The Bottom Line
The Third Circuit, in Artesanias Hacienda Real S.A. de C.V. v. N. Mill Capital, LLC (In re Wilton Armetale, Inc.), 968 F.3d 273 (3d Cir. 2020), issued a decision with potential implications for creditors who wish to pursue causes of action after a bankruptcy trustee refuses to act on such claims. The Third Circuit held that if a bankruptcy trustee clearly abandons a cause of action, the right of creditors to pursue that cause of action “spring[s] back to life.”
What Happened?
Statutory Background
Certain claims a creditor may have against non-debtor third parties, such as fraudulent transfer claims, are “derivative” of claims that the debtor’s estate has against those same parties. When a debtor files for bankruptcy, any causes of action held by the debtor become property of the estate — including claims that third parties depleted the debtor’s assets — because every creditor has a similar claim for diversion of assets that belong to the debtor. Bankruptcy Code Sections 323(a) and (b) give the bankruptcy trustee the sole authority to pursue those claims at the outset of bankruptcy, to prevent creditors from simultaneously pursuing claims. Only when a particular creditor suffers a direct, particularized injury that can be directly traced to the defendant’s conduct is the claim personal to that creditor and not property of the estate.
Case Background
Years prior to the present case, Artesanias Hacienda Real S.A. de C.V. (AHR) sued Wilton Armetale Inc. (the “Debtor” or “Wilton”) and its then-owner, alleging that Wilton failed to pay AHR for certain goods it purchased. AHR ultimately obtained a judgment for approximately $900,000 and all the owner’s shares in Wilton. After AHR assumed control of Wilton, AHR discovered that Wilton’s prior owner, the prior owner’s law firm and another creditor (the “Non-Debtor Third Parties”) had diverted non-real estate assets from Wilton to hinder AHR’s ability to enforce and collect its judgment. AHR sued the Non-Debtor Third Parties. Soon after the lawsuit was filed in United States District Court for the Eastern District of Pennsylvania (the “District Court”), the insolvent Wilton filed for bankruptcy. The bankruptcy estate possessed potential claims relating to the plundering of estate assets, but the Chapter 7 trustee abandoned the claims rather than spending the estate’s limited remaining resources pursuing them. Meanwhile, the District Court held that AHR’s claims were “related to” the Debtor’s Chapter 7 proceeding and referred the matter to bankruptcy court. The bankruptcy court found that only the trustee had standing to pursue the asserted claims (even though the trustee had abandoned the claims), and the District Court affirmed.
Third Circuit’s Decision
The Third Circuit began by discussing the confusion engendered by use of the word “standing” to describe the authority of a creditor to bring a derivative claim. Noting that the statutory requirements for bankruptcy “standing” exceed the elements of constitutional standing, the Third Circuit held that a proper analysis should focus on a creditor’s “authority” to act on behalf of the bankruptcy trustee.
The Third Circuit agreed that only a bankruptcy trustee has initial authority to assert the types of claims asserted by AHR, but held that if a trustee abandons such claims, the abandoned claims flow back to the prior holder(s). The Third Circuit clarified that evidence of the trustee’s abandonment must be clear.
The Third Circuit distinguished its prior decision in In re Cybergenics, 226 F.3d 237 (3d Cir. 2000), noting that Cybergenics instead reaffirms that outside of the bankruptcy context, claims relating to asset plundering belong to creditors, thus supporting the Third Circuit’s holding that trustees can abandon asset-plundering claims back to the creditors who held them before bankruptcy.
Why This Case Is Interesting
The Third Circuit’s clarification that constitutional standing differs from bankruptcy standing ends the confusion between these concepts. Creditors of a bankrupt debtor who were harmed by a third party depleting an estate’s assets may have a path to pursuing such claims independently. However, it is important to note that the Third Circuit’s decision relied, in part, on the trustee’s clear abandonment of the estate’s claims. A trustee’s abandonment of such claims may indicate that the claims do not justify the costs of litigation.
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