Opinion ID: 782113
Heading Depth: 2
Heading Rank: 3

Heading: Possible Substitutes for Derivative Standing for Creditors' Committees

Text: 110 Lincolnshire does not deny that derivative standing for creditors' committees is potentially beneficial, but it contends that such standing is not as critical as the Committee suggests because bankruptcy courts, and committees themselves, have many other remedies available. We explore these in turn.
111 Lincolnshire first argues that, although the usual Chapter 11 case proceeds without a bankruptcy trustee, a creditors' committee can move to appoint one pursuant to § 1104. That provision allows any party in interest (including a creditors' committee) to request appointment of a trustee for cause, or if the appointment would be in the interests of creditors. 11 U.S.C. § 1104(a). Cause to appoint a trustee may include fraud, dishonesty, incompetence, or gross mismanagement ... either before or after commencement of the case. Id. § 1104(a)(1). Lincolnshire posits that a trustee's independent nature would allow it to pursue avoidance claims without the conflicts of interest that can affect debtors-in-possession. 112 Amici Law Professors aptly respond that disallowing derivative suits and forcing creditors' committees to move to appoint trustees would amount to replac[ing] the scalpel of derivative suit with a chainsaw. (Law Professors' Brief at 13.) Appointing a trustee in a Chapter 11 case is an extraordinary remedy, 7 Collier on Bankruptcy ¶ 11402[1] (15th rev. ed. 1998), and there is a corresponding strong presumption that the debtor should be permitted to remain in possession. In re Marvel Entertainment Group, Inc., 140 F.3d 463, 471 (3d Cir.1998). The problem is that appointing a trustee amounts to replacing much of a debtor's high-level management, and that creates immense costs in two ways. First, there is a statutory fee (which can be substantial) to which trustees are entitled for their services. See 11 U.S.C. §§ 326(a) (setting forth fee schedule), 330(a) (setting forth trustee's right to compensation); cf. 11 U.S.C. § 1107(a) (providing that debtors-in-possession are not entitled to statutory trustee's fees). 9 More important, however, is the cost implicit in replacing current management with a team that is less familiar with the debtor specifically and its market generally. The idea that existing management is best positioned to rescue a debtor from bankruptcy is precisely the reason why the appointment of a trustee is exceptional in Chapter 11 reorganizations, but occurs immediately in Chapter 7 liquidations. See Kenneth N. Klee & K. John Shaffer, Creditors' Committees Under Chapter 11 of the Bankruptcy Code, 44 S.C. L. Rev. 995, 1045, 1049 (1993) (observing generally that the incremental costs of a trustee usually outweigh[] the benefits, and that maximization of value rarely lies down this path.). 113 In short, we believe that appointing a trustee is too drastic a step to constitute a serious alternative to allowing derivative suits by creditors' committees. Indeed, because much of Chapter 11 is premised on allowing current management to remain in control of the debtor, it is unlikely that Congress intended to force a court to displace that management in the relatively commonplace event that a debtor makes a questionable decision not to prosecute a fraudulent avoidance claim. 114
115 Amicus Smurfit-Stone Corporation submits that, if appointing a trustee is too radical an alternative, a creditors' committee might instead move the court to appoint an examiner under § 1104(c). That provision states that a party in interest may request the appointment of an examiner to conduct such an investigation of the debtor as is appropriate, and that the court may order an appointment after notice and a hearing. An examiner's duties include investigation of the debtor, the debtor's business, and any other matter relevant to the case or to the formation of a plan. See § 1106(b). Smurfit-Stone observes that a debtor's management remains in place when an examiner is appointed. Perhaps most important, however, is the fact that an examiner has all of the duties of a trustee that the court orders the debtor in possession not to perform. 11 U.S.C. § 1106(b). At least one court has interpreted this language to mean that an examiner may initiate and pursue causes of action on behalf of the debtor. See In re Carnegie International Corp., 51 B.R. 252, 256 (Bankr.S.D.Ind. 1984). 116 Although this alternative is less drastic than the appointment of a trustee, we nevertheless harbor doubts about its ability to substitute for derivative suit. One concern is that, like a trustee, an examiner would incur direct costs through its fees, so to that extent this remedy is inferior to the alternative of derivative suit by a creditors' committee. The more serious problem, however, is that it is less than obvious that § 1106(b) actually does permit examiners to initiate actions on the debtor's behalf. The full text of that section states: 117 An examiner appointed under section 1104(d) of this title shall perform the duties specified in paragraphs (3) and (4) of subsection (a) of this section, and, except to the extent that the court orders otherwise, any other duties of the trustee that the court orders the debtor in possession not to perform. 118 11 U.S.C. § 1106(b). Although this catch-all language is expansive, it is subject to the interpretive canon ejusdem generis, which states that where general words follow specific words in a statutory enumeration, the general words are construed to embrace only objects similar to those enumerated by the preceding specific words. Circuit City Stores, 532 U.S. at 114-15, 121 S.Ct. 1302 (citation omitted). Sections (3) and (4) allow the examiner to investigate the acts, conduct, assets, liabilities, and financial condition of the debtor, the operation of the debtor's business and the desirability of the continuance of such business, and any other [relevant] matter, and also to file a statement of investigation. 