Fifth Circuit Holds Avoidance Actions Can Be Sold in Bankruptcy Cases


The Fifth Circuit Court recently ruled that companies in bankruptcy can sell their legal rights to recover certain payments made before filing (avoidance actions) to outside parties. This decision, made on January 22, 2024, in Briar Capital Working Fund Capital, L.L.C. v. Remmert (In Re South Coast Supply Company) applies not only to preference actions (preferential treatment of one creditor) but likely extends to fraudulent transfers as well. The court’s reasoning suggests this ruling encompasses all avoidance actions, giving debtors in bankruptcy more flexibility in managing their assets.

Courts have been divided on the issue of avoidance actions, but this latest ruling could provide the Supreme Court an opportunity to speak on this subject matter. Currently, the Fifth, Eighth, and Ninth Circuit Courts have held that preference claims, as described under 11 U.S.C. § 547, may be sold. The South Coast Supply Company case exemplifies the benefits of selling avoidance actions, as the debtor was able to generate $700,000 for the benefit of its creditors.

Background of the South Coast Supply Company Case

The United States Court of Appeals for the Fifth Circuit held that preference actions could be sold to a third-party, non-estate representative and acknowledged the lack of precedence. The appeal No.22-20536 was entitled In the Matter of South Coast Supply Company, Briar Capital Working Fund, L.L.C. v. Robert W. Remmert. It begins by calling it a res nova issue, meaning it is unprecedented, and the ruling will set a new precedent that could shape the course of future rulings.

South Coast Supply Company (the debtor), a struggling parts distributor, borrowed $800,000 from its Chief Financial Officer (CFO), Robert Remmert, in 2016. South Coast was able to pay back some of the loan but was unable to pay back the rest when Remmert resigned and demanded immediate payment. After filing for Chapter 11 bankruptcy, the debtor began an avoidance action against Remmert to recover the more than $300,000 in payments debtor paid as alleged preferences.

Briar Capital, South Coast’s secured lender of approximately $2.6 million, was potentially oversecured and under the bankruptcy code, entitled to receive post-petition interest and legal fees (administrative expense claim). The original plan proposed that Briar’s collateral would be surrendered to satisfy the secured claim but would not reimburse its administrative expense claim. After Briar Capital’s objection, the plan was then modified to provide that Briar Capital would abandon the security interest in $700,000 of sale proceeds and waive its administrative expense claim in exchange for the debtor’s interest in the preference claim against its former CFO.

The court approved the modified plan, allowing Briar Capital the preference claims against the former CFO, authorizing them to prosecute the case on behalf of the bankruptcy estate, and allowing them to receive 100% of anything recovered from that preference action. Before the preference action trial, the district court dismissed the action based on a lack of standing, as Briar was not an estate representative. Additionally, it determined the recovered funds would not directly benefit the debtor’s estate or other creditors.

Court Statements on Preference Claims

The Fifth Circuit acknowledged that the appeal raised a variety of issues but hinged on the question of whether preference claims may be sold. On appeal, the Fifth Circuit overturned the lower court’s decision regarding who could pursue preference actions, ruling that preference actions can be sold and that Briar Capital had legal standing to prosecute the preference action.

The Fifth Circuit held that Section 363(b) of the Bankruptcy Code allows a debtor to sell property of the estate, and that avoidance actions, including preference claims are property of the estate as defined in Sections 541(a)(1) and (a)(7). As such, preference claims may be sold to third-parties. Therefore, third-party purchasers such as Briar Capital have a legal basis to pursue these claims, regardless of their status as estate representatives.

The court acknowledged the authorization of estate representatives to pursue claims in Section 1123(b) but emphasized that it does not represent the sole method for liquidating estate assets. Section 363 offers another mechanism that does not require the transfer of property to an estate representative. This broader interpretation of the available options when liquidating assets during a bankruptcy paves the way for more efficient estate asset management.

