PRESERVATION AND PROSECUTION OF AVOIDANCE ACTIONS:

ISSUES OF CURRENT INTEREST

Marcia L. Goldstein Scott E. Cohen Samuel S. Cavior WEIL, GOTSHAL & MANGES LLP

Southeast Bankruptcy Law Institute: Thirtieth Annual Seminar on Bankruptcy Law and Rules

Atlanta, Georgia April 1-3,2004

TABLE OF CONTENTS

Page

I . A Review of the Law of Avoidance Actions ..................................................................... 1

A . Introduction .................................................................................................................. 1

B . The Avoidance Provisions ........................................................................................... 1

1 . Section 547 - Preferential Transfers ...................................................................... 1 a . Introduction ...................................................................................................... 1

b . Elements ........................................................................................................... 2

c . Exceptions to the Recovery of a Preferential Transfer .................................... 6

2 . Section 548 - Fraudulent Transfers and Obligations ............................................. 9 a . Actual Fraud ................................................................................................... 10

b . Constructive Fraud ......................................................................................... 11

c . Good Faith Defense ....................................................................................... 14

3 . Other Avoidance Provisions ................................................................................ 14 a . Section 544 - Transactions Voidable Under Nonbankruptcy Law ............... 14

b . Section 545 - Certain Statutory Liens ........................................................... 15

c . Section 553 - Voidable Setoffs ...................................................................... 15

d . Section 549 - Unauthorized Postpetition Transfers ....................................... 15

e . Section 724(a) - Liens Securing Noncompensatory Fines and Penalties ......................................................................................................... 15

4 . Recovery of Prope rty ........................................................................................... 16 a . Section 550 - Liability for Transfers ............................................................. 16

b . Section 55 1 - Preservation of Avoided Transfers ......................................... 17

I1 . Selected Issues of Current Interest ................................................................................... 18 A . Standing of Parties to Pursue Avoidance Actions ..................................................... 18

1 . Direct Standing .................................................................................................... 18 a . Trustee in Bankruptcy .................................................................................... 18

b . Debtor in Possession ...................................................................................... 18

2 . Derivative Standing ............................................................................................. 18

a . Support for Derivative Standing .................................................................... 19

i

TABLE OF CONTENTS (continued)

Page

b . Recent Caselaw on Derivative Standing: Cybergenics .................................. 20

3 . Standing of Postconfirmation Agent .................................................................... 22

1 . Expiration of Statute of Limitations .................................................................... 23

c . Standard for Granting Derivative Standing ................................................... 21

B . Potential Loss of Avoidance Actions ......................................................................... 22

2 . Assumption of Executory Contracts .................................................................... 23

3 . Extinguishment of Avoidance Claims ................................................................. 24 4 . Postpetition Financing and Attachment Upon Avoidance Proceeds ................... 25

5 . Allowance of Claims ............................................................................................ 26

a . Res Judicata ................................................................................................... 26

b . Section 502(d) ................................................................................................ 28

C . Representation of Estate by Creditor’s Counsel to Pursue Avoidance Actions ........ 30

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PRESERVATION AND PROSECUTION OF AVOIDANCE ACTIONS: ISSUES OF CURRENT INTEREST

I. A Review of the Law of Avoidance Actions

A. Introduction

The Bankruptcy Code provides the trustee in bankruptcy with powers to set aside certain transfers effected prior to the commencement of a case under the Bankruptcy Code. These "avoidance powers'' go beyond the avoidance rights available to creditors outside of bankruptcy and are crucial tools for the trustee in fulfilling its function of collecting estate property and maximizing the value of the estate. Where a case is commenced under chapter 11 of the Bankruptcy Code, the debtor generally remains in possession of its property and operates its business. Section 1107 grants to a "debtor in possession" the powers of a trustee in bankruptcy. Accordingly, a debtor in possession may exercise the trustee's avoiding powers outlined herein.

The avoidance powers are set forth in Bankruptcy Code sections 544, 545, 547,548, 549,553 and 724, which describe transactions and interests that are voidable and prescribe the requirements for their avoidance. Most provisions also include exceptions to voidability that distinguish between legitimate transactions and those that violate the goals of the bankruptcy system by unfairly diminishing the estate or undermining the order of distributions in bankruptcy. Procedurally, the trustee seeks avoidance of a voidable transaction or interest by commencing suit in the bankruptcy court, in the form of an adversary proceeding. Under 28 U.S.C. 0 157(b)(2), actions to avoid transfers and interests and to recover property are core proceedings that may be heard and determined by bankruptcy judges.

B. The Avoidance Provisions

Although numerous sections of the Bankruptcy Code provide for the avoidance of certain transactions under a variety of circumstances, the two most potent avoidance

' provisions are the power to avoid preferential transfers, which favor one creditor over other creditors, and the power to avoid fraudulent transfers, which actually or constructively defraud creditors of the debtor.

1. Section 547 - Preferential Transfers

a. Introduction

Preferential transfers are certain prepetition transfers of the debtor's property that have the effect of favoring the transferees over other creditors. Such favoritism is problematic because it undermines the bankruptcy principle that similarly situated creditors receive equal treatment. Further, preference law

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discourages creditors from "racing to the courthouse" to seize property of a debtor and to pursue other remedies during specified periods before the commencement of bankruptcy proceedings when it is presumed that the financial problems of the debtor are known to creditors, resulting in the debtor's dismemberment before bankruptcy relief can be obtained. See Mortenson v. National Union Fire Ins., 249 F.3d 667,671 (7th Cir. 2001) (rule against preferences premised upon tendency of troubled debtors to pay the most pressing creditors); Lindquist v. Dorholt (In re Dorholt, Inc.), 224 F.3d 871, 873 (8th Cir. 2000) (preference rule 'lis intended to discourage creditors from racing to dismember a debtor sliding into bankruptcy and to promote equality of distribution to creditors in bankruptcy").

b. Elements

Section 547 provides that a trustee may avoid a transfer of property of the debtor if the trustee can prove each of the following five elements: (1) the transfer was made ''to or for the benefit of a creditor;" (2) the transfer was made for or on account of a debt which was owed prior to the time of the transfer; (3) the debtor was insolvent at the time the transfer was made; (4) the transfer was made within ninety days before the commencement date or, if the transfer was made to an insider, within one year before the commencement date; and ( 5 ) the transfer resulted in the creditor receiving more than it would have received if the estate were liquidated in a chapter 7 case. 11 U.S.C. §547(b).

The trustee bears the burden of proof as to all five elements. 11 U.S.C. §547(g); see also Batlan v. Transamerica Comm. Fin. Corp. (In re Smith's Home Furnishings, Inc.), 265 F.3d 959,963 (9th Cir. 2001); Boberschmidt v. Society Nat ' I Bank (In re Jones), 226 F.3d 917,921 (7th Cir. 2000); Stingley v. Allied Signal, Inc. (In re Libby Int'l, Inc.), 247 B.R. 463,466 (8th Cir. BAP 2000).

(i) Property of the Debtor

In order for a transfer of property to be avoided as a preference, the property transferred must be owned by the debtor. Generally speaking, property belongs to the debtor for purposes of $547 if its transfer would deprive the estate of something that could otherwise be used to satisfy creditors, i.e. if it "would have been part of the estate had it not been transferred before the commencement of bankruptcy proceedings." Begier v. IRS, 496 U.S. 53 (1 990).

Some courts apply a "diminution of the estate" test, which asks whether a transfer "diminishes directly or indirectly the fund to which creditors of the same class can legally resort for the payment of their debts, to such an extent that it is impossible for other creditors of the same class to obtain as

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great a percentage as the favored one." Adams v. Anderson (In re Superior Stamp & Coin Co.), 223 F.3d 1004, 1008 (9th Cir. 2000).

A transfer of property held by the debtor in trust for another entity cannot be recovered as a preference because the debtor holds only the legal, not the equitable, interest -in that property. See Jenkins v. Chase Home Mortg. Corp. (In re Maple Mortg.), 81 F.3d 592, 596 (5th Cir. 1996), citing Begier, 496 U.S. at 59.

(ii) Transfer

Section lOl(54) broadly defines a transfer as "every mode, direct or indirect, absolute or conditional, voluntary or involuntary, of disposing of or parting with property or with an interest in property, including retention of title as a security interest and foreclosure of the debtor's equity of redemption."

The following have been construed as transfers for purposes of applying the preference provisions of the Bankruptcy Code: the creation of a lien in favor of a previously unsecured creditor, see Grant v. Kaufman (In re Hagen), 922 F.2d 742 (1 lth Cir. 1991); the perfection of a lien or security interest outside the time permitted for perfection, see In re Klingbeil, 1 19 B.R. 178 (Bankr. D. Minn. 1990); the creation of judicial liens, see T.M. Sweeney & Sons, LTL Sews., Inc. v. Crawford (In re T.M. Sweeney & Sons, LTL Sews., Inc.), 120 B.R. 101 (Bankr. N.D. Ill. 1990); the execution on garnished funds, see Klingbeil, 1 19 B.R. 178; the recovery from a cash bond posted to obtain a stay pending the appeal of a judgment, see In re Thompson McKinnon Sec., Inc., 125 B.R. 94 (Bankr. S.D.N.Y. 1991); and the pledge of assets to secure a letter of credit, see Kellogg v. Blue Quail Energy (In re Compton Corp.), 83 1 F.2d 586 (5th Cir. 1987), on reh 'g, 835 F.2d 584 (5th Cir. 1988); see also American Bank v. Leasing Sew. Corp. (In re Air Conditioning Inc.), 845 F.2d 293 (1 lth Cir. 1988), cert. denied, 488 U.S. 993 (1988).

(iii) To or for the Benefit of a Creditor

Typically, transfers sought to be avoided as preferences are transfers made directly to the creditor. However, a creditor may also be the beneficiary of indirect transfers. See Craps Plus+ v. Foothill Capital Corp. (In re Craps Plus+), 220 B.R. 33 1 ,337 (Bankr. W.D. Tex. 1998), citing In re Compton Corp., 831 F.2d 586 (5th Cir. 1987) (creditor was indirectly benefited by a pledge of assets by the debtor to its bank to secure letter of credit in favor of the creditor); see also Levit v. Ingersoll Rand Fin. Corp. (In re Deprizio Construction Co.), 874 F.2d 1186, 1196-98 (7th Cir. 1989) (which

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prompted amendment of $550, limiting a trustee's recovery under certain scenarios involving indirect benefits to insiders).

