Document ID: s3://data.kl3m.ai/documents/govinfo/USCOURTS/USCOURTS-ca8-07-01821/USCOURTS-ca8-07-01821-0/pdf.json

Parties Involved:
Kip M. Kaler
Not Party
North Dakota Breeders Fund
Appellee
North Dakota Purse Fund
Appellee
North Dakota Racing Commission
Appellee
PW Enterprises
Appellant
Racing Services

State of North Dakota
Appellee

Document Text:

United States Court of Appeals

FOR THE EIGHTH CIRCUIT

___________

No. 07-1821

___________

In re: Racing Services, Inc., *

*

Debtor *

______________ *

*

PW Enterprises, Inc., a Nevada *

Corporation, *

*

Appellant, *

* Appeal from the United States

v. * Bankruptcy Appellate Panel for the

* Eighth Circuit.

North Dakota Racing Commission, *

a regulatory agency; North Dakota *

Breeders Fund, a special fund; North *

Dakota Purse Fund, a special fund; *

North Dakota Promotions Fund, a *

special fund; State of North Dakota, *

a governmental entity, *

*

Appellees. *

*

Kip M. Kaler, Bankruptcy Trustee for *

Racing Services, Inc. * ___________

Submitted: January 18, 2008

Filed: August 29, 2008

___________

Before WOLLMAN, BRIGHT, and SMITH, Circuit Judges.

___________

Appellate Case: 07-1821 Page: 1 Date Filed: 08/29/2008 Entry ID: 3465856
1

On appeal, the State of North Dakota filed a single brief on behalf of itself and

the other Appellee-Defendant state entities: North Dakota Racing Commission, North

Dakota Breeders Fund, North Dakota Purse Fund, and North Dakota Promotions

Fund.

-2-

BRIGHT, Circuit Judge.

The Bankruptcy Code expressly authorizes a trustee (or debtor-in-possession)

to bring an adversary proceeding to avoid certain transfers as preferential or

fraudulent. In some cases, however, courts have allowed creditors to bring such

“avoidance claims” if it would benefit the estate. A creditor who brings avoidance

claims in place of the trustee is said to possess “derivative standing.” In this case, we

must decide whether the bankruptcy court erred in holding that, as a matter of law, a

creditor may never obtain derivative standing to pursue avoidance claims absent a

showing that the trustee was “unable or unwilling” to do so. We have jurisdiction

pursuant to 28 U.S.C. § 158(d)(1) and now reverse and remand.

I

When it was a going concern, debtor Racing Services, Inc. (“Racing Services”)

operated a horse race wagering service business. On February 3, 2004, Racing

Services filed a voluntary Chapter 11 petition for reorganization in the United States

Bankruptcy Court for the District of Delaware. The case was subsequently transferred

to North Dakota and converted to a liquidation proceeding under Chapter 7 because

reorganization was not possible. Appellant PW Enterprises, Inc. (“PW Enterprises”)

is Racing Services’ largest non-governmental creditor and holds an unsecured claim

of more than $2 million. PW Enterprises has actively participated in this case,

including sitting on the Creditors’ Committee when the case was in Chapter 11.

Appellees State of North Dakota and affiliated state entities (collectively the “State”)1

assert a $6 million priority tax claim. PW Enterprises argues because of the size of

Appellate Case: 07-1821 Page: 2 Date Filed: 08/29/2008 Entry ID: 3465856
2

Neither the Trustee nor Racing Services are parties to this appeal.

3

PW Enterprises also argued that Racing Services made certain transfers to the

State for which it was not responsible for under North Dakota law. Thus, PW

Enterprises sought to void these transfers for the benefit of the estate.

4

In pertinent part, Section 547 provides:

(b) Except as provided in subsections (c) and (i) of this section, the

trustee may avoid any transfer of an interest of the debtor in property--

 (1) to or for the benefit of a creditor;

 (2) for or on account of an antecedent debt owed by the debtor before

such transfer was made;

 (3) made while the debtor was insolvent;

 (4) made--

 (A) on or within 90 days before the date of the filing of the petition;

or

 (B) between ninety days and one year before the date of the filing of

-3-

the State’s claim, it (along with the other unsecured creditors) currently stands to

recover nothing.

On January 31, 2006, five days before the statute of limitations was to expire,

PW Enterprises approached the Chapter 7 Trustee Kip Kaler (“Trustee”)2

 and

requested that he initiate an adversary proceeding against the State to, among other

things, avoid certain preferential and fraudulent transfers made to the State by Racing

Services that were, in PW Enterprises’ view, improperly classified as “taxes.”3

 At the

Trustee’s request, PW Enterprises prepared a draft complaint for his review. The

Trustee declined to bring the specific claims that PW Enterprises wanted him to assert.

