The “New” Federal Pleading Standard after Twombly and Iqbal
The typical standard of pleading in federal cases has long been governed by Federal Rules of Civil Procedure 8 and 9. Historically, it was well settled that a complaint should not be dismissed for failure to state a claim unless it appeared “beyond doubt” that the plaintiff could prove no set of facts in support of its claims.1 However, two recent Supreme Court decisions have threatened to dramatically change the framework under which federal complaints are analyzed for sufficiency: Bell Atlantic Corp. v. Twombly and Ashcroft v. Iqbal.2
In Twombly, the Supreme Court articulated its replacement of the traditional pleading standard under Rule 8 with a new requirement that a complaint state “enough factual matter” to make the claim “plausible.”3 Earlier this year, the court reaffirmed this paradigm shift, adding that a new federal heightened pleadings standard requires that “a complaint must contain sufficient factual matter, accepted as true, to ‘state a claim for relief that is plausible on its face’” in order to survive a motion to dismiss for failure to state a claim.4 The traditional notion that a court must accept a complaint’s allegations as true was held to apply strictly to factual statements, and not to “threadbare recitals” of a cause of action’s elements, supported by mere conclusory statements.
“A claim has facial plausibility when the plaintiff pleads factual content that allows the court to draw the reasonable inference that the defendant is liable for the misconduct alleged.”5 “The plausibility standard is not akin to a ‘probability requirement,’ but it asks for more than a sheer possibility that a defendant has acted unlawfully.”6
Under Iqbal, federal courts must now carefully separate the factual allegations of a complaint from cursory recitations of legal conclusion. A court may then, in its discretion, dismiss a complaint for failure to state a claim where it does not appear, from the purely factual allegations therein, more likely than not that illegal conduct occurred. Since Federal Rules of Civil Procedure 8 and 9 are made applicable to bankruptcy proceedings by operation of Federal Rules of Bankruptcy Procedure 7008 and 7009, Twombly and Iqbal will likely have a profound effect on complaints filed in bankruptcy court, and avoidance and recovery claims asserted in adversary proceedings will undoubtedly be subject to the same increased judicial scrutiny as their non-bankruptcy counterparts.
The Caremerica Decisions
A series of recent decisions in the Caremerica bankruptcy has already put avoidance actions to the Twombly/Iqbal test.7 In those bankruptcy cases, the trustee filed a number of adversary complaints alleging certain preferential and fraudulent transfers made by the debtor to the various defendants.
Analysis of Preferential Transfer Claims
In Caremerica I, the trustee sought to set aside allegedly preferential and fraudulent transfers made by the debtor in an apparent attempt to avoid attachment of the debtor’s bank accounts by creditors. When the defendants moved to dismiss the trustee’s complaint under Federal Rule Civil Procedure 12(b)(6) for failure to state a claim upon which relief may be granted, the court analyzed the trustee’s allegations in light of the Twombly and Iqbal decisions. The court first found that the trustee’s complaint was insufficient as to the preference claims, holding that the trustee had failed to plead with requisite specificity the majority of the elements of an avoidable preference under §547 of the Bankruptcy Code.
Immediately fatal to the trustee’s preference claims was the court’s finding that the trustee had failed to carry his burden in showing that the transfers at issue were transfers of the debtor’s property.8 Although the bank statements and summary of transfers included in the complaint’s exhibit lent sufficient factual support to the allegation that various transfers were made from related entities’ accounts to the defendants, the evidence did not indicate the source of the funds entering the related entities’ accounts or which entity initiated each transfer.9 Accordingly, the court held that the trustee’s allegations of transfers of interests of the debtors in property failed to meet the “plausibility” standard imposed post-Iqbal.
The court also found that the trustee made simply the “conclusory assertion” that each alleged preferential transfer was made “for, or on account of, an antecedent debt” owed by the debtor to the defendant before such transfer was made. (Id.) However, to satisfy the plausibility requirement for this element under Iqbal, the court held that the trustee must allege facts regarding the specific nature and amount of the antecedent debt at issue.10
A debtor is presumed to have been insolvent on, and during the 90 days immediately preceding, the date of the filing of its petition in bankruptcy.11 However, for transfers to insiders made between 90 days and one year prior to filing, there is no such presumption. In light of Iqbal, the court found that the trustee must allege sufficient facts to show that insolvency during this period was plausible.12 Citing In re Troll Communications,13 the Caremerica I court held that the trustee’s facial allegations of the debtor’s insolvency failed to satisfy the plausibility requirement. As a result of the trustee’s failure to demonstrate a number of the prima facie elements of a preferential transfer, the trustee’s preference claims were dismissed.
