Photo Credit: BHPH Report Staff, Experts put 18% Annual Rise in Bankruptcies Into Context, BHPH, (Jan. 4, 2024), https://www.autoremarketing.com/bhph/experts-put-18-annual-rise-in-bankruptcies-into-context/.
Authored by Justin St. Amour
Most ordinary people have never had any experience within the realm of bankruptcy or never want to have any run ins with bankruptcy due to its negative connotation. However, bankruptcy provides a beneficial course of action for those in need of a fresh start in the form of debt relief. Just like the majority of the population with daily life activities, the parties participating in bankruptcy proceedings prefer to have the proceeding close as fast as possible as long as it serves their best interest. Permitting a trustee to sell preference actions as estate property is one solution that bankruptcy courts can provide to carry out the fundamental goals of bankruptcy effectively and efficiently.
Consumers and businesses looking for a fresh start may elect to file for bankruptcy under Chapter 7.[1] A Chapter 7 bankruptcy case is different than other forms of bankruptcy in that it does not consist of reorganization or the filing of a payment plan.[2] Instead, upon the filing of a Chapter 7 petition, a trustee is appointed and is immediately tasked with maximizing the value of the estate by identifying the debtor’s nonexempt property and using that property to pay the debtor’s creditors.[3] This is commonly known as “liquidation.”[4] Once a bankruptcy case has commenced, an “estate” consisting of all of the debtor’s property is created.[5] Any legal or equitable interest in property that the debtor possessed as of the commencement of the case is pulled into the bankruptcy estate.[6] To fulfill the primary goal of liquidating all of the debtor’s nonexempt assets to maximize recovery for creditors, a trustee will attempt to sell any nonexempt property for good value.[7] In doing so, the trustee is tasked with closing the estate “as expeditiously as is compatible with the best interest of [the] parties in interest.”[8]
The Bankruptcy Code grants a trustee certain rights and powers upon the filing of a Chapter 7 bankruptcy petition.[9] Among these powers lie the trustee’s ability to avoid and recover preferential transfers made by the debtor prior to the filing of the petition.[10] A preferential transfer is a pre-petition transfer made by an insolvent debtor to a creditor that favors one creditor over another.[11] In order for the trustee to be able to “claw back” transfers such as these, the transfer must be made either “90 days before the date of the filing of the petition” for non-insiders or “one year before the date of the filing of the petition” for insiders.[12] If a trustee determines that a preferential transfer exists, it may choose to pursue an action to recover those funds or “avoid” the transfer for the benefit of the estate.[13]
Historically, courts have held that a trustee is not permitted to sell preference actions.[14] This is largely because preference actions have never been viewed as property of the bankruptcy estate under section 541 of the Bankruptcy Code. Property under section § 541(a)(1) includes “all legal or equitable interests of the debtor in property as of the commencement of the case.” To be considered estate property under that provision, the debtor itself must hold a legal or equitable interest in the action or asset prior to the filing of the bankruptcy petition.[15] State law generally governs a debtor’s property interest for the bankruptcy estate.[16] And courts have declined to find that preference actions are estate property because no state law gives a debtor itself a property interest in avoiding preferential transfers.[17]
Further, many have argued that a trustee’s ability to avoid and recover preferential transfers is one of many powers Congress granted to the trustee and that a statutorily created “power” is not something that can be sold as estate property.[18] The avoidance powers are specifically granted to a trustee under section 547 and do not arise until a debtor actually files for bankruptcy. Because Congress specifically tasked a trustee with the powers granted to it under section 547, and because this power does not arise until a debtor actually files for bankruptcy, many courts have consistently held that a preference action is simply not a legal or equitable interest that a debtor holds pre-petition and cannot be estate property under section 541(a)(1).
However, courts consistently and routinely find that causes of action belonging to the estate may be sold by the trustee.[19] The Supreme Court has also held that Chapter 5 actions (a.k.a preference action) are causes of action that the bankruptcy estate captures.[20] Putting this together, allowing a trustee to sell a preference action, a Chapter 5 cause of action, would substantially benefit the trustee as he attempts to expeditiously sell estate property to maximize the value of the estate.