See PW Enters., Inc. v. North Dakota (In re Racing Servs., Inc.), 363 B.R. 911, 913

(8th Cir. BAP 2007) (detailing Trustee’s reasons for declining to bring an adversarial

proceeding against the State). On February 2, 2006, without the bankruptcy court’s

permission, but within the two-year statute of limitations, PW Enterprises filed the

complaint, which included avoidance claims under 11 U.S.C. §§ 547, 548.4

Appellate Case: 07-1821 Page: 3 Date Filed: 08/29/2008 Entry ID: 3465856
the petition, if such creditor at the time of such transfer was an insider;

and

 (5) that enables such creditor to receive more than such creditor would

receive if--

 (A) the case were a case under chapter 7 of this title;

 (B) the transfer had not been made; and

 (C) such creditor received payment of such debt to the extent provided by

the provisions of this title.

11 U.S.C. § 547(b).

In pertinent part, Section 548 provides:

(a) (1) The trustee may avoid any transfer (including any transfer to or

for the benefit of an insider under an employment contract) of an interest

of the debtor in property, or any obligation (including any obligation to

or for the benefit of an insider under an employment contract) incurred

by the debtor, that was made or incurred on or within 2 years before the

date of the filing of the petition, if the debtor voluntarily or

involuntarily--

 (A) made such transfer or incurred such obligation with actual intent

to hinder, delay, or defraud any entity to which the debtor was or

became, on or after the date that such transfer was made or such

obligation was incurred, indebted; or

 (B) (i) received less than a reasonably equivalent value in exchange

for such transfer or obligation; and

 (ii) (I) was insolvent on the date that such transfer was made or

such obligation was incurred, or became insolvent as a result of such

transfer or obligation;

 (II) was engaged in business or a transaction, or was about to

engage in business or a transaction, for which any property remaining

with the debtor was an unreasonably small capital;

 (III) intended to incur, or believed that the debtor would incur,

debts that would be beyond the debtor's ability to pay as such debts

matured; or

-4-

Appellate Case: 07-1821 Page: 4 Date Filed: 08/29/2008 Entry ID: 3465856
 (IV) made such transfer to or for the benefit of an insider, or

incurred such obligation to or for the benefit of an insider, under an

employment contract and not in the ordinary course of business.

11 U.S.C. § 548(a)(1).

-5-

Subsequently, in April 2006, PW Enterprises moved for leave to pursue these claims,

i.e., sought derivative standing.

With the exception of the State, no party opposed PW Enterprises’ April 2006

motion. The Trustee filed a formal response stating that he “does not resist PW

[Enterprises’] motion . . . but requests that the [Bankruptcy] Court make clear, that the

action pursued is an action of the estate and for the benefit of the estate from which

no single creditor shall have a disproportionate gain.” In response, PW Enterprises

affirmed that it was “not seeking standing to pursue the [avoidance] Claims for its

own benefit . . . [but] for the benefit of the estate” and “agree[d] to advance the fees

and costs attendant to the prosecution of the Complaint.”

On July 10, 2006, the bankruptcy court held a telephonic hearing on PW

Enterprises’ motion and denied it on August 7, 2006. The bankruptcy court concluded

that PW Enterprises did not have standing to pursue an adversary action against the

State because it failed to establish that the Trustee abused his discretion or acted

unjustifiably by failing to pursue the avoidance claims. The bankruptcy court did not

address PW Enterprises’ contention that a creditor may proceed derivatively if the

trustee consents to, or does not oppose, the action.

The Bankruptcy Appellate Panel (“BAP”) affirmed the bankruptcy court’s

decision denying PW Enterprises’ motion. The BAP declined to resolve the issue of

whether derivative standing was appropriate when a trustee consents. Rather, the

BAP concluded that the bankruptcy court properly denied PW Enterprises derivative

Appellate Case: 07-1821 Page: 5 Date Filed: 08/29/2008 Entry ID: 3465856
5

The State suggests that in this case the denial was especially appropriate

because PW Enterprises moved to proceed derivatively after the expiration of the

statute of limitations. The State, however, does not develop this argument. Rather,

the State’s timing argument focuses primarily on the fact that PW Enterprises filed its

motion to proceed derivatively after filing its complaint.

-6-

standing because it did not first seek permission with the bankruptcy court to file its

complaint. See In re Racing Servs., Inc., 363 B.R. at 916-17.

