Iowa District Court: Avoidance Claims Cannot Be Encumbered by Pre-Bankruptcy Liens

Causes of action for avoidance and recovery of preferential, fraudulent, or unauthorized transfers often are a means of generating value for the benefit of the estate and creditors in a bankruptcy case. For this reason, many courts are skeptical of efforts to encumber avoidance actions so that a single creditor or creditor group derives the benefit of such claims to the detriment of other creditors.  

The U.S. District Court for the Northern District of Iowa addressed this issue in Keystone Savings Bank v. Hanrahan, No. C24-104-LTS-MAR, 2025 WL 2014326 (N.D. Iowa July 17, 2025). Applying the rationale universally accepted by other courts, the district court affirmed a bankruptcy court's determination that bankruptcy avoidance claims are not subject to a prepetition lender's liens on "proceeds" or "general intangibles," even if the debtor may have had some "inchoate interest" in such avoidance actions prior to filing for bankruptcy. 

Broad Scope of Property of the Estate

When a debtor files a bankruptcy petition, the filing creates an "estate" that consists of, among other things, "all legal or equitable interests of the debtor in property as of the commencement of the case" (with certain exceptions) as well as all property that the estate acquires "after the commencement of the case." 11 U.S.C. §§ 541(a)(1) and (a)(7). Also included in "property of the estate" is "[a]ny interest in property that the trustee [or debtor-in-possession ("DIP")] recovers" under various provisions of the Bankruptcy Code (see 11 U.S.C. § 541(a)(3)), including section 550, which authorizes the trustee or DIP to recover any property (or its value) that has been fraudulently or preferentially transferred by the debtor during a specified period prior to its bankruptcy filing.

The estate also includes any property interest that a bankruptcy court orders to be transferred to the estate or preserved for the estate's benefit because it is either a lien securing an equitably subordinated claim (see 11 U.S.C. § 510(c)) or an avoided transfer (see 11 U.S.C. § 551). In addition, under section 541(a)(6) of the Bankruptcy Code, estate property includes any "[p]roceeds, product, offspring, rents, or profits of or from property of the estate," with certain exceptions. 

Section 541 "is intended to include in the estate any property made available to the estate by other provisions of the Bankruptcy Code." City of Chicago, Illinois v. Fulton, 141 S. Ct. 585, 589 (2021). 

Carefully defining the scope of estate property in a given case may be critical to the outcome of the bankruptcy. Property of the estate is protected (with certain exceptions) by the automatic stay under section 362; it may generally be sold, used, or leased under section 363; and, if unencumbered or non-exempt, it is generally available to stakeholders for distribution under a chapter 9, 11, 12, or 13 plan. Given the importance of estate property, courts have found that a wide variety of interests of the debtor qualify as property of the estate. See United States v. Whiting Pools, Inc., 462 U.S. 198, 204 (1983) ("Both the congressional goal of encouraging reorganizations and Congress' choice of methods to protect secured creditors suggest that Congress intended a broad range of property to be included in the estate."); see, e.g., ACandS, Inc. v. Travelers Cas. & Sur. Co., 435 F.3d 252 (3d Cir. 2006) (insurance policies were estate property); Whetzal v. Alderson, 32 F.3d 1302 (8th Cir. 1994) (causes of action); Windstream Holdings, Inc. v. Charter Commc'ns Inc. (In re Windstream Holdings, Inc.), 634 F. Supp. 3d 99 (S.D.N.Y. Oct. 6, 2022) (executory contracts and, in certain circumstances, intangible assets like goodwill), aff'd, 105 F.4th 488 (2d Cir. 2024). 

Bankruptcy Avoidance Actions 

An indispensable tool available to a bankruptcy trustee (or a DIP), by operation of section 1107(a)), is the power to augment the estate by avoiding and recovering certain transfers or obligations incurred by the debtor prior to filing for bankruptcy that either are fraudulent or unfairly prefer certain creditors. With respect to the former of these categories, section 548 of the Bankruptcy Code provides in part that the trustee "may avoid any transfer … of an interest of the debtor in property, or any obligation … incurred by the debtor, that was made or incurred within 2 years before the date of the filing of the petition." 11 U.S.C. § 548(a)(1). 