(iv) Antecedent Debt

An antecedent debt is a debt that is owed prior to the time of the transfer in question. The controlling factor is the date of the incurrence of the debt, which for preference purposes is the time when the debtor becomes legally obligated to pay. See Harrah 's Tunica COT. v. Meeks (In re Armstrongj, 291 F.3d 517,525 (8th Cir. 2002), citing Laws v. United Mo. Bank, 98 F.3d 1047 (8th Cir. 1996), cert. denied, 520 U.S. 1168 (1997); Peltz v. United Health Care (In re Bridge Info. Sys.), 299 B.R. 567,572 (Bankr. E.D. Mo. 2003); Peltz v. New Age Consulting Sews. (In re USN Communs., Inc.), 279 B.R. 99, 102 (Bankr. D. Del. 2002).

Consequently, a transfer may be construed as being "on account of an antecedent debt" if it is made after the receipt of goods or services by the debtor, even if the debtor pays the debt within the time limits provided in the invoice rendered by the supplier of such goods or services. See In re First Jersey Securities, Inc., 180 F.3d 504 (3d Cir. 1999); Vanguard Airlines, Inc. v. Airline Automation, Inc. (In re Vanguard Airlines, Inc.), 295 B.R. 329,334 (Bankr. D. Mo. 2003).

(v) Insolvency

Under $547(f) of the Bankruptcy Code, a debtor is presumed to be insolvent during the ninety days immediately preceding the commencement of bankruptcy proceedings. This presumption applies to transfers made to all types of unsecured creditors. Where, however, a transfer is made to a creditor that is an insider, see 11 U.S.C. $101(31) (defining "insider"), the ninety-day period is enlarged and the transfer may be avoided if made within one year before the commencement date. See 11 U.S.C. $547(b)(4)(B). The trustee in these preference actions does not have the benefit of the presumption of insolvency beyond ninety days, however, and must accordingly prove insolvency. See In re Lamar Haddox Contr., Inc., 40 F.3d 118, 121 (5th Cir. 1994); Burdick v. Lee, 256 B.R. 837,841 (D. Mass. 2001).

The Bankruptcy Code defines an insider by providing a nonexhaustive list of examples. See 11 U.S.C. $101(31). Insider status is a question of fact which is decided on a case-by-case basis. See Hirsch v. A. Tarricone, Inc. (In re A. Tarricone, Inc.), 286 B.R. 256,262 (Bankr. S.D.N.Y. 2002); Yoppolo v. Lindecamp (In re Fox), 277 B.R. 740 ,744 (Bankr. N.D. Ohio 2002). The factors that courts generally consider in determining insider

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status are whether the alleged insider dealt at arm's length with the debtor and the level of authority and control the alleged insider exercised over the debtor. See In re A. Tarricone, Inc., 286 B.R. at 262 (listing cases).

(vi) Time of Transfer

The trustee is allowed to recover payments made only within the applicable ninety-day or one-year period immediately preceding the commencement date. Courts apply different tests in determining insolvency and the value of property but, regardless of the test utilized, the date used to measure insolvency for purposes of 9547(b)(3) is the date of the actual transfer. See Roeder v. Alleman (In re Davis), 120 B.R. 823,825 (Bankr. W.D. Pa. 1990); accord Barber v. Prod. Credit Sews. of W. Central Ill. (In re KZK Livestock, Inc.), 290 B.R. 622, 625 (Bankr. N.D. Ill. 2002). In Barnhill v. Johnson, 503 U.S. 393 (1992), the Supreme Court held, with regard to the preference period under §547(b), that a transfer by check should be deemed to occur on the date the check is honored by the drawee bank as opposed to when it is presented to the recipient.

(vii) Receipt of More Than Is Recoverable in a Chapter 7 Case

Even if a transfer satisfies all other elements of $547(b), it is still not a voidable transfer unless the transfer enabled the transferee to receive more than it would have received in a liquidation of the debtor's estate in a case under chapter 7 of the Bankruptcy Code. Only in the unlikely event that the estate has sufficient funds to pay in full the claims of all unsecured creditors in a chapter 7 case would an unsecured creditor that is paid, in whole or in part, during the preference period not receive more than it would in a chapter 7 liquidation. See Goldberg v. Such (In re Keplinger), 284 B.R. 344, 347 (N.D.N.Y. 2002); Guttman v. Assocs. Commer. Corp. (In re Furley 's Transp., Inc.), 272 B.R. 161, 174 (Bankr. D. Md. 2001); Hays v. DMAC Invs., Inc. (In re RDMSports Group, Inc.), 250 B.R. 805,814 (Bankr. D. Ga. 2000); Hunter v. Snap-On Credit Corp. (In re Fox), 229 B.R. 160, 166 (Bankr. D. Ohio 1998), citing Chattanooga Wholesale Antiques Inc., 930 F.2d 458,465 (6th Cir. 1991).

In determining whether a creditor received more than it would have in a chapter 7 liquidation, the commencement date is the relevant date for the liquidation analysis. See Sloan v. Zions First Nut 'I Bank (In re Castletons Inc.), 990 F.2d 55 1,554 (10th Cir. 1993); Neuger v. United States (In re Tenna Corp.), 801 F.2d 819,822 (6th Cir. 1986), citing Palmer Clay Prods. Co. v. Brown, 297 U.S. 227 (1936); accord Mendelsohn v. National Westminster Bank, U.S.A. (In re Frank Santora Equipment Corp.), 256 B.R. 354,375 (Bankr. E.D.N.Y. 2000); but see Philip Sews. Corp. v. Luntz (In re

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Philip Sews. Corp.), 284 B.R. 541, 551 (Bankr. D. Del. 2002) ("the analysis cannot ignore actual events that occur post-petition," such as assumption of a relevant executory contract).

A preferential transfer occurs only where transfers are made either to unsecured creditors or to undersecured creditors other than from the collateral (if any) securing their claims. No preference can occur where transfers are made to a fully secured creditor because the claims of such a creditor would be satisfied from its collateral. See Batlan v. Transamerica Comm. Fin. Corp. (In re Smith's Home Furnishings, Inc.), 265 F.3d 959, 963 (9th Cir. 2001); Krafsur v. Scurlock Permian Corp. (In re El Paso Refinery L.P.), 171 F.3d 249,253 (5th Cir. 1999); Committee of Creditors Holding Unsecured Claims v. Koch Oil Co. (In re Powerine Oil Co.), 59 F.3d 969,972 (9th Cir. 1995), cert. denied, 516 U.S. 1140 (1996); Janus v. Marc0 Crane & Rigging Co. (In re JIVJ Contr. Co.), 287 B.R. 501 , 514 (9th Cir. BAP 2002).

c. Exceptions to the Recovery of a Preferential Transfer

Notwithstanding a finding that a transfer satisfies all the elements of a preferential transfer, $547(c) of the Bankruptcy Code provides eight types of transfers that may be excepted from avoidance. The excepted transfers include contemporaneous exchanges for "new value," payments made in the ordinary course of business, purchase money security interests, transfers that are followed by the extension of new credit, and floating liens in inventory and receivables, among others. The transferee bears the burden of proof as to the availability of these exceptions. See 11 U.S.C. $547(g); see also Stingley v. Allied Signal, Inc. (In re Libby Int'l, Inc.), 247 B.R. 463,463 (8th Cir. BAP 2000).

(i) Contemporaneous Exchange for New Value

Section 547(c)( 1) provides that a preferential transfer may not be avoided if it was intended by the debtor and the creditor to be a contemporaneous exchange for new value given to the debtor and if it was in fact a contemporaneous exchange. "New value" means "money or money's worth in goods, services or new credit, or release by a transferee of property previously transferred to such transferee in a transaction that is neither void nor voidable by the debtor or the trustee under any applicable law, including proceeds of such property, but does not include an obligation substituted for an existing obligation." 11 U.S.C. $547(a)(2).

A determination of whether parties intended a contemporaneous exchange for value is a question of fact. Tyler v. Swiss Am. Sec., Inc. (In re Lewellyn

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& Co., Inc.), 929 F.2d 424 (8th Cir. 1991); Creditors' Comm. v. Spada (In re Spada), 903 F.2d 971 (3d Cir. 1990). A prior agreement between the parties or a course of dealing can be evidence of intent for purposes of determining whether a transaction was a contemporary exchange. Lewellyn, 929 F.2d at 428-29; Spada, 903 F.2d at 976. Transfers which have been held to constitute a contemporaneous exchange for new value include the transfer of stock to a securities clearing organization in lieu of a timely cash settlement of an obligation of the debtor, see Lewellyn, 929 F.2d 424; Spada, 903 F.2d 971; the grant of a new mortgage on one property in exchange for the release of a mortgage on another property, see Eide v. United States Farmers Home Admin. (In re Quade), 108 B.R. 681 (Bankr. N.D. Iowa 1989); and the conveyance by a debtor of its interest under purchase and escrow agreements in exchange for a cash payment from the creditor, see Spears v. Michigan v. Nut '1 Bank (In re Allen), 888 F.2d 1299 (10th Cir. 1989).

Transfers which have been held not to constitute a contemporaneous exchange for new value include the release of future contractual obligations, see Durant 's Rental Ctr., Inc. v. United Truck Leasing Co. (In re Durant 's Rental Ctr., Inc.), 116 B.R. 362 (Bankr. D. Conn. 1990); the forbearance by a creditor from exercising any existing right or remedy, such as the right to foreclose on collateral, accelerate the maturity of scheduled payments, or institute eviction proceedings; the perfection of a mortgage more than ten days after its creation, see Anderson v. DeLong (In re Chicora Group), 99 B.R. 715 (Bankr. D.S.C. 1988); a cashier's check given by the debtor in exchange for checks which had been returned for insufficient funds, see Mann v. Missouri Gen. Ins. Agency, Inc. (In re St. Louis Globe Democrat, Inc.), 99 B.R. 946 (Bankr. E.D. Mo. 1989); and a postdated check given by a debtor in payment of goods, see Samar Fashions, Inc. v. Matisse Int '1, Inc. (In re Samar Fashions, Inc.), 109 B.R. 136 (Bankr. E.D. Pa. 1990).

(ii) Ordinary Course of Business

Section 547(c)(2) provides an exception for transfers in the ordinary course of business, the most frequently used defense in preference actions. The "ordinary course of business" exception is intended to protect recurring, customary credit transactions and encourage normal financing relations by eliminating the concern that such transactions could be avoided in a subsequent bankruptcy. See Barnhill v. Johnson, 503 U.S. 393,406 (1992); Harrah's Tunica Corp. v. Meek (In re Armstrong), 291 F.3d 517,525 (8th Cir. 2002). Under §547(c)(2), a preferential transfer may not be avoided where (A) the debt was incurred in the ordinary course of business or financial affairs of both the debtor and the creditor; (B) the payment was made in the ordinary course of business or financial affairs of both the

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debtor and the creditor; and (C) the payment was made according to ordinary business terms. 11 U.S.C. §547(c)(2).