On appeal, PW Enterprises argues that the bankruptcy court erred by holding

that a creditor may proceed derivatively only when the trustee acts improperly or

abuses his discretion. While neither defending nor declaiming the bankruptcy court’s

rationale, the State argues that it properly denied PW Enterprises standing because its

motion was untimely, i.e., PW Enterprises sought derivative standing only after filing

its complaint.5

II

We apply the same standard of review as the BAP. We review the bankruptcy

court’s findings of fact for clear error and its legal conclusions de novo. See

Blackwell v. Lurie (In re Popkin & Stern), 223 F.3d 764, 765 (8th Cir. 2000). We

review the bankruptcy court’s order denying PW Enterprises standing, as a matter of

law, de novo. See, e.g., Hartford Underwriters Ins. Co. v. Magna Bank, N.A. (In re

Hen House Interstate, Inc.), 177 F.3d 719, 721 (8th Cir. 1999), aff’d sub nom.

Hartford Underwriters Ins. Co. v. Union Planters Bank, N.A., 530 U.S. 1 (2000).

III

A

We begin by resolving the uncertainty in this Circuit over the availability of

derivative standing when a trustee is “unable or unwilling” to pursue avoidance claims

Appellate Case: 07-1821 Page: 6 Date Filed: 08/29/2008 Entry ID: 3465856
6

A Chapter 11 debtor-in-possession has similar powers and responsibilities as

a Chapter 7 trustee. See 11 U.S.C. § 1107 (debtors-in-possession expressly given the

rights and powers of a trustee). We see no reason to differentiate between these

proceedings for the purpose of the derivative standing analysis.

-7-

under the Bankruptcy Code. As the BAP observed below, bankruptcy courts within

the Eighth Circuit have expressed conflicting views on whether our decision in Nagle

v. Lauer (In re Lauer), 98 F.3d 378 (8th Cir. 1996), formally endorsed the possibility

of derivative standing in this context. See In re Racing Servs., Inc., 363 B.R. at 915-

16 (noting that some bankruptcy courts recognize the possibility of derivative standing

under In re Lauer when a trustee is unwilling to pursue avoidance actions, whereas

other bankruptcy courts outright reject derivative standing or seek further guidance

from the Court of Appeals). In In re Lauer, we affirmed the denial of standing to

creditors who sought to void certain pre-bankruptcy transfers under 11 U.S.C. § 548

because they “alleged no facts to support an inference that the bankruptcy trustee was

unable or unwilling to pursue claims on behalf of the estate.” 98 F.3d at 388. We

stated that as a general rule “[a]bsent evidence that the trustee cannot be relied upon

to assert [claims under §§ 547, 548], claims to avoid preferential transfers may not be

brought by creditors.” Id.

We now make clear what In re Lauer implicitly recognized: derivative standing

is available to a creditor to pursue avoidance actions when it shows that a Chapter 7

trustee (or debtor-in-possession in the case of Chapter 11) is “unable or unwilling” to

do so.6

 In so holding, we join those circuits that have addressed this issue and

uniformly recognized the possibility of derivative standing in this context. See Smart

World Techs., LLC v. Juno Online Servs., Inc. (In re Smart World Techs., LLC), 423

F.3d 166, 176 (2d Cir. 2005) (citing Unsecured Creditors Comm. of Debtor STN

Enters., Inc. v. Noyes (In re STN Enters.), 779 F.2d 901 (2d Cir. 1985)); Official

Comm. of Unsecured Creditors v. Chinery (In re Cybergenics Corp.), 330 F.3d 548,

553 (3d Cir. 2003) (en banc); Fogel v. Zell, 221 F.3d 955, 965 (7th Cir. 2000);

Avalanche Mar., Ltd. v. Parekh (In re Parmetex, Inc.), 199 F.3d 1029, 1031 (9th Cir.

Appellate Case: 07-1821 Page: 7 Date Filed: 08/29/2008 Entry ID: 3465856
7

We agree with the Third Circuit that the Supreme Court’s decision in Hartford

Underwriters Ins. Co. v. Union Planters Bank, N.A., 530 U.S. 1 (2000), does not

foreclose derivative standing under the Bankruptcy Code. See In re Cybergenics

Corp., 330 F.3d at 555-67; see also Term Loan Holder Comm. v. Ozer Group, L.L.C.

(In re Caldor Corp.), 303 F.3d 161, 166 n.2 (2d Cir. 2002) (post-Hartford

Underwriters decision approving derivative standing); Fogel v. Zell, 221 F.3d 955,

965 (7th Cir. 2000) (same). Our basic agreement with the Third Circuit that derivative

standing survives Hartford Underwriters should not be understood, however, as a

wholesale endorsement of its analysis or subsidiary conclusions regarding various

provisions of the Bankruptcy Code.

In Hartford Underwriters, debtor Hen House obtained workers’ compensation

insurance from petitioner Hartford Underwriters (“Hartford”) (which was unaware of

the bankruptcy proceedings) as part of its Chapter 11 reorganization strategy.

