11th Circuit – Creditor Cannot Pursue Pre-Petition Fraudulent Transf...

In SuVicMon Development, Inc. v. Morrison, __ F.3d __, 2021 WL 1136546 (11th Cir. March 25, 2021) (click here for .pdf), the plaintiffs are three corporations that sued the Debtor for fraud and securities violations in state court. Plaintiffs subsequently amended the complaint to include fraudulent transfer claims against Debtor and his two sons. Debtor then filed a Chapter 7 petition, and the Bankruptcy Court lift the automatic stay so the state court case could proceed to liquidation of the claims. A judgment was entered against Debtor on some claims and they were excepted from Debtor’s general discharge. Nevertheless, the Plaintiffs sought to continue the fraudulent transfer claims against the Debtor.

The first argument of Plaintiffs was that the suit was an action to collect the non-dischargeable debt (the securities fraud judgment), and because the debt was non-dischargeable the discharge injunction of 11 U.S.C. §524(a)(2) did not  apply. The Circuit Panel disagreed.

The plaintiffs’ argument is incorrect. The reason is that a fraudulent transfer action is “not a mere ‘collection action,’ ”but “rather a claim that requires an independent adjudication of liability based on statutorily-defined elements.” Under the AUFTA, a creditor has a fraudulent transfer claim against a debtor for actual fraud whenever “the debtor made the transfer with actual intent to hinder, delay, or defraud any creditor of the debtor.”…  A fraudulent transfer can also be found on the basis of constructive fraud, typically when the debtor makes the transfer without receiving “reasonably equivalent value,” under certain circumstances specified in the statute… Fraudulent transfer is a distinct cause of action, and, at least in the case of actual fraud, a tort…

The distinctness of a fraudulent transfer action is shown most clearly by the availability of damages specific to that action. While the remedy for fraudulent transfer may be avoidance of the transfer or execution directly on the transferred asset, see Ala. Code § 8-9A-7(a)(1), (b), under Alabama law it appears that a fraudulent transfer can in some instances result in an award of compensatory damages in addition to the value of the creditor’s underlying claim… It also appears that punitive damages may be available, at least in instances of actual fraud…  The plaintiffs’ reasoning, accordingly, fails to distinguish between the different potential debts involved in this case…

A fraudulent transfer action differs in this respect from execution on a judgment. Modes of execution and associated proceedings, such as writs of execution, attachment, judgment liens, and garnishment, do not constitute a new claim against the debtor or give rise to a new debt distinct from the judgment being executed. The reason for this, however, is that execution and associated proceedings are unlike ordinary causes of
action against the debtor; they mostly are not causes of action at all. Because execution proceedings are ancillary to the prior judgment … they do not require any allegation of wrongdoing but are instead based simply on an executable judgment and the identification of property appropriately subject to execution. Modes of execution are generally in rem, in the sense that they “confer a property interest on the judgment creditor that satisfies the judgment”… Garnishment, by which a creditor may obtain property of the debtor or money due to the debtor from a third party, has been described as quasi in rem:… it typically both gives the creditor a lien on the property… and constitutes an action brought in personam against the garnishee. Another exceptional case is that of an action to enforce a foreign judgment, which is brought in personam against the debtor, but does not depend on any conduct of the debtor and merely makes the judgment effective and executable in the forum jurisdiction…  A fraudulent transfer action is not an execution proceeding, and thus is not a ‘collection action’ in any sense helpful to the plaintiffs’ argument. Fraudulent transfer is a cause of action which can be brought against the debtor in personam…

The plaintiffs’ first argument, then, is unsuccessful: a fraudulent transfer action does not function as an execution proceeding, and the fact that the underlying claim is non-dischargeable does not compel the conclusion that the fraudulent transfer claim is non-dischargeable.

(Several citations omitted).

“The plaintiffs’ second argument is that they should be allowed to proceed nominally against Morrison in order to seek recovery from his sons, the transferees, under the doctrine of In re Jet Florida (883 F.2d. 970 (11th Cir. 1989)).  In Jet Florida, the 11th Circuit held that the holder of a discharged claim could proceed nominally against the debtor for purposes of recovering the claim from the debtor’s insurer.  The Panel, again, disagreed with the Plaintiffs.

We interpret In re Jet Florida as imposing two requirements that must be satisfied before a plaintiff may proceed nominally against a discharged debtor in order to recover from a third party. First, the debtor’s status as a defendant in the case must be a genuine prerequisite to the plaintiff’s recovering from the third party: it must be the case that the plaintiff could not meet the legal conditions for such recovery without suing the debtor. Second, it must be sufficiently certain that maintaining suit against the debtor will not place any economic burden on the debtor, such that the debtor’s fresh start will not be interfered with.

Because this case is the first one in which this Court has reviewed a decision arising under the In re Jet Florida doctrine, we have not previously had occasion to decide the proper standard of review for such cases. We hold that a bankruptcy court’s decision whether to permit suit against a debtor under this doctrine is to be reviewed for abuse of discretion. The reason is that the bankruptcy court’s determination with regard to the second In re Jet Florida requirement—avoidance of economic burden on the debtor— must be taken to be discretionary.

There are a number of grounds for this conclusion. First, a plaintiff requesting leave to maintain suit against the debtor in a nominal capacity is seeking what is at least effectively a modification of the discharge injunction…There are a number of grounds for this conclusion. First, a plaintiff requesting leave to maintain suit against the debtor in a nominal capacity is seeking what is at least effectively a modification of the discharge injunction “longstanding interpretive principle” that “[w]hen a statutory term is obviously transplanted from another legal source, it brings the old soil with it.” … Likewise, in this case, the same interpretive principle would suggest that a decision which has the effect of modifying the discharge injunction should be subject to abuse of discretion review, as has customarily been the case with decisions regarding injunctions. In addition, a decision to permit suit against the debtor under In re Jet Florida is functionally analogous to a decision to grant relief from the automatic stay, which is also reviewed for abuse of discretion…

Second, the bankruptcy court’s determination as to whether it is sufficiently certain that the maintenance of suit will not place an economic burden on the debtor rests largely on questions of fact and involves the kind of case-specific inquiry that often calls for trial-court discretion… The court may need to consider such factors as the kind of third party from which the plaintiff wishes to recover (whether an insurer or some other party) and the financial condition of the debtor, as well as potential economic burdens other than the cost of obtaining defense counsel, such as court costs and the possibility that needing to stand trial might cause a debtor to lose his or her employment… Finally, “exceptions to the general rule of discharge … are to be strictly construed in favor of the debtor.”

We now proceed to explain that, in the case at bar, the bankruptcy court did not abuse its discretion in denying the plaintiffs’ request for permission to maintain suit against [Debtor] under In re Jet Florida. The plaintiffs did not satisfy the prerequisite requirement and thus were not eligible for such permission as a matter of law. Furthermore, the bankruptcy court properly exercised its discretion in determining that the proposed litigation could impose economic burdens on Morrison and hence did not meet the second In re Jet Florida requirement.

Based on the above facts (and authority cited by the Court), the Eleventh Circuit affirmed the decisions of the Bankruptcy and District Courts.

Scott Riddle’s practice focuses on bankruptcy and reorganization. Scott has represented businesses and other parties in Chapter 11 cases for almost 30 years.  You can contact Scott at 404-815-0164 or [email protected].  For more information, click here.