Analysis of Fraudulent Transfer Claims
In addition to preference claims, the trustee in Caremerica also sought to avoid certain alleged fraudulent transfers made within the two-year period prior to the debtor’s petition date. The trustee asserted that these transfers were founded on both actual fraud and constructive fraud.14 Under §548(a)(1), a transfer is avoidable if it was either actually fraudulent in that it “i.) had at its purpose an intent to hinder, delay or defraud the debtor’s creditors,” or that it was constructively fraudulent in that it “ii.) was made while the debtor was in a precarious financial condition, and the transaction did not provide the debtor with a reasonably equivalent value in exchange for the item transferred.”15
Although allegations of actual fraudulent transfer are generally subject to the heightened pleading standard of Federal Rule Civil Procedure 9, claims of constructive fraudulent transfer are subject to the “typical” standard imposed by Federal Rule Civil Procedure 8.16 Nevertheless, the Caremerica I court found the trustee’s claims for actual fraudulent transfer sufficient to survive the defendants’ motion to dismiss, but dismissed those claims arising in constructive fraudulent transfer for lack of plausibility, despite the relatively lower threshold imposed by Federal Rule of Civil Procedure 8 versus Federal Rule of Civil Procedure 9.17
Notably, the Caremerica I trustee acknowledged that his claims sounding in actual fraudulent transfer were subject to the pleading standard of Federal Rule Civil Procedure 9(b), but argued that the particularity requirement imposed by the rule should be relaxed “because he is a third party with secondhand knowledge and limited access to information at the pleading stage.” 18 The Caremerica I court rejected this argument, holding that a “trustee is certainly more likely to have access to this information than the antitrust plaintiffs in Twombly or the Pakistani detainee in Iqbal.”19
Utilizing a similar analytical framework to the above, the court also dismissed the trustee’s preferential and fraudulent-transfer claims in Caremerica II and Caremerica III. In each of the Caremerica cases, however, the court granted the trustee leave to amend his complaint in order to re-plead the dismissed claims with the specificity now required by the Twombly/Iqbal standard.
There can be no doubt that the Twombly/Iqbal decisions will place a more substantial burden on plaintiffs in federal suits. In the bankruptcy context, trustees thrust into investigating a suddenly defunct debtor and inheriting less-than-complete accounting records may find little sympathy from bankruptcy courts in pleading avoidance actions in the manner that they have done for decades. The heightened pleading standard articulated in Caremerica has already been followed in at least one other bankruptcy court.20 It seems inevitable that New Jersey bankruptcy courts will follow suit as well when faced with the issue.
The Supreme Court’s subtle transition from notice pleading to what is essentially fact pleading has not been met without criticism. During the 111th Congress of 2009-10, Sen. Arlen Spector (D-Pa.) introduced to the Senate the Notice Pleading Restoration Act of 2009 (S. 1504). The aim of that act is “a bill to provide that Federal courts shall not dismiss complaints under [R]ule 12(b)(6) or (e)…except under the standards set forth by the Supreme Court of the United States in Conley v. Gibson, 355 U.S. 41 (1957).”
The New Jersey Law Journal also weighed in on the post-Iqbal regime in a recent editorial: “Of course, it is often the case that the facts that would ‘plausibly’ support a theory of liability are in the hands of the defendant, and without discovery, remain unknown to the plaintiff drafting a complaint… This new decision, of course, only applies to pleading in the federal courts. We would like to see the decision limited by the court in the future to complex cases such as Bell Atlantic and Iqbal, but, in any event, we would hope that this approach is not followed by the New Jersey courts.”21
Stephen M. Packman is chair and Douglas G. Leney is a member of the Debtor/Creditor’s Rights Practice Group at Archer & Greiner PC in Haddonfield, NJ.
This article was first published in the February 2010 ABI Bankruptcy Litigation Committee e-Newsletter, Vol. 7, No. 2, and is reprinted herein with the permission of the American Bankruptcy Institute (www.abiworld.org).
- Conley v. Gibson, 355 U.S. 41, 45-46 (1957)
- Bell Atlantic Corp. v. Twombly, 550 U.S. 544, 127 S.Ct. 1955 (2007); Ashcroft v. Iqbal 129 S.Ct. 1937 (2009)
- Twombly, 127 S.Ct. at 1965
- Iqbal, 129 S.Ct. at 137
- Iqbal, 129 S.Ct. at 949 (citing Twombly, 550 U.S. at 556)
- See Angell v. BER Care Inc. (In re Caremerica Inc.), 409 B.R. 737 (Bankr. E.D.N.C. 2009) (Caremerica I); Angell v. Haveri (In re Caremerica Inc.), 409 B.R. 346 (Bankr. E.D.N.C. 2009) (Caremerica II); Angell v. Burrell (In re Caremerica Inc.), 2009 WL 2253225 (Bankr. E.D.N.C. July 28, 2009) (Caremerica III)
- Caremerica I, 409 B.R. at 750-51
- 11 U.S.C. §547(f)
- Id. at 752
- 385 B.R. 110, 114 (Bankr. D. Del. 2008)
- Caremerica I, 409 B.R. at 754-55, 11 U.S.C. §548(a)(1)(A), (B)
- Id. See also 5 Collier on Bankruptcy, ¶548.01 (Alan N. Resnick and Henry J. Sommer, eds, 15th ed. rev.)
- See, e.g., In re Saba Enterprises Inc., 2009 WL 3049651 at *9 (Bankr. S.D.N.Y.) (Sept. 19, 2009) (citations omitted)
- Id. at 756-57
- Caremerica I, 409 B.R. at 755. See also O.E.M./Erie Inc. v. McCallum, 405 B.R. 779, 788 (Bankr. W.D. Pa. 2009) (opining that “there is greater liberality for pleading fraud in a bankruptcy case,” and that flexibility in heightened pleading standard of Federal Rule Civil Procedure 9(b) is “required because it is often the Trustee, a third-party outsider to the fraudulent transaction, that must plead fraud on second hand knowledge for the benefit of the estate and all of its creditors.”)
- Compare, e.g., In re Randall’s Island Family Golf Center Inc., 290 B.R. 55, 65 (Bankr. S.D.N.Y. 2003); In re Chari, 276 B.R. 206, 214 (Bankr. S.D. Ohio 2002), with Caremerica I, 409 B.R. at 754
- See In re McLaughlin, 2009 WL 2878522 (Bankr. D. N.H. Sept. 3, 2009).
- 197 N.J.L.J. 958, New Jersey Law Journal, Volume 197, No. 12, Index 941 (Sept. 21, 2009)