On May 2, 2013, the US Bankruptcy Court for the Western District of Michigan held in In re Jalal Parirokh that avoidance actions are not property of the estate, and therefore could not be sold by the trustee in a section 363(b) sale.

A Chapter 7 case trustee filed a motion seeking authority to sell potential avoidance actions under section 363(b) of the Bankruptcy Code. Avoidance actions are causes of action under Chapter 5 of the Bankruptcy Code that seek to reverse certain transfers of property and recover such property for the benefit of the estate to pay creditors (examples of avoidance actions include preferences and fraudulent transfers).

The trustee sought to sell the estate's right to avoid unspecified transfers that the Debtor may have made to his spouse. However, due to the estate's limited resources, the trustee was unable to specifically identify the exact transfers to be avoided. Therefore, the trustee proposed selling whatever potential avoidance actions that may have existed.

At issue before the Court was whether avoidance actions are property of the estate that a trustee can sell under section 363(b) of the Bankruptcy Code.

The circuit courts are split on this issue. Specifically, the US Courts of Appeals for the Fifth and Ninth Circuits have taken a liberal approach, ruling that avoidance actions are included in property of the estate (see Cadle Co. v. Mims (In re Moore), 608 F.3d 253 (5th Cir. 2010); Duckor Spradling & Metzger v. Baum Trust (In re P.R.T.C., Inc.), 177 F.3d 774, 781 (9th Cir. 1999)). Conversely, the US Court of Appeals for the Third Circuit has held that avoidance actions are not property of the estate (see Official Comm. of Unsecured Creditors of Cybergenics Corp. v. Chinery (In re Cybergenics Corp.), 226 F.3d 237, 242 (3d Cir. 2000)).

The issue remains unresolved in the US Court of Appeals for the Sixth Circuit, which encompasses the Western District of Michigan Bankruptcy Court.

The Court held that avoidance actions are not property of the estate, and therefore are not subject to sale by the trustee.

The Court adopted the Third Circuit's reasoning in Cybergenics that characterized Chapter 5 rights as "powers." It drew an analogy to public officials who do not have the right to sell the powers of their office or delegate their authority to private persons, and held that trustees should be similarly prohibited.

The Court further adopted the Third Circuit's interpretation that fraudulent conveyance rights belong to creditors, not debtors. In addition, it reasoned that Congress had previously decided that property that has been fraudulently conveyed becomes property of the estate only after avoidance and recovery.

This reasoning, coupled with the lack of controlling authority from the Sixth Circuit, led the Court to hold that avoidance actions are not property of the estate which the trustee can sell under section 363(b) of the Bankruptcy Code. Even assuming that avoidance actions are property of the estate subject to sale, the Court would not have approved the sale because the trustee was unable to identify any of:

Therefore, neither the Court nor the trustee could evaluate the causes of action to determine if the sale was in the best interests of the estate, as required by section 363(b).

Whether or not a debtor or trustee may sell avoidance actions in a section 363(b) sale depends on the jurisdiction of the case. While this may be permitted by courts within the Fifth and Ninth Circuits, it is prohibited by courts within the Third Circuit. The outcome is more uncertain in courts where there is no controlling authority on the issue.

For more information on avoidance actions, see Practice Notes, Fraudulent Conveyances in Bankruptcy: Overview and Preferential Transfers: Overview and Strategies for Lenders and Other Creditors.

For more information on section 363 sales, see Buying Assets in a Section 363 Bankruptcy Sale: Overview.