Whether a preferential transfer was in the ordinary course of business is determined by a two-part test. The "subjective prong" of the analysis requires proof that the debt and the payment were "ordinary in relation to other business dealings between that creditor and that debtor." Logan v. Basic Distrib. Corp. (In re Fred Hawes Org.), 957 F.2d 239,244 (6th Cir. 1992); see also Color Tile v. Mfrs. Consol. Sew. (In re Color Tile), 2000 Bankr. LEXIS 1048 (Bankr. D. Del. Sept. 20,2000), citing Fiber Lite Corp. v. Molded Acoustical Prods., Inc. (In re Molded Acoustical Prods., Inc.), 18 F.3d 217 (3d Cir. 1994), and United States Trustee v. First Jersey Securities, Inc. (In re First Jersey Securities, Inc.), 180 F.3d 504 (3d Cir. 1999), andJ.P. Fyfe, Inc. v. Bradco Supply Corp., 891 F.2d 66 (3d Cir. 1989).

Courts have not reached a consensus on the "objective prong'' of the analysis. See generally, Gonzalez v. DPI Food Prods. Co. (In re Furrs Supermarkets), 296 B.R. 33,42 (Bankr. D.N.M. 2003). In In re Tolona Pizza Prods. Corp., 3 F.3d 1029 (7th Cir. 1993), the Seventh Circuit set out a widely accepted position that "ordinary business terms" refers to the general practices of similar industry members. In contrast, the Tenth Circuit applies a "healthy debtor" standard in which "ordinary business terms" are Yhose used in normal financing relations.. .in ordinary circumstances, when debtors are healthy," and do not include industry-wide practices to accommodate borrowers under financial pressure. See Clark v. Balcor Real Estate Fin., Inc. (In re Meredith Hoffman Partners), 12 F.3d 1549 (10th Cir. 1993), cert. denied, 5 12 U.S. 1206 (1 994). In Arrow Elecs. Inc. v. Justus (In re Kaypro), 21 8 F.3d 1070 (9th Cir. 2000), the Ninth Circuit concluded that payments made under a restructuring arrangement are not extra-ordinary per se. In a particularly noteworthy ruling, the Supreme Court held in Union Bank v. Wolas, 502 U.S. 15 1 (1991), that the §547(c)(2) exception is not limited to payments on short-term debt and may apply to payments on long-term debt. See 502 U.S. at 162.

(iii) Purchase Money Security Interests

Section 547(c)(3) provides that a security interest created in property acquired by the debtor is not a preferential transfer to the extent that it is what is commonly referred to as a "purchase money security interest." To qualifl, the security interest must secure new value that was "(i) given at or after the signing of a security agreement that contains a description of such property as collateral; (ii) given by or on behalf of the secured party under such agreement; (iii) given to enable the debtor to acquire such property; and (iv) in fact used by the debtor to acquire such property." 1 1. U.S.C.

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§547(c)(3). In addition, the purchase money security interest must be perfected within twenty days after the grant of the security interest, notwithstanding any different period provided under applicable state law. See 11 U.S.C. 9547(c)(3)(B).

(iv) Subsequent New Value

Section 547(c)(4) provides that a creditor who received a preferential payment and thereafter extended new value to the debtor may reduce the amount of the preference recovery by the amount of the new value. Specifically, the exception provides that a trustee may not avoid a preferential payment to the extent that after the transfer, the creditor gave to or for the benefit of the creditor new value which was not secured. 1 1 U.S.C. $547(c)(4). Accordingly the 'hew value" exception requires that the new value extended by the creditor is on an unsecured basis and remains unpaid. See TWA Inc. Post Confirmation Estate v. City & County of Sun Francisco Airports Comm 'n (In re TWA Inc. Post Confirmation Estate), 2004 Bankr. LEXIS 38, *17-18 (Bankr. D. Del. Jan. 20,2004), citing New York City Shoes, Inc. v. Bentley Int 'I, 880 F.2d 679 (3d Cir. 1989); Moglia v. Am. Psych. Ass 'n (In re Login Bros. Book Co.), 294 B.R. 297,299 (Bankr. N.D. Ill. 2003), citing In re Prescott, 805 F.2d 719,728,731 (7th Cir. 1986); Field v. Md. Motor Truck Ass 'n (In re George Transfer, Inc.), 259 B.R. 89,94 (Bankr. D. Md. 2001).

(v) Inventory and Receivables Security Interest

Section 547(c)(5) excepts from avoidance those transfers that create security interests in working capital assets (such as accounts receivable, inventory, or the proceeds thereof), but only to a limited extent. This provision relates to revolving credit loans secured by working capital assets where the debtor converts new inventory into accounts receivable through sales that subject the accounts receivable to the security interest of the revolving credit lender. Such transfers are excepted from avoidance only to the extent that the lender has not improved its collateral position from the beginning of the applicable preference period to the commencement date. See 11 U.S.C. §547(c)(5).

(vi) Statutory Liens and Consumer Debts

The final three exceptions are used less frequently and relate to statutory liens, alimony, maintenance, and support payments. Under §547(c)(6) of the Bankruptcy Code, an otherwise preferential transfer is excepted to the

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extent that the transfer was the fixing of a statutory lien that is not otherwise avoidable under 9545 of the Bankruptcy Code. Under §547(c)(7) of the Bankruptcy Code, the payment of a debt to a spouse, former spouse, or child of the debtor for alimony, maintenance, or support pursuant to a separation, divorce decree, or other order of a court of record is exempt from the preference statutes. And under §547(c)(8), a transfer valued at less than $600 in an individual debtor case involving primarily consumer debts is exempt from avoidance.

2. Section 548 - Fraudulent Transfers and Obligations

A trustee in bankruptcy may avoid both a fraudulent transfer of property (or an interest in property) and a fraudulent incurrence of an obligation by a debtor. Regardless of whether the debtor transfers property or incurs an obligation, however, avoidance is premised upon the transaction being either actually or constructively fraudulent. The former focuses on the subjective intent of the transferor, while the latter looks more to objective criteria specified by the Bankruptcy Code.

Unlike preference actions, two independent sources of law govern the avoidance of fraudulent transfers - federal law and state law. The applicable federal law is §548 of the Bankruptcy Code. The applicable state law generally is either the Uniform Fraudulent Conveyance Act (YJFCA") or the Uniform Fraudulent Transfer Act (YJFTA"), which have been enacted in six states and thirty-seven states, respectively. In this connection, §544(b) of the Bankruptcy Code empowers a trustee in bankruptcy to prosecute any state-law avoidance actions that could be prosecuted by a general unsecured creditor. Given the substantial similarities between the federal and state fraudulent transfer statues, the power of §544(b) derives from the extended statutes of limitations for fraudulent transfer actions under the laws of many states. For a fraudulent transfer to be voidable under $548 of the Bankruptcy Code, the transfer must occur within one year prior to the bankruptcy commencement date. However, if the trustee brings a state-law fraudulent transfer action pursuant to 9544(b), the statute of limitations is governed by applicable state-law limitations periods, which range from two to six years from the date the transfer occurred.

There are two categories of fraudulent transfers: (i) "actual" fraudulent transfers, which are based on a finding of an actual intent to hinder, delay, or defraud a creditor, and (ii) "constructive" fraudulent transfers, which are based on an evaluation of the financial condition or position of the transferor. The former focuses on the subjective intent of the transferor; the latter looks more to specified objective criteria.

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a. Actual Fraud

To sustain a fraudulent transfer cause of action under §548(a)( l)(A), the trustee must prove that the property was transferred or the obligation was incurred within one year before the commencement date, and that the debtor transferred the property or incurred the obligation with the actual intent to hinder, delay, or defraud any entity to which the debtor was indebted at the time of the transfer or became indebted thereafter. See 11 U.S.C. §548(a)( l)(A).

A court may make a finding of actual intent based upon circumstantial evidence. See Robertson v. Dennis (In re Dennis), 330 F.3d 696,701-02 (5th Cir. 2003), citing Pavy v. Chastant (In re Chastant), 873 F.2d 89,91 (5th Cir. 1989); see also Premier Capital, Inc. v. Diamond (In re Diamond), 2003 Bankr. LEXIS 322, *7 (Bankr. D.N.H. Mar. 27,2003) (discussing actual intent under $727 and citing Annino, Draper & Moore, P.C. v. Lang (In re Lana), 256 B.R. 539,541 (1st Cir. BAP 2000)). Among the pertinent "badges of fraud" recognized by courts in determining the actual intent of a debtor are the pendency or threat of suits by creditors, inadequacy of consideration, the financial condition of the debtor before and after the transaction, whether the debtor retained post-transfer possession of property, whether the transaction was at armls length, the timing of the transfer in relation to the filing of the bankruptcy petition, and a special relationship between the parties. See Burtch v. Harris (In re Harris), 2003 Bankr. LEXIS 1757, *4-5 (Bankr. D. Del. Dec. 30,2003); see also UFTA 94(b) (identifying eleven badges of fraud). Although a court may regard evidence of one of the "badges of fraud" as suspicious, the presence of several may be regarded as conclusive. See Annino, Draper & Moore, P.C. v. Lang (In re Lana), 246 B.R. 463,469 (Bankr. D. Mass. 2000).

b. Constructive Fraud

In an action based on constructive fraud, the actual intent of the transferor and the transferee is irrelevant; the inquiry focuses instead on the financial condition of the transferor immediately before and after the transfer. See Clark v. Security Pacific Bus. Credit (In re Wes Dor, Inc.), 996 F.2d 237,240 (10th Cir. 1993).

Under §548(a)(l)(B), a fraudulent transfer action can be sustained if the trustee can prove the following: (i) within one year before the commencement of the bankruptcy case the debtor either transferred its interest in property or incurred an obligation; (ii) the debtor received less than a reasonably equivalent value in exchange for the transfer or obligation; and (iii) the debtor was insolvent on the date the transfer was made or obligation was incurred (or became insolvent as

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result of the transfer or obligation), or the debtor was left with an unreasonably small amount of capital with which to engage in business or a transaction, or the debtor intended to incur debts beyond its ability to pay them as they matured. 11 U.S.C. $548(a)(l).

