A common feature of many chapter 11 bankruptcies is the debtor-in-possession's use of the various avoiding powers provided under the Bankruptcy Code.^[1] These avoidance actions typically seek to recover cash and other tangible property transferred by the debtor to creditors and other parties. In analyzing such avoidance actions, the courts frequently treat the "recovery" provisions of §550, including the "benefit of the estate" requirement of that section, as a substantive element of the avoidance claim.^[2] See, e.g., Wellman v. Wellman, 933 F.2d 215 (4th Cir.), cert. denied, 502 U.S. 925 (1991) (Chapter 11 debtor lacked standing to pursue avoidance action under §548 seeking recovery of cash and stock transferred by the debtor to a third party because recovery of the transferred property would not "benefit" the debtor's estate under §550). The inclusion of §550 "recovery" as a substantive element of an avoidance claim is significant because, when §550 applies, the courts have stated a number of different definitions of what constitutes a "benefit" to the estate within the meaning of §550(a).^[3]

Consider, however, the situation in which a chapter 11 debtor, whose principal asset is real property, seeks to avoid a voluntary but unperfected lease or lien interest asserted against that property using §544(a).^[4] Both courts and commentators have begun to recognize that injecting a §550 "recovery" requirement is not warranted as a substantive element of every avoidance action, particularly in avoidance actions under §544(a) that seek to avoid lesser interests asserted against property the bankruptcy estate already owns in fee simple.

The Statutory Separation

The statutory structure and legislative history of the Bankruptcy Code make clear that avoidance is an event separate from and which has substantive significance independent of "recovery" under §550. Avoidance of an unperfected interest under §544(a) nullifies the interest as a matter of law and without reference to §550(a). See, e.g., In re Bell, 194 B.R. 192, 197 (Bankr. S.D. Ill. 1996) ("A lien is avoided under §544(a) as a transfer of the debtor's interest in property, and the consequence of such avoidance is nullification of the transfer. This nullification means that the transfer is retroactively ineffective and that the transferee...legally acquired nothing through it..."); In re Ausman Jewelers Inc., 177 B.R. 282, 286 n. 7 (Bankr. W.D. Wis. 1995) (same); 2 David G. Epstein et al., Bankruptcy, §6-79 (West 1992) at pp. 200-01 (same).

The independent nature of §§544 and 550 is further illustrated by the fact that they have different statutes of limitations. See §546(a) (two-year statute of limitations for avoidance actions under §544) and §550(f) (recovery actions must be brought within one year of avoidance of the subject transfer). Congress specifically recognized that avoidance is a concept separate from recovery. Section 550 "enunciates the separation between the concepts of avoiding a transfer and recovering from the transferee."^[5] This statutory structure supports the position that recovery is a concept that is separate from and goes beyond avoidance to provide a remedy when avoidance alone does not achieve complete relief for the debtor. See Epstein, §6-79 at 201 ("Recovery goes beyond avoidance. Recovery is a bankruptcy remedy for avoidance that makes the transferee of the affected property, and also people for whose benefit the transfer was made, personally accountable to the estate for the return of the property or its value. [Citing §550] Avoidance is always necessary for recovery, but recovery is not always necessary or even useful after avoidance"); In re Mako Inc., 127 B.R. 471, 473 (Bankr. E.D. Okla. 1991) (§550 "stands as a recovery statute only and not as a primary avoidance basis for an action"); In re O.P.M. Leasing Services Inc., 32 B.R. 199, 202 (Bankr. S.D.N.Y. 1983) (same); In re Barnett, 30 B.R. 119, 122 (Bankr. N.D. Ala. 1983), ("The only effect that 11 U.S.C. §550 has on the avoidance powers of the debtor is to limit those powers as to recovery of tangible property in the hands of third-party transferees.").

Judicial View on the Distinction

Under these principles, some courts have recognized, either directly or implicitly, that when the nullifying effect of avoidance under §544(a) is applied to the avoidance of a lien or lease interest asserted in property the debtor already owns in fee simple, §550 "recovery" is inapplicable to the avoidance action. These cases recognize that when a debtor already holds ownership title in the property and seeks to avoid a lesser interest asserted against the property, avoidance achieves complete relief because the debtor does not need to "recover" any additional title or interest in the property after avoidance.

In the recent case of In re Glanz, 205 B.R. 750 (Bankr. D. Md. 1997), the court recognized that avoidance under §544(a) of a lesser (lien) interest in real property by a debtor fee simple owner achieves complete relief for the debtor without reference to §550. "[T]he plaintiff's cause of action under §544 is not affected by the provisions of §550. The avoidance of the unperfected lien pursuant to §544(a) is a meaningful event in and of itself, and requires no further action to be taken by the debtor. There is simply nothing to recover under §550(a), and therefore the "benefit to the estate" analysis discussed in the [Wellman] decision is not directly applicable to this lien avoidance action." Glanz, 205 B.R. at 758. The Bell court applied a similar analysis, finding that avoidance (i.e., nullification) of a lien in property the debtor already owned achieved complete relief. "[T]he trustee's avoidance of the creditor's lien [under §544(a)] results in nullification of the transfer of property represented by those liens, and the security transactions are ineffective not only to the trustee but also as to the debtor and creditor themselves as the immediate parties to the transactions... The former lienholder's interest in the debtor's property automatically becomes property of the estate [referencing §§541(a)(4) and 551], and merges with any residual interest in the debtor which passed to the estate when the bankruptcy case commenced." Bell, 194 B.R. at 197-98.6

Similarly, courts addressing the avoidance of unperfected leasehold interests in the debtor's property also have recognized implicitly that avoidance of the leasehold interest is a complete remedy that does not require §550 "recovery." See, e.g., In re Webber Lumber & Supply Co. Inc., 134 B.R. 76, 77-80 (Bankr. D. Mass. 1991) (court rules that debtor can avoid an unrecorded commercial real property lease under each independent basis of §544(a); court does not analyze or discuss §550); In re Belize Airways Ltd., 12 B.R. 387, 389-90 (Bankr. S.D. Fla. 1981) (same).

