Chapter 11 plans frequently include provisions establishing liquidating trusts or litigation trusts, which authorize a plan trustee to litigate unresolved claims after confirmation. This practice is expressly authorized by §1123(b)(3) of the Bankruptcy Code, which allows a "representative of the estate" to enforce any "claim...belonging to the debtor."

In the past, numerous courts have construed §1123(b)(3) to authorize a plan trustee to exercise one or more of the statutory avoidance powers granted to a bankruptcy trustee. However, the Supreme Court's determination that the phrase "the trustee may" in §506(c) of the Bankruptcy Code meant "only the trustee may" in Hartford Underwriters Insurance Company v. Union Planters Bank N.A., 120 S. Ct. 1942, 530 U.S. 1, 147 L. Ed. 2d 1 (2000), together with the Third Circuit's decision in In re Cybergenics Corp., 226 F.2d 237 (3rd Cir. 2000),¹ determining that avoidance powers are not assets owned by a debtor, call into question the assumptions underlying the earlier decisions allowing plan trustees to exercise avoidance powers after confirmation.

Hartford Underwriters

Hartford Underwriters requires that the operative phrase "the trustee may," which is included in each of the avoidance powers available under §§544, 547, 548, 549 and 550, be construed as a limitation on who can exercise those powers. The same rules of statutory construction also dictate that a court consider the framework of the Code and the language of §1123(b)(3) before assuming that the statutory avoidance powers available to a bankruptcy trustee are also "claims" "belonging to the debtor" that can be retained and enforced by a "representative of the estate" under a confirmed chapter 11 plan.

In Hartford Underwriters, the Supreme Court explained Congress's intent in selecting the phrase "the trustee may" in §506, as follows:

Here, the statute appears quite plain in specifying who may use §506(c)—the trustee. It is true, however, as [the] petitioner noted, that all this actually "says" is that the trustee may seek recovery under the section, not that others may not. The question thus becomes whether it is a proper inference that the trustee is the only party empowered to invoke the provisions (footnote omitted). We have little difficulty answering yes.

120 S.Ct. at 1947.

The Supreme Court limited the scope of its decision² to not address the validity of the practice of "derivative standing," by which some bankruptcy courts have permitted creditors or committees to bring avoidance actions during bankruptcy cases on behalf of the debtor's estate. Nevertheless, the limiting effect of the phrase "the trustee may" should apply to each of the Code's statutory avoidance powers, because when "a statute authorizes specific action and designates a particular party empowered to take it, [it] is surely among the least appropriate in which to presume nonexclusivity," and "the fact that the sole party named—the trustee—has a unique role in bankruptcy proceedings makes it entirely plausible that Congress would provide a power to him and not to others." Id.

Drawing a contrast to other Code sections, the Supreme Court recognized that where Congress intended that a provision of the Bankruptcy Code could be enforced by several persons, it made that intention clear. "Section 502(a), for example, provides that a claim is allowed unless a party in interest objects, and §503(b)(4) allows an entity to file a request for administrative expense." Id. at 1948. The Court found that "the broad phrasing of these sections, when contrasted with the use of 'the trustee' in §506(c), supports the conclusion that entities other than the trustee are not entitled to use §506(c)." Id. at 1948.

The Hartford Underwriters court also considered whether the broad catch-all provision of §1109 might provide a basis for someone other than a trustee to recover under §506(c). Although it found §1109 inapplicable because the case had been converted to chapter 7, the court stated that "[i]n any event, we do not read §1109(b)'s general provision of a right to be heard as broadly allowing a creditor to pursue substantive remedies that other Code provisions make available to other specific parties." Id. at 1948.

Although decided before Hartford Underwriters, the district court for the Middle District of Florida adopted a similar construction of "the trustee may" phrase, when it held that a bankruptcy court may not authorize an individual creditor to pursue on behalf of a chapter 7 estate, a fraudulent conveyance claim under §548. Surf N Sun Apts. Inc. v. Dempsey, 253 B.R. 490 (M.D. Fla. 1999):

Congress's demonstrated willingness and ability to expressly vest creditors with various rights and powers in other Code sections compels the conclusion that §548's silence as to creditors was intentional rather than accidental. The plain meaning of §548 is obvious: "the chapter 7 trustee has standing to pursue the action to the exclusion of all other affected parties, including creditors either individually or as a group." In re Adam Furniture Indus., 191 B.R. 249, 253 (Bankr. S.D. Ga. 1996). In light of §548's plain and unambiguous language, this court's sole function is to enforce it according to its terms. Consequently, the court holds that the bankruptcy court erred as a matter of law in granting Dempsey standing to prosecute a fraudulent transfer action on behalf of the chapter 7 bankruptcy estate. (citation omitted). That power belongs to the bankruptcy trustee alone.