The Eighth and Fifth Circuits recently addressed specifically whether a trustee may sell preference actions to third parties and held that a trustee’s avoidance powers are part of the bankruptcy estate and, therefore, can be sold under section 363.[21]
The Eighth Circuit in Simply Essentials was the first circuit court to explicitly hold that a preference action may be sold by the trustee. The court in Simply Essentials concluded that Chapter 5 avoidance actions are estate property and, therefore, may be sold by the trustee under section 363.[22] In reaching its decision, the court relied on a principle laid out by the Supreme Court that a debtor need not hold a possessory interest in property to be considered property of the bankruptcy estate.[23] Instead, the Eighth Circuit recognized that a debtor’s pre-petition “inchoate or contingent interests” are included as estate property.[24] Applying those principles, the Eighth Circuit determined that because a debtor has the right to file for bankruptcy, that right creates an inchoate interest in preference actions as of the commencement of the case and is property of the bankruptcy estate under section 541(a)(1).[25]
Importantly, the Eighth Circuit held that even if preference actions are not estate property under section 541(a)(1), they are property of the estate under section 541(a)(7).[26] Section 541(a)(7) includes as estate property “[a]ny interest in property that the estate acquires after the commencement of the case.”[27] Interpreting that provision, the court concluded that the Bankruptcy Code itself makes preference actions available to the estate post-petition and, therefore, captures preference actions as estate property.[28]
The Appellant in Simply Essentials raised two arguments against rendering preference actions as part of the bankruptcy estate.[29] The Appellant first argued that an interpretation including preference actions as estate property was not appropriate because it rendered section 541(a) redundant and superfluous.[30] The court acknowledged the possible surplusage in its interpretation but decided (1) that the “canon against surplusage is not an absolute rule[],”[31] and (2) that the provision’s legislative history coupled with the complexity of the Bankruptcy Code itself allowed for its conclusion even if it did create some surplusage.[32] The Appellant further argued that because a trustee acts on behalf of all creditors in a fiduciary capacity, allowing a trustee to sell preference actions would be a violation of that duty.[33] The Eighth Circuit rejected that argument by recognizing that a trustee’s fiduciary duties include maximizing the value of the estate and that the trustee, in some instances, cannot financially afford to pursue the action or does not have enough time to pursue the action. [34] Due to these concerns, the court found that allowing a trustee to sell a preference action may actually be the best and most efficient option for a trustee to fulfill his fiduciary obligations and maximize the value of the estate.[35]
Most recently, the Fifth Circuit in South Coast Supply Company echoed the reasoning of the Eighth Circuit and held that even though a trustee historically has been the only party permitted to bring a preference action, preference actions are causes of action that a debtor holds pre-petition and are thus property of the bankruptcy estate that may be sold.[36] In concluding that a trustee may sell a preference action to an outside creditor or third party, the Fifth Circuit specifically noted that section 541(a)(1) is to be read broadly and that “conditional, future, speculative, or equitable nature[s] of an interest [do] not prevent it from being property of the bankruptcy estate.”[37] Applying that principle and adopting the Eighth Circuit’s reasoning, the court in South Coast Supply Company found that a debtor holds a sufficient interest in claims to avoid preferential transfers as of the commencement of the case to be included as estate property under section 541(a)(1).[38]
To support its conclusion further, the Fifth Circuit noted that the Bankruptcy Code captures causes of action as estate property.[39] It acknowledged, same as the Eighth Circuit did in Simply Essentials, that section 541(a)(1) includes as estate property any property “made available to the estate by other provisions of the Bankruptcy Code.”[40] The Fifth Circuit reasoned that (1) because the Bankruptcy Code captures causes of action that are made available by other provisions of the Code and that (2) because preference actions are created and lie solely within the Code itself, preference actions fit squarely within section 541(a)(1) and may be sold under section 363.[41]
