Contributed by Laura Napoli
Does the Barton doctrine, a common law bankruptcy rule requiring a party who wants to sue a court-appointed receiver to obtain leave to sue from the appointing court, still apply, even though bankruptcy law has changed substantially since the doctrine’s creation in 1881? The Third Circuit had to answer this question in In re VistaCare Group, LLC, when a purchaser of real property from a chapter 7 estate sought to sue the trustee who sold the land to it.
William Schwab was the chapter 7 trustee of VistaCare Group, LLC, a health care company. Vista Care’s assets included Parkside, a subdivision consisting of 45 lots of land in Lancaster County, Pennsylvania. Forty-four of these lots contained mobile homes, and a retirement home was on the remaining lot (“Lot 45”). The subdivision plan contained a restriction that title to the land must remain with the developer at all times and could not be transferred to the lots’ residents.
The chapter 7 trustee first filed a motion in bankruptcy court seeking to sell Parkside as two separate parcels, with one parcel consisting of Lot 45 and the other consisting of the remaining 44 lots. The bankruptcy court granted the trustee’s motion after the trustee assured it that he would also get the township’s permission for this sale. The trustee then sold Lot 45 to CGL, LLC after receiving the necessary permission from the township.
The trustee next turned to the sale of the remaining 44 lots and unhappily discovered that many of the residents on these lots had permanently affixed their mobile homes to the land. To sell these lots, the trustee worked with the township to remove the restriction that title had to remain with the developer, and the township agreed that the trustee could sell the lots piecemeal to the individual residents. The trustee then proceeded to sell most of the lots to the mobile home residents; however, CGL was not aware of the trustee’s agreement with the township and did not know that the trustee was selling the lots to individuals.
When CGL learned what the trustee had done, it filed a motion in bankruptcy court asking for leave to sue the trustee in the court of common pleas. In response, the trustee asserted that under Barton v. Barbour, CGL could not proceed in state court without the bankruptcy court’s explicit permission. The trustee urged the bankruptcy court to deny permission to CGL.
Observing that the Bankruptcy Code had substantially changed the bankruptcy laws since Barton, the bankruptcy court expressed doubt as to whether CGL needed its permission to sue the trustee in state court, stating that Barton was “antiquated and probably not controlling in the Third Circuit.” Nevertheless, the court ultimately granted CGL’s motion, and the district court affirmed the bankruptcy court without discussing Barton at all. The trustee then appealed to the Third Circuit.
Breathing Life into Barton
The Third Circuit held that Barton was still relevant despite subsequent changes in bankruptcy law. It began by focusing on section 959(a) of the Judicial Code, which excuses a party from the need to seek permission to sue a trustee from the appointing court when a trustee is operating the debtor’s business. The Third Circuit concluded that Congress had created section 959(a) as a statutory exception to Barton for cases where the trustee was continuing the debtor’s business as opposed to just administering the estate and determined that, therefore, Congress had implicitly recognized Barton’s applicability.
The Third Circuit next turned to specific concerns the bankruptcy court had raised with the Barton doctrine. Under the Bankruptcy Code, trustees are appointed by the United States Trustee and not by a bankruptcy court, as was the case with equity receivers. Thus, the bankruptcy court reasoned, it was possible that Barton was no longer valid because Barton requires leave of the appointing court. The Third Circuit disagreed, finding that changing the way trustees were appointed did not alter the trustee’s fundamental role as a fiduciary, officer of the bankruptcy court, and statutory successor to an equity receiver. Thus, the Third Circuit found no merit to the contention that Barton was no longer valid because bankruptcy courts no longer appoint trustees.
The bankruptcy court also questioned Barton’s continued applicability in light of section 362 of the Bankruptcy Code, the automatic stay. The bankruptcy court found that the automatic stay addressed the same policy concerns underlying Barton and replaced the protection Barton was meant to give by making it more difficult for a third party to drain estate assets. The Third Circuit, however, found several other policy rationales for Barton that were distinct from the concern addressed by the automatic stay, including that, by protecting trustees from frivolous lawsuits, Barton encouraged qualified individuals to serve as trustees and that, by requiring prospective plaintiffs to justify their claims to the bankruptcy court, Barton allowed bankruptcy courts to monitor the trustee’s work more effectively. Furthermore, the Third Circuit observed that the power of a court to stay collection efforts against the debtor’s estate has always been a fundamental part of bankruptcy law, even prior to the enactment of section 362. Because Barton applied under the pre-Bankruptcy Code system, where similar automatic stay provisions also applied, the court found that section 362 did not serve to eliminate the Barton doctrine.
The Third Circuit then addressed the bankruptcy court’s final question on Barton: Given that section 323(b) of the Bankruptcy Code provides that a trustee can “sue and be sued” but does not mention a leave-of-court requirement, how can such a requirement exist? The Third Circuit acknowledged that section 323(b) recognizes a trustee’s capacity to be sued; however, it determined that Congress had left the procedures that must be followed in order to sue a trustee up to case law. The Third Circuit thus rejected the argument that section 323(b) indicated Congress’s intent to abrogate the Barton doctrine.
Abuse of Discretion?
After concluding that the Barton doctrine remains valid despite changes in bankruptcy law, the Third Circuit turned to the question of whether the bankruptcy court had abused its discretion by granting CGL’s motion for leave to sue the chapter 7 trustee. When a party seeks leave of court to sue a trustee, the party must make a prima facie case against the trustee and must show that its claim is “not without foundation.” The Third Circuit determined that the bankruptcy court had not abused its discretion in concluding that CGL had met its burden of establishing a prima facie case. In its complaint and in subsequent testimony, CGL alleged that when it purchased Lot 45, it assumed that the restriction prohibiting sales to individual residents was still in place with respect to the other 44 lots. Indeed, CGL stated that single ownership of the remaining lots was critical to its decision to purchase Lot 45. The Third Circuit found that the bankruptcy court had appropriately determined that the issues in CGL’s case involved questions of state subdivision law and that a state court was therefore the appropriate forum in which to resolve CGL’s suit. The court concluded that the bankruptcy court’s decision to allow CGL to sue Schwab was not an abuse of discretion.
By acknowledging Barton’s continued relevance despite changes in bankruptcy law, the Third Circuit joined other circuits in affirming this age-old protection for trustees and the bankruptcy estate. The court’s thorough and well-reasoned analysis of Barton and the Bankruptcy Code breathes new life into this old rule.