(i) Elements of Constructive Fraud

(a) Transfer

The Bankruptcy Code broadly defines the term "transfer." See 11 U.S.C. $ lOl(54). In applying this definition, courts have determined that transactions constituting "transfers" for purposes of fraudulent transfer law include an election to carry forward a net operating loss, see United States v. Sims (In re Feiler), 218 F.3d 948 (9th Cir. 2000); Towers v. United States (In re Feiler), 21 8 B.R. 957 (Bankr. D. Cal. 1998); the grant of a mortgage, see In re Brantz, 106 B.R. 62 (Bankr. E.D. Pa. 1989); and a purchase of a life insurance policy by the debtor with its remaining nonexempt property, see Staats v. Beckman (In re Beckman), 104 B.R. 866 (Bankr. S.D. Ohio 1989).

(b) Reasonably Equivalent Value

The Bankruptcy Code does not define the term "reasonably equivalent value." Section 548(d), however, defines "value" to mean "property, or satisfaction or securing of a present or antecedent debt of the debtor, but.. .not [to] include and unperformed promise to furnish support to the debtor or to a relative of the debtor." 11 U.S.C. $548(d). The "reasonably equivalent value" test is "an objective test, not affected by the subjective good, or bad, faith of the transferee." Pareira v. Checkmate Communications Co. (In re Checkmate Stereo & Elecs., Ltd.), 9 B.R. 585,591 (Bankr. E.D.N.Y. 1981), a f d , 21 B.R. 402 (E.D.N.Y. 1982); see also Mishkin v. Ensminger (In re Adler, Coleman Clearing Corp.), 247 B.R. 51,114 (Bankr. S.D.N.Y. 1999).

In determining whether the debtor received reasonably equivalent value, the transaction is analyzed from the perspective of the benefit the debtor receives in exchange and not from the perspective of the gain or loss realized by creditors or other third parties. See Solomon v. Stillwater Nut 'I Bank & Trust Co. (In re Solomon), 299 B.R. 626, 634 (1 0th Cir. BAP 2003); Rambo v. Chase Manhattan Mortg. Corp. (In re Rambo), 297 B.R. 418,429 (Bankr. E.D. Pa. 2003). Therefore, transfers made or obligations incurred by the debtor that directly benefit third parties and not the debtor may be fraudulent because the debtor receives no consideration for making the transfer. However, transfers made or

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obligations incurred by the debtor that directly benefit third parties may not be fraudulent if the debtor received consideration in the form of a sufficient indirect benefit.

Most courts recognize that a determination of reasonably equivalent value depends on the facts of each case and that no specific formula can be used. See Peltz v. Hatten (In re USN Communs., Inc.), 279 B.R. 710, 732 (D. Del. 2002), a f d , 2003 U.S. App. LEXIS 5842 (3d Cir. Mar. 25, 2003); Chapman v. Baldi (In re Gropman, Inc.), 2002 U.S. Dist. LEXIS 15654 (D. Ill. Aug. 20,2002), citing Barber v. Golden Seed Co., Inc., 129 F.3d 382,387 (7th Cir. 1997); see also Lowe v. B.R.B. Enters., Ltd. (In re Calvillo), 263 B.R. 214 ,220 (W.D. Tex. 2000); Balaber-Strauss v. Sixty-Five Brokers (In re Churchill Mortg. Inv. Corp.), 256 B.R. 664, 678-679 (Bankr. S.D.N.Y. 2000). For purposes of determining whether the value of the property or consideration given in exchange for a transfer or the incurrence of an obligation constitutes reasonably equivalent value, the consideration is valued as of the date of the transfer (i.e. subsequent appreciation or depreciation is not counted). See Kittay v. Peter D. Leibowits Co. (In re Duke & Benedict, Inc.), 265 B.R. 524, 532 (Bankr. S.D.N.Y. 2001), citing Butler Aviation Int '1, Inc. v. Whyte (In re Fairchild Aircraft Corp.), 6 F.3d 11 19 (5th Cir. 1993), and Cooper v. Ashley Communications, Inc. (In re Morris Communs. NC, Inc.), 914 F.2d 458 (4th Cir. 1990).

In BFP v. Resolution Trust Corp., 5 1 1 U.S. 53 1 (1994), the Supreme Court held that the price received at a nonjudicial foreclosure sale is conclusively presumed to be "reasonably equivalent value" for the foreclosed property if the sale meets all the requirements of state-law foreclosure procedures and is not collusive. Under these circumstances, the Supreme Court ruled, "the only legitimate evidence of the property's value at the time it is sold is the foreclosure sale." Id. at 549.

Further, most courts have applied fraudulent transfer law in the context of failed leveraged buyouts. In such instances, the principal attack is the lack of reasonably equivalent value received by, or the lack of fair consideration given to, the target company in exchange for its transfer of the liens against its assets of the incurrence of obligations to the acquisition lenders. The potential defendants in a fraudulent conveyance action based on a leveraged buyout include selling shareholders, secured lenders, unsecured lenders, and subsequent holders of leveraged buyout debt. See, e.g., Moody v. Security PaciJic Bus. Credit, 971 F.2d 1056 (3d Cir. 1992); Lippi v. City Bank, 955 F.2d 599 (9th Cir. 1992); Mellon Bank v. Metro Communs. Inc., 945 F.2d 635 (3d Cir. 1992); Wieboldt Stores, Inc. v. Schottenstein, 94 B.R. 488 (N.D. Ill. 1988); but see Kaiser Steel Corp. v. Pearl Brewing Co. (In re Kaiser Steel Corp.), 952 F.2d 1230 (10th Cir. 1991), cert. denied, 505 U.S. 1213 (1992) (trustee could not recover from selling shareholders of publicly traded

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corporation because their payments constituted non-avoidable "settlement payments" under §546(e)).

(c) Financial Peril

In addition to the other elements, the trustee in bankruptcy must demonstrate one of three financial conditions: (i) the insolvency of the debtor at the time of the transfer (or as a result of the transfer), (ii) the retention by the debtor of unreasonably small operating capital, or (iii) the intentional incurrence of debts by the debtor beyond its ability to pay. See 11 U.S.C. §548(a)(l)(B). The first condition requires a determination of insolvency, which the Bankruptcy Code defines differently for partnerships, municipalities, and other entities. 11 U.S.C. 0 lOl(32). Courts have developed various tests for determining insolvency.

Determining whether the transferor has been left with "unreasonably small capital" is grounded in the specific facts of each case. See Wells Fargo Bank v. Desert View Bldg. Supplies, Inc., 475 F. Supp. 693 (D. Nev. 1978), a f d mem., 633 F.2d 221 (9th Cir. 1980); Huennekens v. Gilcom Corp. of Va. (In re Sunsport, Inc.), 260 B.R. 88, 114 (Bankr. E.D. Va. 2000). The term "capital" has been construed to mean net worth (assets minus liabilities), see Jacobson v. First State Bank (In re Jacobson), 48 B.R. 497 (Bankr. D. Minn. 1985); unencumbered assets (free assets or the value of equity in specific assets), see Teitelbaum v. Voss (In re Tuller 's, Inc.), 480 F.2d 49 (2d Cir. 1973); Diller v. Irving Trust Co. (In re College Chemists), 62 F.2d 1058 (2d Cir. 1933); cash capital, see In re Atlas Foundry Co., 155 F. Supp. 615 (D.N.J. 1957); working capital, see Zuk v. Hale, 330 A.2d 448 (N.H. 1974); specific assets, whether encumbered or not, see Jacobson, 48 B.R. 497; the initial capitalization of a company, see generally Duberstein v. Werner, 256 F. Supp. 5 15 (E.D.N.Y. 1966); and assets considered in conjunction with cash flow, see Credit Managers Ass 'n v. Federal Co., 629 F. Supp. 175 (C.D. Cal. 1985).

"Unreasonably small capital" has been construed to mean an operating condition short of equitable insolvency. One court determined that "[ulnreasonably small capitalization is not the equivalent of insolvency in either the bankruptcy or the equity sense. . . . [It] encompasses difficulties which are short of insolvency in any sense but are likely to lead to insolvency at some time in the future." Vadnais Lumber Supply v. Byrne (In re Vadnais Lumber Supply, Inc.), 100 B.R. 127, 137 (Bankr. D. Mass. 1989); see also Peltz v. Hatten (In re USN Communs., Inc.), 279 B.R. 710,744 (D. Del. 2002), a f d , 2003 U.S. App. LEXIS

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5842 (3d Cir. Mar. 25,2003), citing Moody v. Security Pacijk Bus. Credit, Inc., 971 F.2d 1056, 1070 (3d Cir. 1992).

With respect to the third alternative for satisfying the third element of constructive fraud under $548(a)( l)(B), in determining whether a debtor intended to incur debts beyond its ability to pay when due, a trustee is not required to show that the debtor had specific knowledge of an actual inability to pay particular debts. To the contrary, a showing that the debtor had knowledge of a generalized inability to service debt suffices. See Lackawanna Pants Mfg. Co. v. Wiseman, 133 F. 2d 482 (6th Cir. 1943); New York Credit Men 's Adjustment Bureau, Inc. v. Adler, 2 B.R. 752 (S.D.N.Y. 1980).

c. Good Faith Defense

Section 548(c) provides a limited defense to the avoidance of fraudulent transfers. A transfer or obligation not otherwise voidable under $9 544,545 or 547 effectively will not be avoided under $548 to the extent that the transferee or obligee gave value to the debtor in "good faith" in exchange. Thus, to the extent of the value given, such a transferee "has a lien on or may retain any interest transferred or may enforce any obligation incurred." 11 U.S.C. $548(c).

3. Other Avoidance Provisions

a. Section 544 - Transactions Voidable Under Nonbankruptcy Law

(i) Nonbankruptcy Rights of Certain Hypothetical Creditors

Section 544(a) ( W a the "strong-arm" clause) confers upon the trustee the rights of certain kinds of creditors (a judicial lien creditor, an execution creditor, and a bona fide purchaser of real property) who may be entitled to avoid certain liens under applicable nonbankruptcy law. There need not be any such creditors in the instant case for the trustee to exercise the rights of such creditors. 11 U.S.C. $544(a).

