Volume 1, Number 1
Ability
of an Unsecured Creditor
Committee to
Pursue Avoidance Actions
Upheld by Third Circuit
In Cybergenics
Case1
Written
by David B. Wheeler
Moore & Van Allen, PLLC
In an en banc decision, the Third Circuit Court of Appeals upheld the derivative standing of a creditors’ committee to pursue avoidance actions. In doing so, it overruled the rulings of the U.S. District Court and the panel of the Court of Appeals2, which found that the U.S. Supreme Court decision, Hartford Underwriters Insurance Co. v. Union Planters Bank, N.A.3, limited standing for the pursuit of avoidance actions to a trustee or in the chapter 11 context, a debtor in possession and therefore, precluded the pursuit of avoidance actions by a creditors’ committee.
At the outset of its 63-page opinion, the court aptly observed that the Supreme Court in Hartford Underwriters explicitly noted that “derivative standing,” the basis for the standing asserted by the creditors' committee, was not at stake in that case.4 Specifically, the Supreme Court noted:
We do not address whether a bankruptcy court can allow other interested parties to act in the trustee’s stead in pursuing recovery under §506(c). Amici American Insurance Association and National Union Fire Insurance Co. draw [to] our attention the practice of some courts of allowing creditors or creditors committees a derivative right to bring avoidance actions when the trustee refuses to do so, even though the applicable Code provisions, see, 11 U.S.C. §§544, 545, 447(b), 548(a), 549(a), mention only the trustee. See, e.g. In re Gibson Group, Inc., 66 F.3d 1436, 1438 (6th Cir. 1995). Whatever the validity of that practice has been it has no analogous application here since petitioner did not ask the trustee to pursue payment under §506(c) and did not seek permission from the Bankruptcy Court to take such action in the trustee’s stead. Petitioner asserted an independent right to use §506(c), which is what we reject today.
Notwithstanding the inapplicability of Hartford Underwriters, the court emphasized the necessity of identifying a clear basis for the “derivative standing” of a creditors' committee.
First reviewing a committee’s right to raise, appear, and be heard in any issue in a chapter 11 case under §1109(b), the court conceded that such statutory authority, in and of itself, did not rise to the level of providing standing to pursue avoidance actions. However, the court reasoned that any such limitation would only defeat a committee’s automatic standing as opposed to derivative standing. Moreover, the court observed, “Read fairly, §1109(b) addresses only a committee’s direct rights — it says nothing whatever about a court’s power to allow derivative standing to remedy a violation of those rights.” 5 The court found that the broad description of a committee’s role contained in Bankruptcy Code §1103(c)(5) provided a sufficient basis for a committee to be authorized to pursue avoidance actions “where the usual representative is delinquent.” 6 In other words, a committee does not have the automatic right to pursue such causes of action absent specific authorization from the bankruptcy court and a showing that the trustee or debtor in possession is not properly pursuing such actions.
In support of a court’s authority to award and recognize derivative standing, the Court found significant, if not absolute, support in §503(b)(3)(B), providing for a priority payment of the expenses of “a creditor that recovers, after the court’s approval, for the benefit of the estate, any property transferred or concealed by the debtor.” 7 It then turned to the equitable nature of a bankruptcy court to sew up its finding in support of a committee’s derivative standing:
We believe that the ability to confer derivative standing upon creditors' committees is a straightforward application of bankruptcy court’s equitable powers.8
Explaining further, the court reasoned:
The problem at bar is that the intended system broke down. The debtor refused to bring an action that the bankruptcy court found would benefit the Estate and thereby violated its fiduciary duty to maximize the Estate’s value. It is in precisely this situation that the bankruptcy courts’ equitable powers are most valuable, for the courts are able to craft flexible remedies that, while not expressly authorized by the Code, effect the result of the Code was designed to obtain. As the Supreme Court has noted, “Equity eschews mechanical rules; it depends on flexibility,” Holberg v. Armbcht, 327 U.S. 392, 396 (1946), and “there is inherent in the Court’s of equity, a jurisdiction to…give effect to the policy of the legislature.” Mitchell v. Robert Demario Jewelry, Inc., 361 U.S. 288, 292 (1960) (quoting Clark v. Smith, 13 Bet. 1985, 203 (1839)).
Suffice it to say that this by no means constitutes an exhaustive analysis of this lengthy opinion. However, it returns stability to the practice of creditors’ committees and other interested third parties to pursue avoidance actions when authorized by the court.
1 2003 U.S. App. LEXIS 10703 (May 29, 2003) [Back to text]
2 304 F.2d 316 (2000) [Back to text]
3 530 U.S. 1 (2000) [Back to text]
4 2003 U.S. App. LEXIS 10703, 6 [Back to text]
5 Id @ 21 [Back to text]
6 Id @ 23 [Back to text]
7 See, Id [Back to text]
8 Id @ 31 [Back to text]
OTHER
STORIES
IN THIS ISSUE:
Delaware
Bankruptcy Court Rules State
Property Law Inapplicable
in Preference Action