Liquidating Trust Plans in the Tenth Circuit Recovering on Avoidance Claims, 0321 COBJ, Vol. 50, No. 3 Pg. 24
| Author | BY MICHAEL J. GUYERSON |
| Position | Vol. 50, 3 [Page 24] |
BANKRUPTCY LAW
BY MICHAEL J. GUYERSON
This article discusses liquidating trust plans in Tenth Circuit chapter 11 reorganization plans, with a focus on maximizing the recovery of avoidable transfers. It uses the Atna Liquidating Trust as an example for the analysis.
The U.S. Bankruptcy Code (Code)1 provides for the use of a liquidating trust under § 1123 (b)(3) to enforce a bankruptcy estate's claims and interests. A liquidating trust allows a debtor to transfer causes of action and other assets to the trust for future liquidation and distribution to the debtor's creditors, who are the trust beneficiaries. The liquidating trust is a tool commonly used by bankruptcy practitioners to recover avoidable transfers.
This article discusses liquidating trusts in chapter 11 reorganization cases in the Tenth Circuit and explores methods for maximizing the recovery of avoidable transfers in bankruptcy. It uses In re Atna Resources Inc.2 as an example for analyzing the issues.
Liquidating Trusts in Chapter 11 Cases
Many companies that file for chapter 11 bankruptcy relief ultimately liquidate their assets and claims. These chapter 11 plans typically provide for the controlled liquidation of assets and the pursuit of avoidance claims, such as preference or fraudulent conveyance claims under article V of the Code. The Atna case is a good example of how this approach works.
In 2015, Atna Resources Inc. and its six affiliates filed separate voluntary petitions for relief under chapter 11 in the U.S. Bankruptcy Court for the District of Colorado. The seven Atna entities, each a standalone company, had a complicated ownership structure. The common element among them was their use of a centralized cash management system through which all deposits were swept into a centralized account, regardless of which separate entity created the income. Funds were then redistributed from the centralized account to individual accounts for each entity. Each entity then paid its own bills, but given the centralized account, income from one entity was routinely used to pay the debts of another.
The use of a centralized account is common and may be acceptable when the involved entities are solvent and cash is flowing. However, when some or all of the subsidiary companies are insolvent, using funds from one entity to pay another's debts becomes a potential fraudulent conveyance.
The chapter 11 plan for Atna and its affiliated entities was confirmed by the court. The plan created the Atna Liquidating Trust (the Trust) as a standalone liquidating grant or trust entity in accordance with U.S. Treas. Reg. 301.7701 -4(d). The Trust was designed to operate without court supervision with a trustee empowered to bring Code article V avoidance actions, such as those for preferential payments and fraudulent conveyances.
The Trust was typical of those used in Colorado and nationally. Virtually the same liquidating plan provisions and trust agreement were successfully used in other Tenth Circuit confirmed chapter 11 liquidating plans.[3] Most debtors under such plans have multiple subsidiary operations and use some form of centralized bank account or cash management account system. Transfers are made from one account to the other, or are swept into a centralized account and then redistributed to separate accounts from which payments are finally made to creditors or other parties. But debtors and trustees of liquidating trusts trying to recover these payments face unique challenges in the Tenth Circuit. One such obstacle is what has become known as the Slack-Homer doctrine.
Slack-Horner and § 548 Claims
Title 11 U.S.C. § 550(a) permits the trustee to recover avoided transfers, such as fraudulent conveyances under Code § 548, from either the initial transferee or a subsequent transferee. A transfer occurs each time a payment or transfer is made from one account to another of a related company or affiliate. The Slack-Horner doctrine, in a nutshell, requires that each movement of funds from one entity to another is a transfer that must be avoided before the end transfer can be recovered. This Tenth Circuit doctrine arguably glosses over what happens when all such transfers are controlled by one group of companies or individuals. In practical terms, the rule makes it more difficult to recover fraudulently transferred property for the benefit of the estate in situations where multiple debtors transferred funds to and among each other via a centralized cash management system.
In Slack-Homer, the debtor owned a parcel of real estate. In 1983, the county treasurer conducted a tax sale of the property for nonpayment of real property taxes. Simons was the successful bidder at the tax sale and received a tax sale certificate of purchase. Simons also paid the delinquent real property taxes for years 1982 through 1987. In December 1987, Simons obtained and recorded a treasurer's deed to the property. The debtor filed for bankruptcy in September 1988. The bankruptcy trustee sought to avoid the transfer of the debtor's interest in the property to Simons under the then-applicable version of 11 U.S.C. § 548(a)(2). The Tenth Circuit held that the debtor's interest in the property "was transferred by operation of law from the debtor to the state" when the treasurer's deed was signed.4 The state, in turn, "transferred all interest in the property to Simons"[5] because, as the court noted, "[t]he interest in the property must have passed to the state in order for the state to issue a deed conveying the property to Simons."[6]
The Tenth Circuit noted that 11 U.S.C. § 550 permits the trustee to recover avoided transfers from "either the initial transferee or a subsequent transferee."7 However, the court stated that "to recover from a subsequent transferee the trustee must first have the transfer of the debtor's interest to the initial transferee avoided under § 548."[8] In sum, the Tenth Circuit held that there were two separate transfers, and the first transfer to the state needed to be avoided as a precondition to avoiding the second to Simons.
Accordingly, recovery in the Tenth Circuit requires the joinder of the initial transferee in an avoidance action, even though that transferee may be a co-debtor or may no longer have an interest in the property. This complicates avoidance litigation, particularly because as long as the plaintiff in the avoidance litigation sustains the burden to show that the initial transfer is avoidable, § 550 on its face ostensibly allows recovery from a subsequent transferee.
To illustrate this dilemma, a litigant could argue under Slack-Homer that a fraudulent transfer may be recovered only from a party that received an interest in property from the debtor. It follows that transferees receiving property from the initial transferee would have received no property from the debtor and consequently would have no liability to the estate. Thus, a savvy initial transferee could avoid liability by simply transferring the property received from the debtor to another party. Accordingly, Slack-Homer may be viewed as writing the § 550 expanded scope of transferee liability out of the Code. This construction of § 550 is a minority view.
Another approach is illustrated in...
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