Creditors' Committee Denied Standing To Bring Derivative Claims On Behalf Of LLC Debtor In Bankruptcy

Published date26 October 2020
Law FirmJones Day
AuthorMr Dan Moss and Mark Douglas

The practice of conferring "derivative standing" on official creditors' committees to assert claims on behalf of a bankruptcy estate in cases where the debtor or a bankruptcy trustee is unwilling or unable to do so is a well-established means of generating value for the estate from litigation recoveries. However, in a series of recent decisions, the Delaware bankruptcy courts have limited the practice in cases where applicable non-bankruptcy state law provides that creditors do not have standing to bring claims on behalf of certain entities. The latest of these rulings was handed down recently by Judge Karen B. Owens in the chapter 11 cases of Dura Automotive Systems, LLC and its affiliates (collectively, "Dura"). The court ruled that an official creditors' committee could not be granted derivative standing to prosecute claims against Dura's prepetition lenders because Delaware's limited liability company ("LLC") law restricts standing to prosecute actions on behalf of an LLC to its members and their assigns. See In re Dura Automotive Systems, LLC, No. 19-12378 (KBO) (Bankr. D. Del. June 9, 2020) (unpublished bench ruling).

The court's approach adopted in Dura Automotive has not been followed in most other cases. Many other bankruptcy courts, including the New York bankruptcy court overseeing the chapter 11 cases filed in February 2020 by The McClatchy Co. and its affiliates, have granted standing to committees in cases involving LLCs organized under state laws with restrictions similar to Delaware's LLC law.

Derivative Standing

Standing is the ability to commence litigation in a court of law. It is a threshold issue'a court must determine whether a litigant has the legal capacity to pursue claims before the court can adjudicate the dispute. In the bankruptcy context, various provisions of the Bankruptcy Code confer standing on various entities (e.g., the debtor, the debtor-in-possession ("DIP"), a bankruptcy trustee, creditors, equity interest holders, official committees, and indenture trustees) to, among other things, participate generally in a bankruptcy case or commence litigation involving causes of action or claims that either belonged to the debtor prior to filing for bankruptcy or are created by the Bankruptcy Code.

The right to participate generally in a chapter 11 case is more explicit. Section 1109(b) of the Bankruptcy Code provides that any "party in interest," including the debtor, the trustee, a committee of creditors or equity security holders, a creditor, an equity security holder, or an indenture trustee "may appear and may be heard on any issue" in a chapter 11 "case." This general right to participate, however, does not confer standing upon every party in interest to engage in litigation expressly contemplated by other provisions of the Bankruptcy Code, such as lien and transfer avoidance. Many Bankruptcy Code provisions deal with claims or causes of action belonging to the debtor prior to filing for bankruptcy, which become part of the debtor's bankruptcy estate on the petition date. Standing to prosecute such estate claims is expressly given by the Bankruptcy Code to the bankruptcy trustee (or the DIP, by operation of section 1107(a) of the Bankruptcy Code).

Most courts, however, will allow official creditors' committees to commence litigation on behalf of the estate under narrowly defined circumstances, reasoning that certain provisions of the Bankruptcy Code imply a qualified right to derivative standing for official creditors' committee, including: (i) section 1109(b); (ii) section 1103(c)(5), which provides that a creditors' committee may "perform such ... other services as are in the interest of those represented"; and (iii) section 503(b)(3)(B), which provides that the court shall grant administrative priority in payment for 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." Courts have also reasoned that derivative standing is an appropriate exercise of the court's broad equitable powers under section 105(a) of the Bankruptcy Code to "issue any order, process, or judgment that is necessary or appropriate to carry out the provisions" of the Bankruptcy Code. See generally Collier on Bankruptcy ' 1103.05[6][a] (16th ed. 2020).

One of the seminal cases addressing this issue is Unsecured Creditors Committee of Debtor STN Enterprises, Inc. v. Noyes (In re STN Enterprises), 779 F.2d 901 (2d Cir. 1985). In STN Enterprises, the U.S. Court of Appeals for the Second Circuit Court ruled that, in considering an official creditors' committee's request for leave to sue a director for misconduct, a court is required to consider whether the debtor unjustifiably failed to initiate suit against the director and whether the action is likely to benefit the debtor's estate (i.e., the time and expense for such litigation is justified given the likelihood of success in such litigation).

The Second Circuit later refined the doctrine of "derivative standing" in Commodore Int'l Ltd. v. Gould (In re Commodore Int'l Ltd.), 262 F.3d 96 (2d Cir. 2001). In Commodore, the court ruled that a committee may bring suit even if the trustee or DIP does not unjustifiably refuse to do so as long as: (i) the trustee or DIP consents; and (ii) the court finds that the litigation is (a) in the best interests of the...

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