As corporate bankruptcy filings increase, one debtor corporation is more likely to find that it has claims against another unaffiliated debtor corporation. The US Bankruptcy Code is generally not drafted with this situation in mind, and questions may arise regarding the effect of one debtor's bankruptcy on another's. Recently, the Southern District of New York Bankruptcy Court considered whether the avoidance actions pursued in the bankruptcy of OneStar under Sections 547 and 549 of the Bankruptcy Code1 could be maintained against WorldCom, which had confirmed in its own bankruptcy a Chapter 11 Plan of Reorganization discharging all claims against it under Section 1141 of the Bankruptcy Code.2 The Bankruptcy Court held that the OneStar avoidance actions could be pursued against WorldCom, notwithstanding WorldCom's discharge, because the discharge is binding only on WorldCom's creditors and their successors, not on the bankruptcy estate represented by OneStar's bankruptcy trustee.3
One Bankruptcy After Another
WorldCom filed its Chapter 11 cases in July 2002. During its Chapter 11 cases, WorldCom received payments from OneStar for telecommunications services purchased from WorldCom by OneStar. In October 2003, WorldCom confirmed its Chapter 11 Plan of Reorganization, which contained an extensive provision discharging all claims against WorldCom. Before that Chapter 11 Plan became effective, OneStar filed its own Chapter 11 case in December 2003. The WorldCom Chapter 11 plan became effective in April 2004, and the OneStar Chapter 11 reorganization was converted to a Chapter 7 liquidation in January 2005. In August 2005, the OneStar Chapter 7 Trustee sued WorldCom to avoid and recover under Section 547 payments made to WorldCom from October through December 2003, the 90-day "preference period" preceding OneStar's bankruptcy filing.4
Whether Avoidance Actions Are Claims
The Chapter 7 Trustee for OneStar first argued that WorldCom's discharge did not apply to the OneStar avoidance actions because those actions were not "claims" that were subject to the discharge. The Bankruptcy Court ruled against the OneStar Trustee on this issue. The Bankruptcy Court held that the avoidance actions were "claims" of the type that could be subject to the WorldCom discharge under its Chapter 11 Plan and Section 1141 of the Bankruptcy Code authorizing that discharge. The Bankruptcy Court reached this conclusion notwithstanding the fact that the payments to WorldCom were made—and indeed OneStar's bankruptcy giving rise to the avoidance actions was filed—only after WorldCom filed its bankruptcy filing and after its Chapter 11 Plan was confirmed. This ruling has significance beyond the "debtor against debtor" context, as it confirms the principle that a Chapter 11 Plan can discharge claims arising both before and after a bankruptcy filing, and, in some circumstances, claims arising up until the date a Chapter 11 Plan becomes effective.
Whether the OneStar Trustee is Bound by the Discharge
The Chapter 7 Trustee for OneStar next argued that WorldCom's discharge was not binding on the OneStar Trustee because the OneStar Trustee brought the avoidance actions on behalf of OneStar's bankruptcy estate and not as a successor to OneStar itself. The Bankruptcy Court ruled that the OneStar Trustee was the successor in interest to OneStar, and was bound by the WorldCom discharge in that capacity. But the Bankruptcy Court ruled that the OneStar Trustee also acted in a separate capacity—as representative of OneStar's bankruptcy estate and the creditors of OneStar with an interest in that estate. In this separate capacity the OneStar Trustee was not a successor in interest to OneStar and was not bound by the WorldCom discharge. Because the OneStar Trustee brought the avoidance actions in its capacity as representative of OneStar's bankruptcy estate and not in its capacity as successor to OneStar, the OneStar Trustee's pursuit of the avoidance actions was not barred by the WorldCom discharge. This result followed from the Bankruptcy Court's holding that the avoidance actions only arose upon the filing of OneStar's bankruptcy and that those actions became a part of OneStar's bankruptcy estate "at their inception." At no time did OneStar hold the avoidance actions in its own right, and therefore at no time could the OneStar Trustee be a successor to OneStar in pursuing those actions.5
The Bottom Line
In the current economic climate, the otherwise rare instance of one bankruptcy estate asserting claims against another bankruptcy estate may become more common. The WorldCom-OneStar decision demonstrates how the status of a claimant as a representative of a bankruptcy estate may allow it to assert claims against another bankruptcy estate without regard to a discharge, and how being a representative of a bankruptcy estate may change the litigation battlefield. Bankruptcy discharge is a powerful weapon with a broad reach—but some claims of a bankruptcy trustee or debtor in possession may be outside its range.
1 11 U.S.C. §§ 547 and 549.
2 11 U.S.C. § 1141.
3In re WorldCom, Inc., Chapter 11 Case No. 02-13533 (ALG), Bankr. S.D.N.Y., February 26, 2009.
4 The OneStar Chapter 7 Trustee also sought to avoid and recover under Section 549 a smaller amount paid to WorldCom after OneStar's bankruptcy filing.
5 Although the actions were pursued by the OneStar Trustee after conversion of the OneStar bankruptcy to a Chapter 7 liquidation, based on the Bankruptcy Court's reasoning, the result may have been the same if OneStar had pursued the actions as debtor-in-possession during its Chapter 11 reorganization.