11 U.S.C. §§ 1106(a)(3)-(4). Critically, these sections permit only investigating and reporting on that investigation — they stop far short of authorizing examiners to litigate based on their findings. 119 Therefore, although an examiner's proper role in Chapter 11 proceedings is hardly at issue in this case, we conclude that § 1106(b)'s broad grant is most naturally interpreted to authorize only acts relating directly to investigation. This conclusion comports with Congress's evident understanding of the examiner's role, for the sponsors of the Code stated: The investigation of the examiner is to proceed on an independent basis from the procedure of the reorganization under chapter 11 in order to ensure that the examiner's report will be expeditious and fair. 124 Cong. Rec. H11,103 (daily ed. Sept. 28, 1978), reprinted in 1978 U.S.C.C.A.N. 6472-73. This independent role would likely be jeopardized by an examiner's litigation against a debtor, and we therefore do not believe that an examiner can serve as a substitute for either a trustee or a creditors' committee for the purpose of avoiding fraudulent transfers. 120
121 The third option advanced is that a creditors' committee could move the bankruptcy court to order the debtor to file an avoidance action. In the case at bar, the Bankruptcy Court would no doubt have granted the Committee's motion to compel that action, for it made a finding of fact that the debtor's refusal to bring suit was unreasonable. But this solution is not realistic — given management's sometimes severe conflicts of interest, a court order to file an avoidance action would frequently amount to instructing management to sue itself. To put it mildly, that is unlikely to result in vigorous prosecution of the claim. 122
123 The District Court observed that if the Committee could not bring a derivative avoidance action, it might instead convert the case to a Chapter 7 liquidation or dismiss the petition pursuant to 11 U.S.C. § 1112. These solutions are far more radical than even the appointment of a trustee. Converting the case to Chapter 7 would cause the immediate appointment of a trustee, the option rejected supra, and would cause dissolution of the Committee. More importantly, though, Chapter 7 proceedings are liquidations, and this option would amount to instructing management: Pursue this action, or we will move to dissolve your company. While that might yield results, such coercion is unlikely to yield a zealous prosecution of the claim. It also washes out the baby with the bath water, for the principal purpose of Chapter 11 is to avoid liquidating viable businesses. 124 Moving to dismiss the bankruptcy petition makes no more sense. Bankruptcy brings with it many advantages for a debtor, such as the power to avoid union contracts and to defer or even avoid short-term financial commitments. Dismissing a bankruptcy petition might therefore be the equivalent of forcing a company to close its doors. That, of course, is hardly an alternative to derivative standing. 125 5. Moving the bankruptcy court to authorize a committee to bring a post-confirmation avoidance action 126 Finally, amicus Smurfit-Stone notes that a creditors' committee might be authorized to bring a post-confirmation avoidance action in a plan of reorganization. See 11 U.S.C. § 1123(b)(3)(B). It submits that this would give a creditors' committee the ability to protect its interest in a variety of ways. First, although § 1121(b) provides a debtor-in-possession with 120 days of exclusivity in which to file a plan of reorganization, any extension of that period requires leave of court. See 11 U.S.C. § 1121(d). Smurfit-Stone suggests that a committee might object to any motion to extend that period unless the debtor-in-possession agrees to pursue the action itself, or to file a plan permitting the committee to pursue the action. Alternatively, a committee may safeguard its interests by filing its own plan of reorganization once the exclusivity period expires. Finally, the committee might move to terminate the exclusivity period in order to expedite the filing of its own plan. 127 These are indeed options open to committees, but like the other alternatives discussed supra, they would be far more disruptive to the reorganization process than the simple step of allowing a creditors' committee to sue derivatively. The problem with ending exclusivity, either by moving immediately or objecting to an extension of the initial 120-day window, is that it would lead immediately to a sea of direct claims that were previously channeled through the debtor. In other words, although a particular creditor might be able to sue to recover its fraudulently conveyed property, so too might every other creditor and claimant. To the extent Congress has determined that exclusivity is valuable to a reorganization, this would be a highly disruptive substitute. There is no reason to suppose that Congress intended to leave only this option available to creditors' committees when a debtor unreasonably refuses to pursue an avoidance action. 6. Summary 128 We conclude that, on balance, derivative standing is a valuable tool for creditors and courts alike in Chapter 11 proceedings, and we do not believe that any of the proffered alternatives could serve as a realistic substitute for that standing. Because it helps to ensure that creditors' claims are not frustrated by fraudulent transfers, derivative standing seems clearly to give effect to the policy of the legislature. Mitchell, 361 U.S. at 292, 80 S.Ct. 332, and bankruptcy courts' equitable powers therefore allow them to confer such standing upon creditors' committees.