In Hafen v. Adams (In re Hafen), 616 B.R. 570 (B.A.P. 10th Cir. 2020), a bankruptcy appellate panel from the Tenth Circuit ("BAP") held that the bankruptcy court is the only court with subject-matter jurisdiction to decide whether a claim or cause of action is property of a debtors' bankruptcy estate. As a consequence, the BAP held that the bankruptcy court abused its discretion by permitting a state court to determine whether creditors had "standing" to sue third-party recipients of allegedly fraudulent transfers. The decision illustrates the distinction between "bankruptcy standing" and "constitutional standing" to sue in federal courts.

Jurisdiction Over Estate Property in Bankruptcy

Federal district courts have "original and exclusive jurisdiction" of all "cases" under the Bankruptcy Code. 28 U.S.C. 1334(a). District courts also have "original but not exclusive jurisdiction of all civil proceedings arising under" the Bankruptcy Code, "or arising in or related to cases" under the Bankruptcy Code. 28 U.S.C. 1334(b). District courts may (and do), however, refer these cases and proceedings to the bankruptcy courts in their districts, which are constituted as "units" of the district courts. 28 U.S.C. 157(a).

A federal district court in which a bankruptcy case is commenced or pending also has exclusive jurisdiction over all of the debtor's property, wherever located, property of the debtor's bankruptcy estate (as defined in section 541(a) of the Bankruptcy Code), and all claims or causes of action involving the retention of bankruptcy professionals. 28 U.S.C. 1334(e). Under section 541(a)(1), the estate includes "all legal or equitable interests of the debtor in property as of the commencement of the case." Accordingly, claims and causes of action belonging to the debtor on the petition date are estate property. See In re Wilton Armetale, Inc., 968 F.3d 273, 280 (3d Cir. Aug. 4, 2020) (citing 11 U.S.C. 541(a)(1); U.S. v. Whiting Pools, Inc., 462 U.S. 198, 205 n.9 (1983); Bd. of Trs. of Teamsters Local 863 Pension Fund v. Foodtown, Inc., 296 F.3d 164, 169 (3d Cir. 2002)).

As the "representative of the estate" with the "capacity to sue and be sued" on its behalf (see 11 U.S.C. 323(a), (b)), the bankruptcy trustee or, by operation of section 1107(a) of the Bankruptcy Code, a chapter 11 debtor-in-possession ("DIP"), has the exclusive authority to assert estate claims and causes of action. Armetale, 968 F.3d at 280. Thus, after a debtor files a bankruptcy petition, the debtor's creditors lack authoritysometimes referred to as "standing"to assert claims that are estate property. Id.; accord In re Emoral, Inc., 740 F.3d 875, 879 (3d Cir. 2014); Highland Capital Mgmt. LP v. Chesapeake Energy Corp. (In re Seven Seas Petrol., Inc.), 522 F.3d 575, 584 (5th Cir. 2008); Logan v. JKV Real Estate Servs. (In re Bogdan), 414 F.3d 507, 51112 (4th Cir. 2005).

In keeping with 28 U.S.C. 1334(e), nearly all courts that have considered the question have concluded that the jurisdiction to determine what qualifies as estate property lies exclusively with the bankruptcy court. See, e.g., Brown v. Fox Broad. Co. (In re Cox), 433 B.R. 911, 920 (Bankr. N.D. Ga. 2010) ("It is generally recognized that '[a] proceeding to determine what constitutes property of the estate pursuant to 11 U.S.C. 541 is a core proceeding under 28 U.S.C. 157(b)(2)(A) and (E),' and that, '[w]henever there is a dispute regarding whether property is property of the bankruptcy estate, exclusive jurisdiction is in the bankruptcy court.'" (citations omitted)); accord Gardner v. U.S. (In re Gardner), 913 F.2d 1515, 1518 (10th Cir. 1990); Brown v. Dellinger (In re Brown), 734 F.2d 119, 124 (2d Cir. 1984); Montoya v. Curtis (In re Cashco, Inc.), 614 B.R. 715, 722 (Bankr. D.N.M. 2020); In re DeFlora Lake Dev. Assocs., Inc., 571 B.R. 587, 593 (Bankr. S.D.N.Y. 2017); In re Brown, 484 B.R. 322, 332 n.2 (Bankr. E.D. Ky. 2012); Mata v. Eclipse Aerospace, Inc. (In re AE Liquidation, Inc.), 435 B.R. 894, 90405 (Bankr. D. Del. 2010); Heolena Chem. Co. v. True (In re True), 285 B.R. 405, 412 (Bankr. W.D. Mo. 2002); Manges v. Atlas (In re Duval Cty. Ranch Co.), 167 B.R. 848, 849 (Bankr. S.D. Tex. 1994).

