X

Thank you for sharing!

Your article was successfully shared with the contacts you provided.
On Sept. 20, the 3rd U.S. Circuit Court of Appeals issued an opinion that may have a significant impact on the traditional role of a creditors’ committee in instituting causes of action that a debtor-in-possession, or a trustee, will not bring. The facts of Official Committee of Unsecured Creditors of Cybergenics Corp. v. Chinery, et al., No. 01-3805, presented a common situation in a Chapter 11 case. The debtor, Cybergenics Corp., filed a voluntary petition pursuant to the provisions of Chapter 11 of the Bankruptcy Code in August 1996. Cybergenics had been founded in 1985 as a marketer of nutritional food supplements. Sometime in 1994, a third party initiated negotiations to buy the company in a leveraged buyout; the acquisition was completed in December of that year. Despite continued infusions by the LBO acquirer of the company and the lenders who financed the LBO, a filing was necessary. Cybergenics remained a debtor-in-possession and an official committee of unsecured creditors was appointed; at no time in the case was appointment of a trustee sought. Rather than reorganize, the debtor sought — and had approved — a sale of all of its assets pursuant to � 363 of the code in a court-supervised auction. After approval of the sale, the debtor sought dismissal of the Chapter 11 case, but the committee objected, believing that certain transactions relating to the LBO could give rise to fraudulent transfer actions. The debtor responded that it declined to prosecute any fraudulent transfer actions, and the committee, based on its own investigation of the LBO, sought leave from the bankruptcy court to bring the actions on behalf of the estate under the often used and widely recognized theory of “derivative standing.” The bankruptcy court, after a hearing, concluded that the committee could do so. The target defendants appealed. In their appeal, the defendants contended that by virtue of its sale of “all” of its assets, the debtor had sold any fraudulent transfer claims that may have existed to the purchaser and thus, there was no asset to administer. The district court agreed, finding that the fraudulent transfer claims (if any) were property of the estate and, having been sold, were no longer assets of the debtor’s estate. The circuit court reversed ( In re Cybergenics Corp., 226 F.3d 237 (3rd Cir. 2000)), holding that state law provides that fraudulent transfer claims belong to creditors, that the asset sale could not have included a sale of the potential fraudulent transfer claims, and that, although these claims belonged to creditors, a trustee or debtor-in-possession was expressly authorized as a representative to bring such claims on behalf of the estate pursuant to � 544(b) of the code. The circuit court thus remanded the case for further proceedings. After remand, the defendants again moved to dismiss, but this time raised, for the first time, that a plain reading of � 544(b) authorized only a trustee or a debtor-in-possession, and that no one else (including a creditors’ committee) had standing to bring such an action, citing the decision of the U.S. Supreme Court in Hartford Underwriters Ins. Co. v. Union Planters Bank, 530 U.S. 1 (2000). The district court agreed with the defendants, holding that the committee could not bring suit under the “derivative standing” theory. It found that the code does not authorize a committee to bring a fraudulent transfer action derivatively, and that the Supreme Court’s interpretation of the term “the trustee may” in the Hartford Underwriters case applied to the provision of � 544(b) of the code. The committee again appealed. In the Hartford Underwriters case, the issue before the Supreme Court was whether or not an individual administrative creditor in a Chapter 7 case could bring an action under � 506(c) of the code to recover payment of its claim. The Supreme Court, noting that the language of � 506(c) of the code stated that ” … [t]he trustee may recover … ,” concluded that this phrase meant that the trustee, and only the trustee, had standing to pursue claims under � 506(c). The Supreme Court, however, declined in that case to consider whether this reasoning would apply to other portions of the code in which the phrase ” … [t]he trustee may … ” is utilized. Specifically, the Supreme Court did not address the validity of the practice under which courts often grant to other parties-in-interest, especially creditors’ committees, a derivative right to bring avoidance actions (for example, preference actions and fraudulent transfer actions). Here, then, the 3rd Circuit was confronted with this very issue. The 3rd Circuit first noted that under � 544(b) of the code, “the trustee may avoid any transfer of an interest in property … that is voidable under state law.” Thus, a trustee (and, when no trustee has been appointed in a Chapter 11 case, a debtor-in-possession) may bring state law causes of action, such as fraudulent transfer actions. It further noted that in Hartford Underwriters, the Supreme Court (per Justice Scalia) found that the phrase ” … the trustee may … ” indicated that Congress intended that this power was reserved to a trustee (or debtor-in-possession), and was not to be used by other parties. Importantly, however, in a footnote, the Supreme Court limited its holding “by declining to address ‘whether a bankruptcy court can allow other interested parties to act in the trustee’s stead in pursuing recovery under 506(c)’ or other Code provisions.” Indeed, the Supreme Court acknowledged the “derivative standing” practice often used by courts in allowing committees to bring avoidance actions, but since the case did not present the issue, it did not assess the legality of the practice. The 3rd Circuit noted that, since 506(c) was not implicated here, it had to decide the issue, which was addressed but not answered, by the footnote. Does Hartford Underwriters apply to actions under � 544(b) of the code? Does the plain language of � 544(b) and Hartford Underwriters invalidate the “rather well-established” practice of allowing creditors’ committees (and individual creditors) to bring avoidance actions when the trustee of the debtor-in-possession will not? The answer was yes. The 3rd Circuit first discussed and recognized the often-adopted practice of allowing parties other than the trustee to bring avoidance actions when: (a) a colorable claim exists, (b) the authorized party refuses to bring