The Third Circuit Court of Appeals recently held that a party seeking to sue a trustee in bankruptcy must still obtain permission from the appointing bankruptcy court, but only in instances when the trustee is being sued for acts in his official capacity and not in instances when the trustee is merely continuing the business affairs of the debtor’s business. See In re VistaCare Group, LLC, no. 11-2695 (3d Cir. May 4, 2012).
A trustee was appointed in the chapter 7 bankruptcy case of VistaCare Group, LLC (the “Debtor”). The Debtor’s bankruptcy estate included a 12.2 acre parcel of land in Lancaster County, Pennsylvania that was subdivided into 45 lots, 44 of which were zoned for mobile homes. The remaining lot (“Lot 45”) contained a four-story retirement facility.
During the bankruptcy, the Trustee sold Lot 45 to a third party and the 44 individual lots to the majority of the residents with homes on the lots, despite certain subdivision restrictions covering all the lots.
The purchaser of Lot 45 was not happy that the lots were being sold to the homeowners of mobile homes. It therefore filed a motion in the bankruptcy court for leave to file suit against the trustee in Lancaster’s Court of Common Pleas. In the motion, the purchaser alleged that the sales of the individual lots were unlawful, in breach of the subdivision plan, and damaged the property interests of the owner of the facility lot, without due process of law.
The trustee responded to the motion by arguing that under the long-standing Supreme Court precedent of Barton v. Barbour , 104 U.S. 126 (1881), the trustee could not proceed with the state court suit without the permission of the bankruptcy court and leave should be denied because the purchaser’s claims were frivolous.
The Barton doctrine provides that, in cases outside of bankruptcy where a receiver is appointed, the appointing court must approve any suit against the receiver to ensure a consistent and equitable administration of the receivership property, because a judgment against a receiver would be satisfied out of the receivership property. Thus, according to the Barton case, requiring a party with claims against the receiver to obtain permission from the appointing court before filing suit in another jurisdiction would prevent the “usurpation of the powers and duties which belonged exclusively to the appointing court and protect the duty of that court to distribute the trust assets to creditors equitably and according to their respective priorities.”
The Barton doctrine is not dependent on any federal statute, but instead on principles of common law. Although the Barton case involved an equity receiver, subsequent courts extended the doctrine to bankruptcy trustees, reasoning that much like a receiver, a trustee is appointed by the court to oversee the debtor’s estate, and therefore is “an officer of the court” whose “possession [is] protected because it [is] the court’s.” (quoting Vass v. Conron Bros. Co., 59 F.2d 969, 970 (2d Cir. 1932) (L. Hand, J.)).
The bankruptcy court found that the Barton doctrine was antiquated and not controlling in the Third Circuit, reasoning that although courts may have applied the doctrine to bankruptcy trustees under the bankruptcy laws before 1978, the Bankruptcy Reform Act of 1978, commonly known as the Bankruptcy Code, §§ 101-1527, fundamentally overhauled the bankruptcy laws, and in the process, raised serious doubts as to whether the Barton doctrine still applied to bankruptcy trustees. See, e.g., In re Lambert, 438 B.R. 523 (Bankr. M.D. Pa. 2010). While expressing doubts about the applicability of the Barton doctrine, the bankruptcy court nonetheless went on to determine the motion for leave of court, on its merits, and ruled that the purchaser of Lot 45 was permitted to file his claims, which were not frivolous.
The U.S. District Court affirmed this decision, and the trustee appealed to the Third Circuit.
The primary issue presented on appeal was whether a party must first obtain leave of the bankruptcy court before it brings an action in another forum against a bankruptcy trustee for acts done in the trustee’s official capacity, pursuant to the long-established Barton doctrine.
Joining the First, Sixth and Ninth Circuit Courts of Appeal, the Third Circuit held that the Barton doctrine continued to exist, but on a limited basis. Under its limited applicability, a plaintiff must still seek leave (permission) by the bankruptcy court before instituting an action against a trustee, but only for acts done in the trustee’s official capacity.
According to the Third Circuit, although Congress has never expressly codified the Barton doctrine, implicit in a provision of the Judicial Code, 28 U.S.C. § 959(a), is a general rule that a party seeking to sue a receiver or trustee must first obtain permission from the appointing court. Section 959(a) provides, in relevant part, that “Trustees, receivers or managers of any property, including debtors in possession, may be sued, without leave of the court appointing them, with respect to any of their acts or transactions in carrying on business connected with such property.”
The Third Circuit reasoned that when Congress enacted section 959(a), six years after the Barton decision, it intended to narrow the Barton doctrine so that it would no longer apply in cases where the receiver or trustee was “continuing the debtor’s business.” According to the Third Circuit, section 959 clearly provides that where the acts complained of involve the trustee’s conducting the debtor’s business in the ordinary course or his pursuing that business as an operating enterprise, an aggrieved party need not seek permission from the appointing court before filing suit in another forum. (citing In re Crown Vantage, 421 F.3d 963, 971-72 (9th Cir. 2005)).
On the other hand, the Barton doctrine still applies when a trustee or receiver “acting in his official capacity conducts no business connected with the property other than to perform administrative tasks necessarily incident to the consolidation, preservation, and liquidation of assets in the debtor’s estate.” In those cases, leave of court is still required before filing suit against the trustee.
While the Third Circuit’s opinion reversed that bankruptcy court’s finding that the Barton doctrine did not survive the enactment of the Bankruptcy Code, the Third Circuit affirmed the bankruptcy court’s ruling granting leave of court to allow the state court lawsuit to be brought by the purchaser of Lot 45. The fact that the Third Circuit did make its extensive ruling resulted in valuable clarity into the limited applicability of this doctrine. So, trustees should now be aware that, after the passage of 28 U.S.C. § 959, they are protected, on a limited basis, by the Barton doctrine.