Although Hen House failed to pay its premiums, Hartford continued to provide

insurance. The Chapter 11 reorganization failed, however, and the bankruptcy court

converted the case to a Chapter 7 liquidation. At this point, Hartford learned of Hen

House’s bankruptcy and sought recovery of the overdue premiums. The parties

agreed that under 11 U.S.C. § 503(b) the unpaid premiums qualified as

“administrative expenses” and therefore took priority over any unsecured claims, but

not over secured claims, see 11 U.S.C. § 506. Because the estate lacked

unencumbered funds to pay the premiums and virtually all of Hen House’s assets were

held by secured creditors, Hartford – as an administrative claimant – was not likely

to recover anything unless its claim took priority over at least some of the secured

claims. Hartford attempted to accomplish this by filing an application with the

bankruptcy court under § 506(c), which provides an exception to the typical priority

order.

Under § 506(c), “[t]he trustee may recover from property securing an allowed

secured claim the reasonable, necessary costs and expenses of preserving, or disposing

of, such property to the extent of any benefit to the holder of such claim.” 11 U.S.C.

§ 506(c) (emphasis added). Hartford argued it could properly invoke § 506(c) to

recover the unpaid premiums, despite not being the trustee, because: (1) the provision

does not restrict its enforceability to the trustee; (2) pre-Bankruptcy Code practice

recognized administrative claimant standing; and (3) policy considerations favor

-8-

1999); Canadian Pac. Forest Prods. Ltd. v. J.D. Irving, Ltd. (In re Gibson Group, Inc.),

66 F.3d 1436, 1440-41 (6th Cir. 1995); La. World Exposition v. Fed. Ins. Co., 858

F.2d 233, 247-48 (5th Cir. 1988).7

Appellate Case: 07-1821 Page: 8 Date Filed: 08/29/2008 Entry ID: 3465856
granting standing to administrative claimants. 

The Supreme Court unanimously rejected these arguments. The Court carefully

noted, however, that its decision did not “address whether a bankruptcy court can

allow other interested parties to act in the trustee’s stead in pursuing recovery under

§ 506(c)” because “it ha[d] no analogous application . . . since [Hartford] did not ask

the trustee to pursue payment . . . and did not seek permission from the Bankruptcy

Court to take such action.” Hartford Underwriters, 530 U.S. at 13 n.5. The Court

made clear that it had rejected only “the assert[ion] [of] an independent right to use

§ 506(c).” Id. Hartford Underwriters therefore does not control because it did not

answer the question before us: whether the bankruptcy court may authorize a creditor

to bring claims the Bankruptcy Code expressly reserves to the trustee (or debtor-inpossession). 

Finally, we note that no court of appeals has expressly rejected the possibility

of derivative standing when a trustee is unable or unwilling to pursue avoidance

actions. But see Scott v. National Century Fin. Enters., Inc. (In re Baltimore

Emergency Servs. II, Corp.), 432 F.3d 557, 560-61 (4th Cir. 2005) (expressing

hostility toward the availability of derivative standing under the Bankruptcy Code);

In re Cybergenics Corp., 330 F.3d at 580-87 (Fuentes, J., dissenting, joined by Alito,

Sloviter, Smith, JJ.) (arguing that the analytical framework of Hartford Underwriters

forecloses the availability of derivative standing.).

-9-

Even those bankruptcy courts that correctly read In re Lauer as permitting

derivative standing, however, “disagree[d] as to what constitutes the trustee’s inability

or unwillingness to bring suit which justifies derivative standing.” In re Racing

Servs., Inc., 363 B.R. at 915. This discord is hardly surprising because In re Lauer did

not detail what a creditor must actually show to establish inability or unwillingness

on the part of the trustee. Taken to an extreme, the literal import of its “unable or

unwilling” language suggests that a creditor could proceed derivatively by merely

showing that the trustee is unable to pursue the creditor’s claims because the trustee

is ‘too busy,’ ‘lacks funds,’ or ‘just doesn’t want to.’ We now make clear that In re

Lauer demands more of a creditor who seeks derivative standing. If creditors could

obtain derivative standing too readily, they “could usurp the central role that the

trustee or debtor-in-possession plays as the representative of the estate.” In re

Baltimore Emergency Servs. II, Corp., 432 F.3d 557, 562 (4th Cir. 2005). And so, to

Appellate Case: 07-1821 Page: 9 Date Filed: 08/29/2008 Entry ID: 3465856
8

A creditor’s request for derivative standing must be supported by competent

evidence, for example, in the form of affidavits or through oral testimony at an

evidentiary hearing. See, e.g., In re STN Enters., 779 F.2d at 905.

