Restructuring

Contributed by Laura Napoli
Recently, Barton v. Barbour, a Supreme Court decision from 1881, has received renewed attention.  Last month, we blogged about In re VistaCare Group, LLC, No. 11-2695, 2012 WL 1563924 (3d Cir. May 4, 2012), in which the Third Circuit held that Barton was still relevant despite changes in bankruptcy laws.  A few weeks ago, the United States Bankruptcy Court for the Eastern District of Virginia announced another decision involving Barton.  Instead of focusing on whether Barton applied, as the Third Circuit did in VistaCare, the court in In re Cutright, No. 08-70160-SCS, 2012 WL 1945703 (Bankr. E.D. Va. May 30, 2012) looked into how Barton applied to determine whether a chapter 7 trustee could be sued in state court.
A Simple Sale?
Back in 2008, Tracy Cutright, the debtor, filed for bankruptcy, and Tom Smith was appointed as chapter 7 trustee.  On his schedule of assets, Cutright listed a property in Virginia Beach, Virginia, in which he claimed an undivided interest.  The chapter 7 trustee decided to liquidate the property for the benefit of the estate.
To that end, the chapter 7 trustee entered into a purchase agreement with Dell Eisenbarth, as purchaser of the property.  When the chapter 7 trustee executed the purchase agreement, he believed, per the debtor Cutright’s schedule of assets, that Cutright was the only one with any interest in the property.  After the bankruptcy court approved the sale of the property, however, the chapter 7 trustee performed a title search and learned that another Cutright, Jacqueline Cutright, might also have an interest in the property.  Upon learning of Ms. Cutright’s potential interest, the chapter 7 trustee reached out to her to obtain her consent to the sale.
After some difficulty, the chapter 7 trustee located Ms. Cutright and sent her the documents necessary to complete the sale; however, Ms. Cutright responded by saying that she believed that she no longer owned the property and could not sign the documents.  After failing to obtain Ms. Cutright’s consent, the chapter 7 trustee determined that he did not have enough time to file a motion in court to compel the sale of Ms. Cutright’s interest in light of a looming foreclosure sale of the property.  Earlier in the case, CitiMortgage, a secured lender, had obtained relief from the automatic stay to foreclose upon its deed of trust on the property if the chapter 7 trustee failed to complete a sale of the property by a certain time, and that time had expired.  For his part, the purchaser simply decided to try to purchase the property at the foreclosure sale, and he was successful in doing so.
Thinking that all was now well, the chapter 7 trustee closed the bankruptcy case, and the purchaser began work on the property. Unfortunately, the purchaser later discovered that the foreclosure was not on the first deed of trust and that his purchase of the property was not valid.  The foreclosing lender returned the purchaser’s deposit, and the purchaser sought to reopen the bankruptcy case and obtain the bankruptcy court’s leave to sue the chapter 7 trustee in state court for breach of contract.  In support of his complaint, the purchaser argued that because the chapter 7 trustee tried to sell Jacqueline Cutright’s interest in the property, which was not property of the bankruptcy estate, the chapter 7 trustee should be liable in his personal capacity because he acted outside of the scope of his authority.
The Purchaser’s Motion to Reopen
The bankruptcy court first considered the purchaser’s motion to reopen the bankruptcy case.  Noting that the decision to reopen a bankruptcy case is usually within the bankruptcy court’s discretion, the court looked to whether the purchaser had demonstrated sufficient cause for the court to reopen the case.  The court concluded that reopening the bankruptcy case would serve no purpose because, as the court subsequently explained, the purchaser’s request for leave to sue the chapter 7 trustee in state court must be denied.
Suing the Chapter 7 Trustee in State Court
The court next turned to the purchaser’s request for permission to sue the chapter 7 trustee in state court.  The purchaser asked for this permission pursuant to the Barton doctrine, which requires plaintiffs to obtain the bankruptcy court’s permission before suing a bankruptcy trustee in another forum for acts done in the trustee’s official capacity.
