Creditors’ recoveries often hinge on claw-back lawsuits that trustees bring under bankruptcy law and non-bankruptcy law.[1]  Trustees can file claims based on non-bankruptcy law because Bankruptcy Code section 544(b) allows them to assert claims that creditors have standing to file outside of bankruptcy.  This powerful tool enables trustees to challenge transactions that date back years before a bankruptcy filing.[2]

Section 544(b) states that trustees “may avoid a transfer of an interest of the debtor that is voidable under applicable law by a creditor holding an [allowable] unsecured claim.” (Emphasis supplied.)  The most common statute that trustees invoke is state fraudulent transfer law.  But do other statutes – federal or state – apply as well?

One statute that has come up in the case law is the Federal Debt Collections Practices Act (“FDCPA”).   It is utilized for debts owed to the United States and its agencies and departments.  Its reach-back period is six years.  But in MC Asset Recovery LLC v. Commerzbank A.G. (In re Mirant Corp.), 675 F.3d 530 (5th Cir. 2012), the Fifth Circuit Court of Appeals held that the FDCPA did not qualify as “applicable law” under Bankruptcy Code section 544(b).  Mirant concluded that the legislative history of section 544(b) didn’t support allowing a bankruptcy trustee to sue under the FDCPA.

Other courts, however, have faulted the Fifth Circuit’s analysis and conclusion.  See Vierira v. Gaither (In re Gaither), 595 B.R. 201 (Bankr. D.S.C. 2018); Hillel v. City of Many Trees, LLC (In re CVAH, Inc.), 570 B.R. 816 (Bankr. D. Idaho 2017); Gordon V. Harrison (In re Alpha Protective Services, Inc.), 531 B.R. 889 (Bankr. M.D. Ga. 2015); and Tronox Inc. v. Kerr McGee Corp. (In re Tronox Inc.), 503 B.R. 239 (Bankr. S.D.N.Y. 2013). Generally, these courts have concluded that the phrase “applicable law” in section 544(b) should be read more broadly than how the Fifth Circuit interpreted it.

The most recent decision was issued last week in a chapter 7 case, In re Grobner, No. 17-90819, 2019 Bankr. LEXIS 1450 (Bankr. C.D. Ill. May 8, 2019).  Six years before the bankruptcy, the debtors had transferred a home to their daughter for $100.  The home was worth more than $350,000.  The debtors also owed the U.S. Small Business Administration (“SBA”) $418,000 on a loan.  The Court noted that the SBA was the "triggering creditor" that made the FDCPA applicable to this case. 

The chapter 7 trustee sued the daughter to void the transfer of the debtors’ home, asserting that the property should be turned over to the estate for sale or a judgment entered against the daughter for the value of the property. 

The daughter sought to dismiss the complaint for failure to state a claim.  Citing Mirant, she argued that the FDCPA isn’t “applicable law” under Bankruptcy Code section 544(b).  Bankruptcy Judge Mary P. Gorman disagreed.  “[T]his [c]ourt finds the reasoning of the cases that hold that the FDCPA may be used by trustees to avoid fraudulent transfers to be persuasive.  Section 544(b) refers to ‘applicable law’ and contains no limits on modifiers of that term.”  2019 Bankr. LEXIS 1450, at *9. 

The court observed that the Seventh Circuit Court of Appeals has said that section 544(b) “enables the trustee to do in a bankruptcy proceeding what a creditor would have been able to do outside of bankruptcy – except the trustee will recover the property for the benefit of the estate.”  Id. (quoting In re EquipmentAcquisition Resources, Inc., 742 F.3d 743, 746 (7th Cir. 2014)).  In addition, “if any unsecured creditors could reach an asset of the debtors outside bankruptcy, the trustee can use [section] 544(b) to obtain that asset for the estate.”  In re Leonard, 125 F.3d 543, 544 (7th Cir. 1997).

But there was a wrinkle in Grobner that impacted the outcome.  The trustee alleged in one single count of the complaint both Illinois’ version of the Uniform Fraudulent Transfer Act (“IUFTA”) and the FDCPA.  Judge Gorman said the trustee had to separate them into two counts.  “[E]ach cause of action stands alone; they should not be combined in one count.”  2019 Bankr. LEXIS 1450, at *11.  The court dismissed the complaint but allowed the trustee to replead.

Furthermore, Judge Gorman noted that the FDCPA, with its six-year statute of limitations, could not be used to extend the limitations beyond the four years found in the IUFTA.  Since the transfer of the home took place more than four years before the bankruptcy filing, a separate count under just the IUFTA could be attacked as falling outside the statute of limitations.  But that argument is left for another day after a new complaint is served.  Irrespective of what happens with that count, the trustee's separate count to claw-back money related to the SBA loan should survive. 

[2] Under federal law, trustees can seek to claw-back transfers that occur up to two years before a bankruptcy filing.  11 U.S.C. § 548.  State law avoidance statutes often have reach-back periods of up to six years.