Third Circuit Holds Creditors’ Committee Lacks Capacity to Invoke Section
544(b) to Avoid Fraudulent Transfer Claims
By Scott D. Cousins,
William E. Chipman, Jr.
and C. Michael Terribile,
Greenberg Traurig, Wilmington Office
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In a possibly far-reaching decision, the Third Circuit Court of Appeals
has held that only a trustee (which includes a debtor-in-possession) may
invoke 11 U.S.C. § 544(b) to avoid fraudulent transfer claims. Official
Committee of Unsecured Creditors of Cybergenics Corp. v. Chinery, No.
01-3805, __ F.3d __, 2002 WL 31102712 (3d Cir. (N.J.) Sept. 20, 2002). The
Third Circuit based its holding on the plain language of section 544(b)
of the Bankruptcy Code and the Supreme Court’s decision in Hartford Underwriters
Ins. Co. v. Union Planters Bank, N.A., 530 U.S. 1 (2000). The Court’s
decision rejects the common practice of bankruptcy courts allowing creditors’
committees to bring such claims derivatively. This decision promises to
influence numerous cases and may have unforeseen effects on other areas
of bankruptcy practice.
Summary of the Case
|"This decision promises to influence
numerous cases and may have unforeseen effects on other areas of
In Cybergenics, a chapter 11 case, the Official Committee of Unsecured
Creditors sued to reverse certain transactions as fraudulent transfers under
section 544(b). Initially, the Committee asked Cybergenics, the debtor-in-possession,
to prosecute the fraudulent transfer claims, but Cybergenics refused. Subsequently,
the Committee obtained court authorization to bring the claims derivatively
on behalf of the debtor-in-possession.
Thereafter, on defendants’ motions to dismiss, the District Court reversed,
holding that the Committee did not have the capacity to assert a section
544(b) claim. In affirming the District Court, the Third Circuit relied
on a strict reading of the phrase "trustee may" in section 544 to hold that
the plain language of the statute precluded the Committee from asserting
the claim. The Court relied on the Supreme Court’s strict statutory interpretation
of the same phrase as used in section 506(c) of the Bankruptcy Code in
Hartford, where the Supreme Court held that only the trustee
(or debtor-in-possession) could utilize the recovery power granted by that
section. Further, the Third Circuit stated that the bankruptcy court had
no authority to authorize a creditor or creditors’ committee to bring suit
under section 544 derivatively.
Committee Arguments and the Responses from the Court
The Committee made numerous arguments before the Third Circuit, all of
which were rejected. The Committee argued that Hartford was a chapter
7 case, whereas Cybergenics was a chapter 11 case, which provides
creditors’ committees with rights unavailable in a chapter 7 liquidation,
citing sections 1109(b) and 1103(c)(5) of the Bankruptcy Code. The Third
Circuit noted that section 1109(b) grants a creditors’ committee a broad
right to be heard. It does not, however, confer authority upon a creditors’
committee to initiate an action where the trustee (or debtor-in-possession)
declined to bring suit. In the Court’s view, it only establishes a right
to be heard as a party when a proceeding has already been initiated by the
statutorily-authorized party. Next, the Third Circuit noted that if section
1103(c)(5), a "catch all provision," is given the broad scope urged by the
Committee, this "roving grant of power" to undertake any action in a committee’s
interest would swallow all other conflicting Bankruptcy Code provisions
and any limitations contained therein.
The Third Circuit noted that footnote 5 of the Supreme Court’s decision
in Hartford declined to decide whether its analysis of section 506(c)
extended to the Bankruptcy Code’s fraudulent transfer provisions or whether
the pursuit of derivative claims was prohibited under the Bankruptcy Code.
The Third Circuit disagreed with other courts’ reliance on footnote 5 in
conferring derivative standing to creditors or creditors’ committees to
bring avoidance actions. After examining the cases from other circuits,
the Third Circuit found that those opinions failed (1) to give appropriate
weight to the Supreme Court’s strict interpretation of the Bankruptcy Code
or (2) were decided prior to Hartford.
Finally, the Committee argued that well-settled practice and policy considerations
supported the right of the Committee to bring derivative fraudulent transfer
actions. The Third Circuit rejected this argument stating that achieving
a better policy outcome is a task for Congress, not the courts.