As a threshold issue, the court needed to determine whether Barton applied to the case.  Under the Barton doctrine, leave is not required if the actions complained of were not taken in the trustee’s official capacity.  The purchaser had alleged that chapter 7 trustee exceeded the scope of his official capacity by entering into the purchase agreement to sell property that was not part of the estate.  In contrast, the chapter 7 trustee argued that the purchase agreement related to his duty to liquidate the estate’s assets.  The court concluded that, even if the chapter 7 trustee’s conduct could be characterized as improper, it had occurred within the context of his duty as trustee to liquidate estate assets.  The court found that the chapter 7 trustee never consummated the sale of the property; instead, he attempted to obtain Ms. Cutright’s consent and, upon failing to do so, did not sell any interest in the property at all.  Because the chapter 7 trustee had acted within the scope of his authority, the court concluded that its leave was necessary to sue the chapter 7 trustee in state court.
After resolving the question of whether leave was required, the court next considered whether it should grant the purchaser leave to sue the chapter 7 trustee.  To address this question, the court used a two-tiered analysis first articulated by the Ninth Circuit Bankruptcy Appellate Panel in Kashani v. Fulton.  Under Kashani’s two-prong test, the plaintiff must first establish a prima facie case against the trustee and then, only if the first requirement is met, the court must balance the parties’ interests to determine whether leave to sue should be granted.
At the court’s request, the purchaser had submitted a proposed complaint against the chapter 7 trustee.  After reviewing the proposed complaint, the court determined that the purchaser had successfully stated a breach of contract claim under Virginia state law against the chapter 7 trustee and that, therefore, the first prong of the Kashani test was satisfied.
Turning to the second Kashani prong, the court observed that the Ninth Circuit had established several factors to aid its analysis.  For example, the Kashani court asked whether the claims pertain to actions of the trustee while administering the estate.  Here, the purchaser’s breach of contract claim concerned representations in the purchase agreement that the chapter 7 trustee had the power to transfer full title to the property when, in fact, the estate held only a half-interest in the property.  Although the terms of the purchase agreement encompassed Ms. Cutright’s alleged interest, because the agreement also pertained to property in which the estate did have an interest, the court determined that the purchaser’s claims related to the chapter 7 trustee’s administration of the bankruptcy estate.  This weighed in favor of denying the purchaser’s leave to sue.
Kashani also asked whether the claims relate to conduct within the scope of the trustee’s authority, triggering quasi-judicial or derived immunity.  The concept of quasi-judicial or derived judicial immunity affords immunity from suit to a trustee who acts within the scope of his authority.  This immunity only applies to suits by third parties and does not apply to suits by beneficiaries of the bankruptcy estate.  Because the purchaser’s connection to the estate arose only when he attempted to purchase estate property, the court determined that the purchaser was a third party, non-beneficiary of the estate.  The court next found that the chapter 7 trustee did not exceed the scope of his authority because his execution of the purchase agreement did not amount to seizure or possession of Ms. Cutright’s property.  In contrast, the chapter 7 trustee expressly did not interfere with Ms. Cutright’s alleged rights as a joint tenant because he attempted to obtain her consent upon learning of her tenancy and ultimately never consummated the sale of the property.  For these reasons, the court concluded that execution of the purchase agreement was within the scope of the chapter 7 trustee’s authority under section 704(a)(1) of the Bankruptcy Code to sell property in which the estate had an interest.  Because the chapter 7 trustee acted within the scope of his authority, the court concluded that he would likely be immune from liability in the purchaser’s proposed litigation.
The Kashani court also asked whether the proposed plaintiff was seeking to “surcharge” the trustee by seeking judgment against the trustee personally.  In this case, the court found that the purchaser was seeking to recover damages from the chapter 7 trustee in the trustee’s personal capacity.  Thus, this factor weighed in favor of denying the purchaser’s suit.
Finally, the court turned to the last factor highlighted by the Kashani court: whether the claims involve the trustee’s breach of fiduciary duty through negligent or willful misconduct.  Although a claim based in tort or contract often weighs in favor of resolution by a state court, if the claim is “so intertwined” with the trustee’s duties under the Bankruptcy Code, the state court may nevertheless be an inappropriate forum.  Because the purchaser was not a beneficiary of the estate, the court found that the chapter 7 trustee had no fiduciary duties to the purchaser; however, because the purchaser’s claim arose out of the purchase agreement, into which the chapter 7 trustee entered pursuant to his Bankruptcy Code duties, the court found that the purchaser’s claim was “so intertwined” with the chapter 7 trustee’s execution of his statutory duties that a state court would be an improper forum for the purchaser’s claim.
After examining the proposed lawsuit using the factors articulated in Kashani, the court concluded that leave to sue the chapter 7 trustee in state court must be denied.