Again, similar to the Eighth Circuit, the Fifth Circuit held that preference actions are also estate property under the reading of section 541(a)(7).[42] In justifying its conclusion, the court in South Coast Supply Company relied on its own precedent that explained section 541 to be an “all-embracing definition” that includes interests in property that are “created with or by property of the estate.”[43] Following this interpretation, the court held that because preference actions are clearly made available by the Bankruptcy Code after the commencement of the case, they are estate property under section 541(a)(7).[44]
Addressing policy concerns, the Fifth Circuit reiterated that the fundamental and core principle of bankruptcy is to maximize the value of assets and promote equal distribution.[45] To further those underlying policy goals, the court described a situation in which the estate may not have enough funds to pursue the action itself and explained that allowing the trustee to sell a preference action to a better-suited creditor would ultimately allow more flexibility for the bankruptcy court and can theoretically benefit all creditors.[46]
Bankruptcy practitioners, debtors, creditors, and trustees should all be aware of this recent development in preference actions. For a trustee, the ability to sell a preference action to a third party can drastically save valuable time and, in some instances, could inject more funds into the bankruptcy estate than would be if the trustee pursued the action himself.[47] For creditors, the opportunity to bid on preference actions allows them to use more discretion in determining whether they would be better served leaving the pursuit of preference actions in the trustee’s hands, or to take the action up on their own initiative. For practitioners, arguing that debtor’s hold an “inchoate or contingent” interest in preference actions pre-petition may provide the best argument that preference actions are property of the estate under section 541(a)(1). To establish that preference actions are estate property under section 541(a)(7), your best bet may be to follow the reasoning of the Fifth and Eighth Circuit and argue that the Bankruptcy Code itself makes preference actions available after the bankruptcy case commences which is sufficient to be estate property.
From a public policy standpoint, it makes perfect sense to allow a trustee to sell preference actions because doing so may substantially affect the efficiency in maximizing the value of the estate and distributing assets equally. On the other hand, a strict textualist may have a hard time coming to this conclusion given Congress has tasked a trustee with acting in a fiduciary capacity and has granted him with certain “powers” that state law fails to provide for. In sum, the push to allow trustees to sell preference actions has more positive consequences than negative and should continue to be analyzed.
[1] See Bankruptcy, U.S. Courts, https://www.uscourts.gov/services-forms/bankruptcy#:~:text=Businesses%20may%20file%20bankruptcy%20under,are%20filed%20under%20Chapter%2015 (last visited Mar. 29, 2024) (explaining who may be qualified for certain chapters under the Bankruptcy Code and how bankruptcy may provide benefits).
[2] See Chapter 7 – Bankruptcy Basics, U.S. Courts, https://www.uscourts.gov/services-forms/bankruptcy/bankruptcy-basics/chapter-7-bankruptcy-basics (last visited Mar. 29, 2024).
[3] Id.
[4] Id.
[5] Id.
[6] 11 U.S.C. § 541(a)(1).
[7] Chapter 7 – Bankruptcy Basics, supra note 2; see 11 U.S.C. § 363(b)(1) (“The trustee . . . may use, sell, or lease . . . property of the estate . . . .”).
[8] 11 U.S.C. 704(a)(1).
[9] See Mission Prod. Holdings, Inc. v. Tempnology, LLC, 139 S. Ct. 1652, 1663 (explaining that sections 544-553 make up a trustee’s avoidance powers).
[10] 11 U.S.C. § 547.
[11] Id.
[12] Id.
[13] Id. §§ 547, 550(a) (“[T]o the extent that a transfer is avoided under section . . . 547 . . . the trustee may recover, for the benefit of the estate, the property transferred . . . .”).
[14] See generally In re Sapolin Paints, Inc., 11 B.R. 930, 937 (Bankr. E.D.N.Y. 1981) (collecting cases).
[15] In re Bracewell, 454 F.3d 1234, 1237 (11th Cir. 2006) (“That mean the property of the debtor’s estate is property the debtor had when the bankruptcy case commences . . . .”).
[16] Butner v. United States, 440 U.S. 48, 55 (1979).
[17] Brendan Gage, Is There a Statutory Basis For Selling Avoidance Actions, 22 J. Bankr. L. & Prac. 3 Art. 1 (2013).