However, in the interests of justice or comity with state courts, a bankruptcy court may relinquish its exclusive jurisdiction to make that determination by abstaining under 28 U.S.C. 1334(c)(1) in deference to another tribunal better suited to adjudicate the issue. See In re Ament, 2020 WL 354888, at *4 (Bankr. D.N.M. Jan. 21, 2020) ("Construing 1334(c)(1) and 1334(e) together, it is clear that, although the bankruptcy court has exclusive jurisdiction over property of the estate once a petition is filed, the bankruptcy court may choose to abstain from exercising its jurisdiction and modify the stay to allow a state court to divide community property."); accord In re Maxus Energy Corp., 560 B.R. 111, 120 (Bankr. D. Del. 2016); In re Thorpe, 546 B.R. 172, 177 (Bankr. C.D. Ill. 2016), aff'd, 569 B.R. 310 (C.D. Ill. 2017), aff'd, 881 F.3d 536 (7th Cir. 2018).

Hafen

Several years before filing a chapter 7 case in 2004 in the District of Utah, securities broker-dealer Roy Nielson Hafen ("debtor") operated a Ponzi scheme that defrauded investors. Although the debtor's chapter 7 schedules listed the defrauded investors as creditors and the creditors were notified of the bankruptcy filing, the investors did not file proofs of claim or otherwise participate in the bankruptcy case. The debtor received a bankruptcy discharge in 2004.

Alleging that the debtor had concealed assets, several investors sought to reopen the case 13 years later. Without seeking bankruptcy court authority, the investors also sued the debtor, his wife, and several related entitles in state court seeking to avoid and recover fraudulent transfers and undisclosed assets under state law.

The debtor argued that the causes of action in the state court complaint belonged to his bankruptcy estate and filed a motion in the bankruptcy court to sanction the investors for violating the discharge injunction under section 524(a) of the Bankruptcy Code. In connection with the hearing on the motion, the debtor and the investors agreed that the state court could decide whether the investors had standing to sue. The debtor's newly appointed chapter 7 trustee did not weigh in on the matter.

The bankruptcy court denied the motion for sanctions and ruled that whether the investors had standing to sue could be decided by the state court. In so ruling, the bankruptcy court relied on the investors' representation that they did not intend to collect any judgment from the debtor but from third parties, which is permitted under section 524(e). The debtor appealed to the BAP.

The BAP's Ruling

A three-judge panel of the BAP reversed the ruling and remanded the case below.

Writing for the panel, Judge Terrence L. Michael held that the bankruptcy court erred by not deciding whether the investors had "standing" to assert the claims asserted in their complaint. Judge Michael looked to 28 U.S.C. 1334(e)(1) and the Tenth Circuit's determination in Gardner that lawmakers intended "to grant comprehensive jurisdiction to the bankruptcy courts so that they might deal efficiently and expeditiously with all matters connected with the bankruptcy estate" (internal quotation marks and citations omitted). On the basis of these authorities, he wrote that "[t]he jurisdiction to determine what is property of the estate lies exclusively with the bankruptcy court."

Judge Michael explained that the investors' standing to assert fraudulent transfer claims totally depended on whether such claims constituted property of the bankruptcy estate, "an issue over which the Bankruptcy Court has exclusive jurisdiction." If the fraudulent transfer claims were estate property, he wrote, "only the chapter 7 trustee has standing to pursue those claims." According to Judge Michael, standing to pursue assets that were not disclosed in the debtor's bankruptcy filing also hinged on whether the claims belonged to the estate. In both instances, he ruled, the bankruptcy court did not have discretion to allow the state court to resolve the standing question.

