Creditors’ Committee Denied Standing; Archdiocese Justified in Not Pursuing Claims
By Stephanie M. Acree
An official unsecured creditors committee’s motion to pursue alleged fraudulent transfers from the Archdiocese of Milwaukee in the wake of a priest sexual abuse scandal was denied Dec. 10 by the U.S. Bankruptcy Court for the Eastern District of Wisconsin (In re Archdiocese of Milwaukee, Bankr. E.D. Wis., No. 11-20059 (SVK), 12/10/12).
Judge Susan V. Kelley found that the committee did not have the derivative standing necessary to exercise the trustee’s avoidance powers because the committee had not stated a colorable claim and because the debtor had not unjustifiably refused to bring the action.
Sheltering Funds During Scandal
The Archdiocese of Milwaukee filed for Chapter 11 protection on Jan. 4, 2011. According to the allegations of the official committee of unsecured creditors, the Archdiocese of Milwaukee Finance Council met on March 7, 2003, to discuss a sexual abuse lawsuit that had been brought against one of its priests. At the meeting, the council discussed possible means of compensating victims, the potential cost of law suits, as well as “setting up a [t]rust [f]und to shelter the Parish Deposit Fund.”
According to an affidavit submitted by the debtor, the Parish Deposit Fund was created as an “optional pooled investment fund for Catholic entities, and the [d]ebtor and the Parishes contributed funds.” Also according to the affidavit, the fund was held in a segregated account and the parishes could receive all or a portion of their money back with minimal delay.
$35 Million Transfer
In 2005, the debtor transferred in excess of $35 million from the fund to the Southeastern Wisconsin Catholic Parishes Investment Management Trust and/or directly to parishes and other affiliates of the debtor.
On May 25, 2012, the committee moved the court to authorize it to avoid and recover the transfer made from the fund, arguing that the transfer was made with the actual intent to hinder, delay, or defraud creditors based on the language from the finance council’s meeting minutes in which they discussed creating a trust to “shelter” the fund. The committee argued that it could recover the alleged fraudulent transfers pursuant to either Section 544(a)(2) or 544(b) of the Bankruptcy Code.
‘Execution Returned Unsatisfied’
The court said that normally, a trustee or debtor-in-possession has the power to avoid certain transfers for the benefit of the estate. However, a creditors’ committee may be granted derivative standing by the bankruptcy court to pursue such actions if: (1) the claim is colorable, meaning it could survive a motion to dismiss; and (2) the debtor unjustifiably refuses to pursue it.
Looking first at Section 544(a)(2), the court said this statute can be used to prosecute fraudulent transfers, assuming it is permitted by state law. Section 544(a)(2) refers specifically to a creditor that has “an execution against the debtor that is returned unsatisfied.” The court said the relevant Wisconsin statute is Chapter 816, which the court said “does not provide a creditor with the right to pursue a fraudulent transfer.
“Because Bankruptcy Code § 544(a)(2) limits the [c]ommittee to the powers of a creditor with an execution returned unsatisfied, and in Wisconsin, such a creditor is confined to the powers spelled out in Chapter 816, and Chapter 816 does grant the right to institute a fraudulent transfer suit, the [c]ommittee cannot use § 544(a)(2) to avoid the transfer,” the court said. “The Court is not suggesting that a creditor can no longer pursue fraudulent transfers in Wisconsin, but rather that a trustee in bankruptcy cannot use § 544(a)(2) as a predicate for pursuing a creditor’s fraudulent transfer claim.”
Statute of Limitations
Turning to Section 544(b), which allows a trustee to “avoid any transfer of an interest of the debtor in property or any obligation incurred by the debtor that is voidable under applicable law by a creditor holding an unsecured claim,” the court said the committee was standing on “firmer ground” with regard to this section. The court said that the trustee’s rights under Section 544(b) are derivative of and therefore limited to the rights of an actual existing unsecured creditor.