[18] Id.; In re Teleservices Grp., Inc., 463 B.R. 28, 34 (Bankr. W.D. Mich. 2012) (“Although the recovery of an avoided transfer certainly augments the estate, the trustee’s ability to actually avoid the transfer is not an interest acquired from the debtor, but rather a power that derives from the Code itself.”); In re McGuirk, 414 B.R. 878, 879 (N.D. Ga. 2009) (“A trustee’s avoidance powers, including those under Section[] 547 . . . are unique statutory powers . . . . Standing to assert actions under Section[] 547 . . . is limited to the trustee . . . .”); In re Sweetwater, 55 B.R. 724, 731 (D. Utah 1985) (“The avoiding powers are not ‘property’ but a statutorily created power to recover property.”).
[19] See, e.g., In re Moore, 608 F.3d 253, 257-58 (5th Cir. 2010); In re Parker, 499 F.3d 616, 624 (6th Cir. 2007); In re Lahijani, 325 B.R. 282, 287 (9th Cir. B.A.P 2005).
[20] See United States v. Nordic Village Inc., 503 U.S. 30, 37 (1992) (“[T]he right to recover a post-petition transfer under [section] 550 is clearly a ‘claim’ . . . and is ‘property of the estate’ [under section 541].”); Granfinanciera, S.A. v. Nordberg, 492 U.S. 33, 53-54 (explaining that fraudulent conveyance actions under section 548(a)(2) are statutory causes of action).
[21] In re S. Coast Supply Co., 91 F.4th 376, 385 (5th Cir. 2024); Pitman Farms v. ARKK Food Co. (In re Simply Essentials, LLC), 78 F.4th 1006, 1011 (8th Cir. 2023).
[22] 78 F.4th at 1011.
[23] Simply Essentials, 78 F.4th at 1008-09 (quoting United States v. Whiting Pools, Inc., 462 U.S. 198, 206 (1983)).
[24] Id. at 1009 (citing Segal v. Rochelle, 382 U.S. 375, 379 (1966)).
[25] Id. (“Because debtors have the right to file for bankruptcy . . . the debtor has an inchoate interest in the avoidance actions prior to the commencement of the bankruptcy proceedings. Therefore, avoidance actions are property of the estate under § 541(a)(1).”).
[26] Id. (“Even if we were to conclude the debtor does not have an interest in the avoidance actions prior to the commencement of the bankruptcy proceeding, the avoidance actions clearly qualify as property of the estate under subsection (7) . . . .”).
[27] 11 U.S.C. § 541(a)(7) (emphasis added).
[28] Simply Essentials, 78 F.4th at 1009.
[29] Id.
[30] Id. (“Section 541(a)(6) specifies that proceeds from property of the estate are included in property of the estate. . . . Additionally, other subsections of § 541(a) specify that property from some avoidance actions are property of the estate. . . . Therefore—according to Pitman Farms—if avoidance actions are property of the estate, the Bankruptcy Code would not have to specify the proceeds of such actions are property of the estate.”).
[31] Id. (citing Marx v. Gen. Revenue Corp., 568 U.S. 371, 385 (2013)).
[32] Id. at 1009-10.
[33] Id. at 1010.
[34] Simply Essentials, 78 F. 4th at 1010.
[35] Id. (“When an estate cannot afford to pursue avoidance actions, the best way to maximize the value of the estate is to sell the actions. Our interpretation of the Bankruptcy Code . . . is consistent with the congressional intent behind including a fiduciary duty to maximize the value of the estate.”).
[36] 91 F.4th at 382.
[37] S. Coast Supply Co., 91 F.4th at 382 (citing In re Kemp, 52 F.3d 546, 550 (5th Cir. 1995)).
[38] Id. (citing Simply Essentials, 78 F.4th at 1006).
[39] Id. (citing In re Equinox Oil Co., 300 F.3d 614, 618 (5th Cir. 2002)).
[40] Id. at 381 (citing Whiting Pools, 462 U.S. at 205); Simply Essentials, 78 F.4th at 1008.
[41] Id. at 382.
[42] Id.
[43] S. Coast Supply Co., 91 F.4th at 382 (citing In re TMT Procurement Corp., 764 F.3d 512, 525 (5th Cir. 2014)).
[44] Id.
[45] Id. at 384 (“[B]ankruptcy courts must ensure that fundamental bankruptcy policies of asset value maximization and equal distribution are satisfied.”).
[46] Id.
[47] See id. (describing a situation where the estate was maximized by a preference action sale).
American Journal of Trial Advocacy 