Fraudulent transfers that can be avoided include both: (i) actual fraudulent transfers, which are transfers made with "actual intent to hinder, delay, or defraud" creditors (see 11 U.S.C. § 548(a)(1)(A)); and (ii) constructive fraudulent transfers, which are "transactions that may be free of actual fraud, but which are deemed to diminish unfairly a debtor's assets in derogation of creditors." Collier on Bankruptcy ("Collier") ¶ 548.05 (16th ed. 2025); 11 U.S.C. § 548(a)(1)(B). 

A transfer is constructively fraudulent if the debtor received "less than a reasonably equivalent value in exchange for such transfer or obligation" and was, or as a result thereof became, insolvent, undercapitalized, or unable to pay its debts as such debts matured. See Collier at ¶ 548.05; 11 U.S.C. § 548(a)(1)(B). 

Fraudulent transfers may also be avoided by a trustee or DIP under section 544(b) of the Bankruptcy Code, which provides that, with certain exceptions, "the trustee may avoid any transfer of an interest of the debtor in property or any obligation incurred by the debtor that is voidable under applicable law by a creditor holding an unsecured claim that is allowable under section 502 of [the Bankruptcy Code] or that is not allowable only under section 502(e) of [the Bankruptcy Code]." 11 U.S.C. § 544(b)(1). This provision permits a trustee to step into the shoes of a "triggering" unsecured creditor that could have sought avoidance of a transfer under applicable non-bankruptcy law (e.g., the Uniform Fraudulent Transfer Act or its successor, the Uniform Voidable Transactions Act, which has been enacted in many states). See generally Collier at ¶ 544.06. Section 544(b) is an important tool, principally because the reach-back period for avoidance of fraudulent transfers under state fraudulent transfer laws (or even non-bankruptcy federal laws, such as the Internal Revenue Code) is typically longer than the two-year period for avoidance under section 548. Id. 

Section 547(b) of the Bankruptcy Code provides that, with certain exceptions, a trustee or DIP, "based on reasonable due diligence in the circumstances of the case and taking into account a party's known or reasonably knowable affirmative defenses under subsection (c)," may avoid "any transfer" made by an insolvent debtor within 90 days of a bankruptcy petition filing (or up to one year, if the transferee is an insider) to a creditor for or on account of an antecedent debt, if the creditor, by reason of the transfer, receives more than it would have received in a chapter 7 liquidation and the transfer had not been made. 11 U.S.C. § 547(b). 

Section 547(c) sets forth nine defenses or exceptions to avoidance. These include, among other things, contemporaneous exchanges for new value, ordinary course of business transfers, transfers involving purchase-money security interests, and transfers after which the transferor subsequently provides new value to the debtor. 

Unauthorized postpetition transfers of estate property may be avoided under section 549, and other provisions of the Bankruptcy Code authorize the trustee or DIP to avoid certain other kinds of transfers. See 11 U.S.C. § 545 (certain statutory liens); 11 U.S.C. § 553(b) (certain setoffs); 11 U.S.C. § 724(a) (avoidance of liens securing certain claims for damages, fines, penalties, and forfeitures). 

If a transfer is avoided under any of these provisions, section 550 of the Bankruptcy Code authorizes the trustee or DIP to recover the property transferred or its value from the initial or subsequent transferees, with certain exceptions. 