Other courts have adopted the position that §550 "recovery" is a substantive element of all avoidance actions regardless of the type or nature of avoidance action. The court in Weaver v. Aquila Energy Marketing Corp., 196 B.R. 945, 954-55 (S.D. Tex. 1996), found that §550 "recovery" is a substantive element of all avoidance actions. However, the Weaver court candidly acknowledged that this holding finds no support in the applicable statutory language of the Bankruptcy Code or in the clear Congressional intent that avoidance is separate from recovery under §550. Weaver, 196 B.R. at 954-55.7 The court in In re Farmer, 209 B.R. 1022, 1025 (Bankr. M.D. Ga. 1997) stated that the "enhancement of value [created when a lien in the debtor's property was avoided under §547] is itself a recovery of ïthe property transferred' as contemplated by [§550]." However, while the Farmer court spoke in terms of what §550 "contemplated," it recognized that the increased value of the estate's interest in the underlying property automatically resulted from avoidance alone; and that what actually must be considered was whether such avoidance alone was the proper remedy before proceeding under §550 to recover payments made to the creditor and additional cash recoveries from the creditor. Farmer, 209 B.R. at 1025. See, also, In re Dunes Hotel Associates, 194 B.R. 967, 984-87 (Bankr. D.S.C. 1995) (court treats §550 "recovery" as a substantive element of debtor-in-possession's action to avoid an unperfected leasehold interest asserted in the debtor's real property asset).

Conclusion

In light of these differing interpretations of the interplay between §§544(a) and 550, the ultimate question of whether §550 "recovery" is a substantive element of all avoidance actions (especially those that seek only to avoid lesser interests asserted in property the debtor already owns) is an issue where guidance is needed and is likely to be obtained from the circuit courts of appeals. The issue presently is before the Fourth Circuit Court of Appeals. Stay tuned.

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Footnotes

^[1] The avoiding powers allow a debtor-in-possession to avoid various types of transfers and interests. See, e.g., §544 (transfers voidable by hypothetical lien creditor and certain other creditors and bona fide purchasers); §545 (statutory liens); §547 (preferential transfers); §548 (fraudulent transfers); §549 (certain post-petition transactions).[RETURN TO TEXT]

^[2] Section 550(a) provides that "[e]xcept as otherwise provided in this section, to the extent that a transfer is avoided under §§544, 545, 547, 548, 549, 553(b) or 724(a) of this title, the trustee may recover, for the benefit of the estate, the property transferred, or, if the court so orders, the value of such property,..." 11 U.S.C. §550(a).[RETURN TO TEXT]

^[3] See, e.g., Wellman, 933 F.2d at 218; In re Tennessee Wheel & Rubber Co., 64 B.R. 721, 725-26 (Bankr. M.D. Tenn. 1986), aff'd, 75 B.R. 1 (M.D. Tenn. 1987); In re Southern Indus. Banking Corp., 59 B.R. 638, 641 (Bankr. E.D. Tenn. 1986); In re Trans World Airlines Inc., 163 B.R. 964, 972 (Bankr. D. Del. 1994); In re Rooster Inc., 127 B.R. 560, 573 n. 15 (Bankr. E.D. Pa. 1991); In re Funding Systems Asset Management Corp., 111 B.R. 500, 523-24 (Bankr. W.D. Pa. 1990); Harstad v. First American Bank, 39 F.3d 898 (8th Cir. 1994).[RETURN TO TEXT]

^[4] Section 544(a) provides that a debtor-in-possession (empowered as a trustee) may avoid any transfer of property of the debtor that is voidable by: (i) a hypothetical judicial lien creditor; (ii) a hypothetical execution creditor; and (iii) a hypothetical bona fide purchaser of real property. 11 U.S.C. §544(a). [RETURN TO TEXT]

^[5] See H.R. Rep. No. 95-595, 95th Cong., 1st Sess. 375 (1977), reprinted in 1978 U.S.C.C.A.N. 5787, 6331; S. Rep. No. 95-989, 95th Cong., 2d Sess. 90 (1978), reprinted in 1978 U.S.C.C.A.N. 5787, 5876.[RETURN TO TEXT]

^[6] See, also, Epstein at §6-80. Epstein rejects the argument that a trustee (or debtor-in-possession) must always be able to recover property under §550 in order to give meaning to the avoidance powers, noting that:

This argument ignores the fact that an automatic consequence of avoidance, beyond its nullifying effect, is preservation of the lien or other interest that is avoided, and that the preserved interest automatically becomes part of the estate without recovery. Thus, when a transfer is avoided, the interest which the transfer created becomes part of the estate without further ado. It merges with any residual interest in the debtor which passed to the estate when the bankruptcy case was commenced. Epstein, §6-80 at 205-06.

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^[7] The Supreme Court has rejected this type of judicial rewriting of the statutory language of the Bankruptcy Code. See, e.g., Union Bank v. Wolas, 502 U.S. 151, 158-163 (1991); Patterson v. Shumate, 504 U.S. 753, 761 (1992).[RETURN TO TEXT]