Delaware Bankruptcy Court Approves Trustee's Use of Prejudgment Asset Freeze Injunction in Fraudulent Transfer Case
An asset freeze injunction, which is an order of the court preventing a defendant from transferring assets until the case against it concludes, is an effective tool in the litigation arsenal of a bankruptcy trustee or other plaintiff. The use of this type of preliminary injunction, however, was called into question by the U.S. Supreme Court’s decision in Grupo Mexicano de Desarrollo v. Alliance Bond Fund Inc., 527 U.S. 308 (1999). There, the Supreme Court held that in a contract action for money damages where no equitable relief is sought and no interest in the defendant's assets is claimed, a district court lacks authority to issue a preliminary injunction freezing a defendant's assets before a judgment is entered. Id. at 333. The issue of whether such an injunction can be imposed in a fraudulent transfer action turns on whether the claims asserted are legal or equitable in nature.
This issue was clarified by the recent decision of the Delaware bankruptcy court in Miller v. Mott (In re Team Systems International, LLC), 2023 WL 1428572 (Bankr. D. Del. Jan. 31, 2023). Surveying the U.S. Supreme Court decisions bearing on the issue, the court found that where the plaintiff seeks to recover a specific asset as a fraudulent transfer, as opposed to the recovery of cash that had been transferred, the cause of action is equitable and therefore an asset freeze injunction would be an available remedy. Id. at *8.
The result is different, however, for the recovery of cash transfers based on the rationale that “where equity is invoked simply to recover cash that had been transferred, the complaint should be viewed as a legal claim on the ground that equitable relief (such as the imposition of a constructive trust on specific cash) is unavailable when an adequate remedy at law is available.” Id. at *9. The adequate remedy at law in that instance is a money judgment. Id. at *8.
Although in Team Systems, the trustee sought to recover cash transfers as fraudulent transfers, he coupled this claim with a claim for an accounting in order to locate the transferred assets. Finding that a claim for an accounting is equitable in nature, the court held that an asset freeze injunction was an available remedy in the trustee’s fraudulent transfer action even though the principal form of relief sought was to recover the cash transfers. Id.
The decision and rationale in Teams Systems is consistent with preexisting federal authority on this issue. See e.g. CSC Holdings, Inc. v. Redisi, 309 F.3d 988, 996 (7th Cir.2002) (upholding preliminary injunction freezing defendant's assets and finding Grupo Mexicano inapplicable on the grounds that plaintiff sought an accounting and constructive trust); Motorola Credit Corp. v. Uzan, 202 F.Supp.2d 239, 250 (S.D.N.Y.2002) (finding that Grupo Mexicano did not bar plaintiffs' request for a preliminary injunction since, in addition to asserting money damages, plaintiffs there also asserted a demand for a constructive trust, and other equitable remedies).
Although not discussed in Teams Systems, an additional basis for issuing such injunctions when the fraudulent transfer action is brought in bankruptcy court may be found in 11 U.S.C. § 105(a), which provides the bankruptcy court with the power to issue any order “necessary or appropriate to carry out the provisions of this title.” At least one federal court has found this provision to be an independent source of power for an asset freeze injunction in bankruptcy cases. Adelphia Communications Corp. v. Rigas (In re Adelphia Communications Corp.), No. 02-Civ, 8495 GBD.02-41729 REG, 2003 WL 21297258, at *4 (S.D.N.Y. June 4, 2003) (by authority of 11 U.S.C. §105(a), “[t]he bankruptcy court, therefore, may issue a pre-judgment order preventing a party from disposing of assets”).
The lesson of these decisions for a party seeking to enjoin a defendant from transferring assets while its fraudulent transfer action is pending is to include a claim for an accounting and, if the litigation is in bankruptcy court, assert 11 U.S.C. § 105(a) as source of authority for the injunction.
Irve J. Goldman is the chair of the Bankruptcy and Creditors Rights practice at Pullman & Comley, LLC, and has been certified as a business bankruptcy specialist by the American Board of Certification since 1993. He can be reached at firstname.lastname@example.org.