I

Extending the Statute of Limitations for

Preference Actions? The Seventh Circuit Rules!

Bruce NathaN, esq. aNd tereNce WatsoN, esq.

S e l e c t e d t o p i c

It is generally known that lawsuits for the recovery of preference and other avoidance claims must be com-menced within two years of the entry of the order for relief.1 What is less known, and might cause heartburn to more than a few recipients of alleged preferential transfers, is that this two-year limitation period may be extended for up to one additional year, for as much as a total of one day less than three years, provided that a trustee is appointed or elected within the initial two-year limitation period. The courts have grappled with whether this additional one-year extension of statute of limitations for preference and other avoidance actions can be triggered by the appointment of an interim trust-ee under Section 701 of the Bankruptcy Code, or wheth-er the election or appointment of a permanent trustee under Section 702 is required to trigger the extension.

The United States Court of Appeals for the Seventh Circuit recently advanced this issue by holding, in Fogel v. Shabat, et al. (In re Nachson Draiman), that the appointment of an interim trustee within two years of the order for relief does not trigger the additional one-year extension of the statute of limitations, even when the interim trustee later assumes the role of the perma-nent trustee. This is consistent with most decisions addressing this issue, including an earlier holding of the United States Court of Appeals for Third Circuit in In re American Pad & Paper Co., which similarly held that the appointment of an interim trustee does not trigger the extension of the statute of limitations for the commencement of preference and other avoidance actions where the permanent trustee was elected at the

Section 341 meeting of creditors more than two years after the order for relief.2 Therefore, a permanent trust-ee, rather than an interim trustee, must be elected or appointed within two years of the order for relief in order to trigger the additional one-year extension of the statute of limitations to commence preference and other avoidance lawsuits.

the relevant statutory Provisions Section 701 of the Bankruptcy Code, entitled “Interim trustee,” provides in relevant part for the prompt “appoint[ment]” of an interim trustee following the order for relief in a Chapter 7 case. The interim trustee’s appointment is terminated upon the election or desig-nation of a permanent trustee.

Section 702 of the Bankruptcy Code, entitled “Election of trustee,” provides in relevant part that (i) a trustee may be “elected” during a meeting of creditors held under Section 341, and that (ii) if a trustee is not elected under Section 702, then “the interim trustee shall serve as the trustee in the case.”

Finally, Section 546(a) of the Bankruptcy Code estab-lishes a two-year limit for the commencement of certain specified actions, including preference and other avoid-ance actions. Congress amended Section 546(a) in 1994 to extend the statute of limitations to commence such actions for an additional year running from the date of the appointment or election of certain trustees, if such appointment or election occurs within two years of the order for relief. Specifically, Section 546 provides, in pertinent part, as follows:

The PublicaTion For crediT & Finance ProFessionals $7.00

n a T i o n a l a s s o c i a T i o n o F c r e d i T M a n a g e M e n T

July

/Au

gu

st 2

013

1 B u s i n e s s C r e d i t j u ly / a u g u s t 2 0 1 3

a meeting of creditors was held on june 30, 2011, but a permanent trustee was not elected. as a result, the trustee became the permanent trustee by operation of law pursuant section 702(d), and commenced preference actions against certain defendants on May 11, 2012.

(a) An action or proceeding under Section 544, 545, 547, 548, or 553 of this title may not be commenced after the ear-lier of—

(1) The later of—

(A) 2 years after the entry of the order for relief; or

(B) 1 year after the appointment or election of the first trustee under Section 702, 1104, 1163, 1202, or 1302 of this title if such appointment or such election occurs before the expiration of the period specified in subparagraph (A); or

(2) The time the case is closed or dismissed.

11 U.S.C. § 546.

the Factual Background of In re Draiman On May 14, 2009 (the petition date) Nachshon Draiman (the debtor) commenced a Chapter 11 proceeding in the United States Bankruptcy Court for the Northern District of Illinois. The debtor’s bankruptcy case was converted to Chapter 7 on May 13, 2011. That same day, Richard Fogel (the Trustee) was appointed as interim trustee under Section 701(a)(1).