9

We emphasize that the burden of persuasion always remains with the creditor.

And so, even if the trustee offers no reasons for his refusal to pursue the creditor’s

proposed claims, the bankruptcy court may nevertheless reject the creditor’s request

to proceed derivatively. But see In re Gibson Group, Inc., 66 F.3d at 1446 (“A

creditor has met its burden [by showing] . . . it has fulfilled the first three requirements

and the trustee . . . declined to take action without stating a reason. The burden then

-10-

prevent derivative adversary proceedings from becoming the norm in bankruptcy, we

agree with our sister circuits that the critical inquiry is whether the trustee (or debtorin-possession) abused its discretion by unjustifiably refusing to pursue the creditor’s

proposed claims. See Fogel, 221 F.3d at 966; In re Gibson Group, Inc., 66 F.3d at

1442; La. World Exposition, 858 F.2d at 247-48; In re STN Enters., 779 F.2d at 905.

We therefore hold, to establish derivative standing, a creditor must show: (1)

it petitioned the trustee to bring the claims and the trustee refused; (2) its claims are

colorable; (3) it sought permission from the bankruptcy court to initiate an adversary

proceeding; and (4) the trustee unjustifiably refused to pursue the claims. We expect

in most cases creditors will readily satisfy the first three elements without much

difficulty – petitioning the trustee and bankruptcy court ought to be mere formalities.

And a creditor’s claims are colorable if they would survive a motion to dismiss. The

real challenge for the creditor will be to persuade the bankruptcy court that the trustee

unjustifiably refuses to bring its claims. To satisfy its burden, the creditor, at a

minimum, must provide the bankruptcy court with specific reasons why it believes the

trustee’s refusal is unjustified.8

 A creditor thus does not meet its burden with a naked

assertion that ‘the trustee’s refusal is unjustified.’ If presented with nothing more than

this, the bankruptcy court may properly deny a creditor’s motion without explanation.

The creditor, not the bankruptcy court, has the onus of establishing the trustee

unjustifiably refuses to bring the creditor’s claim.9

Appellate Case: 07-1821 Page: 10 Date Filed: 08/29/2008 Entry ID: 3465856
shifts to the [trustee] to establish, by a preponderance of the evidence, that [his] reason

for not acting is justified.”).

-11-

We hesitate to speculate, however, on the type of factual showing that would

demonstrate a trustee unjustifiably refuses to pursue a creditor’s claims. Our inability

to do so stems from the fact that the circumstances which make a trustee’s decision

unjustified in one bankruptcy may not necessarily support the same conclusion in

another. But we also believe the universe of circumstances in which the trustee’s

refusal to bring a creditor’s claims is unjustified to be somewhat limited. At one end

of the spectrum, a trustee almost certainly abuses his discretion by refusing to bring

a creditor’s claim that, if successful, would clearly benefit the estate. At the other end,

a trustee certainly does not abuse his discretion by refusing to bring a claim that would

yield insignificant benefits to the estate. A more difficult situation, however, is when

the creditor establishes that its claims, if successful, would offer more than marginal

benefits to the estate but not necessarily a windfall. See also In re STN Enters., 779

F.2d at 906 (suggesting that a trustee’s refusal to pursue claims might be unjustified

when a creditor (or creditors’ committee) is willing to shoulder the costs of litigation

and the fee arrangement imposes no net burden on the bankruptcy estate); William B.

Tanner Co. v. United States (In re Automated Business Sys., Inc.), 642 F.2d 200, 201-

02 (6th Cir. 1981) (holding that a creditor had standing to file an avoidance action

where trustee refused to bring suit due to lack of funds). In short, we trust that

bankruptcy judges will, in the first instance, refine the contours of when derivative

standing is appropriate.

At bottom, the determination of whether the trustee unjustifiably refuses to

bring a creditor’s proposed claims will require bankruptcy courts to perform a costbenefit analysis. See In re STN Enters., 779 F.2d at 905. While by no means

exhaustive, among the factors the court should consider in conducting this analysis

are: (1) “[the] probabilities of legal success and financial recovery in event of

success”; (2) the creditor’s proposed fee arrangement; and (3) “the anticipated delay

Appellate Case: 07-1821 Page: 11 Date Filed: 08/29/2008 Entry ID: 3465856
-12-

and expense to the bankruptcy estate that the initiation and continuation of litigation

will likely produce.” Id. at 905-906. We do not suggest, however, that the bankruptcy

court “undertake a mini-trial” in evaluating a creditor’s request for derivative

standing. Id. at 905 (citing Eisen v. Carlisle & Jacquelin, 417 U.S. 156, 177-78 (1974)

(no mini-trial in class actions)). But the bankruptcy court must support its decision

to grant or deny standing with a written or oral explanation that reflects it conducted

the appropriate cost-benefit analysis.

