11 USC § 541 in the Context of Alter Ego Claims

Excerpted from a Brief in Support of Defendant’s

Opposition to a Motion for Leave to File a Second Amended Complaint

Introduction

Section 541(a) sets forth what constitutes property of a bankruptcy estate.  Any claims which the debtor could make that might inure to the benefit of the estate and therefore its creditors are claims belonging to the trustee.  In the present case, Plaintiff claims that the Debtor and the Non/Debtor co-defendants engaged in certain contractual breaches and tortious conduct including but not limited to fraud, resulting in financial loss and injury to her.  She filed her claims pre-petition.  Ordinarily, the provisions of §362 might apply so as prevent or preclude her from pursuing her claims at least against the debtor absent a lifting of the stay.  But in this case, one or more of the Non/Debtor co-defendants removed this action to the bankruptcy court affording plaintiff free reign to pursue her claims there, without hindrance.  The nature of the claims is not such that a trustee would or could bring on behalf of the estate or on behalf of its creditors as they are claims against the Debtor.  A Debtor does not sue itself.  Alter-ego lawsuits may be pursued against the debtor in bankruptcy court, without lifting the automatic stay. Despite the apparent silence of the Code on this point, the Code implicitly permits the filing of suit in the bankruptcy court against a debtor without violating the automatic stay.  The action as removed to bankruptcy court was nothing more or less than any other adversary claim.  Instead of hanging their hats on what, if any, protection the provisions of the automatic stay might have afforded them, the Defendants in this case removed the action.  They opened the door and laid out the red carpet for the Plaintiff to pursue her claims.  Instead of doing so, she waited five months, and filed for remand and in so doing looked the proverbial gift horse in the mouth and kicked it.  Then, after waiting around for two years, she now seeks the benefit of a tolling period so as to avoid the mandate of NRCP 41(e).  No such tolling period is warranted.

Section 541[1]

Filing a bankruptcy petition, whether done voluntarily or involuntarily, begins a case in the bankruptcy court.  The bankruptcy court where the case is started is the appropriate tribunal for the bankruptcy case’s administration and the disposition of motions and adversary proceedings which are brought by or against the debtor, the debtor-in-possession or the trustee, and third parties in regards to property of the debtor or the debtor’s estate.[2]

Property of the Estate

Once a bankruptcy case is begun, § 541 establishes the parameters of the estate’s property and identifies what actually is property of the estate.[3] The applicable provision is § 541(a)(1), which states that property of a debtor’s estate includes “[e]xcept as provided in subsections (b) and (c)(2) of this section, all legal or equitable interests of the debtor in property as of the commencement of the case.”[4]

A limitation on the property of the estate is that it is comprised of only the legal and equitable interests of the debtor and not of any other party.[5]

If a debtor had a cause of action when its bankruptcy case began, that cause of action or claim constitutes an interest which is included within § 541(a)(1) and therefore constitutes property of the estate.[6]  But if a cause of action, under state law, is an asset of the corporate creditors personally, instead of to the corporation, those causes of action are not assets of the estate under § 541(a).[7]

The Automatic Stay

If, under state law, an alter-ego claim is property of the estate, then the automatic stay under § 362(a)(3) applies to prevent a creditor from bringing that claim. In this way, the automatic stay will increase the assets that are available for distribution to all creditors and the automatic stay will protect all creditors from distribution to the few on a first-come first-served basis and limit standing to the trustee who can then assert that claim on behalf of all creditors.

Alter-ego lawsuits may be pursued against the debtor in bankruptcy court, without lifting the automatic stay.