Sale of Avoidance Actions in Bankruptcy 

Several circuit courts of appeals have concluded that avoidance actions are estate property that may be sold or assigned by a bankruptcy trustee or DIP during a bankruptcy case. The Ninth Circuit held to that effect in both In re Prof'l Inv. Props. of Am., 955 F.2d 623, 625–26 (9th Cir. 1992) (ruling that a trustee's strong-arm powers were transferable to a purchaser of the estate's claim to proceeds from sale of property and noting that "[i]f a creditor is pursuing interests common to all creditors or is appointed for the purpose of enforcement of the plan, he may exercise the trustee's avoidance powers"), and In re P.R.T.C., Inc., 177 F.3d 774, 780–81 (9th Cir. 1999) ("Although no provision of the bankruptcy code similarly authorizes others to exercise [the trustee's] powers, '[i]t is a well-settled principle that avoidance powers may be assigned to someone other than the debtor or trustee pursuant to a plan of reorganization' under 11 U.S.C. § 1123(b)(3)(B)") (citation omitted); see also In re Lahijani, 325 B.R. 282, 288 (9th Cir. BAP 2005) ("While there is some disagreement among courts about the exercise by others of the trustee's bankruptcy-specific avoiding power causes of action, the Ninth Circuit permits such actions to be sold or transferred."). 

In Mellon Bank, N.A. v. Dick Corp., 351 F.3d 290, 291 (7th Cir. 2003), cert. denied, 541 U.S. 1037 (2004), the Seventh Circuit held that "the right to recover a preference is an asset of the estate that may be assigned or distributed to a particular class of creditors to satisfy their entitlements."  

In Pitman Farms v. ARKK Food Co. (In re Simply Essentials), 78 F.4th 1006 (8th Cir. 2023), the Eighth Circuit similarly held that avoidance actions are estate property that may be sold by a trustee or DIP. In so ruling, the court reasoned that avoidance actions: (i) are property of the estate because a debtor "has an inchoate interest in the avoidance actions prior to the commencement of the bankruptcy proceedings," and that inchoate interest qualifies as estate property under section 541(a)(1) of the Bankruptcy Code, which includes, with some exceptions, "all legal or equitable interests of the debtor in property as of the commencement of the case"; and (ii) are estate property under section 541(a)(7), which defines "estate property" to include "[a]ny interest in property that the estate acquires after the commencement of the cases." Id. at 1009. The Eighth Circuit concluded that avoidance actions are "brought for the benefit of the estate and therefore belong[] to the estate" and that the sale of avoidance actions "is consistent with the congressional intent behind including a fiduciary duty to maximize the value of the estate." Id. at 1008–09. 

In Matter of South Coast Supply Co., 91 F.4th 376 (5th Cir. 2024), cert. denied sub nom. Remmert v. Briar Cap. Working Fund Cap., LLC., 144 S. Ct. 2631 (2024), the Fifth Circuit determined that avoidance actions (in that case, a preference claim) are property of the estate that can be sold to creditors as a means of generating value. Concluding that avoidance actions are estate property under both sections 541(a)(1) and 541(a)(7), the court of appeals cited a previous Fifth Circuit decision for the proposition that "'[t]he scope of property rights and interests included in a bankruptcy estate is very broad: The conditional, future, speculative, or equitable nature of an interest does not prevent it from being property of the bankruptcy estate.'" Id. at 381 (quoting In re Kemp, 52 F.3d 546, 550 (5th Cir. 1995)); see also In re Moore, 608 F.3d 253, 262 (5th Cir. 2010) ("fraudulent-transfer claims are property of the estate under §541(a)(1) … and … may be sold pursuant to §363(b)").  

Liens on Avoidance Actions 

Courts have long agreed that prepetition liens cannot attach to avoidance actions, and that avoidance actions are not "proceeds" of a prepetition lender's collateral. Thus, a prepetition lender's liens on after-acquired property under section 552(b) of the Bankruptcy Code as an exception to the general rule under section 552(a) invalidating prepetition liens on "property acquired by the estate or by the debtor after the commencement of the case" have been preserved. See, e,g., In re AMKO Fishing Co., 2018 WL 3748820, at **7–8 (B.A.P. 9th Cir. Aug. 7, 2018); In re Connolly Geaney Ablitt & Willard, P.C., 585 B.R. 644, 653 (Bankr. D. Mass. 2018); In re Residential Cap., LLC, 497 B.R. 403, 414-15 (Bankr. S.D.N.Y. 2013); In re Pierport Dev. & Realty, 491 B.R. 544, 549 (Bankr. N.D. Ill. 2013); In re Ludford Fruit Prod., Inc., 99 B.R. 18, 25 (Bankr. C.D. Cal. 1989)). 