Ultimately, the bankruptcy court’s decision whether to grant a creditor

derivative standing will be reviewed for an abuse of discretion. This standard of

review reflects the understanding that the decision of whether to permit a creditor to

assert claims the Bankruptcy Code expressly reserves for the trustee (or debtor-inpossession) is a quintessential exercise of the bankruptcy court’s equitable powers.

See, e.g., In re Cybergenics Corp., 330 F.3d at 567-69. And like other equitable

determinations, it warrants considerable deference from a reviewing court. See, e.g.,

C.T. Dev. Corp. v. Barnes (In re Oxford Dev., Ltd.), 67 F.3d 683, 685 (8th Cir. 1995)

(“[W]e review the bankruptcy court’s equitable determinations for abuse of

discretion.”) (citing Foy v. Klapmeier, 992 F.2d 774, 779 (8th Cir. 1993)). Such

deference ensures that bankruptcy courts will neither feel constrained from flexibly

exercising their equitable powers to grant or deny creditors derivative standing nor

fear unenlightened second-guessing by the court of appeals.

B

PW Enterprises did not argue that the Trustee unjustifiably refused to pursue

its claims. Rather, PW Enterprises sought permission to proceed derivatively under

circumstances in which the Trustee did not oppose its complaint (or consented to its

filing). This is an issue of first impression in this Circuit.

Appellate Case: 07-1821 Page: 12 Date Filed: 08/29/2008 Entry ID: 3465856
10Although In re Spaulding Composites was a Chapter 11 case, we find that

distinction to be inconsequential. As noted above, a Chapter 7 trustee has similar

duties and powers as a Chapter 11 debtor-in-possession. Equally inconsequential is

the fact that a creditors’ committee, rather than a creditor, sought derivative standing

in In re Commodore Int’l Ltd. The Second Circuit has held that creditors and

creditors’ committees may alike obtain derivative standing when the trustee consents.

See Glinka v. Murad (In re Housecraft Indus. USA, Inc.), 310 F.3d 64, 71 n.7 (2d Cir.

2002) (“Although STN and Commodore both involved creditors’ committees, the

holdings of those cases also apply to individual creditors such as BNP. Numerous

-13-

In In re Commodore Int’l Ltd., the Second Circuit held that a creditors’

committee may proceed derivatively when the debtor-in-possession (or trustee)

consents to its suit. See 262 F.3d 96, 99-100 (2d Cir. 2001). In reaching this

conclusion, the Second Circuit found persuasive the following reasoning from a Ninth

Circuit Bankruptcy Appellate Panel decision:

The [trustee or] debtor in possession has an obligation to pursue all

actions that are in the best interests of creditors and the estate. An

unsecured [creditor or] creditors’ committee has a close identity of

interests with the [trustee or] debtor in possession in this regard.

Allowing the [trustee or] debtor in possession to coordinate litigation

responsibilities with an unsecured [creditor or] creditors’ committee can

be an effective method for the [trustee or] debtor in possession to

manage the estate and fulfill its duties . . . . Rather than a flat prohibition,

impartial judicial balancing of the benefits of a committee’s

representation better serves the bankruptcy estate.

Id. at 99 (quoting Liberty Mut. Ins. Co. v. Official Unsecured Creditors’ Comm. of

Spaulding Composites Co. (In re Spaulding Composites Co.), 207 B.R. 899, 904 (9th

Cir. BAP 1997)). 

Like the Second Circuit, we are persuaded by the reasoning of In re Spaulding

Composites, and hold that a creditor may proceed derivatively when the trustee (or

debtor-in-possession) consents (or does not formally oppose) the creditor’s suit.10 See

Appellate Case: 07-1821 Page: 13 Date Filed: 08/29/2008 Entry ID: 3465856
courts have granted individual creditors standing to sue in the stead of a trustee or

debtor-in-possession.”)(citations omitted).

-14-

also In re Parmetex, Inc., 199 F.3d at 1031 (“Although Defendants are correct that a

trustee must generally file an avoidance action under Chapter 7, we hold that under

these particular circumstances – where the trustee stipulated that the Creditors could

sue on his behalf and the bankruptcy court approved that stipulation – the Creditors

had standing to bring the suit.”) (emphasis added). 

We also adopt the Second Circuit’s standard for establishing derivative standing

when the trustee (or debtor-in-possession) consents:

A creditor[] . . . may acquire standing to pursue the debtor’s claims if (1)

the [creditor] has the consent of the debtor in possession or trustee, and

(2) the [bankruptcy] court finds that suit by the [creditor] is (a) in the

best interest of the bankruptcy estate, and (b) is necessary and beneficial

to the fair and efficient resolution of the bankruptcy proceedings.

