Avoidance Actions Are All or Nothing, the Fourth Circuit Rules

Many lawyers and clients unfamiliar with the upside-down world of avoidance litigation tend to think that traditional rules of setoff should govern the resolution of avoidance action litigation: "the debtor's entitled to "x"; the creditor's entitled to "y"; net-net...." As the Fourth Circuit reminds us in In re Coleman, (2005 WL 2665798) (4th Cir., 10/20/05), avoidance litigation often starts with a more "all or nothing" approach.

The case reminds me of another classic "all or nothing" type case that often trips people up: Moore v. Bay, 284 U.S. 4 (1931). Unlike today's weighty US Supreme Court opinions, Moore v. Bay is only one page. Apparently that's all Justice Oliver Wendell Holmes (then about 90 and one year from retirement) had the strength to say about the topic. Subject to some important nuances, that case is generally understood to mean that a transfer avoidable by a bankruptcy trustee as to a single creditor (even as to just a nickel), is avoidable to the entire extent of the transaction (even if the transaction is worth millions). This is as inequitable a result as one gets in bankruptcy, and if any bankruptcy case deserves to be reviewed again by the US Supreme Court it's Moore v. Bay, but that's a discussion for another day.

In the Fourth Circuit's Coleman case, a bank initiated foreclosure proceedings against a debtor's home, which was stayed by the debtor's chapter 11 filing on the day before the planned foreclosure sale. The Fourth Circuit described the interesting procedural posture of the case as follows:

Shortly after filing for Chapter 11 relief, Debtor initiated an adversary proceeding against the Bank, the trustees named under deeds of trust, and the IRS. Debtor claimed that the deeds of trust that she and her husband had given to the Bank were void as fraudulent conveyances under Virginia and Tennessee law because they represented the Colemans' improper attempt to hinder, delay, and defraud Debtor's creditors, including the IRS. Thus, she sought to invoke her "strong arm" powers as a debtor in possession ... to set the deeds of trust aside. Under her proposed bankruptcy plan, if she were successful in avoiding the deeds of trust, she would sell the Properties as needed to pay her creditors and the administrative expenses of the estate....

[T]he Bank moved to dismiss Debtor's Chapter 11 petition on the ground that it was not filed in good faith [and] was "nothing more than an attempt by the debtor to impermissibly and wrongfully clothe herself with the 'strong arm' powers of a debtor in possession or bankruptcy trustee and thereby gain a strategical and tactical advantage over the Bank and the IRS with respect to the claims of said creditors."

The bankruptcy court subsequently confirmed Debtor's bankruptcy plan, subject to the outcome of the adversary proceeding. See In re Coleman, 275 B.R. 763, 771-72 (Bankr. W.D. Va. 2002). The court also denied the Bank's motion to dismiss, finding that Debtor's adversary proceeding was not frivolous, that Debtor's creditors would benefit from a successful prosecution of the adversary proceeding to set aside the deeds of trust, and that the relief Debtor sought under Chapter 11 was quite similar to that which she could have sought under Chapter 7. See id. at 770-71.

Following a trial on the adversary proceeding, ... the bankruptcy court determined that the deeds of trust were voidable fraudulent conveyances because they were motivated in part by the Colemans' desire to hinder the IRS from collecting the Colemans' back taxes and because the Bank's officer in charge of the loans was aware of that motive. See Coleman v. Cmty. Trust Bank (In re Coleman), 285 B.R. 892, 905-09 (Bankr. W.D. Va. 2002). The court nevertheless ruled that the deeds of trust would be avoided only to the extent necessary to pay the claims and administrative expenses of the estate. See id. at 909-12. The deeds of trust thus would remain in effect to allow the Bank to recover any surplus. See id. at 912. The court explained that "this result most effectively upholds the policies and specific statutory provisions of the Bankruptcy Code and the laws of Virginia and Tennessee to avoid voluntary fraudulent transfers where the rights of third parties are concerned, but to uphold and enforce them as between the parties themselves."

Reviewing the decision of the district court de novo (because a "ruling concerning the proper interpretation of a statute is a legal determination"), the Fourth Circuit held that applying the plain language of § 544 permits the Debtor to avoid the deeds of trust entirely, and thus the bankruptcy court erred in limiting the extent to which they could be avoided. The Fourth Circuit reasoned as follows:

The Bank argues that even if the language of § 544, when viewed in isolation, suggests that avoidance must be all or nothing, § 550--the recovery statute--creates an ambiguity in § 544. Section 550(a) provides, with certain exceptions not relevant here, that "to the extent that a transfer is avoided under section 544 .., the trustee may recover, for the benefit of the estate, the property transferred...." 11 U.S.C.A. § 550(a) (West 2004) (emphasis added). Based on the emphasized language, the Bank contends that, like property recovery, transfer avoidance could be limited to the extent necessary to benefit the creditors and pay the administrative expenses of the estate.

We do not accept this assertion. In the absence of equivalent language in § 544, the presence of the phrase "for the benefit of the estate" in § 550 merely highlights the fact that Congress knew how to include such a limitation when it wanted to. See Keene Corp. v. United States, 508 U.S. 200, 208 (1993) ("Where Congress includes particular language in one section of a statute but omits it in another, it is generally presumed that Congress acts intentionally and purposely in the disparate inclusion or exclusion." (internal quotation marks & alterations omitted)).

The Bank nevertheless maintains that the § 550 language creates an ambiguity with regard to § 544 because the concepts of avoidance and recovery are intertwined. We agree that the concepts are intertwined to the extent that property cannot be recovered under § 550 until an action is brought to avoid the transfer of that property. See Glanz v. RJF Int'l Corp. (In re Glanz), 205 B.R. 750, 757 (Bankr. D. Md. 1997). But the opposite is certainly not true, as the case before us demonstrates. Once Debtor avoided the deeds of trust, no recovery was necessary; the avoidance itself was the meaningful event. See id. at 758. Thus, the recovery statute has no application here.

© Steve Jakubowski 2005

Hat tip to Ryan Zeller