Finding the Shoes that Fit: How Derivative is the Trustee\u27s Power to Avoid Fraudulent Conveyances under Section 544(b) of the Bankruptcy Code

Section 544(b) of the Bankruptcy Code, which enables a bankruptcy trustee to avoid transfers that an actual unsecured creditor could have avoided under state law, is a powerful tool most often used to recover assets that were fraudulently transferred several years before a debtor\u27s bankruptcy case. This power is often described as permitting the trustee, for the benefit of the bankruptcy estate and all of the debtor\u27s unsecured creditors, to “stand in the shoes” and assert the rights of the particular unsecured creditor. In a recent case, In re Allou Distributors, Inc., the Bankruptcy Court for the Eastern District of New York held that a Chapter 7 trustee, acting under § 544(b), could avoid a transfer of assets, if made by an insolvent debtor for less than fair consideration, by relying on the rights of an actual unsecured creditor that held a claim both on the date of the transfer and on the date of the commencement of the bankruptcy case, even if the claim was not the same on both dates and the earlier claim had been paid in full before bankruptcy. This decision raises important questions regarding the derivative nature of § 544(b) and could have far-reaching implications with respect to the scope of a bankruptcy trustee\u27s power to recover fraudulently conveyed assets. The court\u27s reasoning has the potential of expanding the trustee\u27s powers beyond the power of any actual creditor at the time of bankruptcy, thus departing from the derivative nature of § 544(b). At the same time, by not linking the trustee\u27s powers under § 544(b) to the rights of future creditors under applicable state fraudulent conveyance statutes, the decision has the potential of narrowing the trustee\u27s avoidance powers in certain situations. The Allou Distributors decision and its potential application to other cases highlight the importance of understanding the relationship of federal and state law, the derivative nature of § 544(b), and the provisions of applicable state fraudulent conveyance statutes