Committee Options from the Court
The Third Circuit noted that a creditor or committee is left with several
options should they desire to pursue fraudulent transfer claims where the
debtor-in-possession refuses to do so. These options include the following:
- Section 1103(c)(4) expressly authorizes a creditors’ committee to
move for the appointment of a trustee under section 1104; or
- As "a party in interest," a Committee can move to dismiss the bankruptcy
petition under section 1112, so that individual creditors may pursue state
law avoidance claims in state court; or
- The Third Circuit noted in footnote 11 of the opinion that section
1123(b)(3)(B) of the Bankruptcy Code may permit a plan of reorganization
to designate a representative, including a committee to enforce certain
claims, such as avoidance claims, for the estate’s benefit.
Possible Wide-Ranging Effects
What Effect does Cybergenics have on Pending Derivative Litigation?
By refusing to allow the Committee to substitute a trustee as the real
party in interest under Fed. R. Civ. P. 17(a), the Third Circuit has left
open the question of whether its ruling may have an effect on pending derivative
litigation commenced by committees other than pursuant to a confirmed plan
as provided for by section 1123(b)(3)(B). Rule 17(a) states that "[n]o action
shall be dismissed on the ground that it is not prosecuted in the name of
a real party in interest until a reasonable time has been allowed" for the
substitution of such party. The Third Circuit concluded that the Committee’s
decision not to seek the appointment of a trustee at any point in the proceeding,
and pursue its claims on its own, was not an "understandable mistake" which
would support the substitution of a real party in interest under Rule 17(a).
It is uncertain whether the courts within the Third Circuit will apply the
holding in Cybergenics to currently-pending cases or dismiss this
portion of Cybergenics as dicta.
What Effect Does Cybergenics Have Upon Interim and Final DIP Orders?
It is unclear at this point what effect the Cybergenics case will
have upon certain standard provisions in many debtor-in-possession financing
orders. For example, bankruptcy courts within the Third Circuit might feel
compelled to limit releases by debtors of their prepetition secured lenders
that provide DIP financing. While these provisions were frequently contained
in interim DIP Orders entered by bankruptcy courts within the Third Circuit,
the court may, instead, permit such provisions only in final DIP orders
after formation of any committees. Similarly, debtors and secured lenders
will certainly have to address how the investigation of the liens and security
interests of prepetition secured lenders will be conducted. Pre-Cybergenics,
such investigations were almost exclusively conducted by creditors’ committees.
Post-Cybergenics, perhaps counsel for a creditors’ committee will
insist upon retaining the right to investigate such claims while leaving
the right to pursue such claims pre-confirmation with the debtor. If after
its investigation the creditors’ committee believes that meritorious claims
against the lenders should be pursued, and the debtor refuses to pursue
such claims, there would appear to be a solid basis for the court to order
the appointment of a chapter 11 trustee.
Will there be Statute of Limitations Issues?
Footnote 11 of the Cybergenics case suggests that under section
1123(b)(3)(B), a plan of reorganization may empower a trustee to retain
a representative to enforce avoidance claims, presumably including a creditors’
committee. In cases where a plan cannot be confirmed in less than two years,
committees may be barred from pursuing such claims as a result of the two-year
statute of limitations to bring avoidance actions under section 546(a) of
the Bankruptcy Code.
Potential Conflicting View Within the Third Circuit?
In another recent Third Circuit opinion, issued just three days after
the Cybergenics opinion, the Court suggests in footnote 7 that the
Office of the United States Trustee might have standing to bring a preference
action under section 307 of the Bankruptcy Code. Under that section, the
U.S. Trustee "may raise and may appear to be heard on any issue in any case
or proceeding under this title but may not file a plan pursuant to 1121(c)"
of the Bankruptcy Code. 11 U.S.C. § 307. The exact same language appears
in section 1109(b), which was rejected as a basis for the Committee to bring
an avoidance action in Cybergenics. This footnote certainly appears
to be inconsistent with the Third Circuit’s holding in Cybergenics.
See In re Pillowtex, Inc., No. 01-2775, ___ F.3d ___, n.7, 2002 WL
31104187 (3d Cir. Sept. 23, 2002) (Sloviter, J.).
Is Cybergenics Ripe for Supreme Court Review?
The Third Circuit in Cybergenics declined to follow the opinions
of other circuit courts which have approved the right of creditors’ committee
to bring derivative fraudulent transfer actions, including the Second, Fifth,
Sixth, Seventh and Ninth Circuits (the Eighth Circuit has recognized that
derivative suits are at least an option). Thus, there is a split of authority
in the Circuits and Supreme Court review appears ripe.
© 2002 Greenberg Traurig
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