In re Commodore Int’l Ltd., 262 F.3d at 100 (emphasis added, internal quotation

marks omitted).

The Second Circuit described its approach as “a reasoned and practicable

division of labor between the creditor[] and the debtor in possession or trustee, while

also providing bankruptcy courts with significant authority both to manage the

litigation and to check any potential for abuse by the parties.” Id. We agree with this

assessment. We emphasize, however, that compared to situations in which a creditor

seeks derivative standing because the trustee acts unjustifiably, a creditor will

typically face a comparatively greater burden to establish derivative standing when

the trustee consents. That is not to say the creditor’s evidentiary burden differs

between the contexts. Rather, bankruptcy courts must not lose sight of the fact that

a creditor must show that its proposed “consensual” derivative action is both

“necessary and beneficial to the fair and efficient resolution of [the bankruptcy

Appellate Case: 07-1821 Page: 14 Date Filed: 08/29/2008 Entry ID: 3465856
11Because the trustee is generally in the best position to evaluate whether a

proposed action is necessary for a fair resolution of the bankruptcy proceedings, we

expect them to withhold their consent (or oppose the action) when a proposed action

is truly unnecessary (e.g., bordering on frivolous). Indeed, we would be surprised if

trustees were routinely not pursuing all necessary actions because a failure to do so

might possibly constitute a breach of their fiduciary duties.

12We noted above that bankruptcy courts should employ a cost-benefit analysis

to determine whether derivative standing is appropriate under circumstances in which

the trustee “unjustifiably” refuses to bring the creditor’s claims. Bankruptcy courts

should perform a similar analysis when confronted with a request for “consensual”

derivative standing. Lest a bankruptcy court be tempted by form over substance,

however, we note that neither the timing nor form of a trustee’s (or debtor-inpossession’s) consent should affect its determination of whether a creditor (creditors’

committee) has in fact obtained the necessary consent. The only pertinent

consideration with respect to consent is whether the trustee’s representations can be

fairly understood as either affirmatively consenting to or affirmatively not opposing

a proposed derivative action. That the trustee’s “consent” pre-dates or post-dates a

creditor’s motion for “consensual” derivative standing is irrelevant.

-15-

proceedings].” Id. (emphasis added). In other words, not every “beneficial” action

is “necessary” for a given proceeding.11

Accordingly, bankruptcy courts should not passively view the trustee’s consent

as a proxy that a proposed derivative action is “necessary and beneficial.” If they did,

bankruptcy courts would be effectively ceding their gatekeeper function to the trustee.

We therefore make plain that a trustee’s consent is a necessary, but not sufficient

condition for granting a creditor derivative standing in this context. Regardless of

whether a creditor seeks derivative standing because the trustee “unjustifiably” refuses

to pursue its claims or consents to the creditor’s complaint, the bankruptcy court has

the same obligation – to carefully scrutinize the request and satisfy itself that

derivative standing is proper under the circumstances.12

Appellate Case: 07-1821 Page: 15 Date Filed: 08/29/2008 Entry ID: 3465856
-16-

C

Finally, we address the BAP’s alternative basis for denying PW Enterprises

standing. The BAP concluded that the bankruptcy court properly denied PW

Enterprises standing because it did not first seek permission from the bankruptcy court

to file its complaint. In essence, the BAP held that it would have been a proper

exercise of the bankruptcy court’s discretion to deny PW Enterprises standing because

it filed its motion to proceed derivatively after its proposed complaint and was

therefore untimely. We hold this was error.

First, the bankruptcy court’s decision denying PW Enterprises derivative

standing did not rest on the timing of its motion. Second, and more importantly, we

reject the BAP’s rule that “[a] creditor simply cannot file an avoidance action on the

eve of the expiration of the statute of limitations and two and a half months later ask

the court for retroactive permission to file the suit.” In re Racing Servs., Inc., 363

B.R. at 916-17. Although not entirely clear, the BAP appears to have adopted a per

se rule barring a creditor (or creditors’ committee) from filing an adversary complaint

unless it first obtains permission from the bankruptcy court. The BAP reasoned that

such a rule would serve an important goal underlying the Bankruptcy Code: “swift

and efficient administration of [the] bankruptcy estate.” Id. at 916.

