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Pirates and Plunderers Beware: Third Circuit Clarifies Bankruptcy Standing to Allow Creditor to Sue Alleged Plunderers of Corporate Debtor


The Business Advisor

Summer 2020

The United States Court of Appeals ruled on August 4, 2020 in a published opinion that a creditor to a defunct Pennsylvania business retained the right to pursue legal claims for damages it alleges is owed to it even after a chapter 7 bankruptcy trustee refused to pursue the matter on behalf of the debtor’s estate. [In re Wilton Aretale, Inc., __ F.3d __; 2020 WL 4460000 (3d Cir. Aug. 4, 2020)]. The decision is an important one for creditors of bankrupt companies who want to bring their own causes of action related to improper dissipation or distribution of corporate assets in those situations where the bankruptcy trustee refuses to act on such claims. The pertinent facts are as follows.

Artesanias Hacienda Real S.A. de C.V. (“AHR”) filed a complaint against Wilton Armetale, Inc. (“Wilton” or the “Debtor”) and its sole shareholder, director, and officer, Ivan Jeffery, seeking a money judgment for goods it sold to Wilton for which it had not been paid. Ultimately, the court entered summary judgment in favor of AHR and against Wilton in the amount of $900,658.17, plus prejudgment interest. Shortly thereafter, the court entered summary judgment in favor of AHR and against Jeffery in the amount of $900,658.17, plus interest, and ordered Jeffery to deliver to AHR’s counsel all shares of stock in Wilton. AHR recorded the summary judgment order with the Lancaster County Prothonotary as a judgment lien against Wilton’s Mt. Joy real estate. Per the court’s order, Jeffery delivered his Wilton shares to AHR’s affiliate, following which the affiliate terminated Jeffery’s positions with the company, installed new management, and contacted Leisawitz Heller – counsel to both Wilton and Jeffery – to waive attorney client privilege and demand the documents that AHR believed were necessary to enforce its lien.

AHR alleges that during the discovery that followed, it uncovered evidence that Jeffery, in his capacity as Wilton’s sole director, signed an agreement to sell all of Wilton’s non-real estate assets for only $725,000 to North Mill Capital LLC’s hand-picked liquidator Gordon Brothers, thereby leaving Wilton without funds or resources to protect its Mt. Joy real estate (which had been appraised as having an “as is” fair market value of $895,000). AHR further alleges that Leisawitz Heller, as Wilton and Jeffery’s counsel, arranged for North Mill to sign a separate agreement providing that Jeffery would receive a bribe equal to 20 percent of the net proceeds of the real estate transaction, in exchange for approving the sale. North Mill, again with Leisawitz Heller’s assistance, then allegedly filed inflated confessions of judgment against Wilton and sought to foreclose on Wilton’s real estate. AHR asserts that, but for the purported scheme, AHR could have enforced its recorded judgment lien and so recovered the judgment owed AHR from the sale of Wilton’s real estate.

AHR filed a complaint regarding the above allegations against North Mill and Leisawitz Heller. The next month, Wilton filed for bankruptcy. AHR filed an amended complaint asserting causes of action for aiding and abetting breach of fiduciary duties, conspiracy to breach fiduciary duties, conspiracy for fraudulent transfer, and conspiracy to engage in the commercially unreasonable disposition of assets. In the bankruptcy proceeding of Wilton, and in order to resolve AHR and North Mill’s competing claims to a warehouse owned by Wilton, the chapter 7 trustee agreed to a settlement that split the proceeds of the sale between AHS and North Mills, release the estate’s claims against North Mill, and not interfere with AHS’s pending claims against North Mill and others. Although the bankruptcy estate of Wilton had potential claims relating to the plundering of its assets, the chapter 7 trustee lacked the funds to assert such claims and decided to abandon such claims.

After the bankruptcy settlement, AHR’s lawsuit went back to the district court where it was filed. In light of the pending bankruptcy case of Wilton, the district court referred the matter once again to the bankruptcy court after finding that the claims asserted by AHR were inextricably related to Wilton’s chapter 7 proceeding. The bankruptcy court subsequently ruled that only the trustee had standing to pursue the types of claims asserted by AHR, and the ruling was affirmed on appeal by the district court.

