The Statute of Limitations in Bankruptcy Cases: Higher Courts Come to the Rescue
Phillips, K. Todd, Business Credit
Every credit manager fears bankruptcy preference litigation. In a strange construction of the bankruptcy code, most companies face a greater risk of preference litigation in a Chapter 11 organization case than in a Chapter 7 liquidation proceeding. The greater risk derives from the courts' interpretation of the statute of limitations. A statute of limitations is a legislative provision which provides that a plaintiff must file a lawsuit within a specified period of time or the lawsuit (regardless of its merits) will be barred forever. Statutes of limitations exist for the benefit of defendants to protect them from stale claims, to allow for the destruction of old records, and, generally, to allow the public to face forward in time and not concern itself with old transactions.
Preference and most other bankruptcy related actions are subject to the statute of limitations codified in bankruptcy code 546(a) [11 U.S.C. 546(a)]. Section 546(a) provides that such actions must be brought before the "earlier of two years after the appointment of a trustee ... or the time the case is closed or dismissed."
In a Chapter 11 case, a trustee is not usually appointed. Instead, bankruptcy code 1101(1) provides that in most cases the Chapter 11 debtor operates as a "debtor-in-possession." Section 1107(a) provides that a debtor-in-possession is granted virtually all of the rights, powers, functions, and duties of a trustee, and is subject to all limitations on a trustee.
Since the statute of limitations exists for the benefit of the potential defendant, the logical conclusion would be that the two-year statute of limitations applies to a debtor-in-possession. However, for more than a decade, virtually every bankruptcy court has held that the two-year statute does not apply to a debtor-in-possession. These courts hold that the only limitation on a debtor-in-possession is the dismissal or closing of the Chapter 11 case, which usually takes far more than two years. The courts have stated a variety of reasons for this holding but each can be reduced to a hypertechnical reading of Code 546(a) which provides that the two-year period begins to run upon "the appointment of a trustee." These courts reason that since a trustee is not appointed when there is a debtor-in-possession, the two-year-period never begins to run. …