The issue of whether a liquidating agent (or other estate representative) in a Chapter 11 case has standing to prosecute fraudulent conveyance claims against third-party professionals who may also have some involvement with management-led misconduct was the question presented in the case of In re Stanwich Financial Services, 2013 U.S. Dist. LEXIS 41863 (D.Conn., March 26, 2013). In the Stanwich case, the liquidating agent, as the successor to the official committee of unsecured creditors appointed in Stanwich’s Chapter 11 case, sought to recover payments received by certain professionals who allegedly brokered and otherwise assisted with the leveraged buyout of a particular entity.

Applying the Wagoner rule set forth in the Second Circuit case of Shearson Lehman Hutton v. Walter Wagoner Jr. (2d Cir. 1991)—i.e., that a claim against a third party for defrauding a corporation with the cooperation of management accrues to the creditors, not to the guilty corporation—the U.S. Bankruptcy Court for the District of Connecticut concluded that, in fact, the liquidating agent lacked the requisite standing to assert the alleged fraudulent transfer claims.

On appeal, the U.S. District Court for the District of Connecticut disagreed, finding that the Wagoner rule is inapplicable where standing has been statutorily conferred. This article explores the origins of the Second Circuit’s Wagoner rule and the rights afforded to a trustee standing in the shoes of a bankrupt corporation under title 11 of the U.S. Code (the Bankruptcy Code), in general, and, in particular, the reasons underlying the district court’s conclusion that (i) the Wagoner rule was inapplicable, (ii) the liquidating agent had standing to assert the fraudulent transfer claims against third-party professionals, and (iii) the case should be remanded to the Bankruptcy Court for further proceedings.

The ‘Wagoner’ Facts

A look back at the origins of the Wagoner rule will be most helpful before diving into the particular facts of the Stanwich case. In Shearson Lehman Hutton v. Wagoner, Herbert Kirschner, a member of Jehovah’s Witnesses, formed a corporation in July 1982 and was responsible for managing, directing and controlling its trading and business activities. The Kirschner corporation opened several accounts with Shearson/American Express (Shearson Lehman Hutton’s predecessor) and used these accounts to execute various trades on which Shearson took commissions; because the Kirschner corporation’s trading was active, Shearson agreed to provide Kirschner with office space in its offices.

While Kirschner was trading through his corporation, he was simultaneously issuing notes and loan agreements from his corporation to fellow Jehovah’s Witnesses (which notes and loan agreements were not sold or listed on any stock exchange) and using those proceeds to support his continued trading in his corporation’s accounts, in violation of Connecticut state law as neither Kirschner nor his corporation was licensed or registered as a broker or investment advisor.

Seven months after its formation, the Kirschner corporation experienced losses, and Shearson attempted to offer advice to Kirschner to help minimize additional losses. While Kirschner initially confirmed that he was the sole owner of the corporation and was trading only with his own funds, a year later, one of Shearson’s managers became aware that Kirschner might be using loan proceeds derived from others to trade in the corporation’s accounts. Shortly thereafter, Shearson closed the corporation’s accounts and terminated Kirschner’s use of Shearson’s office space and equipment. The Kirschner corporation filed for bankruptcy shortly thereafter.

In 1985, the corporation’s noteholders commenced various actions against Shearson in federal court. Three years later, Walter Wagoner Jr., the bankruptcy trustee for the corporation’s estate, filed a demand for arbitration with the arbitration division of the New York Stock Exchange asserting (i) certain contractual claims stemming from the customer agreements on behalf of the corporation, and (ii) breach of fiduciary duty claims against Shearson. The demand alleged that Shearson sought to strip the corporation of its assets by (i) manipulating Kirschner into “excessively speculative trading” by disregarding various applicable rules and requirements and by providing office space and equipment usage to Kirschner, and (ii) controlling Kirschner by allowing him to trade with highly leveraged funds through the use of Shearson facilities.

In response, Shearson asked the New York Stock Exchange to decline to accept the arbitration, and when its request was denied, Shearson moved for a temporary restraining order and a preliminary injunction in the district court. Those motions were referred to a magistrate who subsequently issued a ruling denying the preliminary injunction motion, holding that (i) the claim being alleged by the trustee appeared to be a timely commenced breach of contract claim (within the applicable six-year statutory period); (ii) while the claims bordered on being frivolous, such determination should be left to the arbitrators, and (iii) the trustee had standing to raise the claims at issue. On reconsideration, the magistrate reversed himself, ruling that because the corporation’s claims sounded in tort—and did not adequately allege a breach of contract—the motion for an injunction should be granted because the three-year statute of limitations (applicable to tort claims) had expired.

As a result, the district court granted the preliminary injunction on that basis and, two years later, granted a permanent injunction barring the trustee from instituting or pursuing arbitration of its claims against Shearson.