On appeal, however, the Third Circuit disagreed with the conclusions of the bankruptcy court and district court. As an initial matter, the Third Circuit clarified that standing in bankruptcy is not an element of standing under the United States Constitution. The Third Circuit pointed out that, although a court-appointed bankruptcy trustee manages the property of the bankruptcy estate, including causes of action, using the term “standing” with respect to the sole authority of such trustee to assert such causes of action is confusing. In order to avoid confusion, the Third Circuit stated that, rather than use the term “standing,” a proper analysis should focus on the trustee’s “authority” to act on behalf of the bankruptcy estate.

Citing to the United States Supreme Court’s opinion in Lexmark International Inc. v. Static Control Components [572 U.S. 118 (2014)], the Third Circuit said that there is a clear distinction between statutory authority under the Bankruptcy Code and standing as defined in the United States Constitution.

“In Lexmark, the Supreme Court reaffirmed that constitutional standing has only three elements: (1) ‘a concrete and particularized injury in fact’; (2) that is ‘fairly traceable’ to the defendant’s conduct; and (3) that ‘a favorable judicial decision’ would likely ‘redress.’ Once a plaintiff satisfies those elements, the action ‘presents a case or controversy that is properly within federal courts’ Article III jurisdiction.’ Other requirements, whether prudential or ‘tied to a particular statute,’ do not affect our constitutional jurisdiction.”

The Third Circuit quickly disposed of any argument that AHR lacked constitutional standing to pursue the claims, finding that the allegations in the complaint related to the plundering of Wilton’s assets clearly established the type of harm that affords a litigant constitutional standing in federal court.

Turning to whether AHR’s claims were property of Wilton’s bankruptcy estate, the Third Circuit found that AHR’s claims did become property of the bankruptcy estate upon Wilton’s filing of a chapter 7 petition. In finding that the claims asserted by AHR were property of the estate, the Third Circuit cited long-established case law holding that individual creditors have statutory authority to bring only personal claims and not general claims that benefit all creditors of the bankruptcy estate. Claims alleging that third parties depleted the debtor’s assets are general, because every creditor has a similar claim for diversion of assets that belong to the debtor. Evaluating the claims asserted by AHR, the Third Circuit determined that the claims were general in nature because AHR’s claims depend on harm suffered by Wilton and only indirectly by AHR. Thus, the Third Circuit concluded that, under the Bankruptcy Code, the statutory authority to assert the types claims asserted by AHR belong solely to a bankruptcy trustee in the first instance.

The Third Circuit’s conclusion that only a bankruptcy trustee has the authority to assert the types of claims asserted by AHR did not end the analysis, however, since the court noted that a trustee has various options when it comes to addressing claims belonging to the bankruptcy estate. The trustee can prosecute such claims, settle such claims, or otherwise abandon the claims. With respect to abandonment, for example, the Third Circuit noted that if the cost of pursuing such claims is burdensome or otherwise outweighs the likely gain to the estate, the trustee is free to abandon such claims. Once abandoned, the abandoned property (in this case, claims and causes of action) can flow back to any party that has an interest in such claims, and the creditor’s right to pursue such claims springs back to life in the hands of such creditor.

In reviewing the settlement reached in the bankruptcy and subsequent abandonment order, the Third Circuit found that the trustee expressly abandoned the causes of action asserted by AHR back to AHR. While the District Court believed that the Third Circuit’s opinion in Cybergenics [In re Cybergenics, 226 F.3d 237 (3d Cir. 2000)] precluded the trustee from transferring the causes of action back to AHR, the Third Circuit rejected such a reading of the opinion. According to the Third Circuit, the opinion in Cybergenics reaffirms that outside of the bankruptcy context, claims related to asset plundering belong to the creditors of a debtor, thus supporting its holding that trustees can abandon asset-plundering claims back to creditors who had them before bankruptcy. Accordingly, the Third Circuit held that the effect of the abandonment order was to spring back to life the claims asserted by AHR and with AHR’s authority to assert such claims fully restored.

The Third Circuit’s opinion is important, since it clarifies matters pertaining to the authority of creditors to assert claims when a bankrupt company’s assets are plundered. By differentiating constitutional standing from bankruptcy standing, the Third Circuit brings to an end the confusion in the lower courts between these two distinct and unrelated concepts. Importantly, creditors of bankrupt debtors who believe company assets were plundered may now have an avenue to pursue such claims on their own behalf.