Id. at 493-94.

Based on this reasoning, the Surf N Sun court held that "the bankruptcy court may not...unilaterally confer standing upon the creditor to pursue the claim itself. If such authority is to be granted, it must come from Congress and not the courts." Id. at 494-95.

The Retention of Claims by a Representative of the Estate After Confirmation

The statutory construction mandated by the Hartford Underwriters decision requires some statutory authorization for the transfer of a trustee's avoidance power to a private party, to be exercised after confirmation. Reorganization plans that create liquidating trusts or litigation trusts to pursue claims on behalf of the debtor's estate post-confirmation have successfully relied on §1123(b)(3) in the past. In relevant part, §1123(b)(3) says that the contents of a plan may provide for:

(A) Settlement or adjustment of any claim or interest belonging to the debtor or to the estate; or
(B) The retention and enforcement by the debtor, by the trustee, or by a representative of the estate appointed for such purpose, of any such claim or interest.

Several courts have construed these provisions to authorize a plan to provide that a trustee's avoidance powers will be retained and enforced by a representative of the estate after confirmation. McFarland v. Leyh (In the Matter of Texas General Petroleum Corp., 52 F.3d 1330 (5th Cir. 1995). See, e.g., Citicorp Acceptance Co. v. Robinson (In re Sweetwater), 884 F.2d 1323, 1327 (10th Cir. 1989); Nordberg v. Sanchez (In re Chase & Sanborn Corp.), 813 F.2d 1177, 1180 (11th Cir. 1987); In re Kroh Bros. Development Co., 101 B.R. 1000, 1005 (W.D. Mo. 1989). However, these courts did not have the benefit of the Hartford Underwriters decision. Furthermore, the analysis of these courts focused on who would benefit from an avoidance recovery, and whether avoidance powers may be considered "claims," but these decisions devote little if any attention to the question of whether avoidance powers ever "belong" to a debtor. Upon closer examination, as discussed more fully below, it appears that the avoidance powers are simply not claims belonging to a debtor, and therefore no section of the Code authorizes a plan trustee to exercise such powers after confirmation.

Do Avoidance Powers Belong to the Debtor?

Recent decisions in slightly different contexts have cast some light on these questions. For example, in Stangel v. United States, 219 F.3d 498 (5th Cir. 2000), the Fifth Circuit applied the Hartford Underwriters analysis of the phrase "the trustee may" to a chapter 13 debtor's attempt to avoid a tax lien under §545. The court determined that only the trustee in a chapter 13 case had standing to exercise this power. The court had no difficulty reaching this conclusion, noting that the only avoidance power granted a debtor is the power under §522 to avoid certain transfers related to exempt property, and that the catchall provisions of §1303, which authorize a chapter 13 debtor to exercise certain powers of the trustee, did not include authority to assert any other avoidance powers.

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...Congress gave only limited avoidance powers to debtors—the ability to avoid liens impairing exempt property under §522.

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Looking at this issue from a different perspective, in Cybergenics I, the Third Circuit considered whether statutory avoidance powers are assets owned by a debtor. There, the bankruptcy court had authorized the sale of substantially all of the debtor's assets to a third party prior to confirmation of a plan. After the sale, the creditors' committee demanded that the debtor-in-possession (DIP) bring a fraudulent transfer action against participants of a pre-petition leveraged buyout. After the DIP refused, the bankruptcy court authorized the committee to prosecute the action. In an appeal of that decision to the district court, the defendants successfully argued that the DIP no longer owned the claim because it had been included in the "all assets" sale. To resolve the appeal of the district court's decision, the Third Circuit explained that it had to decide whether "fraudulent transfer claims...[were] assets of Cybergenics." 226 F.2d at 240.

The Third Circuit described §548 as a "legal fiction" that enables a trustee or DIP to bring certain causes of action that actually belong to its creditors in order to recover property on behalf of the bankruptcy estate:

The fact that §544(b) authorizes a DIP, such as Cybergenics, to avoid a transfer using a creditor's fraudulent transfer action does not mean that the fraudulent action is actually an asset of the DIP, nor should it be confused with the separate authority of a trustee or a DIP to pursue the pre-petition debtor's causes of action that became property of the estate upon the filing of the bankruptcy petition. (citation omitted). Rather, it simply enables a DIP to carry out its trustee-related duties.

