Court Opinion

ID: 3042125
Source: CourtListenerOpinion
Date Created: 2015-10-13 23:07:58.074406+00
Date Added: 2024-06-11T12:11:26.634367
License: Public Domain

United States Bankruptcy Appellate Panel
                            FOR THE EIGHTH CIRCUIT

                                    No. 06-6058 ND

In re:                                     *
                                           *
Racing Services, Inc.,                     *
                                           *
         Debtor.                           *
                                           *
PW Enterprises, Inc.,                      *         Appeal from the United States
                                           *         Bankruptcy Court for the
         Plaintiff - Appellant,            *         District of North Dakota
                                           *
               v.                          *
                                           *
State of North Dakota,                     *
North Dakota Racing Commission,            *
North Dakota Breeders Fund, and            *
North Dakota Purse Fund,                   *
                                           *
         Defendants - Appellees,           *
                                           *
and                                        *
                                           *
Kip M. Kaler, Chapter 7 Trustee,           *
                                           *
         Objector - Appellee.              *

                              Submitted: February 15, 2007
                                 Filed: March 9, 2007
Before SCHERMER, FEDERMAN, and VENTERS, Bankruptcy Judges

SCHERMER, Bankruptcy Judge

       PW Enterprises, Inc. (“Plaintiff”) appeals the bankruptcy court’s order denying
its request for standing to prosecute a nine-count complaint against the State of North
Dakota, the North Dakota Racing Commission, the North Dakota Breeders Fund, the
North Dakota Purse Fund, and the North Dakota Special Promotions Fund
(collectively “Defendants”). We have jurisdiction over this appeal from the final
order of the bankruptcy court. See 28 U.S.C. § 158(b). For the reasons set forth
below, we partially affirm and partially reverse and remand.

                                       ISSUE

        The issue on appeal is whether the bankruptcy court erred when it denied the
Plaintiff’s request for standing to prosecute a nine-count complaint seeking the
disallowance of claims, the avoidance and recovery of certain transfers, and the
equitable subordination of claims. After denying the request for standing, the court
struck the complaint. We conclude that the bankruptcy court did not err in denying
the Plaintiff’s request for standing to prosecute the avoidance and recovery actions.
However, the bankruptcy court erred when it struck those counts of the complaint
seeking the disallowance and equitable subordination of claims because the
Bankruptcy Code expressly grants the Plaintiff standing to prosecute those requests
for relief. Accordingly, the bankruptcy court erred when it struck the entire complaint
and should have instead only struck those counts involving the avoidance and
recovery actions.

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                                  BACKGROUND

      Racing Services, Inc. (“Debtor”) filed a voluntary petition for relief under
Chapter 11 of the Bankruptcy Code on February 3, 2004 (“Petition date”). The case
was converted to a case under Chapter 7 of the Bankruptcy Code on June 15, 2004.
Kip M. Kaler (“Trustee”) was appointed Trustee of RSI’s Chapter 7 bankruptcy estate.

       The Defendants assert priority tax claims of $6 million against the Debtor’s
bankruptcy estate. The Plaintiff asserts an unsecured claim in excess of $2 million
against the estate and is the estate’s largest non-governmental creditor. No
distribution from the Debtor’s estate to unsecured creditors is anticipated at this time.

       On January 31, 2006, five days before the statue of limitations for avoidance
actions was set to expire, the Plaintiff presented the Trustee with a proposed
adversary complaint against the Defendants seeking the avoidance and recovery of
certain transfers as well as the disallowance and the equitable subordination of the
Defendants’ claims. The Trustee considered the proposed complaint and decided not
to pursue it. The Trustee based his decision on several factors. First, with respect to
the preference components of the complaint, the Trustee was aware of only a single
payment of less than $200,000 from the Debtor to the Defendants during the ninety-
day period preceding the Petition Date. In order to pursue any additional preference
claims, the Trustee would have to establish that the Defendants were insiders of the
Debtor. The Trustee had no evidence to support insider status. With respect to the
objection to claim, the Trustee’s accountant had analyzed the Defendants’ claims and
had determined that at least half of the $6 million asserted represented true tax claims
entitled to priority. With respect to the equitable subordination claim, the Trustee
determined that it was highly unlikely that the Defendants had engaged in the type of
egregious conduct necessary to support equitable subordination. Furthermore, the
Trustee expected the Defendants to argue that equitable subordination is analogous
to punitive damages which generally cannot be imposed upon government entities like

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the Defendants. Finally, the Trustee determined that the proposed litigation would be
enormously expensive with a nominal likelihood of success.