A leading commentator explained the rationale for this settled proposition as follows:  

Once a bankruptcy case commences, … because all recoveries under the avoiding powers are property of the estate, administered almost exclusively by the trustee for the benefit of the estate as a whole rather than for any creditor individually, it is difficult to see how such recoveries can be other than "after-acquired property" within the meaning of section 552(a), rather than proceeds of prepetition collateral under section 552(b)(1) …. Prebankruptcy state law preferences exist, and may be asserted post bankruptcy under section 544(b) of the Bankruptcy Code. And the assertion by a trustee of state fraudulent transfer law under section 544(b) allows for an expanded recovery under the rule of Moore v. Bay, as well as section 550, underscoring the fact that the recoveries that are property of the estate under section 541(a)(3) are peculiarly postpetition in nature. Indeed, a creditor may not sue to recover a state law fraudulent transfer once a case in bankruptcy is commenced, because this would be taking a chose in action from the estate, thereby violating the automatic stay. On the whole, therefore, the more persuasively reasoned opinions do not permit secured creditors to share in recoveries obtained by bankruptcy trustees or estate representatives pursuant to the avoiding powers, even where such creditors may have independent, traceable rights to those funds. 

Collier at § 552.02[5][d] (footnotes omitted). 

By contrast, bankruptcy courts sometimes grant liens on avoidance actions or recoveries to secure postpetition obligations, such as DIP financing, provided the debtor and the secured lender can demonstrate benefit to the estate that outweighs depriving creditors of recoveries from avoidance claims that would otherwise be unencumbered. See, e.g., Mellon Bank, 351 F.3d at 292–3 (7th Cir. 2003) (where a bankruptcy court, in authorizing DIP financing necessary to permit a distressed debtor to remain in business until its assets could be sold as a going concern, agreed to give prepetition lenders that were otherwise unwilling to participate the first $30 million of any preferences recovered, preference recoveries were for "benefit of the estate," as required by section 550(a) of the Bankruptcy Code, even though the funds recovered went directly to the prepetition lenders), cert. denied, 541 U.S. 1037 (2004).      

Keystone 

BDC Group, Inc. ("BDC") was a solutions-based provider for broadband and communication infrastructure development. BDC filed for chapter 11 protection on June 13, 2023, in the Northern District of Iowa. In 2020 and 2022, BDS borrowed approximately $3.6 million in aggregate from Keystone Savings Bank and its predecessor-in-interest (collectively, "KSB"). The debt was secured by security interests in substantially all of BDC's assets, including "general intangibles" and all "proceeds or products" of the encumbered property. Although the terms of the security agreements differed slightly, "proceeds" were defined in the agreements to include "anything acquired upon the sale, lease, license, exchange, or other disposition of the Property; any rights and claims arising from the Property; and any collections and distributions on account of the Property." 

After BDC filed for bankruptcy, KSB filed a motion with the bankruptcy court seeking a determination that its prepetition security interests were valid and extended to avoidance actions under chapter 5 of the Bankruptcy Code. The unsecured creditors' committee opposed KSB's motion, arguing that avoidance actions come into being only upon the commencement of the bankruptcy case, and therefore cannot be subject to KSB's prepetition liens. 

BDC's chapter 11 case was converted to a chapter 7 liquidation in January 2024, after which the chapter 7 trustee opposed a motion for summary judgment filed by KSB in the lien dispute litigation on the same grounds voiced by the creditors' committee. 

The bankruptcy court denied KSB's motion for summary judgment. In doing so, it rejected KSB's contention that the Eighth Circuit's binding precedent in Simply Essentials, which recognized that, under section 541(a)(1) of the Bankruptcy Code, a debtor has an "inchoate interest" in avoidance actions before the filing of a bankruptcy case, altered longstanding law that prepetition liens do not attach to such actions.  