the claim and (c) the refusal is unjustified given the fiduciary duty of the trustee to maximize the value of a bankruptcy estate. It noted that a number of other courts of appeals have held the practice valid. It further found that in the instant case, the factors usually cited by those circuits (and courts in the 3rd Circuit) in support of “derivative standing” had been met after a hearing. The question, the 3rd Circuit stated, was whether this principle survives Hartford Underwriters. The 3rd Circuit first engaged in a thorough analysis of Hartford Underwriters. It concluded, after noting the “special role” played by trustees in a bankruptcy case, that Congress may well have clearly intended that the trustee would have greater powers than other parties-in-interest in cases, giving trustees rights that others simply should not have. The Supreme Court also noted that if Congress intended others to share power in bringing such actions, it could have said so; instead, it did not refer to other parties. The circuit court thus concluded that it agreed with the district court, which found that there was “no principled basis” for applying different meanings to the phrase “the trustee may” in one portion of the code and in another. The committee advanced several distinctions between the facts of its case and the facts of Hartford Underwriters. It first noted that Hartford Underwriters was a Chapter 7 case — the case before the court was a Chapter 11 case — noting that in a Chapter 11 case a committee, under �� 1103(c) and 1109(b) of the code, has broad powers, including the right to intervene on any issue in a case under Chapter 11, and (under � 1103) the right, among other things, to “perform such other services as are in the interest of those represented.” The court found this argument unpersuasive. It noted that � 1109, as conceded by the committee, does not give a committee a right to institute suit, only a right to be heard by way of intervention. Indeed, the circuit court noted that in dicta, the Supreme Court had anticipated such an argument in Hartford Underwriters, stating that that court would not read � 1109(b) of the code to allow a non-trustee to bring suit (“[i]n any event, we do not read s 1109(b)’s general provision of a right to be heard as broadly allowing a creditor to pursue substantive remedies that other code provisions make available only to other specific parties”). The 3rd Circuit similarly found � 1103 of the code not to provide a sufficient statutory basis for the authority to bring suit, stating that such a “roving grant of power” would “swallow all other conflicting code provisions and any limitations contained in them.” The 3rd Circuit next examined various opinions issued after Hartford Underwriters that have used the “footnote limitation” found therein to keep the “derivative standing” concept alive. That analysis did not persuade the 3rd Circuit to alter its views. It noted that the dicta in Hartford Underwriters, though dicta, should not be ignored. That dicta, the 3rd Circuit noted, helps ” … control and influence the many issues it cannot decide because of its limited docket.” The 3rd Circuit believed that failing to apply Hartford Underwriters to a Chapter 11 derivative creditor suit ” … would yield an outcome other than the one the Supreme Court would likely reach … .” Finally, the creditors’ committee highlighted prior practice and policy reasons for allowing it to prosecute the fraudulent transfer actions. It argued that the practice was well-established before enactment of the code. In response, the 3rd Circuit stated that, while pre-code practice “informs our understanding of the code, it cannot overcome that language.” The 3rd Circuit acknowledged that a trustee (and especially a debtor-in-possession) cannot act in a vacuum; it is often faced with conflicts of interest, which influence its decisions with respect to avoidance actions. Indeed, in the absence of a creditors’ committee, a debtor-in-possession’s decisions may not be scrutinized. Yet, the court noted, it was for Congress, not the courts, to fashion a new procedure for dealing with this issue. It might be sound policy, the court stated, to change the procedures; the 3rd Circuit would not, though, usurp the role of Congress. As a last resort, the committee requested remand so that a trustee could be appointed. This argument was not persuasive. The court noted that at no time did the committee seek a trustee, resorting, instead, to the “derivative standing” argument. Thus, the court would not consider that request on appeal. Where does this decision leave the bankruptcy practitioner? Watch for the appointment of more Chapter 11 trustees, increased administrative costs and perhaps, in the end, a net loss, not gain, for creditors. Myron A. Bloom is a shareholder with the firm of Hangley Aronchick Segal & Pudlin (www.hangley.com). His practice is concentrated in the areas of corporate organization, bankruptcy, commercial workouts and creditors’ rights.

This content has been archived. It is available exclusively through our partner LexisNexis®.

To view this content, please continue to Lexis Advance®.

Not a Lexis Advance® Subscriber? Subscribe Now

Why am I seeing this?

LexisNexis® is now the exclusive third party online distributor of the broad collection of current and archived versions of ALM's legal news publications. LexisNexis® customers will be able to access and use ALM's content by subscribing to the LexisNexis® services via Lexis Advance®. This includes content from the National Law Journal®, The American Lawyer®, Law Technology News®, The New York Law Journal® and Corporate Counsel®, as well as ALM's other newspapers, directories, legal treatises, published and unpublished court opinions, and other sources of legal information.

ALM's content plays a significant role in your work and research, and now through this alliance LexisNexis® will bring you access to an even more comprehensive collection of legal content.

For questions call 1-877-256-2472 or contact us at [email protected]

 
 

ALM Legal Publication Newsletters

Sign Up Today and Never Miss Another Story.

As part of your digital membership, you can sign up for an unlimited number of a wide range of complimentary newsletters. Visit your My Account page to make your selections. Get the timely legal news and critical analysis you cannot afford to miss. Tailored just for you. In your inbox. Every day.

Copyright © 2020 ALM Media Properties, LLC. All Rights Reserved.