United States: Stretching The Limits To Avoid Fraudulent Transfers – Equitable Tolling Under Section 546 Of The Bankruptcy Code

Last Updated: March 18 2014
Article by Peter C. Blain

Section 546 of the United States Bankruptcy Code, 11 U.S.C. § 101-1532 (the "Code"), establishes a statute of limitations within which an avoidance action, including a fraudulent transfer action under Code section 548 (or section 544 applying applicable state fraudulent transfer law), may be brought. Generally, in Chapter 11 cases actions to avoid fraudulent transfers must be commenced within later of two years of the entry of the order for relief or one year after the appointment of a trustee if the appointment occurs within the two-year period. While the statute is plainly worded, courts have often applied the doctrine of equitable tolling to expand the time limits within which a fraudulent transfer action under section 548 may be brought. See, e.g., Fogel v. Shabat, (In re Draiman), 714 F.3d 462 (7th Cir. Apr. 8, 2013); Jackson v. Astrue, 506 F. 3d 1349 (11th Cir. 2007); Jobin v. Boryla (In re M & L Bus. Mach. Co.), 75 F.3d 586 (10th Cir. 2007); Pugh v. Brook (In re Pugh), 158 F. 3d 530 (11th Cir. 1998); Ernst & Young v. Matsumoto (In re United Ins. Mgmt., Inc.), 14 F. 3d 1380 (9th Cir. 1994); cf. Bailey v. Glover, 88 U.S. (21 Wall.) 342 (1874).

Courts frequently apply the doctrine of equitable tolling to expand the statute of limitations if the filing of a timely suit was prevented by fraudulent concealment or misrepresentation. Barr v. Charterhouse Group International, Inc. (In re Everfresh Beverages Inc.), 238 B.R. 558 (Bankr. S.D.N.Y. 1999). Even if the fraud was not fraudulently concealed, courts have equitable tolled the statute of limitations if the fraudulent transfer was not discoverable within the applicable time limits. The Mediators Inc. v. Manney (In re The Mediators Inc.), 190 B.R. 515 (S.D.N.Y. 1995).

Equitable tolling has also been applied when the entity to which the cause of action belonged was adversely dominated preventing the action from being timely brought to the detriment of another interested party. Freeland v. Enodis Corp., 540 F.3d 721 (7th Cir. 2008). In a bankruptcy proceeding, a fraudulent transfer action usually may only be brought by the trustee or debtor in possession. However, courts often grant derivative standing to committees or other third parties to bring the action if the trustee or debtor in possession has unjustifiably refused or abused its discretion by not bringing the suit. Unsecured Creditors Comm. v. Noyes (In re STN Enters.), 779 F.3d 901 (2d Cir. 2001).

An illustration of the application of the doctrine of equitable tolling in this instance is found in Hyundai Translead, Inc. ex rel. Estate of Trailer Source, Inc. v . Jackson Truck & Trailer Repair, Inc., 419 B.R. 749 (M.D. Tenn. 2009). There, Trailer Source, a Hyundai dealer, allegedly fraudulently transferred trailers sold to it by Hyundai to avoid paying debts it owed to Hyundai. Hyundai filed a complaint against the Trailer Source and certain other parties to avoid the fraudulent transfer, and also filed an involuntary Chapter 7 bankruptcy petition against Trailer Source. The order for relief was entered and a Chapter 7 trustee was appointed.

Hyundai requested that the Chapter 7 trustee investigate the fraudulent transfer claim, but the trustee declined, citing a lack of funds. Hyundai moved the bankruptcy court to grant it derivative standing to pursue the claims, but the court denied the motion. Subsequently, the trustee filed a motion to settle all of the fraudulent transfer claims and the bankruptcy court approved the settlement over Hyundai's objections. Hyundai appealed to the district court, which reversed the bankruptcy court's order approving the settlement and granted Hyundai derivative standing. The decision of the district court was rendered one month after expiration of the two year statute of limitations established by section 546 of the Code.