Despite the apparent silence of the Code on this point, the Code implicitly permits the filing of suit in the bankruptcy court against a debtor without violating the automatic stay. Arneson v. Farmers Ins. Exch. (In re Arneson), 282 B.R. 883, 893 (BAP 9th Cir. 2002); Rein v. Providian Fin. Corp., 252 F.3d 1095, 1101-02 (9th Cir. 2001); In re Briarwood Hills Associates, 237 B.R. 479, 480 (Bankr. W.D.Mo. 1999); Armco Fin. Servs. Corp. v. North Atl. Ins. Co. (In re Bird), 229 B.R. 90, 94-5 (Bankr. S.D.N.Y. 1999); Sobel Bldg. Devel. Partners v. Broach (In re Sexton), 166 B.R. 421, 428 (Bankr. N.D. Cal. 1994); Civic Ctr. Square v. Ford (In re Roxford Foods), 12 F.3d 875, 878 (9th Cir. 1993); Prewitt v. North Coast Village, Ltd. (In re North Coast Village. Ltd.), 135 B.R. 641, 643 (BAP 9th Cir. 1992); United States v. INSLAW, Inc., 289 U.S. App. D.C. 383, 932 F.2d 1467, 1474 (D.C.Cir. 1991); In re Opti-Gage, Inc., 130 B.R. 257, 258-59 (Bankr. S.D. Ohio 1991); Moran Fin. Corp. v. American Consol. Fin. Corp. (In re J. T. Moran Fin. Corp.), 124 B.R. 931, 940 (S.D.N.Y. 1991); Lighthouse Bluffs Corp. v. Atreus Enters., Ltd. (In re Atreus Enters., Ltd.), 120 B.R. 341, 346 (Bankr. S.D.N.Y. 1990); [**24]  Citicorp N. Am., Inc. v. Finley (In re Washington Mfg. Co.), 118 B.R. 555, 561 (Bankr. M.D. Tenn. 1990); In re American Sports Innovations, 105 B.R. 614, 617 (Bankr. W.D. Wash. 1989); Teerlink v. Lambert (In re Teerlink Ranch, Ltd.), 886 F.2d 1233, 1237 (9th Cir. 1989); In re American Spinning Mills, Inc., 43 B.R. 365, 367 (Bankr. E.D. Pa. 1984). Contra, Shugrue v. Air Line Pilots Ass'n Int'l (In re Ionosphere Clubs, Inc.), 922 F.2d 984, 993 (2d Cir. 1990), cert. denied, 502 U.S. 808, 112 S. Ct. 50, 116 L. Ed. 2d 28 (1991).

Such suits are the equivalent to the filing of claims against the estate and allowable under  11 U.S.C.§ 501, despite the automatic stay.  Moran, 124 B.R. at 940.

For example, in the case of In re Transcolor Corp.,[8]  a judgment creditor-indenture trustee filed an adversary complaint against, among others, a chapter 7 debtor-corporation and its parent corporation, as issuers of debentures in the parent’s bankruptcy case, an individual who owned or controlled the companies, as their insider, asserting claims for misrepresentation, concealment by a breach of duty to disclose, and fraudulent conveyance, and seeking to pierce the corporate veil. The court held, among other things, that the judgment creditor did not violate the automatic stay by filing the complaint. The court went on to rule that if a debtor can be sued in the bankruptcy court without violating the automatic stay, then, by definition the automatic stay would not be violated if a lawsuit was filed against a nondebtor in the bankruptcy court.   This is true even if the nondebtor is a guarantor of an obligation of the debtor or the debtor’s codefendant.

If a debtor may be sued in the bankruptcy court without violating the automatic stay, then the stay is not violated when suit is filed against a nondebtor in the bankruptcy court. Non-Debtors would not then enjoy the protection of the automatic stay, Fidelity Nat. Title Assur. Co. of New York v. Bozzuto, 227 B.R. 466, 470 (E.D.Va. 1998); In re Venture Properties, Inc., 37 B.R. 175 (Bankr. D.N.H. 1984); In re Nashville Album Prods., Inc., 33 B.R. 123 (M.D. Tenn. 1983), either as guarantor of an obligation of the debtor, Credit Alliance Corp. v. Williams, 851 F.2d 119 (4th Cir. 1988), or as the debtor's codefendant, Collier v. Eagle-Picher Indus., Inc., 86 Md.App. 38, 585 A.2d 256 (1991).

Standing to Sue

The distinction between suits brought by a corporation against its officers and those brought by defrauded parties against a corporation and its officers is the decisive factor in determining questions of standing to sue. In Drabkin v. L & L Constr. Assocs. (In re Latin Inv. Corp.), 168 B.R. 1 (Bankr. D.D.C. 1993), Judge S. Martin Teel, Jr., held that the bankruptcy trustee had standing to sue third parties who aided and abetted the corporate debtor's insiders in a conspiracy to damage the corporation. In so holding, Judge Teel made the essential decision regarding the trustee's standing to sue, namely that the cause of action was property of the estate which belonged to the corporate debtor and to the debtor's trustee who succeeded to the debtor's property: The trustee succeeds to the property of the debtor's estate. See, 11 U.S.C. §§ 704(1), 541(a)(1). This property includes all causes of action the debtor could have brought outside bankruptcy. Among these causes of action are suits arising from breaches of fiduciary duty by the corporate debtor's principals that could have been brought directly by the debtor or indirectly through shareholder derivative suits. Pepper v. Litton, 308 U.S. 295, 307, 60 S.Ct. 238, 245-46, 84 L.Ed. 281 (1939); Delgado Oil Co. v. Torres, 785 F.2d 857, 860 (10th Cir.1986). But the trustee cannot allege causes of action belonging to individual creditors. Caplin v. Marine Grace Trust Co., 406 U.S. [416] at 434, 92 S.Ct. at 1688. Thus, at issue here is whether at state law the debtor could have brought counts 8 and 9 against the defendants or whether the causes of action alleged in those counts belong to individual creditors.

