Understand the complexities and nuances of the Bankruptcy Code to better advise clients and prepare for court.
By Daniel Gill
June 1 — A Chapter 7 trustee in Pennsylvania can be substituted as plaintiff in an action after the expiration of the applicable statute of limitations, the Pennsylvania Supreme Court held May 25 ( Morrison Informatics, Inc. v. Members 1st Fed. Credit Union, 2016 BL 166363, Pa., No. 18 MAP 2015, 5/25/16 ).
The court noted that the issue was one of first impression in the commonwealth and said public policy favored allowing the substitution if the trustee acted in a “reasonably diligent fashion” and without undue prejudice to the defendant.
Chief Justice Thomas Saylor wrote for the majority and remanded the case to determine whether the trustee will ultimately be allowed to pursue the underlying action for damages.
Justice David Wecht filed a separate opinion concurring in the result but advocating for what he argued should be a more flexible rule.
In May 2011, Morrison Informatics, Inc. and two shareholder/officers filed a lawsuit for damages for fraud, conversion, civil conspiracy, and negligence against a credit union and two individuals. However, the plaintiff company had previously filed a case under Chapter 7 of the Bankruptcy Code. In Chapter 7, a debtor's assets are liquidated by a trustee, and the proceeds are distributed to creditors.
Because of the filing of the bankruptcy case, debtor Morrison Informatics didn't have standing to sue; all of its property — including the right to sue third parties — was property of the bankruptcy estate and under the exclusive control of the trustee, the proper party in interest.
The trustee attempted to substitute in as the real party in interest, but the statute of limitations for the action had expired. The court explained in a footnote that Bankruptcy Code Section 108 (11 U.S.C. §108) didn't help the trustee's cause. Section 108 extends any unexpired non-bankruptcy statutes of limitations for two years from the bankruptcy filing date, but the trustee attempted to substitute himself in more than two years after the commencement of the bankruptcy case.
Because the plaintiff shareholders and the company in bankruptcy lacked standing to file suit, the court of common pleas dismissed the action as void ab initio (meaning that it was void as of the moment of its filing). By the time the matter was before the supreme court, all the parties agreed that the nominal plaintiffs didn't have standing to sue the defendants because of the company's bankruptcy case.
The trial court also held that the trustee, who “must be considered as an entity separate and apart from the Company,” couldn't substitute as plaintiff because of the expiration of the statute of limitations by the time of his attempted substitution. The intermediate court of appeal disagreed. It found that the trustee was the proper real party in interest and should be allowed to substitute as plaintiff, despite the expiration of limitations.
The supreme court noted that there was no disagreement that because of the bankruptcy filing, the company lacked standing and the Chapter 7 trustee was the real party in interest relative to the subject lawsuit. The issue became whether the trustee was “a new party entirely separate and distinct from” the debtor company, such that substitution shouldn't be allowed (because the time to file had expired), or whether the trustee “related back” to the debtor sufficiently to allow the proceeding to continue with the trustee now named as plaintiff.
The court noted that Pennsylvania's rules of civil procedure should be construed liberally to allow the action to go forward. It relied on Penn. Rules of Civil Procedure 1033, which allows for amending an action to add a party or correct the name of a party at any time. The court explained that Rule 1033 “should be granted with liberality so as to secure determination of cases on their merits whenever possible.”Pa. R.C.P. 1033
“A party, either by filed consent of the adverse party or by leave of court, may at any time change the form of action, add a person as a party, correct the name of a party, or otherwise, amend the pleading. …”
The court also considered Federal Rule of Civil Procedure 17(a)(3), which, although it doesn't apply to the state court action, reflects a policy rationale the supreme court would adopt. Rule 17(a)(3) provides that: “[t]he court may not dismiss an action for failure to prosecute in the name of the real party in interest until, after an objection, a reasonable time has been allowed for the real party in interest to ratify, join, or be substituted into the action.”
The supreme court surveyed cases from other jurisdictions that favored liberal amendment and allowed trustees to substitute to protect the interests of creditors of the bankrupt entity. “The vindication of the interests of innocent creditors, and the absence of prejudice to defendants, are primary themes in the line of decisions from other jurisdictions which employ a relation-back approach permitting bankruptcy trustees to enter into actions previously initiated by debtors,” the court said.
The court also noted that while precedent didn't allow relating back in other situations—such as when an estate administrator attempted to substitute by relating back to a deceased party—public policy favored allowing a bankruptcy trustee to relate back if she attempted to do so in a “reasonably diligent fashion” and without undue prejudice to the defendant.
In a concurring opinion, Justice David Wecht explained that the majority was doing the bench and bar a disservice by attempting to reconcile tensions with what he said is prior controlling case law which should have demanded a different result. A trustee in bankruptcy is indeed a “new party” to the action, similar to the successors in interest who were barred from being substituted in the case law discussed by the parties and the majority, he said.
Instead of finding that the trustee “related back” to the debtor, as the majority did, Wecht said that the court should find against a strict application of the “new party” doctrine and should hold that a more liberal rule as to who can substitute and when is in the interests of justice when considering whether to allow a trustee in bankruptcy to substitute for a debtor.
The justice said that such a liberal construction is more in line with the commonwealth's Rules of Civil Procedure and that sound policy supports a system that has the “flexibility necessary to maximize the likelihood that the outcome of litigation will be resolved justly on the merits rather than expediently based upon rigid application of a formalistic rule.”
In its conclusion, the majority held that relation back in favor of a bankruptcy trustee is appropriate, “at least where the trustee has acted in a reasonably diligent fashion to secure his or her substitution, and there is no demonstrable prejudice to defendants.” In a footnote, however, the court specifically stated that it declined to find that the trustee was reasonably diligent or that the defendants were not prejudiced. Those are questions that apparently are to be answered by the lower court reconsidering the case.
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