Bankruptcy is a forum for the insolvent. However, financially healthy businesses and individuals are dragged into bankruptcy court against their will every day. The primary culprit is the adversary complaint filed by a bankruptcy trustee.

The Basics

An insolvent company filing for bankruptcy – commonly referenced as a “debtor” — may seek to reorganize under chapter 11 or liquidate under chapter 7 of the Bankruptcy Code. When a debtor liquidates, a trustee is appointed to manage the liquidation. The Bankruptcy Code empowers a trustee to collect and reduce to money property of the debtor. 11 U.S.C. §704. The trustee has the power to file lawsuits to recover claims that the debtor may have against third parties. A lawsuit within a bankruptcy case is an adversary proceeding and is commenced through the filing of an adversary complaint. An adversary proceeding is similar to a lawsuit filed in state or federal court and includes discovery and motion practice.

Adversary Proceedings Commonly Filed by Trustees

A trustee has the power and authority to file adversary proceedings against third parties to recover money or property. Common adversary complaints filed by a trustee include:

• A complaint to avoid and recover preferential payments. A preference is a payment or transfer made by a debtor to a creditor for a legitimate debt in the 90 days prior to a bankruptcy filing, or a year prior to a bankruptcy filing for insiders or those closely connected to a debtor.
• A complaint to avoid and recover fraudulent conveyances. This lawsuit is typically commenced where a debtor transfers an asset in the years leading up to bankruptcy for no or inadequate consideration. For example, if a debtor transfers real property to ABC Co. two years prior to a bankruptcy filing for $250,000, and the trustee believes the property was worth $500,000, a trustee may sue ABC Co. to recover and sell the property or collect $250,000.
• A complaint to recover money or property owed to the debtor by third parties.
• A complaint to sell property jointly owned by the debtor and a third party.
• A complaint to pursue a cause of action held by the debtor (e.g., breach of contract, patent infringement, etc.).

Responding to an Adversary Complaint

A defendant in an adversary proceeding has 30 days to file a response to a complaint. Below are some helpful strategies in responding to adversary complaints filed by trustees:

1. Communicate with the trustee: A trustee has a fiduciary duty to creditors. A trustee’s goal is to liquidate assets and distribute money to creditors while minimizing legal fees and expense. Most trustees would prefer to settle or resolve a lawsuit prior to litigation. A defendant should reach out to the trustee to learn more about the trustee’s claim and his or her settlement position. The lesser the amount of the trustee’s claim, the more willing a trustee may be willing to settle.
2. Don’t assume the trustee is right: Many unfamiliar with the bankruptcy process assume that a trustee has the powers of a judge, or that a judge will always side with a trustee. This is not true. Trustees are appointed after a bankruptcy filing. They are not intricately familiar with a debtor’s history and are often working with limited information. Parties should not be afraid to ask the trustee to share information so they can better understand the claims in an adversary complaint.
3. Know your trustee: While every trustee follows the same Bankruptcy Code, each trustee is different. While every trustee has a fiduciary duty to creditors, trustees exercise their powers differently. Some trustees are aggressive and litigious. Other trustees are more interested in settling and minimizing expense.
4. Ask for more time: A defendant should seek an extension of the 30-day deadline to file a response to a complaint, so it has more time to evaluate whether to settle or litigate. Trustees and courts routinely grant these requests.
5. Mediation: To the extent that a defendant is unable to settle with the trustee, it should request the appointment of a mediator by the court to help facilitate a resolution.