The Nature of Plaintiff’s Alter Ego Claim

In the present case, Plaintiff is not arguing that Debtor/Defendant(s) is/are the alter ego of any of the other defendant entities. Instead, Plaintiff seeks a determination that Debtor/Defendants and the other entity defendants are the alter egos of Francis Drake, i.e. Francis Drake is the hub and the entities are merely the spokes on a wheel of abuse of the corporate formality. Thus, the nature of the very claims she has made is that what is purported to be the so-called property of the estate is in fact property of Francis Drake.  This is a claim she is entitled to make and pursue as such a claim could not be made by the trustee.

“In the absence of special circumstances, stays pursuant to section 362(a) are limited to debtors and do not include non^-bankrupt co^-defendants.” Ingersoll-Rand Financial Corporation v. Miller Mining Company, Inc., 817 F.2d 1424, 1427 (9th Cir. 1987) (citing, Teachers Ins. And Annuity Ass'n of Am. V. Butler, 803 F.2d 61, 65 (2d Cir. 1986)); see also, In re Arrow Huss, Inc., 51 B.R. 853, 856 (Bankr. D. Utah 1985) (“It is well settled that Section 362 of the Bankruptcy Code, which stays actions against the debtor and against property of the estate, does not forbid actions against its nondebtor principals, partners, officers, employees, co^-obligors, guarantors, or sureties.”). Debtor’s bankruptcy filing did have the effect of staying any proceedings against Debtor at least prior to removal. See, 11 U .S.C. § 362(a)(1). The filing, however, had no such force or effect with respect to the remaining non-bankrupt co-defendants. Id.

The non-debtor defendants in this case could have sought relief from the Court under §105(a) to extend the automatic stay to the remaining defendants. See, In re All Seasons Resorts, Inc., 79 B.R. 901, 903 (Bankr. C.D. Cal. 1987); see also, Ingersoll Rand, 817 F.2d at 1427; In re Arrow Huss, 51 B.R. at 856. However, they did not.  Instead they opted to remove this matter affording Plaintiff the opportunity to pursue her claims because they believed that they would carry the day and prevail against those claims.

Plaintiff could have prosecuted her claims of reverse Alter Ego Against Drake without hindrance in Bankruptcy court subsequent to removal.

The nature of the State Court Action is that Plaintiff the entity defendants including the debtors are the alter egos of Francis Drake. Accordingly, the only parties that benefit from the determination that the entities are the alter ego of Francis Drake are his creditors. Thus there is no claim related to the State Court Action upon which the trustee in the bankruptcy could act to benefit bankruptcy estate.  Inre Folks, 211 B.R. at 386. Accordingly, Debtor’s Chapter 7 trustee is not entitled to bring the sort of alter ego action that Plaintiff seeks to prosecute in the State Court Action. Moreover, Francis Drake is not a debtor in a separate individual bankruptcy, and therefore, there is no trustee that could pursue the claim on his behalf. Thus, there is simply no basis upon which any bankruptcy estate of any of the entities would benefit from the State Court Action.

Even if somehow, the alter ego action was considered property of the estate, the Chapter 7 Trustee opted not to pursue such claims.  Debtor filed the petition for bankruptcy more than three years ago.  Presumably, the trustee reviewed the claims asserted in the State Court Action and any other potential claims by now, which debtor’s schedules disclosed. It is clear that the Trustee does not intend to pursue any further actions, including any alter ego action. Further, the Chapter 7 Trustee was given notice of the Removal and Motion to Remand, and did not file an objection or appearance in either.   It seems clear that the Chapter 7 Trustee did not believe this to be an action of the estate.