(ii) Nonbankruptcy Rights of Actual Unsecured Creditors

As discussed, $544(b) empowers a trustee to prosecute any avoidance actions that could be prosecuted by some actual general unsecured creditor in the case under nonbankruptcy law. 11 U.S.C. 9544(b). In practice, the nonbankruptcy law used is usually the applicable Uniform Fraudulent '

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Conveyance Act, Uniform Fraudulent Transfer Act, or other state fraudulent transfer law.

b. Section 545 - Certain Statutory Liens

A statutory lien is a lien "arising solely by force of a statute on specified circumstances or conditions ... but does not include security interest or judicial lien." 11 U.S.C. $101(53). Under $545, the trustee is empowered to avoid three kinds of statutory liens: (i) those specifically created to take effect upon the debtor's insolvency, bankruptcy, or financial distress (i.e. securing an otherwise unsecured claim in anticipation of financial distress); (ii) those not perfected or enforceable against a hypothetical bona fide purchaser deemed to have purchased the property on the commencement date; and (iii) those for rent or distress of rent (i.e. landlord's liens). See 11 U.S.C. $545.

c. Section 553 - Voidable Setoffs

The right to setoff traditionally has enjoyed special protection under bankruptcy law despite running against the general goal of equal treatment of similarly situated creditors. Under $553, the trustee may avoid setoffs to the extent they involve disallowed claims or arise out of certain transactions, made within 90 days before the commencement date, that tend to manipulate setoff rights to obtain improper advantages. See 11 U.S.C. $553.

d. Section 549 - Unauthorized Postpetition Transfers

Under 9549, the trustee may avoid postpetition transfers of property of the estate that are not authorized by either the Bankruptcy Code or the bankruptcy court, or are authorized only under $8 303(f) and 542(c). See 11 U.S.C. $549.

e. Section 724(a) - Liens Securing Noncompensatory Fines and Penalties

Under $724(a), the trustee may avoid liens that secure certain allowed claims for fines, penalties, forfeiture, or multiple, exemplary or punitive damages to the extent they are not compensation for actual pecuniary loss. See 11 U.S.C. $$ 724(a), 726(a)(4).

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4. Recovery of Property

a. Section 550 - Liability for Transfers

A determination that a transaction is void results in nullification of the transaction. Where the transaction concerned the incurrence of an obligation or the granting of an interest in property, such nullification alone could achieve complete relief for the debtor. But where the transaction involved a transfer of property, avoidance alone will not achieve complete relief for the estate. Section 550 "enunciates the separation between the concepts of avoiding a transfer and recovering from the transferee." H.R. Rep. No. 95-595,95th Cong., 1st Sess. 375 (1977), reprinted in 1978 U.S.C.C.A.N. 5787,6331; S. Rep. No. 95-989,95th Cong., 2d Sess. 90 (1978), reprinted in 1978 U.S.C.C.A.N. 5787, 5876. As a practical matter, recovery should be sought simultaneously with avoidance.

(i) Liability of Transferees

The parties from which a trustee may recover property are not limited to the initial transferee. Section 550(a) provides that a trustee may recover preferentially or fraudulently transferred property, or the value of such property, from (i) the initial transferee, (ii) any entity for whose benefit the transfer was made, or (iii) any immediate or mediate transferee of the initial transferee. See 11 U.S.C. $550(a). Any preferential transfer made within the 90-day preference period may be recovered from any of these transferees; any preferential transfer made to an insider beyond the 90-day preference period, but within the one-year preference period, may be recovered from the insider. See 11 U.S.C. $550(c). When a transfer is avoided, any indebtedness that had been satisfied by the transfer is reinstated.

(ii) Limitations on Recovery

Recovery under $550 has its limits. Although property may be recovered from more than just the initial transferee, $550(d) provides that the estate can obtain only a single satisfaction. See 11 U.S.C. $550(d). In addition, $550(b) protects certain subsequent transferees (bona fide purchasers) from recovery, and $550(e) gives a lien on the recovered property to good faith purchasers to the extent of the cost of any improvements made to the property or the resulting increase in its value. See 11 U.S.C. $5 550(b), (e).

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(iii) "For the benefit of the estate"

Section 550 requires that recoveries be "for the benefit of the estate." See 11 U.S.C. $550(a); see also Acequia, Inc. v. Clinton (In re Acequia, Inc.), 34 F.3d 800 (9th Cir. 1994) (extent of recovery limited to that accruing for the benefit of the estate).

The benefit of the estate is achieved by benefit to creditors, rather than to the debtor alone. P.A. Bergner & Co. v. Bank One, Milwaukee N.A. (In re P.A. Bergner & Co.), 140 F.3d 1 11 1 (7th Cir. 1998), cert. denied, 525 U.S. 964 (1998) (benefit to creditors is necessary and sufficient); see also Harstad v. First Am. Bank, 39 F.3d 898 (8th Cir. 1994); 0fJ;cial Committee of Unsecured Creditors of Cybergenics Corp. v. Chinery, 226 F.2d 237,244 (3d Cir. 2000) ("Cybergenics P), citing Wellman v. Wellman, 933 F.2d 215 (4th Cir. 199 1); Vintero Corp. v. Corporacion Venezolana de Foment0 (In re Vintero Corp.), 735 F.2d 740 (2d Cir. 1984); Whiteford Plastics Co. v. Chase National Bank, 179 F.2d 582 (2d Cir. 1950).

In Mellon Bank, N.A. v. Dick Corp. (In re Qualitech Steel Corp.), 2003 U.S. App. LEXIS 24391 (7th Cir. Dec. 4,2003), Judge Easterbrook clarified that §550(a) does not require that the recovery reach unsecured creditors, but rather the "set of all potentially interested parties" who will receive their shares "depend[ing] on contractual and statutory entitlements." 2003 U.S. App. LEXIS 24391 at *8. In addition, the court confirmed the Seventh Circuit's position, expressed in P.A. Bergner & Co., that $550(a) requires only an indirect benefit to the estate. See id. (recovery was allowable where the earlier grant of a lien on recovery proceeds conferred an ex ante benefit upon the estate by enabling interim financing to fbnd the operation of the debtor's business until it could be sold as a going concern).

b. Section 551 - Preservation of Avoided Transfers

Section 55 1 preserves any voided rights in estate property for the benefit of the estate, i.e. it entitles the estate to succeed to the voided rights of a transferee so that the avoidance benefits the estate rather than any holders of junior interests in the property. 11 U.S.C. $551.

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11. Selected Issues of Current Interest

A. Standing of Parties to Pursue Avoidance Actions

1. Direct Standing

a. Trustee in Bankruptcy

Each of the avoidance provisions of the Bankruptcy Code confers the relevant avoidance power upon the trustee in bankruptcy. See, e.g., 11 U.S.C. $547(a)(1) ("The trustee may avoid.. .'I). Although the granting language itself does not confer such powers to the trustee exclusively, it is fairly well established that only the trustee has standing to bring an avoidance action in his own right. See, e.g., Cybergenics I , 226 F.3d 237 (3d Cir. 2003); Mellon Bank, N.A. v. Dick Corp. (In re Qualitech Steel Corp.), 2003 U.S. App. LEXIS 24391 (7th Cir. Dec. 4,2003); Oflcial Committee of Unsecured Creditors v. Gould (In re Commodore International Ltd.), 262 F.3d 96 (2d Cir. 2001).

b. Debtor in Possession

Subject to certain limitations, the debtor in possession in a chapter 11 case has all the rights and powers of, and is obligated to perform the hnctions and duties of, a trustee in bankruptcy. See 11 U.S.C. $ 1107(a); see also Cybergenics I, 226 F.3d at 243 ("[tlhe terms 'trustee' and 'debtor in possession,' as used in the Bankruptcy Code, are thus essentially interchangeable."). This results in the paradoxical and potentially problematic situation in which the same debtor who earlier made a voidable transfer or incurred a voidable obligation is now the party bound by fiduciary duty to seek to avoid it.

2. Derivative Standing

There may be circumstances when interested parties other than a debtor in possession will want to take steps to ensure that the recovery of voidable transactions for the benefit of creditors is carried out with the same concern for creditors as if a trustee had been appointed. Such circumstances arise, for instance, (i) when the debtor in possession may be reluctant to take action to avoid voidable transactions that benefited the debtor's officers, directors, professional advisors, or business friends, or (ii) when a debtor in possession might not wish to pursue avoidance actions against a iender or supplier whose continued business and goodwill may be needed in the debtor's reorganization.

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In such instances, courts may authorize the statutory committee of unsecured creditors or other creditors to bring a derivative action on behalf of the debtor in possession during the pendency of the case. See OfJicial Committee of Unsecured Creditors v. Gould (In re Commodore International Ltd.), 262 F.3d 96 (2d Cir. 2001) (reviewing numerous decisions allowing creditors or committees to sue in the name of the debtor in possession under avoidance provisions). Pre-Code law also allowed creditors and creditors' committees to sue derivatively for a bankruptcy trustee. See, e.g., Trimble v. Woodhead, 102 US. 647 (1881); Moyer v. Dewey, 103 U.S. 30 1 (1 88 1); Gochenour v. Cleveland Terminals Bldg. Co., 1 18 F.2d 89 (6th Cir. 1941).

a. Support for Derivative Standing

Although the Bankruptcy Code does not expressly authorize a creditors' committee to prosecute claims on behalf of the estate, most courts hold that creditors' committees have an implied right under $8 1103(c)(5) and 1109(b) to initiate adversary proceedings in the name of the debtor, but only with the approval of the bankruptcy court and only when the trustee or debtor in possession unjustifiably fails to bring suit or abuses its discretion by not suing. Section 1103(c)(5) provides that the committee may "perform such other services as are in the interests of those represented." 11 U.S.C. $1 103(c)(5). Section 1109(b) specifies a creditors' committee among the parties in interest that "may appear and be heard on any issue in a [chapter 111 case." 11 U.S.C. $ 1 109(b). "[Tlaken together, [$$ 1 109 and 1 103(c)(5)] evince a Congressional intent for committees to play a robust and flexible role representing the bankruptcy estate, even in adversarial proceedings." OfJicial Committee of Unsecured Creditors of Cybergenics Corporation v. Chinery, 330 F.3d 548, 566 (3d Cir. 2003).

Section 503(b)(3)(B) also provides support for the ability of a creditors' committee to prosecute estate claims. Section 503(b)(3)(B) allows for the priority payment of the expenses of ''a creditor that recovers, after the court's approval, for the benefit of the estate any property transferred or concealed by the debtor." 11 U.S.C. $503(b)(3)(B). This section ''would be meaningless unless authority existed" for committees to pursue derivative claims on behalf of the estate. Cybergenics, 330 F.3d at 567.

b. Recent Caselaw on Derivative Standing: Cybergenics

Recently, the issue of derivative standing for creditors and creditors' committees was clarified by the Third Circuit en banc, which reversed an earlier decision of a three-judge panel of that circuit that ruled that courts cannot authorize derivative standing for a creditors' committee to pursue a fraudulent transfer action under 11 U.S.C. $544(b). Official Committee of

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Unsecured Creditors of Cybergenics Corporation v. Chinery, 330 F.3d 548 (3d Cir. 2003) ("Cybergencis IIZ").

