An appeals court ruled recently that chapter 5 avoidance actions are property of a debtor’s bankruptcy estate that can be sold in section 363 sales. In re Simply Essentials, LLC, No. 22-2011, 2023 U.S. App. LEXIS 21814 (8th Cir. Aug. 21, 2023). The decision follows similar rulings by other appeals courts.
The debtor operated a chicken processing business and, in due course, became financially strapped. Farmers who were creditors put the debtor into bankruptcy by filing an involuntary chapter 7 petition.
The Trustee appointed to handle the case wanted to bring avoidance actions against certain creditors, but the estate lacked funds to pursue the actions. Instead, the Trustee decided to sell them in a section 363 sale.
Two creditors bid at an auction, and then the losing bidder filed an appeal on the question of whether the avoidance actions were property of the estate that could be sold by the debtor.
Bankruptcy Code section 541(a) provides that estate property includes “all legal or equitable interests of the debtor in property as of the commencement of the case.” And section 541(a)(7) states that property of the estate includes “[a]ny interest in property that the estate acquires after the commencement of the case.”
The Supreme Court has made clear that the term “property of the estate” should be interpreted broadly to include “any property made available to the estate by other provisions of the Bankruptcy Code.” See United States v. Whiting Pools Inc., 462 U.S. 198, 205 (1983). In addition, a debtor need not “hold a possessory interest in the property at the commencement of reorganization proceedings.” 462 U.S. at 206.
In Simply Essentials, the Eighth Circuit noted that “property of the estate includes inchoate or contingent interests held by the debtor prior to filing of bankruptcy.” 2023 U.S. App. LEXIS 21824, at *6. “Because debtors have the right to file for bankruptcy and the debtor in possession or the Trustee may file avoidance actions to recover property, the debtor has an inchoate interest in the avoidance actions prior to the commencement of the bankruptcy proceedings. Therefore, avoidance actions are property of the estate under section 541(a)(1).” Id. at *7.
In the alternative, if a debtor doesn’t have an interest in avoidance actions before a bankruptcy case is filed, avoidance actions would come within the definition of property of the estate under section 541(a)(7). That provision includes within the estate’s property “[a]ny interest in property that the estate acquires after the commencement of the case.” Id.
The Eighth Circuit’s decision follows decisions of other federal appeals courts on this issue. See In re Moore, 608 F.3d 253, 262 (5th Cir. 2010); In re Ontos, Inc., 478 F.3d 427, 431 (1st Cir 2007); and Nat’l Tax CredNit Partners, L.P. v. Havlik, 20 F.3d 705, 708-09 (7th Cir. 1994).
In another appellate decision, the Third Circuit years ago stated that avoidance actions are not “assets” of a debtor. In re Cybergenics Corp., 226 F.3d 237, 245 (3d Cir. 2000). But the court also noted that the Bankruptcy Code distinguishes between property of the estate and property of the debtor. Twenty years after Cybergenics, the Third Circuit clarified that “Cybergenics does not hold that trustees cannot transfer causes of action.” In re Wilton Armetale, Inc., 968 F. 3d 273, 285 (3d Cir. 2020).
The upshot is that courts considering the issue have uniformly held that chapter 5 avoidance actions are property of a debtor’s bankruptcy estate that can be sold to help maximize the recoveries of creditors.