       The Trustee informed the Plaintiff of his decision not to pursue the proposed
complaint. On February 2, 2006, on the eve of the expiration of the statute of
limitations with respect to the avoidance actions, the Plaintiff filed the adversary
complaint in its own name without court approval to do so and without even
requesting such court approval.

       On April 26, 2006, the Plaintiff filed a motion with the bankruptcy court
requesting standing to prosecute the adversary complaint on behalf of the estate. The
Trustee filed his response to the motion stating that the Plaintiff had presented him
with the proposed adversary complaint on the eve of the expiration of the statute of
limitations for avoidance actions and that he had reviewed the proposed complaint and
had decided not to pursue it. The Trustee set forth his reasons for not pursuing the
complaint in his response. He stated that he did not resist the motion as long as the
bankruptcy estate did not bear any cost of the litigation. He wanted to ensure that any
benefit of the litigation would inure to the estate and not the Plaintiff. He also
requested that any outcome be economically justified. After hearing, the court denied
the motion and struck the adversary complaint. The Plaintiff appealed the order
denying its request for standing and striking the complaint.

                            STANDARD OF REVIEW

       The facts are not in dispute. We review the bankruptcy court’s order denying
the Plaintiff standing to pursue the complaint and striking the complaint de novo.
Hartford Underwriters Ins. Co. v. Magna Bank, N.A. (In re Hen House Interstate,
Inc.), 177 F.3d 719, 721, (8th Cir. 1999), aff’d sub nom. Hartford Underwriters Ins.
Co. v. Union Planters Bank, N.A., 530 U.S. 1 (2000); see also Scott v. Nat’l Century
Fin. Enter. Inc. (In re Baltimore Emergency Services II Corp.), 432 F.3d 557, 559-60

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(4th Cir. 2005); Smart World Tech., LLC v. Juno Online Serv. Inc. (In re Smart World
Tech., LLC), 423 F.3d 166, 174 (2nd Cir. 2005); Canadian Pac. Forest Prod. Ltd. v.
J.D. Irving, Ltd. (In re Gibson Group, Inc.), 66 F.3d 1436, 1440 (6th Cir. 1995).

                                   DISCUSSION

      In the complaint, the Plaintiff asserts avoidance claims pursuant to Sections
544, 547, and 548 of the Bankruptcy Code and recovery claims pursuant to Section
550 of the Bankruptcy Code. According to Sections 547 and 548 of the Bankruptcy
Code, a bankruptcy trustee may avoid certain transfers as preferential or fraudulent.
11 U.S.C. § 547(b)(“. . . the trustee may avoid any transfer . . . .”); 11 U.S.C.
§ 548(a)(1)(“The trustee may avoid any transfer . . . .”). Pursuant to Section 544 of
the Bankruptcy Code, “the trustee may avoid” certain voidable transfers. 11 U.S.C.
§ 544(b)(1). Pursuant to Section 550 of the Bankruptcy Code, “the trustee may
recover” property the transfer of which is avoided or the value of such property.
11 U.S.C. § 550(a). The issue we must decide is whether the court should have
permitted the Plaintiff, a creditor, to exercise the avoidance and recovery powers
given to the Trustee pursuant to Sections 544, 547, 548, and 550 of the Bankruptcy
Code.

       Every circuit, including the Eighth Circuit, which has addressed the issue has
recognized the possibility of derivative standing to pursue avoidance actions on behalf
of a bankruptcy estate under certain circumstances. Nangle v. Lauer (In re Lauer), 98
F.3d 378, 388 (8th Cir. 1996); Scott v. Nat’l Century Fin. Enter. Inc. (In re Baltimore
Emergency Services II Corp.), 432 F.3d 557 (4th Cir. 2005); Official Comm. of
Unsecured Creditors of Cybergenics Corp. v. Chinery, 330 F.3d 548 (3rd Cir. 2003);
Commodore Int’l Ltd v. Gould (In re Commodore Int’l Ltd.), 262 F.3d 96 (2nd Cir.
2001); Fogel v. Zell, 221 F.3d 995 (7th Cir. 2000); Avalanche Maritime, Ltd. v. Parekh
(In re Parmetex, Inc.), 199 F.3d 1029 (9th Cir. 1999); Canadian Pac. Forest Prod.
Ltd. v. J.D. Irving, Ltd. (In re Gibson Group, Inc.), 66 F.3d 1436 (6th Cir. 1995);

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Louisiana World Exposition v. Fed. Ins. Co., 858 F.2d 233 (5th Cir. 1988); Unsecured
Creditors Committee v. Noyes (In re STN Enter.), 779 F.2d 901 (2nd Cir. 1985).

