Creditors breathed a sigh of relief Thursday, May 29, after the full Third Circuit Court of Appeals overturned a three-judge panel’s decision barring them from bringing lawsuits to recover assets that were fraudulently transferred.

All 11 Third Circuit judges reviewed the decision of three of their colleagues in a case involving Cybergenics Corp., which filed for Chapter 11 protection with the U.S. Bankruptcy Court for the District of Delaware in Wilmington. Appeals from that court go to the Third Circuit in Philadelphia.

Fraudulent transfer occurs when a company sells or transfers an asset when it is insolvent, thus preventing creditors and others from gaining control of it.

The panel’s decision last September stunned bankruptcy professionals because creditors of companies in Chapter 11 routinely file fraudulent transfer actions.

The original decision from the three-judge panel affects fraudulent actions in “tons of cases”, said G. Eric Brunstad, a partner at Bingham McCutchen LLP and a professor at the Yale Law School, one of the lawyers who argued to overturn the decision.

Among them were Akin Gump Strauss Hauer & Feld LLP, on behalf of the unsecured creditors in the Chapter 11 case of Hayes Lemmerz International Inc. and Milbank Tweed Hadley & McCloy LLP on behalf of creditors of bankrupt Safety-Kleen Corp.

“We are satisfied that bankruptcy courts can authorize creditors’ committees to sue derivatively to avoid fraudulent transfer for the benefit of the estate,” the Third Circuit Court wrote in the 63-page decision.

Four of the 11 judges dissented.

What added to the gravity of the three judges’ ruling was that it concerned a case in Delaware’s bankruptcy court, arguably the nation’s busiest and considered to be pro-debtor. “The reversal of the Cybergenics decision will certainly make Delaware a more favorable venue in which to commence cases,” Cieri said.

Not being able to file or threaten to file fraudulent transfer actions would have taken away a prime tactical weapon from creditors, as well as a potential source of recovery on their claims

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