prepetition lenders to perfect liens on avoidance actions arising after bankruptcy.” Rochelle’s Daily Wire, Avoidance Actions Are Estate Property that May Be Sold, the Fifth Circuit Says (available here).
Nelson Mullins will continue to follow whether the Supreme Court decides to hear the Appellant Matter of S. Coast Supply Co.’s petition along with any other developments pertaining to the ability to sell avoidance actions.
