Restructuring

Contributed by Ginger Ellison.
The trustee’s turnover power set forth in section 542(a) of the Bankruptcy Code permits a trustee or debtor in possession to compel an entity to deliver property of the estate, or the value of such property, that is in the entity’s “possession, custody or control” (collectively, “possession”) during the bankruptcy case.  At issue in Shapiro v. Henson was whether the turnover power should be restricted to recovering from entities having possession of such property at the time the motion for turnover was filed.
This was a case of first impression in the Ninth Circuit.  In deciding the identical issue in Brown v. Pyatt (In re Pyatt) the Eighth Circuit followed the rule articulated in Maggio v. Zeitz (In re Luma Camera Service, Inc.), a pre-Bankruptcy Code case which held that where a motion for turnover was brought against an entity by summary proceeding, possession of the property by that entity was required at the time that the motion for turnover was filed.  In Pyatt, the court refused to compel the turnover of funds linked to checks that were written by the debtor and honored after the petition was filed but before the trustee brought the motion for turnover.  It reasoned that the property and its proceeds already had been dissipated and were no longer within the bank’s possession; as a result, they were not within the reach of the trustee’s turnover power.
The Ninth Circuit refused to follow Pyatt, holding that the language of the Bankruptcy Code, pre-Bankruptcy Code turnover practice, and practical considerations all weighed in favor of an interpretation of section 542(a) that would allow the trustee to recover from entities having possession of the estate property or its value at any point during the pendency of the bankruptcy case – as opposed to merely those entities having possession when the trustee brought the motion for turnover.
The court held that two phrases within section 542(a) signaled that the provision’s drafters would support the above interpretation.  First, the phrase “during the case” indicates that the trustee may bring a motion for turnover against an entity that had possession of property of the estate at some point during the bankruptcy case.  In addition, the phrase “or the value of such property” suggests that the entity need not be in possession of the property at the moment the trustee files the motion for turnover; rather, that section 542(a) permits a trustee to recover the property’s value would show that the entity’s present possession of said property is not required for a turnover motion to succeed.  Whereas the court in Pyatt maintained that the term “value of such property” merely reinforces the pre-Bankruptcy Code practice of permitting the trustee to bring a turnover action against someone in possession of the proceeds of property of the estate, the court in Shapiro held that “value of such property” has a meaning entirely separate from “property proceeds.”  On that basis, the Ninth Circuit found that section 542(a) ventured beyond such pre-Bankruptcy Code practice in allowing the trustee to recover against entities that did not possess the sought-after estate property or its proceeds at the time the motion for turnover was filed.
The Ninth Circuit found that the court in Pyatt incorrectly held that pre-Bankruptcy Code turnover practice consistently mandated present possession of the estate property by the entity against which the trustee’s motion to compel turnover was filed.  Rather, pre-Bankruptcy Code turnover practice only required an entity to have possession of the property at the time that the trustee filed the turnover motion where the trustee sought to recover estate property by means of a summary proceeding.  This was because a summary proceeding was typically enforced through a motion for contempt.  In such cases, present possession was necessary to ensure that an entity could not be held in contempt for failing to deliver property that it no longer possessed – often an impossible task.  By contrast, where a trustee sought to recover estate property through a plenary proceeding, present possession was not required under pre-Bankruptcy Code law.  Hence, the Ninth Circuit found, pre-Bankruptcy Code turnover practice only required present possession where the trustee sought turnover through one of two avenues.
Finally, the court held that a broader interpretation would be more practical.  The alternative of allowing trustees to compel turnover only from entities that had possession of estate property or the value of such property when the motion for turnover was filed would permit the entities in question to avoid liability under section 542(a) simply by transferring the property.  Moreover, the trustee’s avoidance powers do not allow the trustee to pursue the initial transferor where such party no longer possesses the sought-after property.  As such, the court reasoned that Congress intended for section 542(a) to fill a gap by allowing the trustee to proceed against a party who had possession of the property in question at the outset of the bankruptcy and who subsequently transferred such property.  Finally, the court held that concerns regarding the trustee’s potential for a double recovery were meritless because the party against whom second recovery is sought has the power to prevent double recovery by raising an equitable defense to turnover.
In summary, the Ninth Circuit declined to adopt the Eighth Circuit’s restrictive interpretation of the trustee’s turnover power.  In so doing, it has read section 542(a) in a manner advantageous to the debtor’s estate.  Rather than permitting the trustee or debtor in possession to recover only against entities in possession of property of the estate at the moment the motion for turnover was filed, the Ninth Circuit allows the trustee or debtor in possession to compel turnover from entities that had possession of the subject property at any point during the bankruptcy case, whether or not they had possession at the time the turnover motion was filed.  With the Ninth Circuit making it easier to recover property of the estate, or the value of such property, one may anticipate that unsecured creditors will reap the benefit in the form of increased distributions.