Are Avoidance Recoveries Capped in the Amount of Unpaid Claims?

June 2020

Publication| Bankruptcy & Corporate Restructuring

Consider this scenario: A debtor confirms its plan and transfers avoidance actions to a litigation trust. The trust then sues the debtor’s former owner, who sold the company through a leveraged transaction prior to bankruptcy, on the basis that the sale was a fraudulent transfer. Let’s assume that the litigation trust sues to recover the full payment to the former owner (e.g., $100 million), but the amount of unpaid creditors’ claims in the bankruptcy case totals only $20 million. If the litigation trust prevails on its fraudulent-transfer claim, can it recover $100 million or $20 million?

Outside of bankruptcy, the answer is clear: Under state law, only a creditor may bring a fraudulent-transfer action, and the creditor may not recover in excess of its unpaid claim. This rule is expressly written into the Uniform Fraudulent Transfer Act (UFTA) and the Uniform Voidable Transactions Act, both of which provide that a creditor “may recover judgment for the value of the asset transferred … or the amount necessary to satisfy the creditor’s claim, whichever is less.”

Surprisingly, inside bankruptcy, courts have been split on this issue. Unlike the UFTA, the Bankruptcy Code provision governing fraudulent transfer recoveries — 11 U.S.C. § 550 (a) — contains no explicit cap. Courts interpreting § 550 (a) have reached divergent conclusions, with some reading it to impose no limit on a fraudulent-transfer recovery and others reading it consistently with state law. This article explores both sides of the issue, beginning with a recent bankruptcy court decision in DSI Renal Holdings.

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