A meeting of creditors was held on June 30, 2011, but a per-manent trustee was not elected. As a result, the Trustee became the permanent trustee by operation of law pursuant Section 702(d), and commenced preference actions against certain defendants on May 11, 2012. The Trustee commenced the law-suits more than two years after the entry of the order for relief on May 14, 2009. However, the lawsuits were commenced within one year of the Trustee’s appointment as interim trustee on May 13, 2011, and that appointment was within two years after the entry of the order for relief on May 14, 2009.

The defendants moved to dismiss the actions on various grounds, and requested an initial ruling on the issue of wheth-er the lawsuits were barred by the statute of limitations. Spe-cifically, the defendants argued that the lawsuits were required to be commenced within two years of the order for relief (i.e., within two years of the petition date), or by May 14, 2011, and that the Trustee’s commencement of the actions on May 11, 2012 was barred by the two-year statute of limitations. The defendants further argued that the Trustee was not entitled to the additional one-year extension of the statute of limitations because (i) no permanent trustee was appointed or elected within two years of the order for relief, or by May 14, 2011, and (ii) the Trustee’s appointment as interim trustee on May 13, 2011 did not trigger the additional one-year extension of the statute of limitations.

the Bankruptcy court’s decision The Bankruptcy Court denied the motions to dismiss, con-cluding that the Trustee was entitled to the additional one-year extension because the Trustee (i) was appointed as inter-im trustee under Section 701 within two years of the order for relief, and (ii) later became the permanent trustee. Although

the Trustee’s assumption of the role of permanent trustee occurred on June 30, 2011, more than two years from the order for relief, the Bankruptcy Court considered the Trust-ee’s earlier appointment as interim trustee on May 13, 2011 as the event that triggered the additional one-year extension of the statute of limitations, thereby rendering the actions timely commenced.

The Bankruptcy Court acknowledged that its holding con-flicted with the Third Circuit’s decision in In re American Pad & Paper Co., affirming the dismissal of preference actions commenced more than two years after the entry of the order for relief as time-barred by the statute of limitations. Specifi-cally, the Third Circuit held that the trustee was not entitled to the additional one-year extension of the statute of limitations from the date of the appointment of the interim trustee because “the plain language of the statute of limitations does not include Section 701 interim trustees, and makes reference only to ‘1 year after the appointment or election of the first trustee under Section 702, 1104, 1163, 1202, or 1302…[there-fore], [r]eading the appointment of an interim trustee under Section 701 as an event that triggers the additional one-year period has no basis in the language of the statute.”

The Third Circuit was not troubled by the fact that the statute of limitations had expired before the trustee was even elected since “other parties in interest could arguably have brought avoidance actions before the running of the two-year period from the entry of the order of relief.” As a result, the Third Circuit noted that “Section 546(a)(1)(B) of the Bankruptcy Code is amenable to a ‘plain language’ analysis, and we decline to read Section 701 into the specific statutory provisions delineated therein.”

Nevertheless, the Bankruptcy Court, in In re Draiman, justi-fied its conclusion that the Trustee was entitled to the addi-tional one-year extension of the statute of limitations from the date of his appointment as interim trustee on multiple grounds. First, precluding the appointment of an interim trustee from triggering an extension of the statute of limita-tions would cause debtors to “hang[ ] on” or otherwise endeav-or to avoid the appointment of a permanent trustee for two years, so as to preclude the timely review and commencement of preference and other avoidance actions. Second, Section 546(a) was not amenable to a plain meaning analysis because of the presence of the term “appointment,” which is not refer-enced anywhere in Section 702 dealing with permanent trust-ees, but is referenced in Section 701 dealing with interim trustees. The inclusion of the term “appointment” in Section 546(a) therefore evidenced the intent to permit the appoint-ment of an interim trustee under Section 701 to trigger the additional one-year extension of the statute of limitations.

This led the Bankruptcy Court to hold that “if the interim trustee continues to serve pursuant to Section 702(d) follow-ing the Section 341 meeting of creditors,” then the interim trustee is entitled to the one-year extension “from the date of its appointment [as interim trustee] under Section 701.” In

2B u s i n e s s C r e d i t j u ly / a u g u s t 2 0 1 3

other words, under the ruling by the Bankruptcy Court, the one-year extension of the statute of limitations is triggered when the trustee is an interim trustee whose appointment as interim trustee occurred within two years of the order for relief, and who later becomes the permanent trustee by default under Section 702(d) because the creditors never elected a permanent trustee at the Section 341 meeting of creditors.

the seventh circuit’s decision The Seventh Circuit reversed the Bankruptcy Court’s decision after granting leave to appeal directly from the Bankruptcy Court. In this regard, the Seventh Circuit stated that, in order to trigger the additional one-year extension of the statute of limitations, (i) a permanent trustee must be elected or appointed within the two-year statutory period, and the Trustee was elected after that period had run, and the Trustee “had had a different status before then,” and (ii) Section 546(a)(1) does not reference Section 701, which governs the appoint-ment of interim trustees. Thus, the Trustee’s appointment as interim trustee, although within the two-year statutory peri-od, did not trigger the additional one-year extension of the statute of limitations.