The “applicable law” in this case was Wisconsin Statute § 242.04(a), which makes avoidable transfers that are made with the actual intent to hinder, delay, or defraud a creditor. The statute of limitations for bringing an action under this statute is four years from when the transfer is made or “if later, within one year after the transfer … is or could reasonably have been discovered by the claimant.”
The committee argued that it could not have reasonably discovered the transfer at the time it took place in 2005. Public disclosure of the transfer revealed that the fund was “closed,” but not that it was transferred to the parishes or the Southeastern Parish Trust. The court said that it is not necessary to know that a particular fraudulent transfer occurred, only that there was something “fishy” about the transfer.
The court said that in this case, it is arguable that there was something “fishy” about the transfer when “over $35 million was removed from the [d]ebtor’s balance sheet in 2005 when the [d]ebtor was being sued for priest sex abuse.” However, the court concluded that the disclosure that the fund had been “closed” “does not suggest by itself that millions of dollars were transferred to the [p]arishes.” Furthermore, the council minutes that discussed “shelter[ing]” the fund were not discovered until the discovery process in the bankruptcy case.
Therefore, the court concluded that it was a “close case” but it was “plausible” that a creditor could not have discovered the transfer at the time it was made.
Good Faith Transferees
However, the court also said that Wisconsin law provides a defense for transferees that “took in good faith and for a reasonably equivalent value.” The committee argued that “given the Archbishop’s ability to manage [p]arish assets and finances, the Archbishop’s knowledge about the transfer should be imputed to the [p]arishes.” However, the court found that there was no evidence that the Archbishop had exercised any of his authority or control over the fund and rather the parishes were given the option of having their funds returned or having them invested in the Southeastern Parish Trust. The court said that based on the circumstances, it could not conclude the transferees harbored any fraudulent intent.
Fund Not Debtor’s Property
The court also questioned whether or not the fund could even be considered property of the debtor’s estate. The committee argued that with regard to the fund, the debtor was acting as a bank and the parishes were depositors, which is considered a debtor-creditor relationship. The debtor argued that the fund was a “resulting trust” or “property being held for the benefit of another.”
The court said that in this case, all of the parishes’ funds were deposited into one segregated bank account, were easily traceable, and “most importantly, the [d]ebtor did not use these funds for operations.” The court said that these facts supported the conclusion that “the parties intended that the [p]arishes’ money deposited into the Parish Deposit Fund at all times belonged to the [p]arishes.”
Therefore, the court concluded that the committee had failed to state a plausible claim that the transfer was made with the debtor’s property.
Costs Outweigh Benefits
Finally, the court analyzed whether or not the debtor was justified in not pursuing the claim, assuming, despite the court’s previous conclusions, that the committee’s claim could survive a motion to dismiss. The court said the relevant factors in this analysis are: “(1) the probabilities of legal success and financial recovery in event of success; (2) the creditor’s proposed fee arrangement; and (3) the anticipated delay and expense to the bankruptcy estate that the initiation and continuation of litigation will likely produce.”
The committee conceded that prosecuting the claims would cost over $1 million in legal fees. The court also noted that while discovery might yield additional evidence, the committee had already been given “thousands of documents” in informal discovery and had only found scant evidence thus far of an intent to defraud. Furthermore, the court noted that the case had already seen significant delays.
“Even assuming that the Committee prevailed in its lawsuits, the ever looming question of collectability remains,” the court said. The court said it was “not unreasonable to surmise that a [p]arish that invested money in the Parish Deposit Fund and received the return of its investment in June 2005 no longer has the money and was unable to replenish it after the Great Recession of 2008.”
Having found that the cost of pursuing the avoidance claims did not outweigh the probable benefits, the court said the debtor was not unjustified in refusing to prosecute the claims. Therefore, having found that the claims were not colorable and that the debtor was not unjustified in refusing to pursue them, the court denied the committee’s motion for derivative standing to pursue the claims.