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american lawyer media news service Philadelphia-In an important bankruptcy decision, a divided 11-judge panel of the 3d U.S. Circuit Court of Appeals has ruled that a creditors’ committee in a Chapter 11 case can be authorized by the bankruptcy court to pursue a lawsuit that the debtor itself opted not to take up. Voting 7-4, the court in Official Committee of Unsecured Creditors of Cybergenics Corp. v. Chinery, No. 01-3805, rejected the argument that the Bankruptcy Code specifically limits the power to bring such lawsuits-so-called “derivative avoidance actions”-to bankruptcy trustees. Four dissenting judges complained that their colleagues’ decision conflicted with U.S. Supreme Court case law and effectively “broadened the statute to add a party that Congress specifically omitted.” Bankruptcy lawyers hailed the May 29 decision as one that would end a brief era of confusion that began in September 2002 when a three-judge panel of the same court held that bankruptcy judges should never authorize creditors’ committees to bring derivative lawsuits. The September decision, authored by Judge Julio M. Fuentes, focused on a three-word phrase-”the trustee may”-that appears several times in the Bankruptcy Code. Fuentes found that the U.S. Supreme Court took a strict reading of the phrase in its 2000 decision in Hartford Underwriters Ins. Co. v. Union Planters Bank, 530 U.S. 1, a Chapter 7 case that interpreted the phrase as it appeared in Section 506(c) to prohibit anyone other than a trustee from seeking to recover administrative costs on its own behalf. Since the same three-word phrase appears in Section 544, Fuentes said, the Hartford Underwriters decision controls the outcome. The reaction in the bankruptcy bar was harshly critical. One commentator for the American Bankruptcy Institute said the decision “departed from 100 years of settled bankruptcy law.” Rehearing requested Lawyers for the Cybergenics unsecured creditors’ committee asked for a rehearing before the full court. In their brief, attorneys Gary D. Sesser and James Gadsden of Carter Ledyard & Milburn of New York argued that the original panel’s ruling was “an unwarranted and improper extension of the Supreme Court’s decision in Hartford Underwriters,” and that it “effectively eliminates a longstanding and salutary bankruptcy practice that predates and was unchanged by the Bankruptcy Code.” If allowed to stand, they argued, the decision “will undermine Congress’ reorganization objectives in enacting Chapter 11 of the code and deprive creditors in dozens of the largest pending bankruptcy cases of the ability to pursue hundreds of transfers involving billions of dollars for the benefit of the estates.” The 3d Circuit’s new ruling sides with the creditors’ committee, finding that Congress wanted courts to allow such lawsuits. Senior Judge Edward R. Becker, writing for the court, said it was important to see the differences between Cybergenics and Hartford Underwriters. When seen in context, Becker said, it is clear that while the Supreme Court took a strict and narrow reading of the phrase “the trustee may” in a Chapter 7 case to bar an individual lender from pursuing its own claim, it would not do so in a Chapter 11 case to bar a creditors’ committee from pursuing claims on the debtor’s behalf. “The petitioner in Hartford Underwriters was an insurer who, by continuing coverage despite [the debtor's] failure to pay its premiums, became an administrative lender with claims subordinate to those of the secured creditors. When it learned of [the] bankruptcy, it attempted to use 506(c) to recover the premiums it was owed, but it did so in a strikingly unilateral fashion,” Becker wrote. “The insurance premiums were not costs incurred by the trustee that, if recovered, would have yielded a common benefit. Instead, they would have satisfied only Hartford’s outstanding claim. “Nor did Hartford seek the court’s or the trustee’s permission to recoup the expense, but rather it sued in its own name and for its own direct benefit,” Becker wrote. The Cybergenics case was “markedly different,” Becker said. “When the committee discovered that certain transfers made by Cybergenics were potentially avoidable as fraudulent, it first petitioned the Cybergenics management to file an avoidance action under Section 544(b),” Becker wrote. “But management refused to file that action, claiming that the costs would likely outweigh the benefits, and it maintained this position even after the committee volunteered to bear all litigation costs. “The committee, finding management’s stance unreasonable, petitioned the bankruptcy court for permission to prosecute a Section 544(b) avoidance action in Cybergenics’s name and on its behalf-any recovery would go not to the Committee, but to the estate itself.” Becker said the bankruptcy court properly concluded that the fraud claims were colorable, and that the committee’s offer to bear the litigation costs insulated the estate from risk.

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