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Delaware Bankruptcy Court Dismisses Fraudulent Conveyance Claims for Transfers Made More Than Two Years Before Bankruptcy

Financial Restructuring and Bankruptcy Alert | April 2, 2012
Steven Ostrow and Devon Morrissey

In the Pitt Penn Holdings bankruptcy (Pitt Penn), the US Bankruptcy Court for the District of Delaware recently dismissed fraudulent conveyance claims under Section 548 of the Bankruptcy Code against former executives of the debtor because the transfers in question occurred more than two years before the bankruptcy filing. [1] The Court declined to apply the doctrine of equitable tolling to allow the claims to survive, despite the fact that it was undisputed that certain former officers engaged in massive fraud before the bankruptcy. The Court held that the equitable tolling doctrine does not apply because the two year look-back period is a substantive statutory element under Section 548, not a statute of limitations. This issue presented a case of first impression in the Third Circuit which primarily includes federal courts in Delaware, Pennsylvania and New Jersey. The Court’s bright line rule reconciled its prior inconsistent rulings on the subject. It also provides creditors and former officers and directors of a debtor a strong defense to avoidance actions under Section 548 of the Bankruptcy Code (but not under state fraudulent transfer laws) that seek to claw-back estate property that was transferred many years before a bankruptcy.

CASE SUMMARY

In April, 2011, almost two years after filing a Chapter 11 petition, Industrial Enterprises of America (Debtor), a Pitt Penn affiliate, filed an action against its former executives, alleging fraudulent transfers of company stock under Section 548 of the Bankruptcy Code and state fraudulent transfer laws. Debtor sought to recover property transferred to various defendants over two years before the bankruptcy. However, under Section 548, a bankruptcy trustee (or debtor-in-possession) may only avoid or set aside a transfer if it was made within the two-year period prior to the filing date of the bankruptcy petition. Consequently, defendants moved to dismiss the claims under Section 548 (not the state law claims) because the transfers occurred outside this two-year window. Debtor responded that the time period should be equitably tolled so that it could bring the Section 548 claim because defendants’ acts concealed the fraud. This  prevented Debtor from discovering the transfers earlier.

The doctrine of equitable tolling is a remedy available to a plaintiff who, despite an exercise of due diligence and because of sufficiently inequitable circumstances, was unaware of a cause of action within the applicable statute of limitations. A court applying this equitable remedy will permit the plaintiff to bring the cause of action, even though the statute of limitations has expired, to avoid dismissal of the claim because of a technicality.  

The Court agreed that a statute of limitation can be equitably tolled to avoid a technical forfeiture of a claim.  However, the Debtor’s argument failed because it assumed that the two-year period under Section 548 acts as a statute of limitations. The Court held that the two year look-back provision is a substantive element of a Section 548 claim and serves as a limit on a bankruptcy trustee’s broad powers, restricting how far a trustee can look back from the petition date. Conversely, Section 546 is a procedural provision, dictating the specific timeframe in which an action may be brought, which is a true statute of limitation that can be equitably tolled.  (Section 546 generally requires a Section 548 claim to be filed within two years after the bankruptcy filing.) Therefore, the Court adopted a bright line rule that the two year look-back period in Section 548 cannot be equitably tolled.

IMPLICATIONS

The Delaware Bankruptcy Court’s decision in Pitt Penn is supported by two prior rulings in the bankruptcy courts of Hawaii and North Carolina. There is one contrary decision by a Connecticut bankruptcy court permitting Section 548 claims to be equitably tolled. The Delaware Court’s holding generally favors defendants in fraudulent transfer actions and potentially reduces avoidance recoveries for all creditors in bankruptcy. However, its overall impact is somewhat limited because the look-back period under many state fraudulent transfer laws (which can also be asserted by debtors and trustees in bankruptcy) is longer than the two-year timeframe under Section 548 of the Bankruptcy Code. 

We regularly represent defendants facing fraudulent transfer and/or preference suits. If you have any questions regarding the Pitt Penn decision or avoidance litigation, please Steve Ostrow (ostrows@whiteandwilliams.com; 212.714.3068), Devon Morrissey (morrisseyd@whiteandwilliams.com; 215.864.6313), or another member of our Financial Restructuring and Bankruptcy Group.


[1] Industrial Enterprises of America, Inc. v. Burtis (In re Pitt Penn Holding Co., Inc.), 2012 WL 204095 (Bankr. D. Del. 2012).

This correspondence should not be construed as legal advice or legal opinion on any specific facts or circumstances. The contents are intended for general informational purposes only, and you are urged to consult a lawyer concerning your own situation and legal questions.
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