Clawback Actions In Bankruptcy: Three Ideas for a Defendant
A bankruptcy case gives rise to certain rights under Chapter 5 of United States Bankruptcy Code. Chapter 5 causes of action are typically pursued by a bankruptcy trustee or a debtor-in-possession, a bankruptcy term for a bankrupt in a reorganization bankruptcy who has not been displaced by a trustee. These causes of action are nicknamed “clawbacks,” because they seek to bring “back” to the bankruptcy estate money or other property that the bankrupt transferred, directly or indirectly, to the defendant.
This article presents three ideas for defendants or prospective defendants in a clawback action. These ideas are far from exhaustive and, of course, this article does not constitute legal advice. It is recommended to seek qualified legal counsel and and share the pertinent facts to obtain specific advice.
Idea #1: Consider clawback ramifications before filing a proof of claim in a bankruptcy case – especially geographically distant bankruptcy cases.
Filing a proof of claim arguably constitutes the filer’s consent to jurisdiction of the pertinent bankruptcy court. This could be unwise: Filing a claim almost always removes the claimant’s ability to argue later, such as in a clawback suit that the bankruptcy court lacks jurisdiction over the claimant. The court may well also construe filing a proof of claim as submitting to equitable claims allowance processes that are wrapped up with clawback suit determinations. If the bankruptcy court deems such submission to have occurred, it will preclude the claimant from any ability to obtain a jury trial of the clawback suit. Granfinancieara S.A. v. Nordberg, 492 U.S. 33, 58 (1989).
Idea #2: If you could benefit significantly from filing a proof of claim and determine to do so despite the risks identified above, you probably wish to attach an addendum to the bankruptcy court’s proof of claim form. The addendum would purport to decline to consent to bankruptcy court jurisdiction and decline to waive any jury rights, and the like. Such an addendum may well be ineffective, but it is often included because there is usually no disadvantage to the addendum. Further, the addendum preserves an argument in favor of the claimant in the event the claimant later becomes a clawback defendant.
Idea #3: Be alert to the possibility the clawback plaintiff has “clawed too sharply,” to coin a phrase. Some courts have become more sensitive to bankruptcy trustees abusing their ability to litigate questionable claims. The Seventh Circuit admonished a bankruptcy trustee for bringing a frivolous claim against the debtor’s accounting firm. In Maxwell v. KPMG, LLP, 520 F.3d. 713 (7th Cir 2008), the court stated:
The extreme weakness of the trustee’s case, both on liability and on damages, invites consideration of the exercise of litigation judgment by a Chapter 7 trustee. The filing of lawsuits by a going concern is properly inhibited by concern for future relations with suppliers, customers, creditors, and other persons with whom the firm deals (including government) and by the cost of litigation. The trustee of a defunct enterprise does not have the same inhibitions. A related point is that while management of a going concern has many other duties besides bringing lawsuits, the trustee of a defunct business has little to do besides filing claims that if resisted he may decide to sue and enforce. Judges must therefore be vigilant in policing the litigation judgment exercised by trustees in bankruptcy, and in appropriate case must give consideration to imposing sanctions for the filing of a frivolous suit.
Maxwell v. KPMG, LLP, 520 F.3d. 713, 719.
The sentiment expressed in Maxwell has also been applied to trustees’ clawback actions. For instance, In re Leann Freeman, 2012 Bankr. LEXIS 6106 (Bankr. E.D. Ca 2012), the trustee took a no-asset case and filed an adversary proceeding against the debtor’s parents alleging a fraudulent transfer of a rental property. The adversary proceeding was not filed until 17 days before the bar date, and the trustee did not seriously investigate the facts behind the sale before filing the adversary complaint. Id. at 16. Once the debtor’s parents responded to the complaint and pled their affirmative defenses, the trustee discovered that the parents had meritorious defenses to the fraudulent transfer claim and that the complaint sought to avoid the wrong transfer. Id. By that time, the new claim which the trustee needed to pursue in an amended complaint was time-barred. Id. at 17. For violating her duty to investigate the claim before filing the adversary proceeding, the court sanctioned the trustee.
Should you ever face a clawback risk, perhaps one or more of the ideas above will help you achieve a fairer result.