       The Eighth Circuit Court of Appeals concluded that creditors cannot bring
avoidance actions under Section 548 of the Bankruptcy Code absent evidence that the
trustee cannot be relied upon to assert such claims. Nangle v. Lauer (In re Lauer), 98
F.3d 378, 388 (8th Cir. 1996). In order for a creditor to assert standing under Section
548, the creditor must establish that the trustee was unable or unwilling to pursue the
claims on behalf of the bankruptcy estate. Id.

       Courts within the Eighth Circuit have split in their interpretation of the Lauer
opinion. A prior panel of the Eighth Circuit Bankruptcy Appellate Panel interpreted
the Lauer opinion as a determination by the Eighth Circuit Court of Appeals that the
statutory language of Section 548 of the Bankruptcy Code expressly confers
avoidance powers exclusively on the trustee. LaBarge v. Benda (In re Merrifield),
214 B.R. 362, 365 (B.A.P. 8th Cir. 1997).1 While this statement is technically true, it
ignores the Eighth Circuit Court of Appeals’ acknowledgment that creditors may be
able to assert avoidance actions where the trustee cannot be relied upon to do so or is
unable or unwilling to pursue such claims.

       Courts within the circuit have recognized derivative standing to pursue
avoidance actions under certain circumstances. At least one court has recognized
derivative standing where the bankruptcy court has approved the assignment of such
claims from the trustee to the creditor. Quad City Bank v. Union Planters Bank (In
re Chapman Lumber Co., Inc.), 2006 WL 3861107 (Bankr. N.D. Iowa 2006). Other
courts have recognized derivative standing where the trustee is unable or unwilling to

      1
        One court has followed the Merrifield decision and focused on the strict
language of the statute to determine that a Chapter 13 debtor lacks standing to
bring an avoidance action because the statutory language limits the authority to the
trustee. Wood v. Mize (In re Wood), 301 B.R. 558 (Bankr. W.D. Mo. 2003).
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do so. However, the courts disagree as to what constitutes the trustee’s inability or
unwillingness to bring suit which justifies derivative standing. Some courts require
the trustee’s failure to bring the avoidance action to be unjustifiable and, accordingly,
an abuse of discretion. Cambridge Tempositions, Inc. v. Cassis (In re Cassis), 220
B.R. 979, 983 (Bankr. N.D. Iowa 1998). Others require the party seeking standing to
have made demand upon the trustee which was refused and to establish a colorable
claim which will benefit the bankruptcy estate. In re Newcorn Enter. Ltd., 287 B.R.
744, 750 (Bankr. E.D. Mo. 2002).

       Other courts have refused to expressly acknowledge the availability of
derivative standing within the Eighth Circuit, concluding that the issue is unclear, yet
have agreed that if it is available a creditor must obtain permission from the
bankruptcy court prior to asserting the claim. St. Francis County Farmers Ass’n v.
Wright (In re Wright), 353 B.R. 627, 652-54 (Bankr. E.D. Ark. 2006); Quad City
Bank v. Chapman (In re Chapman Lumber Co. Inc.), 343 B.R. 217, 220-221 (Bankr.
N.D. Iowa 2006). Regardless, no court has allowed a creditor to assert an avoidance
action without prior court approval to do so. In re Wright, 353 B.R. at 653; In re
Chapman Lumber, 343 B.R. at 221; JBD Pork Inc. v. Bank of America, N.A. (In re
Premier Farms L.C.), 2004 WL 1175223 (Bankr. N.D. Iowa 2004). One court, in
dicta, refused to weigh in on the issue without further guidance from the Eighth
Circuit Court of Appeals. Lee v. Nat’l Home Centers, Inc. (In re Bodenstein), 248
B.R. 808, 817-18 n.39 (Bankr. W.D. Ark. 2000).

       In 2000, the Supreme Court concluded that a creditor could not assert surcharge
rights available to a trustee under Section 506(c) of the Bankruptcy Code. Hartford
Underwriters Ins. Co. v. Union Planters Bank, N.A., 530 U.S. 1 (2000). The language
in Section 506(c) is similar to the language in the avoidance sections at issue today:
the “trustee may. . . .” 11 U.S.C. § 506(c). In the Hartford Underwriters case, the
creditor never sought court permission to pursue the surcharge action. The Supreme
Court noted this fact and expressly left unanswered the question before us today: can

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a bankruptcy court authorize another interested party to act in the trustee’s stead in
pursuing a claim or cause of action belonging to the estate and about which the
Bankruptcy Code states only that the trustee may assert such claim or cause of action.
Hartford Underwriters, 530 U.S. at 14 n.5.

