The Ninth Circuit has held that the two-year statute governing the estate's avoidance claims is equitably tolled as a result of the bankrupt's misbehavior, even though the estate learned of the fraudulent transfers just before the two-year period had ended. [In re Milby, 2017 Westlaw 5586044 (9th Cir.).]
FACTS: An individual filed a Chapter 7 petition. Unbeknownst to her creditors, she had engaged in fraudulent transfers involving family members prior to her bankruptcy filing. She concealed her pre-petition transfers from her bankruptcy trustee.
Just a few days before the expiration of the two-year statute of limitations under 11 U.S.C.A. §546(a)(1), two of her major creditors discovered the fraudulent transfers and informed the trustee about them. The trustee chose not to file an action based on that information. A year later, the bankruptcy court approved the appointment of the two creditors to pursue those claims on behalf of the estate.
The next day, the two creditors filed their fraudulent transfer action. The defendants filed a motion for summary judgment, arguing that the claims were barred by the two-year statute of limitations on avoidance actions. The two creditors argued that equitable tolling applied, given the bankrupt's misconduct in failing to disclose the transfers.
The bankruptcy court held that equitable tolling did not apply because the estate could have asserted the same claims prior to the expiration of the period of limitations. The Bankruptcy Appellate Panel disagreed, holding that equitable tolling could apply and that the bankruptcy court should not have considered the estate's diligence in pursuing the claims after discovering the existence of the fraudulent transfers.
REASONING: The Ninth Circuit affirmed but disagreed with the reasoning of both the Bankruptcy Court and the BAP, citing Gibbs v. Legrand, 767 F.3d 879 (9th Cir. 2014):
The bankruptcy court erred insofar as it held that equitable tolling is inappropriate any time a litigant has the opportunity to file before a limitations period would normally expire but does not do so. In other words, the bankruptcy court erred insofar as it held that failing to file a complaint after extraordinary circumstances cease but before the limitations period would normally expire is dispositive of whether equitable tolling applies. That rule is too narrow.
The BAP, for its part, erred in holding that post-discovery diligence is never relevant to whether equitable tolling applies. That rule is too broad. As we explained in [Gibbs], “[d]iligence after an extraordinary circumstance is lifted may be illuminating as to overall diligence, but is not alone determinative.” . . . . It is “one factor in a broader diligence assessment.” That said, we give diligence before the extraordinary circumstance ends more weight than diligence afterward.
AUTHOR'S COMMENT: Although "equitable tolling" sounds like a narrow procedural issue, this decision is much more significant than it may seem. It is very often the case that bankrupt individuals (and business entities) engage in dubious pre-petition "insolvency engineering" and then conceal their misbehavior during their bankruptcies, hoping to run out the two-year clock. Sometimes, as in this case, the truth emerges right before the two-year period ends, making it impossible for the estate or its creditors to take action in time. This decision gives the estate a little bit of breathing room in order to sort out the facts before filing.
The court did not explain why it took a full year for the bankruptcy court to issue an order authorizing the creditors to prosecute the claim on behalf of the estate; but this opinion stands for the proposition that once the fraudulent transfers have been detected, it is not unreasonable for the estate to delay for at least a year before filing. A year should be enough time for a belatedly-alerted trustee to ferret out the facts and get a complaint on file.
Nevertheless, I have doubts about the court’s reliance on its own opinion in Gibbs for the proposition that post-discovery diligence is relevant to whether equitable tolling applies. Gibbs was a criminal habeas case, far removed from the complexity of a bankruptcy proceeding. Perhaps it makes sense in the context of a relatively simple two-party habeas petition to evaluate the prisoner’s post-discovery diligence.
But in a bankruptcy case involving multiple parties, it is often not feasible for a trustee or a creditor to shoot from the hip and file a sketchy avoidance claim. It makes much more sense to investigate the facts carefully to determine whether the claim is valid and whether the defendants are solvent enough to warrant prosecution. I think the BAP got it right. Maybe someday the circuit will revisit this issue.
These materials were written by Professor Dan Schechter of Loyola Law School, Los Angeles