In a 33 page decision released March 29, 2017, Judge Sontchi of the Delaware Bankruptcy Court ruled on competing motions to dismiss the remaining claims and counterclaims in an adversary proceeding in the Affirmative Insurance bankruptcy – Adversary Proceeding Case No. 16-50425.  Judge Sontchi’s opinion is available here (the “Opinion”).  As Judge Sontchi stated in the Opinion, the issue was a simple one, Opinion at *3, there is a dispute of a material fact between the parties, and dismissal is therefor inappropriate.  Opinion at *4.

The issue arises as the result of the allocation of sales proceeds between parties with a claim on the debtor’s assets.  The plan appointed liquidator (the “AIC Liquidator”) asserts that the funds from the sale should be in its control pursuant to the plan, and held in trust to pay the estate’s tax liability.  Opinion at *12.  JCF AFFM Debt Holdings, L.P. (“JCF”) is the other party in interest in the Opinion.  JCF was a major lender to the debtor, and claimed to hold a validly perfected security interest in the account into which the sales proceeds were eventually deposited.

JCF had filed the complaint that initiated the adversary proceeding.  The AIC Liquidator filed its counterclaims and also moved to dismiss for lack of subject matter jurisdiction, arguing that this was a conflict between two creditors with no impact on the Debtor.

Judge Sontchi first addressed the argument of subject matter jurisdiction, determining that “the threshold question here is whether the funds [at issue] are property of the estate or not.”  Opinion at *21.  As Judge Sontchi ruled, the account at issue is in the name of the Debtor, and accordingly, “its funds are presumably property of the estate under section 541(a) of the Bankruptcy Code.” Opinion at *26. Citing In re BankUnited Financial, Judge Sontchi instructed that “what is or is not property of a bankruptcy estate is an issue that stems from the bankruptcy itself, one that can only arise in a bankruptcy proceeding…”  Opinion at *28.

On pages 31 and 32 Judge Sontchi examines the counterclaims and whether they should be dismissed.  It is interesting to note that a key aspect of his analysis, as I read the Opinion, is the remedy sought in the counterclaims – establishment of a constructive trust.  Judge Sontchi states: “The imposition of a constructive trust may be an appropriate remedy for any of the causes of action asserted.  Thus, if the AIC Liquidator prevails on any of the counterclaims it would be determinative of the ultimate issue of whether the funds are property of the estate. The Court finds that the Counterclaims contain specific factual allegations, taken they are true, to suggest that the AIC Liquidator is entitled to the funds in the …Account.. As such, it is apparent that there is a dispute of a material fact.”  I can’t help but wonder, if the counterclaims had sought relief of a different sort, such as damages, would the outcome have been the same?

At the end of the day, it’s hard to argue that a bankruptcy court doesn’t have jurisdiction over a matter that can, by definition, only arise in a bankruptcy – including determining what constitutes a debtor’s estate.  The determination of what is property of a debtor’s estate is a highly fact sensitive issue, and if there are facts in dispute, it is unlikely that a motion for summary judgment or a motion to dismiss will be granted.  We will, no doubt, continue to see them filed as they play an important role in narrowing the scope of a conflict, but in my experience and observation of the bankruptcy court, they are denied far more frequently than they are granted.

John Bird practices with the law firm Fox Rothschild LLP in Wilmington, Delaware. You can reach John at 302-622-4263, or jbird@foxrothschild.com.