Conclusions From Fifth Circuit Holdings

Bankruptcy proceedings can involve assets that are challenging to convert into cash easily. Claims requiring complex litigation can be especially difficult and slow to liquidate. The ability to swiftly convert assets like these becomes a crucial tool for debtors, trustees, and estate representatives when trying to repay creditors quickly.

The South Coast case exemplifies this concept. The ability to sell avoidance actions in this case allowed South Coast to facilitate a quicker settlement with Briar Capital, releasing valuable collateral, monetizing that intangible asset immediately, and maximizing creditor payout for all involved. This interpretation of the law sets a precedent that will have a significant impact on future legal cases regarding avoidance actions and liquidating assets in bankruptcy proceedings.

Liquidating Assets Under the Bankruptcy Code

The Bankruptcy Code offers various options for debtors or trustees to liquidate assets and distribute proceeds to creditors. The main two methods are appointing an estate representative and a section 363 sale. These methods aim to achieve a fair distribution of assets among estate creditors and allow a debtor to obtain a fresh start.

The traditional approach to liquidating assets under the bankruptcy code involves appointing a disinterested third party, such as an accountant or lawyer, to act as an estate representative. They then take control over any non-exempt assets from the debtor and work to sell them through auctions or private sales. The proceeds are then distributed to creditors based on the priority provided by the Bankruptcy Code.

The second, more streamlined method for liquidating assets is called a Section 363 Sale and is authorized by Section 363 of the Bankruptcy Code. This allows the debtor or trustee to sell assets directly but requires court approval to ensure fairness for creditors and compliance with regulations. Assets can include equipment, intellectual property, inventory, or real estate. Section 363 Sales are faster and require less expense than hiring a separate estate representative to handle selling assets. Following South Coast Supply, it is clear that a debtor may sell avoidance actions under Section 363, as well.

Important Bankruptcy Terms to Know

Learning the complex legalities of bankruptcy law can be challenging. That’s why our bankruptcy lawyers at MehaffyWeber take the time to break down important terms so you understand what is happening every step of the way. Here are a few specific terms used in bankruptcy proceedings:

  • Avoidance Actions – An avoidance action is a term for the broader category of legal tools used in bankruptcy cases that a trustee or debtor-in-possession can use to recover assets or cancel transactions that were deemed unfair to creditors and happened before the bankruptcy case was filed.
  • Debtor – The company filing for bankruptcy protection and the one who owes money to creditors.
  • Creditor – The person or company to whom the debtor owes money.
  • Chapter 7 – The term Chapter 7 refers to the type of bankruptcy case where the debtor (whether an individual or company) intends to liquidate all of its assets.
  • Chapter 11 – The term Chapter 11 refers to the type of bankruptcy case where the debtor (usually a company, but sometimes an individual) seeks to either restructure its debts, liquidate some or all of its assets, and usually emerge as a reorganized operation.
  • Debtor in Possession (DIP) – Within Chapter 11, a debtor company that remains in control over operations.
  • Exempt Assets – Property that is protected from liquidation during bankruptcy, varying based on state.
  • Fraudulent Transfers – This is a type of avoidance action to recover transfers that meet certain requirements.
  • Preference Actions – A preference action is a term for the specific type of avoidance action that focuses on recovering preferential payments made by a debtor to a specific creditor prior to filing for bankruptcy.
  • Res Nova Issue – A legal term from Latin referring to a situation where a question is posed to the court that has not been definitively ruled on by a higher court and thus is an unprecedented issue with no clear legal rulings in the same court system.

This is just a starting point on the bankruptcy terms that are helpful to know within business law. Understanding these concepts can equip you better while you navigate the bankruptcy process. Remember to consult with a qualified bankruptcy attorney for personalized guidance based on the complexities of your particular situation and determining the best course of action for you or your company.

Seek Help With Bankruptcy Cases and Avoidance Actions for Texas Corporations

At MehaffyWeber, our attorneys have decades of experience in business law and keep a close eye on important proceedings, rulings, and precedents such as this one. We will continue to follow the repercussions of this case and others on bankruptcy law so as to best advise our clients. If you have specific questions about how the law affects your company, consult with one of our experienced bankruptcy lawyers today.