Loeffler – Avoidance Actions Left to Sound Discretion of Trustee

By Michael Wennerlund, Law Clerk at The White Law Firm, Nashville, TN

Author: Michael Wennerlund

In re Loeffler, 2011 WL 6736066 (Bankr.D.Colo, Dec. 21, 2011) (Tallman)

In order to satisfy the requirements of the “best interest of creditors” test of §1325(a)(4), Debtor’s plan needs to do no more than provide that the net proceeds from any potential recoveries under §§ 544, 547, and 548, must be paid out to creditors.  The decision of whether to pursue such recoveries rests solely within the sound discretion of the Trustee.  Except for actions to avoid the transfer of exempt property under § 522(h), avoidance actions are not under the control of the debtor.

Case Summary

Debtor, as of April 1, 2007, was the owner of an entity that owned and operated a Japanese restaurant (“Entity”).  On or around this same day, Debtor transferred her stock in Entity to her daughter, with consideration of $300,000.00 payable without interest at a rate of $4,000.00 per month until fully paid.  On April 15, 2007, Creditor (Wells Fargo) obtained a judgment against Debtor in the amount of $174,763.29.  The judgment constituted a lien on Debtor’s real property on which Debtor’s residence was located.  Just prior to the petition date, approximately $150,000 remained owing to the Debtor with respect to the initial sale of the stock in the Entity.  On the eve of bankruptcy filing, the Debtor, Entity, and Debtor’s daughter signed an amendment to the original agreement in November 2010 regarding the stock sale in the Entity.  The amendment made vague references to the Entity’s financial difficulties and it forgave the remaining debt to the Debtor.  In return, the Entity employed the Debtor as a manager at the rate of $3,000.00 per month.

Upon the second motion to confirm Debtor’s plan, Creditor made, inter alia, two arguments: (1) Debtor failed to satisfy the “best interest of creditors” test under §1325(a)(4) by failing to fully account for the estate’s $150,000.00 fraudulent conveyance action and to provide payment of that amount to creditors under her plan; and (2) Debtor failed to satisfy the “best interest of creditors” test by failing to characterize the original stock sale agreement as a fraudulent transfer.

In respect to both of Creditor’s arguments, the bankruptcy court held that in order to satisfy the requirements of the best interests test, Debtor’s plan must provide that any net recovery on the fraudulent conveyance action must be distributed to creditors; however, satisfaction of the best interests test does not require the Debtor herself to personally fund distribution to creditors of the hypothetical value of any such recovery.  A debtor in a chapter 13 case, unlike a debtor-in-possession in chapter 11, exercises no control over avoidance actions of the kind described in §§ 544, 547, and 548.  After performing some comparative statutory interpretation between §1303, §1107, and §1203, the court concluded that with the absence of debtor authority in §1303 to pursue recoveries under §§ 544, 547, or 548, Congress did not intend to give chapter 13 debtors those powers.

In distinguishing between causes of action belonging to the debtor prior to the petition date and trustee avoidance actions, the court held that an avoidance action under the Code only arises upon the filing of a bankruptcy estate—i.e., to the extent that a recovery action has any value, it is value created by the filing of the bankruptcy case.  Under § 541(a)(3), property that is the subject of a trustee recovery under §§ 544, 547, or 548 only becomes property of the estate if and when the trustee recovers it: “[N]o matter how compelling the case appears, a transfer is not a fraudulent conveyance until it is adjudicated as such.  Proceeds of such avoidance actions do not become estate property until actually recovered by the trustee.”

The court denied confirmation to Debtor’s plan because it failed to adequately deal with the two potential avoidance actions: “Debtor’s plan does not provide for the eventuality of an action to recovery a fraudulent conveyance.  Whether or not to pursue such an action is a matter left to the sound discretion of the trustee.  The Debtor may not limit that discretion by a provision of her plan but, by the same token, she need not promise a payout over which she exerts no control.”

What this Case Means to Debtor’s Counsel

Simply put, as long as Debtor’s Counsel proposes a plan in good faith (under §1325(a)(3)) which provides that any recovery received upon an avoidance action—in this case, a fraudulent conveyance action—shall be paid out to the creditors of the estate, the plan should be confirmed absent any other deficiencies that may arise in the plan.  As Loeffler made abundantly clear, the Debtor is under no duty to personally fund distribution to creditors of the hypothetical value of any such recovery.  Such distribution, not surprisingly, is completely within the purview of the plan, and only when the Trustee chooses to pursue such action and recovers for the estate.

What this Case Means to Creditors

Loeffler places creditors in what would appear to be between a rock and a hard place.  Debtors have no affirmative duty to pursue a fraudulent conveyance action, and circuits are split on the question of whether a chapter 13 debtor even has the authority to pursue such recoveries.  On the other hand, the decision of whether to pursue such action rests within “the sound discretion” of the Trustee.  Thus, creditors appear to have no independent authority to pursue such actions to potentially maximize distribution under any give plan.  However, there is recent authority that a court may grant a creditor “derivative standing” to pursue an avoidance action that a trustee declines to pursue within the context of chapter 7 proceedings.  See, e.g., Hyundai Translead, Inc. v. Jackson Truck & Trailer Repair, Inc. (In re Trailer Source, Inc.), 555 F.3d 231 (6th Cir. 2009).  Whether such “derivative standing” exists in the context of a chapter 13 proceeding is yet to be adjudicated.  Nevertheless, the main holding of this case—that the decision to pursue avoidance actions that would potentially increase the total amount of estate assets to distribute to creditors rests solely within the “sound discretion” of the Trustee—is mitigated by the fact that Trustees more than likely are not going to deliberately pass up a good opportunity to increase estate assets.  However, creditors need to be aware that the Trustee is not under an absolute duty to pursue such actions when they present themselves.

What this Case Means to Trustees

As Loeffler plainly holds, the decision of “[w]hether or not to pursue [avoidance actions] is a matter left to the sound discretion of the trustee.”  While it would certainly be advantageous for any trustee to pursue avoidance actions likely to net a recovery for the estate, they are not under any affirmative obligation to do so.  While facially this may seem like a harsh result for creditors, the ability and discretion of a chapter 13 trustee to evaluate any potential avoidance actions without external pressures is necessary to the fluid operation of chapter 13 bankruptcy cases.  Without such discretion, the courts more than likely would be clogged—needlessly so, more often than not—with motions/adversarial proceedings attempting to add as many assets as possible to the estate before confirmation notwithstanding the relative utility in doing so.  Giving the trustee the sole discretion in such matters removes this possibility.

Michael N. Wennerlund is a May 2012 graduate of The Nashville School of Law.  He was the winner of the 2010-2011 NACTT National Law School Writing Competition.  When not searching for future employment in the legal field, he is studying for the July 2012 bar exam.

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