Last updated June 11, 2013 [Updates Highlighted]. The timing of preference claims is affected by 3 major factors: the statute of limitations; the desire of the debtor to re-establish goodwill (and trade credit) with the supply base; and the discontinuation of the debtor’s business operations. This article addresses the statute of limitations. The two other major factors are addressed in a separate article that can be read by clicking this link.
The Statute of Limitations for Bringing Bankruptcy Preference Actions
The statute of limitations period for bringing preference actions is ofter quoted as being 2 years from the date of the filing of the bankruptcy. Actually, the calculation of the statute of limitations is more complicated.
Section 546(a) of the Bankruptcy Code has a 2 part test for determining the time limit for bringing of bankruptcy preference actions. Bankruptcy preference claims are time barred after the later of (1) 2 years after the bankruptcy filing or (2) 1 year after the appointment of a trustee. Because most trustees are appointed within the first year of a bankruptcy filing, as a general rule of thumb, 2 years from the date of filing of the bankruptcy is going to be the cut off date for filing of bankruptcy preference claims.
In those circumstances where a trustee is appointed in the second year of a bankruptcy, it will have a full year to decide whether to bring preference claims. For example, if a debtor’s bankruptcy is converted from a Chapter 11 to a Chapter 7 and a Chapter 7 trustee is appointed 18 months after the bankruptcy if filed, the statute of limitations for the trustee to bring preference actions is extended to 30 months (2 1/2 years) from the original petition date.
The Potential Significance of the Interim vs Permanent Trustee Appointment
Whenever a preference claim is brought by a Chapter 7 trustee, the date of the trustee’s “appointment” determines if the suit is timely. However, most trustees get appointed twice – first on an “interim” basis and then on a “permanent” basis. What date is the date of “appointment” for purposes of the statute of limitations determination? Unfortunately, in many federal court districts the issue is not resolved. Fortunately, in two jurisdictions where a high volume of preference claims are brought, the issue has been decided.
In the Third Circuit (which includes Delaware) and the Seventh Circuit (which includes Illinois), the date of appointment of the permanent trustee under Section 702 is the controlling date for purposes of the statute of limitations. Singer v. Franklin Boxboard Co. (In re American Pad & Paper ), 478 F.3d 546 (3rd Cir. 2007); Fogel v. Shabat (In re Draiman), 714 F.3d 462 (7th Cir. 2013). Under Section 702, the interim trustee appointed by the US Trustee on or about the date of the conversion of a case to Chapter 7, automatically becomes the permanent trustee at the Section 341 meeting of creditors if creditors do not elect a trustee under Section 702.
So is the use of the “permanent” appointment date better or worse for the bankruptcy preference claim defendant? In most cases, use of the permanent appointment date acts to extend the statute of limitations. However, every once in a while, potential preference claim defendants will benefit from the “permanent appointment” requirement. If the conversion of a Chapter 11 case to a Chapter 7 case occurs too near to the expiration of the 2 year statute of limitations, there will be insufficient time for the trustee’s appointment to be made permanent before the statute of limitations expires. In any such late conversion instances, it is important to check the date of the Section 341 meeting to see if it occurred before or after the 2 year statute of limitations ran.
The Equitable Tolling Wild-card
Unfortunately, in the recent decision of the Seventh Circuit in Fogel v. Shabat (In re Draiman), 714 F.3d 462 (7th Cir. 2013), the Court of Appeals in dicta opened the door for application of the concept of “equitable tolling” in order to permit an extension of the statute of limitations in the interim/permanent trustee situation. The Court of Appeals stated:
Furthermore, the statute of limitations in 11 U.S.C. § 546(a) is subject to equitable tolling. See, e.g., Jackson v. Astrue, 506 F.3d 1349, 1354–55 (11th Cir.2007); In re Pugh, 158 F.3d 530, 537 (11th Cir.1998); In re M & L Business Machine Co., 75 F.3d 586, 591 (10th Cir.1996); In re United Insurance Management, Inc., 14 F.3d 1380, 1384–85 (9th Cir.1994); cf. Bailey v. Glover, 88 U.S. (21 Wall.) 342, 345–50, 22 L.Ed. 636 (1874). If without any laxity or other fault the creditors can’t procure the appointment of a permanent trustee within the statutory deadline, the doctrine of equitable tolling would permit an extension.
Draiman, 714 F.3d at 466.
The Other Absolute Bar to Bringing Preference Claims – Maybe
There is one absolute rule for bringing preference claims – bankruptcy preference claims in all instances must be brought before the debtor’s bankruptcy case is closed or dismissed. This is plainly stated in Section 546(a)(2) of the Bankruptcy Code. So how can this get complicated? The typical complicating scenario is one where a motion is filed to reopen a case after it is closed.
Reopening of a closed case can occur for any number of reasons. When the bankruptcy court allows a case to be reopened does the period for bringing preference claims also reopen? The bankruptcy courts that have addressed this question have reached conflicting conclusions.
Although Section 546(a)(2) provides that a proceeding to recover preferential transfers “may not be commenced after … the time the case is closed or dismissed”, some bankruptcy courts have interpreted this to require that the case have been “properly and finally” closed. Using this qualifier, some courts have allowed preference actions to be brought in a reopened bankruptcy case if assets are concealed or transfers that were required to be disclosed were not disclosed. See, e.g., Gross v. Petty (In re Petty), 93 B.R. 208, 212 (B.A.P. 9th Cir. 1988); White v. Boston (In re White), 104 B.R. 951, 955 (S.D. Ind. 1989); Dwyer v. Peebles (In re Peebles), 224 B.R. 519, 520- 21 (Bankr. D. Mass. 1998); and Decker v. Voisenat (In re Serrato), 214 B.R. 219, 226 (Bankr. N.D. Cal. 1997).
Another group of bankruptcy courts have held that once a case is closed bankruptcy preference claims are barred even if the case is subsequently reopened. Mullen v. Kalil (In re Mullen), 337 B.R. 744, 749 (Bankr. D. N.H. 2006); See also Phimmasone v. American General Finance (In re Phimmasone), 249 B.R. 681, 682-83 (Bankr. W.D. Va. 2000); Sandoval v. Century Bank (In re Sandoval), Adv. Proc. 11-1137 (Bankr. D.N.M March 19, 2012) (declining to read the word “properly” into Section 546(a)(2)).