The Delaware Bankruptcy Court Divided: Whether Creditors' Committees Of Bankrupt Delaware Limited Liability Companies May Bring Derivative Claims

• Published date: 06 March 2024
• Subject Matter: Finance and Banking, Insolvency/Bankruptcy/Re-structuring, Financial Services, Commodities/Derivatives/Stock Exchanges, Insolvency/Bankruptcy
• Law Firm: Arnold & Porter
• Author: Mr Benjamin Mintz and Justin Imperato

The Delaware Limited Liability Company Act (the LLC Act) authorizes state-law derivative actions for Delaware limited liability companies (LLCs), but also expressly limits such actions to members of the LLC or an assignee of the LLC's interest. Other parties in interest, such as creditors of the LLC, are not vested with authority to bring such actions.¹ This stands in contrast to Delaware corporations that do not have a similar standing limitation for derivative actions.

On five separate occasions, the United States Bankruptcy Court for the District of Delaware (the Bankruptcy Court) has either held or suggested that the LLC Act precludes a bankruptcy court from granting an official committee of unsecured creditors standing to pursue an estate cause of action on behalf of the bankrupt LLC.²

In In re Pack Liquidating LLC,³ however, the Bankruptcy Court approved the official committee of unsecured creditors' request to bring derivative breach of fiduciary duty claims against the founders of Packable Holdings LLC, a Delaware LLC, in its Chapter 11 cases. Breaking with prior Delaware bankruptcy court precedent, the Bankruptcy Court held that the LLC Act does not preclude it from granting the committee standing to pursue an estate cause of action against an LLC's members or managers for breach of fiduciary duty, reasoning the restrictions on derivative actions under the LLC Act have no bearing on the Bankruptcy Court's power to authorize the committee to bring an estate cause of action.

Hartford and Cybergenics

The Bankruptcy Court based its decision, in substantial part, on the Third Circuit's Cybergenics⁴ decision, which starts where the Supreme Court left off in Hartford Underwriters Ins. Co. v. Union Planters Bank N.A.⁵

In Hartford, the Supreme Court decided whether an administrative claimant of a Chapter 7 bankruptcy estate has standing to bring suit under Bankruptcy Code section 506(c), which allows the trustee to recover costs and expenses of preserving collateral from the secured creditor. The Supreme Court, noting that section 506(c) states that only 'the trustee may recover,' considered whether it was a proper inference that the trustee is the only party that is entitled to invoke that statutory provision and held that the phrase 'the trustee may recover' means here that only the trustee can use the recovery power granted in section 506(c).⁶ The Supreme Court declined to decide whether its rationale extended to Bankruptcy Code avoidance provisions, which also contain the same phrase, 'the trustee may [avoid/recover],' and left open the validity of the practice under which courts grant creditors or creditors' committees derivative standing to bring avoidance actions.

The Third Circuit addressed this open issue in Cybergenics and authorized a creditors' committee to bring fraudulent transfer suits on behalf of the bankruptcy estate. Notwithstanding the Supreme Court's Hartford decision and the language contained in the avoidance provisions of the Bankruptcy Code, all of which provide that 'the...