       Every circuit court which has addressed this issue since the Hartford
Underwriters opinion was decided has recognized the possibility of derivative
standing to pursue avoidance actions on behalf of a bankruptcy estate. Scott v. Nat’l
Century Fin. Enter. Inc. (In re Baltimore Emergency Services II Corp.), 432 F.3d 557
(4th Cir. 2005); Official Comm. of Unsecured Creditors of Cybergenics Corp. v.
Chinery, 330 F.3d 548 (3rd Cir. 2003); Commodore Int’l Ltd v. Gould (In re
Commodore Int’l Ltd.), 262 F.3d 96 (2nd Cir. 2001); Fogel v. Zell, 221 F.3d 995 (7th
Cir. 2000). None has gone so far as to say a bankruptcy court cannot authorize
derivative standing.

       The bankruptcy court thoroughly analyzed Eighth Circuit law on the subject of
derivative standing and concluded that under the circumstances of this case the
Plaintiff should not be granted standing to pursue the avoidance claims against the
Defendants. We need not address the various factors relied upon by the bankruptcy
court in reaching its well reasoned decision because one factor alone is sufficient to
deny the request for standing: lack of prior court permission. At a minimum, prior
court approval is required for a creditor to assert an avoidance action. In re Wright,
353 B.R. at 653; In re Chapman Lumber, 343 B.R. at 221; JBD Pork Inc. v. Bank of
America, N.A. (In re Premier Farms L.C.), 2004 WL 1175223 (Bankr. N.D. Iowa
2004). Without prior approval, derivative standing does not exist.

      The swift and efficient administration of a bankruptcy estate is an important
goal underlying the Bankruptcy Code. This goal is achieved by narrowly defining
standing in a bankruptcy case. Scott v. Nat’l Century Fin. Enter. Inc. (In re Baltimore
Emergency Services II Corp.), 432 F.3d 557, 560-61 (4th Cir. 2005). Otherwise the

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bankruptcy case may be side-tracked by unnecessary ancillary litigation. Requiring
court approval prior to allowing a creditor to file a derivative suit furthers the goal of
efficiency by weeding out unnecessary suits before they are filed. Id. at 562.
Allowing creditors to file suit without obtaining prior permission and to later seek
retroactive approval of derivative standing is contrary to the very purpose of
limitations on standing – preventing unnecessary ancillary litigation even if such
litigation is short-lived. Id. at 563. A creditor simply cannot file an avoidance action
on the eve of the expiration of the statute of limitations and two and a half months
later ask the court for retroactive permission to file the suit. The bankruptcy court did
not err when it denied the Plaintiff’s belated request to assert the avoidance and
recovery actions on behalf of the bankruptcy estate.

       In the remaining counts of the complaint, the Plaintiff seeks the disallowance
of the Defendants’ claims, the denial of priority status to the Defendants’ claims, and
the equitable subordination of the Defendants’ claims. Section 502(a) of the
Bankruptcy Code expressly authorizes objections to claims by any “party in interest.”
 11 U.S.C. § 502(a). As the largest unsecured creditor of the Debtor’s bankruptcy
estate, the Plaintiff is clearly a party in interest with standing to object to the
Defendants’ claims and their priority status. Section 510(c) of the Bankruptcy Code
authorizes the court, after notice and a hearing, to subordinate a claim. 11 U.S.C.
§ 510(c). The language of Section 510(c) contains no restrictions on who may request
the subordination of a claim. Consequently, the Plaintiff does not need permission
from the court to request such relief. The Plaintiff’s motion for authority to prosecute
the complaint was unnecessary as to the counts objecting to the claim and seeking its
subordination. Accordingly, striking these counts was unwarranted. These counts
should be reinstated and the Plaintiff should be allowed to prosecute them.

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                                   CONCLUSION

       The bankruptcy court did not err when it denied the Plaintiff standing to
prosecute the avoidance and recovery claims. However, court approval was not
necessary for the Plaintiff to object to the Defendants’ claims or to seek the equitable
subordination thereof. Accordingly, we AFFIRM the bankruptcy court’s order
denying the Plaintiff standing to prosecute the avoidance and recovery actions and
striking those counts of the complaint seeking such relief (Counts 3 through 8).
However, we REVERSE the order to the extent it struck the Plaintiff’s objection to
the allowance and the priority status of the Defendants’ claims (Counts 1 and 2) and
the Plaintiff’s request for the equitable subordination of the Defendants’ claims
(Count 9). We REMAND to the bankruptcy court to address Counts 1, 2, and 9 of the
complaint.

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