In Cybergenics III, the Third Circuit en banc reversed OfJiciul Committee of Unsecured Creditors of Cybergenics Corp. v. Chinery, 304 F.3d 3 16 (3d Cir. 2002) ("Cybergenics I f ' ) , and held that: "[Blankruptcy courts can authorize creditors' committees to sue derivatively to avoid fiaudulent transfers for the benefit of the estate." 330 F.3d at 580. The Third Circuit en bunc noted that while the case relied upon by the Cybergenics II panel (Hartford Underwriters Insurance Co. v. Union Planters Bank, 530 U.S. 1 (2000)) concerned a third party's usurpation of the trustee's powers under §506(c) (which grants surcharge powers to the trustee with the same language used to grant avoidance powers to the trustee), the Supreme Court had expressly reserved the issue of whether a bankruptcy court can allow other interested parties to act on a trustee's behalf in pursuing recovery under §506(c). The Third Circuit reasoned that while the question in Hartford Underwriters was one of a non-trustee's right unilaterally to circumvent the Bankruptcy Code's remedial scheme, the issue in Cybergenics concerned a bankruptcy court's equitable power to craft a remedy when the Code's envisioned scheme breaks down. Id. at 552-53.

In Cybergenics III, the Third Circuit concluded that $9 1 103(c)(5), 1109(b) and 503(b)(3)(B) evinced Congressional approval of derivative avoidance actions by creditors. The Third Circuit found that "[tlhe possibility of derivative suit by a creditors' committee provides a critical safeguard against lax pursuit of avoidance actions'' and is consistent with Congress's goal in providing bankruptcy courts with a comprehensive '!range of remedies" where a debtor or trustee unreasonably refuses to pursue an action on behalf of the estate. 330 F.3d at 573,579.

c. Standard for Granting Derivative Standing

Before a court will grant derivative standing to a creditors' committee to bring an avoidance action, the court must determine whether the debtor unjustifiably failed to initiate suit against the transferee and whether the action is likely to benefit the debtor's estate. See Unsecured Creditors ' Committee v. Noyes (In re SmEnterprises), 779 F.2d 901 (2d Cir. 1985). In order to comply with this standard, creditors will have to show that: (i) there are colorable claims; (ii) the debtor in possession has refused to bring the claims; and (iii) such refusal is unjustified, given the duty to maximize the value of the estate for creditors. See, e.g., In re Xonics Photochemical, Inc., 841 F.2d 198 (7th Cir. 1988); Southtrust Bank N.A. v. Jackson (In re Dur Jac Ltd.), 254 B.R. 279 (Bankr. M.D. Ala. 2000); Campana v. Pilavis (In re Pilavis), 228 B.R. 808 (Bankr. D. Mass. 1999); compare 0f)cial Committee of Unsecured Creditors v. Gould (In re Commodore International Ltd.), 262 F.3d 96, 100 (2d Cir. 2001) (broadening standard applied in Second Circuit by ruling that a committee may bring suit

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even if the debtor does not unjustifiably refuse to do so, as long as: (1) the trustee or debtor consents, and (2) the courts finds that the litigation is (a) in the best interests of the estate and (b) necessary and beneficial to the fair and efficient resolution of the bankruptcy proceedings); see also Glinka v. Federal Plastics Mfg. (In re Housecraft Industries USA, Inc.), 310 F.3d 64, at 71 n.7 (2d Cir. 2002) (not requiring individual creditors to satisfy a more stringent standard than creditors' committees "because under Commodore, we only grant standing to creditors - either individuals or committees - when doing so is in the best interest of the estate.").

Court approval of derivative standing may be obtained retroactively under certain circumstances. See Oflcial Committee of Unsecured Creditors v. Hudson United Bank (In re America's Hobby Center, Inc.), 223 B.R. 275,28 1- 82 (Bankr. S.D.N.Y. 1998) (creditors' committee was retroactively authorized to challenge a lender's lien despite failure to obtain court approval prior to commencing an avoidance action, the court applied a two-step analysis requiring the committee to show that (1) at the time the action was commenced, time was of the essence and there was little confusion as to who would commence the action, and (2) the action is warranted under the usual standard for granting derivative standing); see also Liberty Mutual Ins. Co. v. Oflcial Committee of Spaulding Composites Co., Inc. (In re Spaulding Composites Co., Inc.), 207 B.R. 899 (9th Cir. BAP 1997); Catwil Corp. v. Derf 11 (In re Catwil Corp.), 175 B.R. 362 (Bankr. E.D. Cal. 1994).

3. Standing of Postconfirmation Agent

Section 1123(b)(3)(B) provides authority for the trustee, the debtor, and specially appointed representatives of the estate to pursue avoidance actions that remain to be pursued postconfirmation. 1 1 U.S.C. 8 1 123(b)(3)(B). In Citicorp Acceptance Co. v. Robison (In re Sweetwater), 884 F.2d 1323 (10th Cir. 1989), the Tenth Circuit addressed the issue of whether an avoidance action constitutes a klaim or interest belonging to the debtor" and concluded that the broad definition of "claim" in 0 10 1 "includes the estate's right to payment under sections 547, 549 and 553." 884 F.2d 1323, 1327 (1 0th Cir. 1989); see also Iron Oak Supply Corp. v. Nibco, Inc. (In re Iron Oak Supply Corp.), 162 B.R. 301,308 (Bankr. E.D. Cal. 1993) ("a preference action qualifies as a 'claim belonging to the estate' for purposes of section 1123(b)(3)(B) because any transfer avoided as a preference is preserved for the benefit of the estate.").

An entity other than the debtor in possession or the trustee seeking to assert a postconfirmation avoidance action must show that (i) it has been appointed, and (ii) it is a representative of the estate. McFarland v. Leyh (In re Texas General Petroleum Corp.), 52 F.3d 1330, 1335 (5th Cir. 1995), citing Retail Marketing Co. v. King (In re Mako, Inc.), 985 F.2d 1052, 1054 (10th Cir. 1993); Pate v. Hunt (In re Hunt), 136 B.R. 437,444 (Bankr. N.D. Tex. 1991). The first element is satisfied

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by court approval of a plan that "clearly appoints a stranger to the estate." Texas General, 52 F.2d at 1335, citing Mako, 985 F.2d at 1055; Citicorp Acceptance Co. v. Robison (In re Sweetwater), 884 F.2d 1323, 1326 (10th Cir. 1989); Nordberg v. Sanchez (In re Chase & Sanborn Corp.), 8 13 F.2d 1 177, 1 180 n. 1 (1 1 th Cir. 1987). Determination as to the second element is made by analysis of the entity's responsibilities, with the "primary concern" being whether recovery would benefit the estate. Texas General, 52 F.2d at 1335, citingsweetwater, 884 F.2d at 1327. Regardless of the whether the entity to assert a postconfirmation avoidance action is a clearly appointed stranger to the estate, the debtor, or the trustee, however, the action must be asserted for the benefit the estate. Id. at n.4, citing Harstad v. First Am. Bank, 39 F.3d 898,902-03 (8th Cir. 1994).

Recently, in Mellon Bank, N.A. v. Dick Corp. (In re Qualitech Steel Corp.), 2003 U.S. App. LEXIS 24391 (7th Cir. Dec. 4,2003), the Seventh Circuit found that (i) the postpetition agent for certain creditors that had been allowed to be secured by the proceeds of avoidance actions had "stepped into the shoes" of the then- dissolved debtor for purposes of prosecuting the avoidance actions, and (ii) the benefit of the estate requirement was satisfied by an ex ante benefit derived from the financing that was made available upon granting of the avoidance action proceeds as security. 2003 U.S. App. LEXIS 24391, * 5 .

B. Potential Loss of Avoidance Actions

1. Expiration of Statute of Limitations

The Bankruptcy Code provides limitations on time to bring avoidance actions. For avoidance of preferential transfers under $547, fraudulent transfers under $0 548 and 544, certain statutory liens under $545, and certain setoffs under $553, an action must be commenced within the longer period of (i) two years from entry of the order for relief or (ii) one year after the appointment or election of the first trustee during those two years, but in no event after the case has been closed or dismissed. See 11 U.S.C. $546. Note that the statute of limitations in $546 applies to avoidance actions under $544(b); any longer limitation periods under state fraudulent conveyance laws operate only to extend the period into which the trustee may "reach back" to avoid transactions.

For avoidance of unauthorized postpetition transfers under $549, an action must be commenced within two years from the date of the transfer sought to be avoided, but in no event after the case has been closed or dismissed. See 11 U.S.C. 9549(d). For recovery of estate property under $550, an action must be commenced within one year from the avoidance of the relevant transaction, but in no event after the case has been closed or dismissed. See 11 U.S.C. §550(f).

There is some difference of opinion among courts on whether these time limitations are true statutes of limitation (i.e. waivable affirmative defenses) or jurisdictional bars to suit. Courts have held that actions may be prosecuted even after such

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limitation periods have expired, where the defendant neglects to raise the expiration as an affirmative defense. See Pugh v. Brook (In re Pugh), 158 F.3d 530 (1 lth Cir. 1998) (finding waivable status and criticizing cases holding otherwise, including Martin v. First National Bank (In re Butcher), 829 F.2d 596 (6th Cir. 1987), cert. denied, 484 U.S. 1078 (1988)). Where time limits were considered waivable, the time could be altered also by agreement of the parties. See, e.g., Service Plastics v. Cameo Container Corp. (In re Service Plastics), 1997 Bankr. LEXIS 1667 (Bankr. N.D. Ill. Oct. 20, 1997) (plan of reorganization shortened time to bring avoidance action).

2. Assumption of Executory Contracts

Where a trustee seeks to challenge prepetition transfers made under the terms of an executory contract, the creditodtransferee may argue that the trustee fails to state a cause of action because, by virtue of the assumption, the trustee is obligated under $365 of the Bankruptcy Code to cure all defaults and continue to perform under the terms of the contract.

In Seidle v. GATXLeasing Corp., 778 F.2d 659 (1 lth Cir. 1985), the Eleventh Circuit Court of Appeals dismissed an avoidance action to recover a prepetition payment made under an executory contract that already had been assumed. The court reasoned that if the creditor had not received the payment during the preference period, it would have received that payment as a cure upon assumption of the contract. Further, the court refused to allow the trustee to use the avoidance action to thwart the obligation to cure prior defaults under the assumed contract. Relying on Seidle, the Ninth Circuit held in Alvarudo v. Wulsh (In re LC0 Enterprises), 12 F.3d 938 (9th Cir. 1993), that a bankruptcy court is not required to "hypothesize whether a hypothetical chapter 7 trustee would assume a lease" where the lease had actually been assumed. 12 F.3d at 940. Echoing the Seidle court, the LC0 court concluded, "The trustee cannot use [section] 547(b) to circumvent the [cure] requirements of [section] 365(b)." Id. at 943.