The Trustee agreed that Section 546(a)(1) is unambiguous, but argued that it should be interpreted to mean that the addi-tional one-year extension of the statute of limitations ran from the date he was appointed interim trustee. Specifically, the Trustee argued that, because Section 702 does not provide for the “appointment” but only for the “election,” of a perma-nent trustee, when Section 546(a)(1)(B) provides that the limitations period runs from the “appointment or election of the first trustee under Section 702,” the statute necessarily refers to the appointment of an interim trustee under Section 701. The Seventh Circuit was not persuaded, and noted that the Trustee’s interpretation “reads the reference to Section 702 right out of Section 546(a)(1)(B).”

The Seventh Circuit was also concerned that the Trustee’s interpretation could encourage creditors to “game the system” by delaying the meeting of creditors to elect a permanent trustee in order to obtain the maximum limitation period.

The Seventh Circuit noted that Section 546(a) was intended to prevent such abuse by discouraging creditors from “dawdling” after conversion to Chapter 7 because any meeting to appoint a trustee after the initial two-year period would be tardy.

Likewise, the Seventh Circuit noted that the Bankruptcy Court’s concern that a debtor could delay conversion from Chapter 11 to Chapter 7 for two years plus one day to prevent a trustee from bringing preference and other avoidance actions was unfounded since a creditor in a Chapter 11 case can move for the appointment of a trustee under Section 1104, while the case is still in Chapter 11, “and if the ground of the motion is…that the appointment is necessary to pre-vent creditors’ claims from being time-barred, the bankruptcy judge would be remiss if he failed to grant the motion.”3 The Seventh Circuit further noted that the Section 546(a) statute of limitations can be tolled on equitable grounds that would permit an extension of the statute of limitations, provided that the creditors were unable to timely elect a permanent trustee through no fault of their own.

Finally, the Seventh Circuit criticized the logic of the Bank-ruptcy Court’s ruling that the Trustee was entitled to the addi-tional one-year extension of the statute of limitations because (i) he was appointed interim trustee within two years of the order for relief, and (ii) he became permanent trustee by default under Section 702(d), which was more than two years after the order for relief. Under its ruling, however, the Bank-ruptcy Court would not have granted the Trustee the addi-tional one-year extension had he been elected as permanent trustee on the day he assumed that role by default.

The Seventh Circuit also referenced and dismissed the Ninth Circuit’s decision in Avalanche Maritime, Ltd. v. Seaplace Ship-ping Ltd. (In re Parmetex, Inc.). In In re Parmetex, the Ninth Circuit concluded that the statute of limitations began run-ning upon the appointment of an interim trustee pursuant to Section 701, rather than the later election of a permanent trustee under Section 702.4 The Ninth Circuit reached this conclusion despite the fact that the predecessor of Section 546(a), like the current version, did not reference Section 701, which governs the appointment of interim trustees.5 Conse-quently, the Ninth Circuit affirmed the dismissal of the adver-sary proceeding as time-barred by the statute of limitations, and rejected the plaintiffs’ argument that the statute of limita-tions “begins to run on the date of qualification of the perma-nent trustee under 11 U.S.C. § 702, not from the [earlier] date of appointment of the interim trustee under 11 U.S.C. § 701.”