‘Wagoner’ Rule

On appeal, Shearson argued that the trustee lacked standing because the claims he alleged on the estate’s behalf (i) belonged to the noteholders, and (ii) were barred because it was the corporation’s sole shareholder and officer who was the principal that engaged in the looting. The trustee disagreed, arguing that he was not asserting the claims of the noteholders. The Second Circuit, therefore, was forced to address the threshold question of the trustee’s standing to assert the particular causes of action in question, and it based its decision on the following well-settled principles of law: (i) the trustee stands in the shoes of the bankrupt corporation and therefore has standing to commence an action such corporation could have commenced had it not sought bankruptcy relief, (ii) the trustee has no standing generally to pursue actions against third parties on behalf of the estate’s creditors; and (iii) when a bankruptcy corporation has joined with a third party in defrauding its creditors, the trustee will not be able to recover against the third party for the damage caused to the creditors. See 11 U.S.C. §§521, 542; Caplin v. Marine Midland Grace Trust, 406 U.S. 416, 249, 32 L.Ed. 2d 195, 92 S. Ct. 1678 (1972).

Applying the foregoing principles to the facts presented, the Second Circuit reached the following conclusions. First, because the first claim alleged in the demand for arbitration was that Shearson churned the corporation’s accounts, and the corporation would have had standing to bring such a claim because churning may give rise to both fraud and breach of contracts claims, the trustee also would have had standing to pursue the churning claims. Second, because the second claim alleged that Shearson essentially aided, abetted and unduly influenced Kirschner in making bad trades that dissipated corporate funds, the trustee lacked standing to pursue this second claim because (i) to the extent the claim alleged money damages to the clients of the corporation, it belonged only to the creditors and the trustee had no standing, and (ii) to the extent the demand alleged money damages to the corporation itself, it was essentially a claim against a third party for defrauding a corporation with the cooperation of management and therefore accrued to creditors, and not to the guilty corporation.

The ‘Stanwich’ Facts

A year after Stanwich Financial Services commenced its Chapter 11 case in June 2001, the official committee of unsecured creditors appointed in the case commenced an adversary proceeding on behalf of the debtor seeking to recover allegedly fraudulent transfers made to the professionals who advised Stanwich in connection with its leveraged buyout (LBO). Pursuant to a court-approved stipulation, the debtor assigned to the committee those claims under the Bankruptcy Code asserted in the complaint, and the committee was granted standing to pursue such claims on the estate’s behalf. In October 2003, the committee filed an amended complaint which supplemented factual allegations and added new counts against the professional defendants including breach of, the aiding-and-abetting of a breach of, and conspiracy to breach fiduciary duties.

Noting that each of the counts against the professionals related to the same alleged wrongdoing—their assistance in completing the LBO—the Bankruptcy Court held that the committee lacked standing to assert such claims as a result of the Wagoner rule. In January 2004, the Bankruptcy Court confirmed the debtor’s first amended Chapter 11 plan which provided for the appointment of a liquidating agent as the successor to the committee. Thereafter, the Bankruptcy Court denied the liquidating agent’s request for leave to amend its complaint, holding that such amendment would be futile in light of the fact that the claims asserted against the professionals were barred by the Wagoner rule, and, as a result, the liquidating agent lacked the requisite standing to assert claims against the professionals. In September 2011, the Bankruptcy Court denied the liquidating agent’s motion for reconsideration, holding, once again, that the liquidating agent lacked standing under the Wagoner rule to pursue its fraudulent transfer causes of action against the professional defendants.

District Court Reverses

On appeal to the district court, the liquidating agent argued that Bankruptcy Code sections 544 and 548 expressly gave it the requisite standing and power to pursue certain avoidance actions that otherwise would belong to creditors, including fraudulent conveyance claims against third-party professionals, and that such authorization and power were not limited at all by the Wagoner rule. The district court agreed.

While the Bankruptcy Court, relying on Second Circuit precedent, including the Wagoner rule, determined that the statutory claims of fraudulent conveyance were merely a pretext for claims the liquidating agent did not otherwise have standing to pursue, the district court noted that the conduct alleged went beyond simply aiding-and-abetting to include the fraudulent transfer of assets. And such claims, the district court concluded, were distinct from the aiding-and-abetting claims, and should therefore have been treated differently for purposes of standing. Indeed, the district court concluded that (i) when acting under section 544(b) of the Bankruptcy Code, the liquidating agent was vested with the rights of actual creditors to avoid certain transfers; (ii) although a liquidating agent cannot use statutory causes of action to avoid the consequences of the Wagoner rule, that rule is not a per se bar to all actions against a third party that arise from the fraudulent conduct of management and the third party; (iii) when Congress has specifically granted the liquidating agent the power to assert the fraudulent transfer claim, Wagoner is inapplicable; and (iv) if transfers were in fact made by Stanwich to its professionals which satisfy the elements of section 548 of the bankruptcy or applicable non-bankruptcy law, the liquidating agent can employ sections 544 and 548 to avoid the transfers. Accordingly, the district court vacated the Bankruptcy Court’s orders and remanded the case back to the Bankruptcy Court for further proceedings.


The takeaway lesson from the Stanwich case is simple and straightforward, but crucial to be mindful of, and taken into account, when investigating the merits, and calculating the value, of certain bankruptcy estate claims and causes of action. And the lesson is this: the Wagoner rule simply does not operate as a per se prohibition against commencing all actions against third-party professionals that arise from the fraudulent conduct of management and the third party. Where the Bankruptcy Code expressly gives a trustee, a liquidating agent or other estate representative the power to avoid certain transfers, thereby statutorily conferring standing on such estate representative, the Wagoner rule is inapplicable.

Steven B. Smith is a partner at Edwards Wildman Palmer and can be reached at