Recently, in Kimmelman v. Port Authority (In re Kiwi Int ' I Air Lines, Inc.), 344 F.3d 3 1 1 (3d Cir. 2003), the Third Circuit Court of Appeals held that prepetition payments made under an executory contract that was later assumed pursuant to $365 were not subject to avoidance under $547. The court found that the prepetition payments did not qualify as voidable preferences because they failed to satisfy the requirement of $547(b)(5) that the allegedly preferred creditor have received more by the transfers than it would have received in a chapter 7 liquidation since the payments at issue would have been payable in full pursuant to the requirement of $365 to cure outstanding defaults under the contract. See also Philip Sews. Corp. v. Luntz (In re Philip Sews. Corp.), 284 B.R. 541,551-52 (Bankr. D. Del. 2002).

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3. Extinguishment of Avoidance Claims

The ability to bring avoidance claims - even those that belong to creditors - can be affirmatively extinguished by a trustee in bankruptcy or debtor in possession. In Haskell v. PWS Holding Corp. (In re PWS Holding Corp.), 303 F.3d 308 (3d Cir. 2002), cert. denied, 538 U.S. 924 (2003), the Third Circuit Court of Appeals found that the confirmation of a plan of reorganization that affirmatively extinguished specific avoidance actions was effective to preclude creditors from prosecuting such actions under state law after the debtor's emergence from bankruptcy. 303 F.3d 308. Relying on Cybergenics I for the proposition that avoidance powers and avoidance actions under 11 U.S.C. $544(b) are not the property of the debtor in possession, but rather belong to creditors, the creditor argued that the debtor in possession could not extinguish the creditor's state law right to bring suit once the automatic stay of $362 was lifted. Reaffirming and clarifying the position expressed in Cybergenics I, the court implicitly recognized that the avoidance powers bestowed upon a debtor in possession to pursue actions for the benefit of the estate also empowered the debtor in possession to settle and extinguish such causes of action: "Much as a party might decide to resolve a claim by reaching an out-of-court settlement, [debtor in possession] resolved the fraudulent transfer claims here by extinguishing them." Id. at 3 15.

4. Postpetition Financing and Attachment Upon Avoidance Proceeds

As part of the quidpro quo for continuing to do business with a debtor postpetition and for postpetition financing, major vendors and DIP financing lenders may demand protections such as a waiver of any avoidance actions that could be prosecuted against them. Concerned that these parties may be forcing such terms on the debtor in possession to the detriment of the estate as a whole, courts are reluctant to approve financing agreements that include such waivers, especially in circumstances where the creditors' committee has not had an opportunity to investigate them. See, e.g., In re Tenney Village Co., 104 B.R. 562 (Bankr. D. N.H. 1989) (denying financing where it would "pervert the reorganizational process from one designed to accommodate all classes of creditors and equity interests to one specially crafted for the benefit" of a postpetition lender); Oflcial Committee of Unsecured Creditors v. Gould Elecs. Corp., 1993 U.S. Dist. LEXIS 143 18 (N.D. Ill. Sept. 22, 1993) (rejecting a financing agreement that, inter alia, provided for waiver of avoidance claims against the lender); Bankr. N.D. Cal. Guidelines for Cash Collateral and Financing Stipulations ("Waivers of avoidance actions arising under the Bankruptcy Code" will %ot normally be approved.").

Even where avoidance actions are not waived, however, a postpetition lender nonetheless may be effectively insulated by virtue of an interest in or rights to proceeds from avoidance actions; i.e. pursuing an avoidance action against a transferee is pointless when that very transferee is entitled to the proceeds thereby recovered. Avoidance powers themselves are not assets of the estate, and thus

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cannot be sold or assigned to third parties in an asset sale. See Cybergenics I, 226 F.2d 237 (3d Cir. 2000); Mellon Bank, N.A. v. Dick Corp. (In re Qualitech Steel Corp.), 2003 U.S. App. LEXIS 24391 (7th Cir. Dec. 4,2003). Proceeds from successful avoidance actions, however, become property of the estate, see 1 1 U.S.C. $0 541,550. As property of the bankruptcy estate, avoidance action proceeds are not subject to the interests of secured parties absent court approval.

The terms of postpetition financing, however, may seek court approval to impose liens upon various assets of the estate, including postpetition collateral such as proceeds from avoidance actions. See 11 U.S.C. $364(c)(2) (postpetition financing may be secured by first liens on unencumbered assets of the estate). Similarly, where adequate protection of secured interests is required (under a variety of scenarios contemplated under $8 362,363 and 364), adequate protection may take the form of a "replacement" lien on proceeds from avoidance actions. See, e.g., In re Qualitech Steel COT., 276 F.3d 245 (7th Cir. 2001) (lien on avoidance proceeds granted as adequate protection for prepetition secured lenders primed under §364(d)).

Courts, however, are reluctant to approve postpetition DIP financing that grants liens on avoidance proceeds. For instance, in a letter submitted at the request of the Delaware District Court, Chief Judge Walsh of the Delaware Bankruptcy Court indicated that proposed postpetition financing orders should, among other things, not grant liens on avoidance actions "absent exigent circumstances." Letter from Hon. Peter J. Walsh to Delaware Bankruptcy Counsel (Apr. 2, 1998), at 4. The local rules of the Bankruptcy Court for the District of Delaware also discourage granting liens on avoidance proceeds, requiring motions for approval of proposed financing orders to identifj and justify "[plrovisions that grant immediately to the prepetition secured creditor liens on the debtor's claims and causes of action arising under 1 1 U.S.C. $6 544,545,547,548, and 549." Bankr. D. Del. L.R. 4001-2(a)(i)(D). Other bankruptcy courts have similar guidelines. See, e.g., Bankr. N.D. Cal. Guidelines for Cash Collateral and Financing Stipulations ("Adequate protection provisions that create liens or claims for relief arising under the Bankruptcy Code (see §$ 506(c), 544,545,547,548, and 549)" will 'hot normally be approved."); Bankr. D. Mass. L.R. 4001-2(~)(4), (d) (providing that proposed financing order provisions for "any grant of a security interest in avoidance power recoveries available to the trustee.. .shall be unenforceable unless.. .(i) the proposed order or agreement specifically states that the proposed terms and conditions vary from the requirements of section (c), and (ii) any such proposed terms and conditions are conspicuously and specifically set forth in the proposed agreement or order.").

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5. Allowance of Claims

a. Res Judicata

Similar to the waiver of avoidance claims in postpetition financing agreements or the affirmative extinguishment of avoidance claims in confirmed plans of reorganization, the ability to bring avoidance actions against the holders of claims allowed during the course of the bankruptcy case may be lost through application of the doctrine of res judicata. Res judicata "generally refers to the effect of a prior judgment in foreclosing successive litigation of the very same claim, whether or not relitigation of the claim raises the same issues as the earlier claim." Eastern Pilots Merger Committee v. Continental Airlines, Inc. (In re Continental Airlines, Inc.), 279 F.3d 226,232 (3d Cir. 2002). Under the doctrine of res judicata, the notion of "claim preclusion" may limit the availability of potential avoidance claims. See Cohen v. TIC Financial Systems (In re Ampace Corp.), 279 B.R. 145 (Bankr. D. Del. 2002) (res judicata precludes a party from relitigating claims that were or could have been asserted in a prior action).

(i) Elements

In order for res judicata to bar a subsequent action, there must be: (1) a final judgment on the merits, rendered by a court of competent jurisdiction, in a prior action; (2) the same parties, or their privies, as in the prior action; and (3) a subsequent action based on the same cause of action. See Cohen v. TIC Financial Systems (In re Ampace Corp.), 279 B.R. 145,154 (Bankr. D. Del. 2002), citing Corestates Bank. N.A. v. Huls America, Inc., 176 F.3d 187, 194 (3d Cir. 1999); Novacare Holdings, Inc. v. Mariner Post-Acute Network, Inc. (In re Mariner Post-Acute Network, Inc.), 267 B.R. 46,52 (Bankr. D. Del. 2001); Gurley v. Hunt, 287 F.3d 728,73 1 (8th Cir. 2002).

(ii) Undisputed Claims Allowed by Plan

Where a creditor's claim is uncontested and allowed by a confirmed plan, certain courts have barred the debtor from asserting an avoidance action because the plan resolves all issues between the parties, including any potential avoidance actions. Mickey's Enter., Inc. v. Saturday Sales, Inc. (In re Mickey's Enter., Inc.), 165 B.R 188 (Bankr. E.D. Tex. 1994); Paramount Plastics v. Polymerland (In re Paramount Plastics, Inc.), 172 B.R. 33 1 (Bankr. W.D. Wash. 1994).

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However, not all courts agree. In Cohen v. TIC Financial Systems (In re Ampace Corp.), 279 B.R. 145 (Bankr. D. Del. 2002), the confirmation of a plan of reorganization that provided a deadline for claims objections was found to have allowed creditor claims that had not been objected to by the deadline. Nevertheless, the court found that a subsequent avoidance action brought against a holder of claim so allowed was not barred by res judicata because the avoidance action involved "an entirely different cause of action" than the claim allowed; it was not unreasonable that the avoidance action was not addressed together with the plan confirmation because their "factual underpinnings" and "theoryf' were different. 279 B.R. at 154.

(iii) Failure to Specifically Preserve Claims

Even where all three elements necessary for the application of res judicata to bar an avoidance action are met, most courts hold that res judicata does not apply where a disclosure statement and/or a plan of reorganization reserves an action for later adjudication. See Cohen v. TIC Financial Systems (In re Ampace Corp.), 279 B.R. 145, 156 (Bankr. D. Del. 2002), citing, e.g., D&K Prop. Crystal Lake v. Mutual Life Ins. Co. of New York, 112 F.3d 257,259-60 (7th Cir. 1997); Kelley v. South Bay Bank (In re Kelley), 199 B.R. 698,704 (9th Cir. BAP 1996); Tracar v. Silverman (In re Am. Preferred Prescription, Inc.), 266 B.R. 273,266 B.R. 273,277 (E.D.N.Y. 2000).

Section 1 123 allows a plan of reorganization to provide for exactly such reservation. See 11 U.S.C. $1 123(b)(3)(B). Creditors defending postconfirmation avoidance actions, however, have argued that the retention language in the confirmed plans was ineffective for lack of specificity. See, e.g., McFarland v. Leyh (In re Texas General Petroleum Corp.), 52 F.3d 1330 (5th Cir. 1995). Courts are divided on the specificity required under $1 123(b)(3)(B).

