The Practical Consequences of Metaphysics: Who Owns a Fraudulent Transfer Claim in Bankruptcy?

Abstract

This article seeks to answer the deceptively complex question: in bankruptcy, who "owns" a fraudulent transfer cause of action? Termed the "metaphysical issue" by the Second Circuit, courts and practitioners have reached a variety of conclusions to this question, mostly rooted in statute taken out of context and oblivious to both the history and purpose underlying such text and the immense practical consequences of getting it wrong. Though the text of the Bankruptcy Code makes it clear that the trustee can bring certain fraudulent transfer claims, the Code does not address what happens to the state law causes of action which, prior to bankruptcy, belong to the creditors and which, after bankruptcy, shape the claims brought by the trustee pursuant to 11 U.S.C. § 544(b). This leaves the question of whether the bankruptcy trustee, upon the filing of a bankruptcy petition, fully owns the fraudulent transfer claims or whether the creditors retain some rights to these claims---rights which, if not fully disposed of by the trustee due to practical or statutory limitations, may rear their head once more. The article evaluates four possible outcomes of ownership: the trustee owning nothing, the trustee holding a duplicate claim, partial ownership vesting in the trustee with a remainder interest for creditors, and full preemption of state law claims by the federal Bankruptcy Code (with full ownership by the trustee). By delving into the history of both bankruptcy and fraudulent transfer law, the purpose of bankruptcy law, and the various ways in which the Bankruptcy Code modifies fraudulent transfer claims, the article provides fresh arguments that anything less than the trustee's full and preempting ownership of federal fraudulent transfer claims would undermine Congressional intent. In addition to legal analysis, the article highlights the practical implications of determining claim ownership, emphasizing the trustee's need for clarity to maximize the value of the bankruptcy estate and the role a coherent understanding of fraudulent transfer claims plays in courts' determination of what constitutes property of the estate. The conclusion offers insights for practitioners, including strategies to mitigate risks associated with creditors using tort claims to bypass the bankruptcy process.

Keywords: fraudulent transfer, fraudulent conveyance, bankruptcy, preemption, 544(b), derivative, voidable