The defendants appealed and several months later the Sixth Circuit Court of Appeal affirmed the decision of the District Court. Thereafter, Hyundai filed a motion to amend its original complaint to add additional allegations. The defendants opposed the motion, arguing that the new allegations were untimely under section 546(a) of the Code.

The court found that under the facts of the case, the statute of limitations was equitably tolled. Despite Hyundai diligently pursuing its motion for derivative standing, including appealing the adverse decision of the bankruptcy court, the district court did not issue its order reversing the denial of standing until one month after the section 546 statute of limitations had expired. The court found nothing dilatory in Hyundai's filing of its motion for derivative standing or its appeal of the denial of that motion. The court also found that the defendants were not prejudiced by allowing Hyundai to amend its complaint. The motion to amend was filed a mere four months after the expiration of the section 546 two-year statute of limitations. Moreover, the defendants were on notice that Hyundai would pursue the fraudulent transfer claims were it eventually granted derivative standing. Finally, the court dismissed the defendants' arguments that Hyundai should have tried to preserve the statute of limitations, such as by seeking a tolling agreement. The court said the defendants may have refused to enter into a tolling agreement and observed that in any event such a request is not a necessary component of diligence. Equitable tolling, said the court, applies where a party timely but unsuccessfully seeks derivative standing to pursue claims that the trustee cannot or will not pursue.

In addition to section 546, which limits the time within which an action may be brought under section 548 of the Code, section 548(a)(1) also provides in part that "The trustee may avoid any transfer...that was made...on or within 2 years before the date of the filing of the petition...." Can the doctrine of equitable tolling be applied to permit the avoidance of fraudulent transfers which occurred more than two years before the petition was filed, but which were perhaps concealed? The courts appear to be split on this issue.

In Official Committee of Unsecured Creditors v. Pardee (In re Stanwich Financial Services. Corp., 291 B.R. 25 (Bankr. D. Conn. 2003), the Creditors Committee filed an action to recover certain prepetition transfers. The defendants in the action filed a motion to dismiss the complaint, asserting that the avoidance of certain prepetition transfers were barred because the transfers occurred prior to the period set forth in section 548. The committee responded that it did not and could not have discovered the transfers earlier than one year before the petition was filed, the look-back period under the version of section 548 then in effect. Citing Young v. United States, 535 U.S. 43 (2002), the court denied the defendants' motion to dismiss, finding that every federal limitation period is subject to the doctrine of equitable tolling, especially statutes of limitations applied by bankruptcy courts which are courts of equity. Holding the opposite, the court in Industrial Enterprises of America, Inc. v. Burtis (In re Pitt Penn Holding Co., Inc.), 2012 W.L. 204095 (Bankr. D. Del. Jan. 24, 2012) agreed that the doctrine of equitable tolling applies to statutes of limitations which are procedural, such as section 546. However, the court held that the two year look-back period in section 548 is not a statute of limitations, but is a substantive part of the statute which cannot be equitably expanded. The court determined that the Stanwich court misunderstood the distinction between procedural statutes of limitations, such as 546, which can be equitably tolled, and substantive statutory elements such as the two year look-back period in section 548, which cannot. Statutes of limitations, said the court, are forward looking and establish a time within which action must be taken. By contrast, the look-back period does not apply to a period within which any action by a trustee can be taken, but instead to a specific period within which a transfer must have occurred to be avoidable. Although Stanwich and cases following it may prevent injustice by expanding the trustee's rights to avoid fraud, particularly if fraudulent transfers are concealed by wrongdoers, the Pitt Penn decision seems to be the better reasoned view on this issue.

Where fraudulent transfers are concealed by the wrongdoers; are not concealed but are not otherwise discoverable; or a party in control of the fraudulent transfer action inappropriately refuses or fails to bring it to the detriment of another, courts will often equitably toll the statute of limitations under section 546 to preserve the cause of action. However, under what appears to be the better reasoned view, unlike section 546 which is procedural, the section 548 time limit making only transfers occurring within two years of the filing of the petition avoidable is substantive and cannot be equitably expanded under the doctrine of equitable tolling.

Originally published in Corporate LiveWire's Expert Guide: Banking & Restructuring 2014 - March 2014

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Peter C. Blain
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