Plaintiff could have sought to deny discharge in the context of the removed action and had the standing to do so.  Under § 727(c), standing to pursue denial of a discharge is limited to “[t]he trustee, a creditor, or the United States trustee.” Neither the chapter7 trustee nor the United States trustee joined in removed complaint, so Plaintiff’s ability to pursue this action turns on her status as a “creditor.” Section 101(10)(A) states that “[c]reditor means an entity that has a claim against the debtor that arose at the time of or before the order for relief concerning the debtor. . .” Without a doubt, Plaintiff had a claim, as used in Section 101(5), against the Debtor.  She was not precluded from pursuing that claim whether by virtue of § 541(a) or § 362.  As a result no tolling period is warranted.

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[1] All statutory references, unless otherwise indicated, are to title 11 of the United States Code, 11 U.S.C.A.A. §§ 101-1330, as amended (the “Bankruptcy Code”).

[2] In re Transcolor Corp., 296 B.R. 343, 353-54, 41 Bankr. Ct. Dec. (CRR) 174 (Bankr. D. Md. 2003).

[3] In re Buildings by Jamie, Inc., 230 B.R. 36, 41 (Bankr. D. N.J. 1998). In re Icarus Holding, LLC, 391 F.3d 1315, 1319, 43 Bankr. Ct. Dec. (CRR) 273 (11th Cir. 2004), certified question answered, 279 Ga. 288, 612 S.E.2d 296 (2005). In re Ozark Restaurant Equipment Co., Inc., 816 F.2d 1222, 1224, 16 Bankr. Ct. Dec. (CRR) 134, 16 Collier Bankr. Cas. 2d (MB) 1148, Bankr. L. Rep. (CCH) P 71780 (8th Cir. 1987) (“Ozark”). In re Mattress N More, Inc., 231 B.R. 104, 107, 41 Collier Bankr. Cas. 2d (MB) 1062 (Bankr. N.D. Ga. 1998). In re Adam Furniture Industries, Inc., 191 B.R. 249, 255, 28 Bankr. Ct. Dec. (CRR) 433, Bankr. L. Rep. (CCH) P 76911 (Bankr. S.D. Ga. 1996).

[4] 11 U.S.C.A. § 541(a)(1). See also, In re Folks, 211 B.R. 378, 384, 31 Bankr. Ct. Dec. (CRR) 324 (B.A.P. 9th Cir. 1997).

[5] In re Schuster, 132 B.R. 604, 608, 22 Bankr. Ct. Dec. (CRR) 236, 25 Collier Bankr. Cas. 2d (MB) 1611 (Bankr. D. Minn. 1991). In re Ozark Restaurant Equipment Co., Inc., 816 F.2d 1222, 1224, 16 Bankr. Ct. Dec. (CRR) 134, 16 Collier Bankr. Cas. 2d (MB) 1148, Bankr. L. Rep. (CCH) P 71780 (8th Cir. 1987).

[6] In re Adam Furniture Industries, Inc., 191 B.R. 249, 255, 28 Bankr. Ct. Dec. (CRR) 433, Bankr. L. Rep. (CCH) P 76911 (Bankr. S.D. Ga. 1996). In re Ozark Restaurant Equipment Co., Inc., 816 F.2d 1222, 1225, 16 Bankr. Ct. Dec. (CRR) 134, 16 Collier Bankr. Cas. 2d (MB) 1148, Bankr. L. Rep. (CCH) P 71780 (8th Cir. 1987). In re Icarus Holding, LLC, 391 F.3d 1315, 1319, 43 Bankr. Ct. Dec. (CRR) 273 (11th Cir. 2004), certified question answered, 279 Ga. 288, 612 S.E.2d 296 (2005). Towe v. Martinson, 195 B.R. 137, 140, 77 A.F.T.R.2d 96-1099

[7] In re Ozark Restaurant Equipment Co., Inc., 816 F.2d 1222, 1225, 16 Bankr. Ct. Dec. (CRR) 134, 16 Collier Bankr. Cas. 2d (MB) 1148, Bankr. L. Rep. (CCH) P 71780 (8th Cir. 1987). In re Inland Shoe Mfg. Co., Inc., 90 B.R. 981, 985 (Bankr. E.D. Mo. 1988).

[8] Nat'l City Bank of Minneapolis v. Lapides (In re Transcolor Corp.), 296 B.R. 343, 358-359 (Bankr. D. Md. 2003)