The Seventh Circuit in In re Draiman dispensed with the Ninth Circuit’s ruling in In re Parmetex by noting that “[a]ll the dis-trict court and bankruptcy decisions that we’ve found, whether inside or outside the Third Circuit, have followed American Pad & Paper rather than Parmetex.” Accordingly, the Seventh Circuit reversed the Bankruptcy Court’s denial of defendants’ motions to dismiss the pending preference actions and con-cluded that the actions were barred by the statute of limitations. The Court relied on the fact that the Trustee’s appointment as

3 B u s i n e s s C r e d i t j u ly / a u g u s t 2 0 1 3

although the trustee’s assumption of the role of permanent trustee occurred on june 30, 2011, more than two years from the order for relief, the Bankruptcy Court considered the trustee’s earlier appointment as interim trustee on May 13, 2011 as the event that triggered the additional one-year extension of the statute of limitations, thereby rendering the actions timely commenced.

interim trustee did not trigger the one-year extension of the limitations period, and as a result, the action was barred by the two-year statute of limitations contained in Section 546(a). In doing so, the Seventh Circuit noted that the “only argument that the [T]rustee develops is semantic—and unconvincing.”

conclusionThe Seventh Circuit’s ruling in In re Draiman continues the trend of court holdings that a permanent trustee seeking to extend the statute of limitations for the commencement of preference and other avoidance actions by an additional year must be appointed or elected within two years of the order for relief. Does this mean that trade creditors can breathe a sigh of relief? The answer is, not necessarily.

The Seventh Circuit’s ruling might end up being a mixed bag for trade creditors. Trade creditors could benefit from the hold-ing that preference and other avoidance actions cannot be com-menced beyond the two-year period after the entry of the order for relief when a permanent trustee is not appointed or elected within the two-year period. However, the tradeoff is that the Seventh Circuit’s holding might compel an interim trustee to “jump the gun” and commence preference or other avoidance actions prior to the expiration of the two-year period after the order for relief. A trustee might also rely on the doctrine of equitable tolling of the statute of limitations to justify the com-mencement of a preference or other avoidance action beyond the two-year period after the entry of the order for relief. This may lead to time-consuming and costly fact-specific litigation unrelated to the merits of the underlying claim.

Thus, in the end, all that glitters is not necessarily gold!

1. In voluntary bankruptcy cases, the order for relief is generally the date of the filing of a bankruptcy petition.

2. Defendants have attempted to limit the scope of the Third Circuit’s holding in In re American Pad & Paper to situations where the interim trustee does not later become the permanent trustee. In that situation, the Third Circuit, in In re American Pad & Paper, held that the interim trustee’s appointment did not trigger the additional one-year extension of the statute of limitations. In In re Draiman, however, the interim trustee later became the permanent trustee. Nevertheless, the Seventh Circuit similarly held that the interim trustee’s appointment did not trigger the one-year extension.

3. The appointment of a Chapter 11 trustee within two years of the entry of the order for relief also triggers the additional one-year exten-sion of the statute of limitations to commence preference and other avoidance actions.

4. In other words, the Third Circuit in In re American Pad & Paper Co. and the Seventh Circuit in In re Draiman both held that the appoint-ment of an interim trustee was not a triggering event under Section 546(a) (e.g., for the additional one-year extension of the statute of limitations to commence preference and other avoidance actions). The Ninth Circuit, in In re Parmetex, however, held that the appointment of an interim trustee was a triggering event under the predecessor version of Section 546(a) dealing with the commencement of the running of the statute of limitations to file preference and other avoidance actions.

5. In re Parmetex dealt with an earlier version of Section 546, which required preference and other avoidance actions to be commenced within two years of the appointment of a trustee, but did not provide a one-year extension of the two-year statute of limitations upon the appointment or election of a trustee.

Bruce S. Nathan, Esq. is a partner in the Bankruptcy, Financial Reorganization and Creditors’ Rights Group in the New York office of the law firm of Lowenstein Sandler LLP. He is a member of NACM and is a former member of the Board of Directors of the American Bankruptcy Institute and is a former co-chair of ABI’s Unsecured Trade Creditors Committee. Bruce is also the co-chair of the Avoiding Powers Advisory Committee working with ABI’s commission to study the reform of Chapter 11. He can be reached via email at bnathan@lowenstein.com.

Terence D. Watson, Esq. is counsel in the Bankruptcy, Financial Reorganization and Creditors’ Rights Group in the New York office of the law firm of Lowenstein Sandler LLP. He can be reached at tdwatson@lowenstein.com.

*This is reprinted from Business Credit magazine, a publication of the National Association of Credit Management. This article may not be forwarded electronically or reproduced in any way without written permission from the Editor of Business Credit magazine.

4B u s i n e s s C r e d i t j u ly / a u g u s t 2 0 1 3