Getting Stuck With the Tab

17 Mar Getting Stuck With the Tab

It often happens that, upon commencement of a bankruptcy case, property which is part of the debtor’s bankruptcy estate is not held or controlled by the trustee (or debtor-in-possession).  To recover that property, Bankruptcy Code section 542 permits the trustee to seek its turnover from the party holding it.

Until very recently, Ninth Circuit law left unanswered the question of whether a party who at one point may have held estate property could remain liable for its turnover even after that property had been transferred elsewhere.  Shapiro v. Henson answers that question in the affirmative.

In a case of first impression, the Ninth Circuit Court of Appeals expanded the trustee’s ability to seek turnover of estate property.  In its analysis, the Court took cues from Section 542’s language which suggests that possession of property may not necessarily be mandatory for turnover.  To support its interpretation of S. 542(a), the Court also reviewed turnover practices before the Bankruptcy Code was promulgated.  Among these, the Court noted that ‘plenary proceedings’ did not require the present possession of property.  The pre-Code possibility of a turnover of property of the bankruptcy estate without possession strengthened the Court’s similar reading of the present statute.

The Ninth Circuit Court also examined Section 550(a), which empowers trustees to recover from initial and intermediate transferees.  Under the Ninth Circuit’s analysis, this section would be redundant if “present possession” was always a requirement for such recovery.  Further, if possession or property was a must for seeking the property’s turnover, merely transferring the property in question would be an easy way to avoid the trustee’s reach.  Finally, the Court considered (but rejected) the analysis behind Eighth Circuit rulings, which designate possession as a pre-requisite to turnover recovery.

In a nutshell Shapiro v. Henson‘s result means:

• A party holding “property of the estate” may be liable at any time for its turnover, regardless of whether or not those parties remain in possession of it at the time the turnover motion is filed.
• The trustee’s ability to seek turnover of estate property is protected in a manner consistent with the trustee’s power to avoid pre- and post-petition transfers – the trustee need not immediately “use” the turnover, or forever “lose” it.
• Out-of-possession debtors and other custodians may be at risk, essentially through no fault of their own.  It is easy, for example, to imagine facts different than those reviewed in this case, where an innocent debtor or receiver finds a bank account balance reduced by virtue of pre-petition checks negotiated post-petition (or by virtue of post-petition levies) effectively beyond the debtor’s control.  Alternatively, a receiver obligated to surrender estate property despite the provisions of Section 543(d) may find him- or herself liable for post-petition funds disbursed prior to the time that turnover is sought.

Shapiro v. Henson protects bankruptcy trustees from having to “chase” estate property through multiple transferees.  But it does so at the cost of an added level of risk imposed on those initial holders of estate property who may not have notice of the debtor’s bankruptcy – or may be unable to prevent transfer of the property.