The BAP also faulted the bankruptcy court's denial of the debtor's motion to sanction the investors. The bankruptcy court found no violation of the discharge injunction because the investors sought to establish the debtor's liability only so that they could recover any judgment from third parties. According to Judge Michael, if the claims were property of the estatemeaning that the investors lacked standing"the 524(e) safe harbor applicable to claims against entities separate from the Debtor may not apply." However, because the evidence did not establish whether the claims were estate property, the BAP remanded the case to the bankruptcy court to "determine whether the causes of action are property of the bankruptcy estate, and, after making that determination, determine whether the Investors had standing to bring those claims."

Outlook

The BAP's analysis of the issues in Hafen in terms of "standing" to assert claims belonging to the bankruptcy estate raises an interesting question regarding the confusing nature of "standing" in bankruptcy. "Standing" is the ability to commence litigation in a court of law. It is a threshold issuea court must determine whether a litigant has the legal capacity to pursue claims before the court can adjudicate the dispute. In bankruptcy cases, the concept most commonly arises in connection with: (i) the right of parties-in-interest (e.g., creditors, shareholders, and committees) to participate in chapter 11 cases; and (ii) the ability of parties other than a bankruptcy trustee or DIP to assert claims or causes of action that may be property of the debtor's bankruptcy estate. This "bankruptcy" or "statutory" standing is distinct from the "constitutional standing" to sue, which is jurisdictionalif a potential litigant lacks constitutional stating, the court lacks jurisdiction to adjudicate the dispute.

The distinction between constitutional and bankruptcy standing was recently examined by the U.S. Court of Appeals for the Third Circuit in Armetale, in which the court of appeals held that the ability of a creditor to sue in bankruptcy is not a question of standing but, rather, an issue of statutory authority. The Third Circuit explained that, in accordance with the U.S. Supreme Court's decision in Lexmark Int'l, Inc. v. Static Control Components, Inc., 572 U.S. 118, 125 (2014), constitutional standing has only three elements: (i) there must be "a concrete and particularized injury in fact"; (ii) the injury must be "fairly traceable" to the defendant's conduct; and (iii) "a favorable judicial decision" would likely redress the injury. Armetale, 968 F.3d at 291 (citing Lexmark, 572 U.S. at 125). Once a plaintiff satisfies those elements, the action "presents a case or controversy that is properly within federal courts' Article III jurisdiction." Id.

Guided by Lexmark and the Seventh Circuit's ruling in Grede v. Bank of N.Y. Mellon, 598 F.3d 899, 900 (7th Cir. 2010), where the court observed that bankruptcy "standing" is doctrinally "abnormal," the Third Circuit concluded in Armetale that "a litigant's 'standing' to pursue causes of action that become the estate's property means its statutory authority under the Bankruptcy Code, not its constitutional standing to invoke the federal judicial power." It accordingly ruled that, although a creditor ordinarily would have constitutional standing to pursue a claim belonging to a bankruptcy estate, it may lack statutory authority to assert the claim unless the trustee or DIP has abandoned the claim or the creditor has suffered a direct, particularized injury.

The U.S. Court of Appeals for the Sixth Circuit also recently examined bankruptcy standing in In re Capital Contracting Co., 924 F.3d 890 (6th Cir. 2019). In that case, a law firm withdrew its claim for fees owed by a chapter 7 debtor it had represented in pre-bankruptcy state court litigation as part of a settlement of the chapter 7 trustee's legal malpractice claims against the law firm. After discussing the distinction between bankruptcy and constitutional standing, the Sixth Circuit ruled that the law firm did not have Article III standing to appeal the bankruptcy court's order approving the trustee's final report, based on the report's failure to list the debtor's appellate rights in the state court lawsuit as an asset. According to the Sixth Circuit, the failure to list those rights as an asset could not financially harm the law firm because it had settled with the trustee and withdrawn its fee claim.

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Tenth Circuit BAP: Bankruptcy Courts Have Exclusive Jurisdiction to Determine Whether Claims Are Estate Property - JD Supra