We find this justification unpersuasive. In most cases, regardless of whether

a creditor seeks permission before or after filing its complaint, the bankruptcy court

will expend similar resources when considering the creditor’s request to proceed

derivatively. The BAP nevertheless believed that “[r]equiring court approval prior to

allowing a creditor to file a derivative suit furthers the goal of efficiency by weeding

out unnecessary suits before they are filed.” Id. (emphasis added). Not only is this

observation far from self-evident, but it confuses the effect of filing a suit with the

effect of its prosecution – only the latter threatens the efficient administration of the

bankruptcy estate. Because a creditor may not prosecute a derivative suit without the

Appellate Case: 07-1821 Page: 16 Date Filed: 08/29/2008 Entry ID: 3465856
13The BAP’s holding relied largely on the Fourth Circuit’s rejection “that it is

possible to grant derivative standing retroactively in the absence of up-front approval

by the bankruptcy court.” In re Baltimore Emergency Servs. II, Corp., 432 F.3d at

563 (citing In re Catwil Corp., 175 B.R. at 365). We do not understand how In re

Catwil Corp. supports the Fourth Circuit’s seemingly broad rule rejecting retroactive

grants of derivative standing. In In re Catwil Corp., the bankruptcy court not only

unequivocally approved of the practice but “approve[d] the [creditors’] Committee’s

application for [retroactive] authorization to prosecute” its complaint. 175 B.R. at

365-66.

-17-

bankruptcy court’s permission, the filing of an adversary complaint in itself does not

affect the estate’s administration. In other words, the timing of the creditor’s motion

is in most cases of little consequence. 

The BAP’s proposed rule is also inconsistent with the practice of numerous

federal courts granting creditors retroactive permission (i.e., nunc pro tunc relief) to

file a derivative adversary complaint. See, e.g., In re Spaulding Composites Co., 207

B.R. at 904-05; Official Comm. of Unsecured Creditors of Nat’l Forge Co. v. Clark

(In re Nat’l Forge Co.), 326 B.R. 532, 545-546 (W.D. Pa. 2005) (citing nearly a dozen

cases in which courts have permitted retroactive grants of derivative standing); Catwil

Corp. v. Derf II (In re Catwil Corp.), 175 B.R. 362, 365-66 (Bankr. E.D. Cal. 1994)

(explaining that bankruptcy courts need not find “extraordinary circumstances” before

granting derivative standing retroactively). While we agree “the better practice is for

the [creditor] to secure approval before filing [its] complaint, we will not foreclose the

ability of a court to make its approval of the [complaint] retroactive to the time of the

filing.” In re Spaulding Composites Co., 207 B.R. at 905. We see no reason to

demand formalistic adherence to a rule that could result in “needless dismissals and

refilings.” Id. And as one bankruptcy court recognized, equity may demand granting

retroactive derivative standing because of extenuating circumstances. In re Catwil

Corp., 175 B.R. at 365 (observing that filing an adversary complaint before seeking

court approval because the statute of limitations is about to run may justify retroactive

authorization).13

Appellate Case: 07-1821 Page: 17 Date Filed: 08/29/2008 Entry ID: 3465856
14Furthermore, bankruptcy courts should not deny a motion for retroactive

standing simply because it was filed after the statute of limitations has run. So long

as the creditor (or creditors’ committee) files its proposed derivative complaint within

the applicable statute of limitations period, the bankruptcy court should evaluate both

whether a retroactive grant of standing is proper and the merits of the proposed

derivative action. In such cases, however, the bankruptcy court should be wary of

denying retroactive standing when the proposed derivative complaint has merit.

-18-

Our rejection of a per se rule forbidding retroactive grants of derivative

standing should not be understood as limiting the bankruptcy courts’ authority to deny

such requests in the appropriate circumstances. But bankruptcy courts should not, as

a matter of course, either reject or grant motions for retroactive authorization. Rather,

they must evaluate each request independently. We caution bankruptcy courts,

however, from exclusively relying on the fact that a creditor filed its motion after its

complaint as a basis for denying meritorious derivative actions.14

IV

We conclude that a creditor (or creditor’s committee) may obtain derivative

standing to pursue avoidance actions under circumstances in which the trustee (or

debtor-in-possession) either unjustifiably refuses to bring the creditor’s proposed

claims or consents to the creditor pursuing such claims in his stead. We also hold that

the bankruptcy courts may retroactively grant a creditor derivative standing. We

emphasize, however, that under no circumstances may a creditor prosecute its

derivative complaint without the bankruptcy court’s permission.

In this case, the bankruptcy court, in the first instance, will have to decide

whether PW Enterprises should be granted retroactive standing to proceed

derivatively. In making this determination, the bankruptcy court should apply the

analysis discussed in Part IIIB of this opinion. Accordingly, we reverse and remand

for further proceedings.

______________________________

Appellate Case: 07-1821 Page: 18 Date Filed: 08/29/2008 Entry ID: 3465856