According to the bankruptcy court, in Simply Essentials the Eighth Circuit narrowly defined a debtor's "inchoate interest" as the debtor's right to file for bankruptcy and invoke the Bankruptcy Code, including its powers to have the trustee or DIP pursue avoidance actions. KSB's expansive interpretation of a debtor's inchoate interest would fundamentally change existing law under which "(1) avoidance actions arise postpetition by statute, (2) the trustee or DIP has the sole right to prosecute such actions, and (3) those avoidance actions can only be pursued for the benefit of all the estate's creditors," unless the trustee or DIP sells the claims to generate value for the estate.  

The court emphasized that KSB's argument was further belied by section 541(a)(7) of the Bankruptcy Code, which clearly states that estate property includes "any interest in property that the estate acquires after the commencement of the case," which would include avoidance actions, and it would make little sense for a single creditor rather than the estate to have control over such an asset.  

Finally, were the court to accept KSB's approach, it would mean that, contrary to the ruling in Simply Essentials and the congressional intent behind including a fiduciary duty to maximize the value of the estate for all creditors, the benefit of avoidance actions would inure to a single creditor rather than all creditors. In re BDC Grp., Inc., 2024 WL 4137984, at **5–8 (Bankr. N.D. Iowa Sept. 10, 2024), aff'd sub nom. Keystone Savings Bank v. Hanrahan, 24-104 (N.D. Iowa July 17, 2025). 

KSB appealed the bankruptcy court's ruling to the district court. 

The District Court's Ruling 

The district court affirmed. U.S. District Judge Leonard T. Strand "agree[d] with the entirety of the Bankruptcy Court's opinion," but addressed certain of KSB's argument in more detail. 

First, Judge Strand rejected KSB's contention that Simply Essentials "overturned prior bankruptcy case law holding that avoidance actions are after-acquired property that cannot be encumbered by pre-petition liens." Keystone, 2025 WL 2014326, at *4. According to the district court, KSB's argument that a debtor's inchoate interest in avoidance claims can be encumbered by a prepetition lien "would turn the reasoning of Simply Essentials on its head by contravening lawmakers' intent in establishing a fiduciary duty to maximize the value of the estate and "allow[ing] a single creditor to diminish the estate at the expense of all creditors." Id. 

Judge Strand agreed with the bankruptcy court and relevant case law concluding that "proceeds" covers only "property that is directly attributable to prepetition collateral, without addition of estate resources." Id. (citations and internal quotation marks omitted), thereby rejecting KSB's argument that avoidance actions are proceeds of the debtor's prepetition inchoate interest in such actions. 

Next, the district court explained that, as the bankruptcy court correctly reasoned, "[t]he inchoate right in avoidance actions that a debtor possesses matures into the debtor's right to file for bankruptcy," after which avoidance claims "arise as a brand-new thing … created postpetition in the trustee or DIP, solely for them to pursue, and solely for the benefit of the estate." Id. (citation and internal quotation marks omitted). 

Outlook 

Although KSB appealed the district court's ruling, that appeal was later dismissed after a settlement was reached between KSB and the chapter 7 trustee of BDC's estate. 

Keystone does not represent a sea change from the prevailing view regarding the inapplicability of prepetition liens to avoidance claims in bankruptcy. Even so, there are some key takeaways from the district court's decision: 

• The expansive definition of "estate property" in section 541 of the Bankruptcy Code encompasses pre-bankruptcy causes of action belonging to the debtor as well as causes of action or claims that spring into existence on the petition date (e.g., avoidance causes of action under the Bankruptcy Code, including claims that a trustee or DIP can assert on behalf of creditors).
• Avoidance claims do not constitute "proceeds" of a prepetition lender's collateral.
• Given the importance of avoidance recoveries for all unsecured creditors, any "inchoate interest" that a debtor may possess pre-bankruptcy in an avoidance cause of action cannot be encumbered by a prepetition lien.