Non-Debtors Are Not The Correct Party To Bring Preference Actions

09/30/13

Summary

In a 14 page decision signed September 30, 2013, Judge Walsh of the Delaware Bankruptcy Court provided a primer on one of the limitations of standing provided in the bankruptcy code in his opinion granting a motion to dismiss.  Judge Walsh’s opinion is available here (the “Opinion”).

Background

On May 21, 2004, the Circuit Court for Montgomery County, Maryland entered four separate judgments pursuant to a civil action against Richard and Graciela Redden (“Debtors”).  All four judgments were transferred on July 15, 2004 to the Superior Court of Delaware in New Castle County, at which time they became judgment liens against the primary residence of Debtors.

On August 12, 2004, the Debtors filed a joint Chapter 7 bankruptcy petition.  The order of discharge was entered on September 2, 2005.  Their case was reopened and they filed a complaint to avoid and recover a preferential transfer from one of the four judgment creditors.  The Court granted the Debtors motion to avoid the judgment lien and the case was again closed on October 29, 2006.  The other three judgment liens remained outstanding.

On November 3, 2009, the Debtors conveyed their residence to the plaintiffs in this case (“Plaintiffs”).  After the three remaining judgment creditors informed the plaintiffs of their intent to foreclose on the property, the Plaintiffs filed a motion to reopen the bankruptcy case and filed a complaint to avoid the three remaining liens.  The case was reopened and the judgment lien holders filed a motion to dismiss the adversary complaint.  Judge Walsh issued his opinion and order granting the motion to dismiss.

Judge Walsh’s Opinion

In granting the motion to dismiss, Judge Walsh provided direction concerning the Plaintiffs’ standing to avoid a preferential transaction and the statute of limitations for preference actions.

Standing

Judge Walsh begins his analysis of the Plaintiffs’ standing by reviewing §§ 522 and 547 of the Bankruptcy Code.  These sections provide the Trustee and Debtor in a bankruptcy standing to bring an adversary case to avoid preferential transfers.  Judge Walsh cites Hartford Underwriters Ins. Co. v. Union Planters Bank, 530 U.S. 1, 7 (2000), in which the Supreme Court considers the exclusivity implied by similar language in § 506 of the Bankruptcy Code.  Opinion at *5.  Judge Walsh states that “[t]he rights given explicitly to the trustee in § 547(b) preclude Plaintiffs, as non-trustees, from exercising avoidance power.”

Judge Walsh then considered whether the Plaintiffs might have derivative standing to pursue their preference claim.  He cited to the Third Circuit’s extensive analysis of derivative standing in The Official Comm. of Unsecured Creditors of Cybergenics Corp. v. Chinery (Cybergenics II), 330 F.3d 548, 558 (3d Cir. 2003).  In that case, The Third Circuit focused on the distinction between a suit to benefit the estate and a suit initiated for the moving party’s “own direct benefit.”  Opinion at *7-8.  In the instant case, however, Judge Walsh notes that the Plaintiffs’ complaint could have no possible effect on the bankruptcy estate, and thus determined this argument was not relevant for the Plaintiffs.

Statute of Limitations

Judge Walsh next considered the statute of limitations for preference actions.  11 U.S.C § 546(a) provides that an action to avoid a preference payment may not be commenced after the earlier of:

(1) the later of –

(A) 2 years after the entry of the order for relief; or

(B) 1 year after the appointment or election of the first trustee under section 702, 1104, 1163, 1202, or 1302 of this title if such appointment or such election occurs before the expiration of the period specified in subparagraph (A); or

(2) the time the case is closed or dismissed.

The Court quickly determines that the statute of limitations had long passed in this case.  Judge Walsh then examined the Plaintiffs’ request that the complaint relate-back to the preference action filed by the Debtor in 2006.  However, this complaint was not an amendment, and thus the relation-back doctrine was inapplicable.  Opinion at *12.

The Plaintiffs’ last argument was that the Court should equitably toll the statute of limitation.  However, the Plaintiffs did not explain why they waited three years from the purchase of the property to file their action.  Thus, a claim of equitable tolling was not supported.  Opinion at *14.  Judge Walsh also notes that a title search would have revealed the three lien claims.  Since the remedy of equitable tolling “is lost upon a lack of showing of diligence to preserve a claim” the Plaintiffs “cannot support a claim of equable [sic] tolling in their favor.” Opinion at *14.

 

In this era of computers and organized records, it is more important than ever to do your due diligence before purchasing a major asset, like property.  The Plaintiffs who filed this complaint would have been better served if they had hired an attorney before buying the property.  As any estate attorney I have spoken with will confirm, it is far less expensive and much more pleasant to prepare for the possible risks than it is to try and fix a deal after the fact.

John Bird practices with the law firm Fox Rothschild LLP in Wilmington, Delaware.  You can reach John at 302-622-4263, or [email protected].

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