Can Creditor Pursue Claims Abandoned by Bankruptcy Trustee?

Can Creditor Pursue Claims Abandoned by Bankruptcy Trustee?

For an unsecured creditor of a company undergoing the bankruptcy proceedings, the road ahead has always seemed to be uncertain with a meek chance of full recovery, at the end of it. In a bankruptcy proceeding, an unsecured creditor is not left with many remedies. With reduced asset valuations, claims of secured creditors, and administrative costs, the unsecured creditor and his/her demand comes last. Also, in case an unsecured creditor, after exhausting all his resources, resorts to pre-petition litigation against non-debtor third party, he is left with no standing in the litigation. As once the bankruptcy petition is filed, all the pre-petition petition claims are placed with the trustee, leaving no way forward for the creditor. This is because the trustee can very well choose to not act on those claims, alleging excessive administrative cost or any other such reason, thereby keeping the unsecured creditor, empty-handed.  

Certain claims of a creditor against non-debtor third parties are treated as “derivatives” of claims that the estate of debtor has against those non-debtor defendants. Therefore, when the debtor files for bankruptcy, all its claims becomes a part of the property of the estate. 11 U.S. Code, Section 323 (a) and (b) vests sole authority into the hand of bankruptcy trustee to pursue these claims. The aim of this provision is to prevent creditors from resorting to simultaneous claims. However, the issue was discussed by the United State Court of Appeals for the Third Circuit in the recent judgment of Artesanias Hacienda Real S.A. de C.V. v. N. Mill Capital, LLC (In re Wilton Armetale, Inc.), 968 F.3d 273 (3d Cir. 2020).

The facts read that plaintiff sold certain goods to the debtor; however, the debtor failed to pay for the goods. Therefore, plaintiff filed a case against the debtor and its then-owner, for recovery of the payment, and received a judgment for $900,000.00 and all the owner’s shares in Wilton. Once the plaintiff assumed the control of the debtor, he discovered that that debtor’s prior owner, prior law firm and another creditor had diverted non-real estate assets from debtor to hinder plaintiff’s ability to enforce its judgment. Plaintiff was left with no resort but to file a lawsuit against the non-debtor third parties before the United States District Court for the Eastern District of Pennsylvania. Soon after, the debtor filed for bankruptcy. Once the bankruptcy proceedings started, the claims against non-debtor third parties became the property of the estate. However, the bankruptcy trustee abandoned the claims. The District Court held that plaintiff’s claim were related to the debtor’s bankruptcy proceedings and thereby referred to the Bankruptcy Court. The Bankruptcy Court held that only the trustee had “standing” to go forward with the claims.

The plaintiff went ahead with an appeal before the Third Circuit (“Court”). The Court addressed the confusion surround the word “standing”. The word “standing” was used to describe the authority of a creditor to pursue a derivative claim. The Court clarified that constitutional standing differs from Bankruptcy or statutory standing. It held that the bankruptcy trustee has the initial authority to pursue the claims, such as the one claimed by the plaintiff. However, if the trustee decides to abandon the claim, it flows back to the prior holder of the claims, (plaintiff in this case). The Court also made it clear that evidence showcasing abandonment of claims by trustee must be substantial.  

This exceptional judgment has waved the path ahead for creditors whose claims are abandoned by the bankruptcy trustee. With the help of the judgment, creditors can pursue such claim independently now.