Cyberginics Redux: Derivative Standing Again Under Fire

In the October 2002 edition of the Business Restructuring Review (vol. 1, no. 7), we discussed a highly controversial decision handed down by the Court of Appeals for the Third Circuit addressing the power of a bankruptcy court to authorize a creditors' committee to commence avoidance litigation on behalf of a bankruptcy estate. In In re Cybergenics ("Cybergenics I") the Third Circuit ruled that only a bankruptcy trustee (and by implication, a chapter 11 debtor-in-possession ("DIP")) may prosecute estate claims to avoid fraudulent transfers. Rejecting an extensive body of contrary authority and longstanding bankruptcy practice, the Court reasoned that a creditors' committee cannot prosecute estate avoidance actions because the provision of the Bankruptcy Code authorizing such actions section 544(b) expressly refers to a "trustee" and, in accordance with U.S. Supreme Court precedent, should not be interpreted to encompass a committee.

The decision's implications were anything but encouraging: in accordance with current practice, committees are frequently authorized to bring litigation on behalf of the estate. Examples include cases where the debtor unjustifiably refuses to pursue colorable claims, the debtor agrees to allow the committee to sue on behalf of the estate, the estate contains insufficient resources to fund litigation or the debtor previously acknowledged the validity of a lender's liens in connection with post-petition financing or use of cash collateral. Many bankruptcy practitioners and commentators criticized the Third Circuit's ruling, contending that its reasoning was flawed and its ramifications were damaging to the bankruptcy process. Apparently, even the Third Circuit was unsure of its conviction. On November 18, 2002, it vacated the three-judge panel's opinion after voting to rehear the case en banc.

That rehearing resulted in another ruling by the Court of Appeals on May 29, 2003 ("Cybergenics II"). In a detailed opinion exploring various sections of the Bankruptcy Code, the Code's historical antecedents, bankruptcy practice and Supreme Court precedent, the Third Circuit did an about-face. Initially, the Court examined provisions in the Bankruptcy Code authorizing the trustee to commence avoidance litigation that could have been brought by creditors outside of bankruptcy (section 544(b)), delineating the powers and standing of a chapter 11 creditors' committee (sections 1103(c) and 1109(b)) and authorizing the court...