Id. at 243. Based on this analysis, the court concluded that the prior sale of all of the debtor's assets had not included a sale of the power to avoid fraudulent transfers because that was never an asset of the debtor or its estate, and reversed the dismissal of the committee's complaint. Id. at 245.

Nothing in the Code suggests that the authority granted to a DIP to exercise the "powers" of the trustee under §1107(a) transforms those powers into the equivalent of a "claim...belonging to the debtor or estate," so that a "representative of the estate...[may enforce] such claim" under §1123(b)(3). Congress's careful selection of different terms in each of the applicable Code sections suggests otherwise.

Tellingly, the broad definition of "claim" in §101(5) does not include a reference to the statutory avoidance powers of the Code, although as noted above, some courts have held otherwise. See In re Sweetwater, 884 F.2d 1323, 1327 (10th Cir. 1989) (broad definition of claim includes the estate's right to payment under §§547, 549, 553 and 544). While the definition of "property of the estate" does include all "legal or equitable interests of the debtor in property as of the commencement date," this should not, as the Cybergenics I court concluded, include the avoidance powers granted to a trustee. This conclusion is also supported by §541(a)(3), which further defines "property of the estate" to include "any interest in property that the trustee recovers under §329(b), 363(n), 543, 550, 553 or 723 of this title." The omission of a reference to the trustee's statutory avoidance powers in this subsection indicates that those powers are not property of the estate.

Perhaps more important, §1123(b)(3) allows the retention of claims or interests "belonging to the debtor." Congress granted several avoidance powers to the bankruptcy trustee and authorized a DIP to exercise such powers under §1107(a). But as noted above, Congress gave only limited avoidance powers to debtors—the ability to avoid liens impairing exempt property under §522.

Only a Trustee or DIP May Bring Avoidance Actions

Under the analysis required by Hartford Underwriters, where Congress has identified a specific party authorized to assert specific powers in one section of the Code and not in others, it must be presumed that Congress intended a different meaning. Thus, the phrase that allows the retention of any "claim or interest belonging to the debtor or the estate" to be enforced by a representative of the estate in §1123(b)(3) should not be treated as the equivalent of a grant of the statutory avoidance powers otherwise available only to the trustee and a DIP. Having consistently granted these avoidance and recovery powers only to the trustee in all but one section of the Bankruptcy Code, it may become much more difficult to persuade a court that Congress also intended that these avoidance powers be lumped into the catch-all phrase "claim or interest belonging to the debtor or the estate" under §1123(b)(3). In fact, such a result may be particularly difficult for a plan that purports to transfer these statutory avoidance powers to an essentially private liquidation trust, created by private parties and subject to few if any of the limitations Congress imposes on a real bankruptcy trustee during a case. Accordingly, if the ability to exercise avoidance powers post-confirmation is a crucial element of a chapter 11 plan, practitioners had better think twice about the impact of Hartford Underwriters before assuming a plan liquidating trustee can do the job.

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Footnotes

¹ In re Cybergenics Corp., 226 F. 2d 237 (3rd Cir. 2000), is not the vacated decision. The subsequent decision in this adversary after remand In re Cybergenics Corp., 304 F.2d 316 (3rd Cir. 2002), has been vacated pending review en banc. To avoid confusion, the earlier decision will be referred to as Cybergenics I, and the later vacated decision, which dealt with the issue of a committee's "derivative standing" to prosecute avoidance actions, will be referred to as Cybergenics II). The argument advanced here does not depend on the outcome of the review of Cybergenics II. Return to article

² "We do not address whether a bankruptcy court can allow other interested parties to act in the trustee's stead in pursuing recovery under §506(c). Amici American Insurance Association and National Union Fire Insurance Co. draw our attention to the practice of some courts of allowing creditors or creditors' committees a derivative right to bring avoidance actions when the trustee refuses to do so, even though the applicable Code provisions (see 11 U.S.C. §§544, 545, 547(b), 548(a) and 549(a)) mention only the trustee. See, e.g., In re Gibson Group Inc., 66 F.3d 1436, 1438 (6th Cir. 1995). Whatever the validity of that practice, it has no analogous application here, since the petitioner did not ask the trustee to pursue payment under §506(c) and did not seek permission from the bankruptcy court to take such action in the trustee's stead. The petitioner asserted an independent right to use §506(c), which is what we reject today. Cf. In re Xonics Photochemical Inc., 841 F.2d 198, 202-03 (C.A. 7 1988) (holding that creditor had no right to bring avoidance action independently, but noting that it might have been able to seek to bring derivative suit)." Id. at 1951 n.5. Return to article