Debtor’s Bankruptcy Filing Serves to Limit Creditor’s Liability to Third Parties

By: Ryan Dolan

St. John’s Law Student

American Bankruptcy Institute Law Review Staff

        In Ritchie Capital Structure Management Trading, LTD., v. General Electric Capital Corporation, the United States Court of Appeals for the Second Circuit held that investors in a debtor’s Ponzi scheme did not have standing to sue the debtor’s lender.^[1]

        Ritchie Capital, the plaintiffs, sued General Electric Capital Corporation (“GECC”), for aiding and abetting fraud, civil conspiracy to commit fraud, and negligence for GECC’s involvement in a Ponzi scheme orchestrated by Thomas Petters (“Petters”).^[2] The Ponzi scheme, in which Petters obtained private investments for the purpose of purchasing electronics to sell to larger companies such as Costco, first affected GECC in 1998.^[3] In 1998, GECC agreed to supply Petters with a line of credit. Eventually, Petters owed GECC $45 million.^[4] Upon GECC’s request, Costco informed GECC’s president that Costco did not make certain purchase orders that Petters previously provided to GECC as evidence of Petters’ business relationship with Costco.^[5] Thereafter, Petters and the president of GECC entered into an agreement, pursuant to which Petters was granted an extension of time to repay GECC.^[6] Petters eventually paid GECC back by securing other third party loans based off of the fraudulent purchase orders used to obtain the loan from GECC. Ritchie Capital alleges that GECC knew about Petters’ fraud, but kept silent, knowing that the only way to recover their investment was to allow Petters to continue in such types of dealings.^[7] In 2008, Petters fraudulently induced loans from Ritchie Capital, which caused Ritchie Capital to lose $157 million.^[8] Ritchie Capital then alleged that GECC’s knowledge of the fraudulent scheme and failure to report it to the authorities amounted to negligence and a direct cause of Ritchie Capital’s lost funds.^[9] The district court dismissed the case holding that Petters had already declared bankruptcy and therefore Ritchie Capital did not have standing to bring the suit.^[10]

        On appeal, the Second Circuit adopting the district court’s analysis held that Ritchie Capital did not have standing to pursue the claims against GECC.  According to the Second Circuit (and the district court), Ritchie Capital’s allegations were general claims and therefore property of  Petters’ estate. Under 11 U.S.C. §541(a)(1), “property of the estate” is defined as “all legal or equitable interests of the debtor in property as of the commencement of the case.”^[11] The Second Circuit noted that this does not establish all actions as the right of the estate, but clarified that “If a claim is a general one, with no particularized injury arising from it, and if that claim could be brought by any creditor of the debtor, the trustee is the proper person to assert the claim, and the creditors are bound by the outcome of the trustee’s action.”^[12] Here, according to the courts, there was no particularized injury to Ritchie Capital. Rather, the injuries Ritchie Capital allegedly suffered at the hands of GECC were generalized among all of Petters’ creditors and Ritchie Capital never had any direct contact or dealings with GECC.^[13] Indeed, the trustee of Petters’ estate had already brought suit against GECC, which had been settled and approved by the Bankruptcy Court in Minnesota.^[14]

        The Second Circuit’s decision promotes judicial efficiency and the need to bring suits when they are first available. Because Ritchie Capital waited until Petters declared bankruptcy, they lost their standing to bring an individual suit and were lumped together with the general debtors. This decision effectively limits the liability that creditors are open to once bankruptcy is declared.