The Twombly-Iqbal Effect On Bankruptcy Litigation

By C. Daniel Lins

Increasingly, courts are holding that bankruptcy lawsuits, such as avoidance actions and nondischargeability actions, are subject to the heightened pleading standards set forth in Bell Atlantic Corp. v. Twombly, 550 U.S. 544 (2007) and Ashcroft v. Iqbal, 129 S.Ct. 1937 (2009). Bare-bones complaints that may have survived motions to dismiss prior to Twombly-Iqbal, are now at risk of dismissal. As such, bankruptcy practitioners filing such actions should strive to provide as much factual detail for each cause of action as possible. And those defending such actions should scrutinize complaints to ensure they are sufficiently pleaded under Twombly-Iqbal -- and file a motion to dismiss under Rules 8 and 12 if they are not.

I.  The Twombly-Iqbal Standard

Rule 8(a)(2) of the Federal Rules of Civil Procedure states that to properly state a claim for relief, a pleading must contain "a short and plain statement of the claim showing that the pleader is entitled to relief." In Conley v. Gibson, 355 U.S. 41, 45-56 (1957), the Supreme Court famously observed that a case should be dismissed for failure to state a claim only if it "appears beyond doubt that the plaintiff can prove no set of facts in support of his claim which would entitle him to relief." In 2007, however, Twombly initiated a tectonic shift in Rule 8 analysis, holding that allegations in a complaint must be more than just conceivable ("no set of facts"), they must be plausible.

In Twombly, customers of local telephone and internet service companies filed a class action lawsuit against regional carriers, asserting that these regional carriers had engaged in conspiracy in restraint of trade. The customers alleged that these regional carriers engaged in "parallel conduct" to inhibit the growth of the local companies, such as making unfair agreements with the local companies for access to the regional networks, providing inferior connections, overcharging, and billing in ways designed to sabotage the local companies' relationships with their own customers. According to the complaint, this "parallel conduct" of the regional carriers was evidence of an unlawful conspiracy.

The Twombly Court held that the allegations of parallel conduct between the defendants coupled with a bare assertion of conspiracy did not state a claim for conspiracy. The Court held that a complaint must allege facts that "plausibly suggest" that there was an agreement between the parties, not merely allege facts that are consistent with such an agreement. Likewise, a complaint must contain more than mere "labels and conclusions, and a formulaic recitation of the elements of a cause of action." The Court specifically rejected the plaintiffs' argument under Conley that the allegations were sufficient unless it appeared that the plaintiffs could "prove no set of facts" that would entitle him to relief. ("The phrase is best forgotten as an incomplete, negative gloss on an accepted pleading standard.").

Two years later, in Iqbal, the Court held that the Twombly standard applied to all federal civil cases. Mr. Iqbal, a Pakistani detainee, filed suit against the Attorney General, FBI Director, and others alleging that they should be held personally liable for alleged discrimination because they agreed to a policy that resulted in his arrest, detention, and harsh conditions of confinement. Citing Twombly, the Court held that Mr. Iqbal needed to plead facts to show that the defendants acted for the purpose of discriminating on account of race, religion, or national origin, and not some lawful reason. In short, the Court held that the complaint did not plausibly suggest that Mr. Ashcroft and the others' purpose was to discriminate against Arab Muslims.

In addition to confirming that Twombly applied to all civil actions, Iqbal established that "only a complaint that states a plausible claim for relief survives a motion to dismiss." A claim is plausible "when the plaintiff pleads factual content that allows the court to draw the reasonable inference that the defendant is liable for the misconduct alleged." The Court then explained that determining plausibility is "a context-specific task that requires the reviewing court to draw on its judicial experience and common sense."

II.  Twombly-Iqbal in Bankruptcy

Since 2009, bankruptcy courts have increasingly applied Twombly-Iqbal -- as would be expected -- to complaints in bankruptcy, perhaps most frequently in preference litigation. Recent decisions applying Twombly-Iqbal in the bankruptcy-litigation context including the following:

In In re Shirk, 437 B.R. 592 (Bankr. S.D. Ohio 2010), Chapter 13 debtors sued the successor in interest to their original mortgage lender, seeking to recover for misrepresentations by the original lender. The Court granted the lender's motion to dismiss, holding, among other things, that a single sentence in the complaint asserting that the lender had accelerated the mortgage in violation of unspecified provisions of the National Housing Act (NHA), without any factual allegations showing that the lender was even subject to the NHA, failed the heightened Twombly-Iqbal standard. The Court reasoned that the claims were mere "naked assertion[s]" and "conclusory allegations" that were "not entitled to the assumption of truth" and therefore must be dismissed under Twombly-Iqbal.

In In re Caremerica, Inc., 409 B.R. 737 (Bankr. E.D.N.C. 2009), the chapter 7 trustee sued the defendants under Bankruptcy Code Sections 547 and 548 seeking to recover preferential and fraudulent transfers to alleged insiders. The defendants filed motions to dismiss alleging that the complaints were not sufficiently pled under Rule 8. The Court, applying the heightened Twombly-Iqbal pleading standard, granted the defendants' motions to dismiss, reasoning: (1) the complaint failed to meet the "plausibility" standard because it did not indicate which debtor entity initiated the transfers in question; (2) the complaint's allegation that the preferential transfers were made for or on account of an antecedent debt was conclusory; and (3) the complaint failed to factually demonstrate that the debtor was insolvent. The Caremerica Court, however, granted the trustee leave to amend his complaint to adhere to the new Twombly-Iqbal standard.

In In re American Camshaft Specialties, Inc., 410 B.R. 765 (Bankr. E.D. Mich. 2009), a chapter 7 trustee sued related corporate entities to recover inter-company transfers between the debtors and those related corporate entities, to recover from common directors of the debtors and the related corporate entities for breach of fiduciary duty, and to substantively consolidate the debtors with the related corporate entities. In ruling on the defendants' motion to dismiss, the court found that the complaint contained sufficient facts to state a plausible claim for breach of duty of loyalty under Twombly-Iqbal. However, applying that same standard, the Court dismissed the substantive consolidation claim because the trustee had not sufficiently pleaded facts necessary to support a cause of action for substantive consolidation. Interestingly, the Court found that allegations of inter-company loans and transfers may have been sufficient to state an avoidance claim, but they were insufficient to state claim for substantive consolidation on the facts of that case.

Bankruptcy courts in Tennessee have also applied Twombly-Iqbal, although in relatively few recorded decisions. See In re Propex, Inc., 415 B.R. 321 (Bankr. E.D. Tenn. 2009) (applying Twombly-Iqbal in dismissing fraudulent conveyance and avoidance action claims); In re Sakalla, 2010 WL 711115 (Bankr. E.D. Tenn. Feb. 24, 2010) (holding creditor sufficiently alleged facts under Twombly-Iqbal to support claims of fraud, defalcation, and intentional injury in nondischargeability complaint). These cases demonstrate that a wide variety of bankruptcy actions are now subject to the heightened pleading requirements set forth in Twombly-Iqbal, and bankruptcy litigators should seek to provide as much factual support for each cause of action as is reasonably possible. Although courts, such as in the Caremerica case, have been pragmatic and liberal in allowing plaintiffs leave to amend complaints that should otherwise be dismissed under Twombly-Iqbal, in the words of Benjamin Franklin, an ounce of prevention is worth a pound of cure.