Many courts have not required great specificity, finding it sufficient that a plan reserves claims of a given type. See, e.g., P.A. Bergner & Co. v. Bank One, Milwaukee, N.A. (In re P.A. Bergner & Co.), 140 F.3d 1 1 1 1, 11 17 (7th Cir. 1998), cert. denied, 525 U.S. 964 (1998) (reasoning that "while there might be some logic in requiring 'specific and unequivocal' language to preserve claims.. . [$ 1 123(b)(3)(B)] itself contains no such requirement"); see also National Envtl. Waste Corp. v. Stephens, Berg & Lasater (In re National Envtl. Waste Corp.), 200 F.3d 1266 (9th Cir. 2000), amended, 2000 U.S. App. LEXIS 18058 (9th Cir. July 27,2000); Goodman Bros. Steel Drum Co. v. Liberty Mutual Ins. Co. (In re Goodman Bros. Steel Drum Co., Inc.), 247 B.R. 604 (Bankr. E.D.N.Y. 2000); Harstad v. First Am. Bank, 155 B.R. 500 (Bankr. D. Minn. 1993). Other courts have rejected the effectiveness of general reservations that fail to adequately disclose

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potential actions against creditors. See, e.g., D&K Prop. Crystal Lake v. Mutual Life Ins. Co. of New York, 1 12 F.3d 257 (7th Cir. 1997); Tracar v. Silverman (In re Am. Preferred Prescription, Inc.), 266 B.R. 273 (E.D.N.Y. 2000); Kelley v. South Bay Bank (In re Kelley), 199 B.R. 698 (9th Cir. BAP 1996); Southtrust Bank N.A. v. WCI Outdoor Products (In re Huntsville Small Engines, Inc.), 228 B.R. 9 (Bankr. N.D. Ala. 1998); Mickey's Enter., Inc. v. Saturday Sales, Inc. (In re Mickey's Enter., Inc.), 165 B.R 188 (Bankr. E.D. Tex. 1994); Paramount Plastics v. Polymerland (In re Paramount Plastics, Inc.), 172 B.R. 331 (Bankr. W.D. Wash. 1994); Westland Oil Dev. Corp. v. Mcorp Mgmt. Solutions, Inc., 157 B.R. 100 (S.D. Tex. 1993); In re Metrocraft Publ'g Sew., Inc., 39 B.R. 567 (Bankr. N.D. Ga. 1984).

The division illustrates a tension between a concern for adequate notice to creditors and an awareness of the importance of 8 1 123 in enabling expeditious confirmation of chapter 1 1 plans. See Amarex, Inc. v. Marathon Oil Co. (In re Amarex' Inc.), 74 B.R. 378,380 (Bankr. W.D. Okla. 1987) ("To say confirmation must await a final decision of all possible preference complaints would either inordinately delay confirmation, with all the attendant expense, or result in a windfall in favor of those who received preferential transfers.").

b. Section 502(d)

Under §502(d) of the Bankruptcy Code, a court will disallow any claim of any entity subject to a voidable transfer unless such entity has paid the amount or turned over any such property relating to such voidable transfer. See 11 U.S.C. §502(d). The provision is meant to "preclude entities which have received voidable transfers fi-om sharing in the distribution of the assets of the estate unless and until the voidable transfer has been returned to the estate," In re Mid Atlantic Fund, Inc., 60 B.R. 604,609 (Bankr. S.D.N.Y. 1986), and to encourage creditors to surrender transferred property to the estate. Campbell v. United States (In re Davis), 889 F.2d 658 (5th Cir. 1989).

Section 502(d) has been used by trustees and debtors in possession to disallow the claims of transferee even after avoidance has become time-barred by expiration of the statute of limitations. See, e.g., United States Lines v. United States (In reMcLean Indus., Inc.), 196 B.R. 670 (S.D.N.Y. 1996); In re Discount Family Boats, Inc., 233 B.R. 365,368 (Bankr. E.D. Tex. 1999). A majority of courts addressing the issue have concluded that the statute of limitations on avoidance actions has no application to objections raised under §502(d). See Service Plastics v. Cameo Container Corp. (In re Service Plastics), 1997 Bankr. LEXIS 1667 (Bankr. N.D. Ill. Oct. 20, 1997), citing In re Stoecker, 143 B.R. 118 (Bankr. N.D. Ill. 1992), a f d in part, rev'd inpart on

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other grounds, 143 B.R. 879 (N.D. Ill. 1993), a f d in part, vacated in part, 5 F.3d 1022 (7th Cir. 1993) (collecting cases).

Where a trustee could have objected to, and sought disallowance of, a claim of a party that is also a transferee of a voidable transfer, such transferees have argued that §502(d) operates to preclude subsequent avoidance actions. Courts are divided as to whether, or under what circumstances, §502(d) has such preclusive effect.

Some courts have held that §502(d) precludes subsequent avoidance actions where claims already have been allowed. In LaRoche Indus., Inc. v. General Am. Tramp. Corp. (In re LaRoche Indus., Inc.), 284 B.R. 406,409 (Bankr. D. Del. 2002), the court concluded that avoidance actions should be barred unless prosecuted before or contemporaneously with any objections to a creditor's claim. Since a claim already had been allowed by court order, the court held that there was no longer a transfer subject to avoidance. The court also observed that it would be unfair to allow a debtor to object to a creditor's claim while concealing an avoidance cause of action. 284 B.R. at 410; cJ Cohen v. TIC Financial Systems (In re Ampace Corp.), 279 B.R. 145 (Bankr. D. Del. 2002) (avoidance action held not precluded where creditor's claim had been only "deemed allowed" under §502(a) rather than allowed by court order following resolution of an objection filed by debtor). Similarly, in Microage v. Viewsonic Corp. (In re Microage, hc.) , 291 B.R. 503 (9th Cir. BAP 2002), the Ninth Circuit BAP found that l'section 502(d) should have been raised as an affirmative defense before the bankruptcy court entered an order allowing [creditorl's claim. Now that the claim has been allowed, [debtor] may not raise §502(d) as a bar to payment. . . . Allowed claims are beyond the reach of §.502(d). 'I 29 1 B.R. at 5 12- 13 (emphasis supplied).

Other courts, however, have been skeptical of the LaRoche analysis and have taken the position that an avoidance action is not precluded where the debtor has not objected to the claim under §502(d) itself. See Peltz v. Gulfcoast Workstation Group (In re Bridge Info. Sys., Inc.), 293 B.R. 479 (Bankr. E.D. Mo. 2003); Rhythms Netconnections, Inc. v. Cisco Sys., Inc. (In re Rhythms Netconnections, Inc.), 300 B.R. 404 (Bankr. S.D.N.Y. 2003) (noting that the statutory language of §502(d) includes "no requirement that preference claims be brought as compulsory counterclaims, even to a proof of claim.").

Recent cases in the Delaware bankruptcy courts illustrate a split of opinion on this issue. Compare Caliolo v. Azdel, Inc. (In re Cambridge Indus. Holdings, Inc.), 2003 Bankr. LEXIS 794, * 5 (Bankr. D. Del. Jul. 18,2003) (finding that §502(d) requires avoidance disputes to be resolved in tandem with claim disputes because "[wlhere there is a court order resolving a dispute over the amount of a creditor's claim, the entry of that order precludes.. .the commencement or continuation of litigation for the recovery from the creditor of allegedly avoidable transfers") with TWA Inc. Post ConJirmation Estate v. City & County of Sun Francisco Airports Comm 'n (In re TWA Inc. Post

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Confirmation Estate), 2004 Bankr. LEXIS 38, *17-18 (Bankr. D. Del. Jan. 20, 2004) (rejecting the LaRoche analysis, approving the interpretations applied in Bridge Info. Systems and Rhythms Netconnections, and holding that §502(d) does not preclude an avoidance action after claims have been resolved).

C. Representation of Estate by Creditor's Counsel to Pursue Avoidance Actions

Many courts have concluded that creditor's counsel may be retained as special counsel to investigate and prosecute avoidance actions. Such courts have noted that, in such circumstances, as long as counsel's creditor-client has not received a voidable transfer, there would be an identity of interest between counsel's two clients and, thus, no actual conflict of interest. See, e.g., Shubert v. Dawley (In re Dawley), 2003 Bankr. LEXIS 639 (Bankr. E.D. Pa. 2003 June 16,2003) (absolutely no basis to disqualifl creditor's counsel as special counsel to recover fraudulent conveyance, where interests of creditor and chapter 7 trustee are congruous and neither U.S. Trustee nor other creditors have objected); In re Sassalos, 160 B.R. 646 (D. Or. 1993) (appointment of creditors' counsel as special counsel for trustee did not violate §327(c) where interests of creditors and trustee identical at time of appointment); In re Fondiller, 15 B.R. 890 (9th Cir. BAP 1981) (creditors' counsel allowed as special counsel for investigation and recovery of fraudulent conveyances, where creditor-clients were not implicated and interests of estate and creditor-clients were identical with respect to special counsel's duties).

In In re Pillowtex, 304 F.3d 246 (3d Cir. 2002), the Third Circuit Court of Appeals reversed the approval of a debtor in possession's counsel that had been retained without a definitive determination as to whether counsel had received a voidable preference, holding that the disinterestedness of such counsel must be resolved prior to retention where there has been a "facially plausible" assertion that counsel received a voidable preference. 304 F.3d at 256. In Pillowtex, the U.S. Trustee had objected to the retention of a law firm on the ground that the firm, which had represented the debtor prior to its bankruptcy filing, had received an extraordinary payment of fees during the preference period. Under an earlier ruling of the Third Circuit Court of Appeals, proposed counsel must be disqualified where there is an actual conflict of interest. See United States Trustee v. First Jersey Securities, Inc. (In re First Jersey Securities, Inc.), 180 F.3d 504 (3d Cir. 1999) (finding a voidable preference and disqualification). In Pillowtex, the firm had argued that it was "not necessary or appropriate for the Debtors' estates to incur the time and expense of litigating the preference issue," and proposed instead that if a preference action were initiated and a final order were entered that determined that the firm had received a voidable preference, the firm would return the funds to the bankruptcy estate and waive any claim therefor in the bankruptcy case. 304 F.3d at 249. Instead of resolving the preference issue, the District Court had accepted the proposal and had approved counsel's retention on those conditions.

In rejecting the adequacy of the conditions to permit retention of the law firm, the Third Circuit observed that "[alt the heart of the U.S. Trustee's objection to the

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retention of [law firm] as counsel before the preference issue was decided is the improbability that [law firm], as counsel to the debtor in possession, would bring an action against itself to recover any preference." Id. at 254. By eliminating that conflict of interest, the appointment of special counsel to investigate and prosecute avoidance actions, or even just the one relevant action, may present a solution to the problem illustrated in Pillowtex.

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