Opinion ID: 782113
Heading Depth: 2
Heading Rank: 1

Heading: The Salutary Effects of Derivative Standing for Creditors' Committees

Text: 92 Before bankruptcy, a debtor's management and its most powerful creditors typically try to work out the debtor's financial distress. In this process, managers frequently experience pressure to take extreme measures to protect the company. (Brief of Amicus Law Professors at 9.) They may make extraordinary concessions to providers of critical services, such as granting new lines on unencumbered property, agreeing to an excessive rate of interest, committing to lavish retention bonuses, or doing virtually anything else to avoiding filing for bankruptcy. See, e.g., Eduardo Porter & Mitchell Pacelle, Judge Increases Severance Pay to Former Enron Employees, Wall St. J., Aug. 29, 2002, at A3 (discussing multi-million dollar retention bonuses paid by Enron insiders before bankruptcy). Whether or not these radical actions are ultimately successful, they often reduce the assets available to the debtor's creditors. 93 The Bankruptcy Code's avoidance powers are intended, inter alia, to deter this kind of managerial overreaching and to encourage creditors to allow a debtor a measure of breathing room. See H.R. Rep. No. 95-595, at 177 (1977) (By permitting the trustee to avoid prebankruptcy transfers that occur within a short period before bankruptcy, creditors are discouraged from racing to the courthouse to dismember the debtor during [its] slide into bankruptcy.). Fraudulent avoidance actions, such as those provided for in § 544(b), are intended to afford unsecured creditors peace of mind, for those creditors are usually the principal victims of managerial misfeasance. 94 Although fraudulent transfers are of concern in many chapters of the Bankruptcy Code, including in Chapter 7 liquidations, they present a particularly vexing problem in reorganizations conducted under Chapter 11. The premise of a reorganization is to ensure that the debtor emerges from bankruptcy as a viable concern. This explains why trustees are a fixture in Chapter 7 liquidations, but they are exceptional in Chapter 11 — it is thought that a debtor's existing management will be more familiar with the company than would be a court-appointed trustee, and that it would therefore be better able to guide the debtor back into solvency. See Sharon Steel Corp., 871 F.2d at 1226 (It is settled that appointment of a trustee should be the exception, rather than the rule.); 7 Collier on Bankruptcy ¶ 1104.02[1] (15th rev. ed. 1998) (noting that appointment of a trustee in a Chapter 11 case is an extraordinary remedy). In Chapter 11 cases where no trustee is appointed, § 1107(a) provides that the debtor-in-possession, i.e., the debtor's management, enjoys the powers that would otherwise vest in the bankruptcy trustee. Along with those powers, of course, comes the trustee's fiduciary duty to maximize the value of the bankruptcy estate. 95 This situation immediately gives rise to the proverbial problem of the fox guarding the henhouse. If no trustee is appointed, the debtor — really, the debtor's management — bears a fiduciary duty to avoid fraudulent transfers that it itself made. One suspects that if managers can devise any opportunity to avoid bringing a claim that would amount to reputational self-immolation, they will seize it. See, e.g., Louisiana World Exposition v. Fed. Ins. Co., 858 F.2d 233 (5th Cir.1988). For that reason, courts and commentators have acknowledged that the debtor-in-possession often acts under the influence of conflicts of interest. Canadian Pa. Forest Prod. Ltd. v. J.D. Irving, Ltd. (In re Gibson Group, Inc.), 66 F.3d 1436, 1441 (6th Cir. 1995). These conflicts of interest can arise even in situations where there is no concern that a debtor's management is trying to save its own skin. For example, a debtor may be unwilling to pursue claims against individuals or businesses, such as critical suppliers, with whom it has an ongoing relationship that it fears damaging. Id. at 1439. Finally, even if a bankrupt debtor is willing to bring an avoidance action, it might be too financially weakened to advocate vigorously for itself. In any of these situations, the real losers are the unsecured creditors whose interests avoidance actions are designed to protect. 96 The possibility of a derivative suit by a creditors' committee provides a critical safeguard against lax pursuit of avoidance actions. Amicus Law Professors explain that parties to bankruptcy workouts are typically sophisticated, and that they understand that their actions will likely be scrutinized after the fact. (Law Professors' Brief at 10.) They also understand that, even though a debtor's management may be reluctant to pursue an avoidance action, a creditors' committee will not be so hesitant. Therefore, the mere threat of a creditors' committee suit is often a potent deterrent to overreaching by creditors and insiders. See In re W. Pac. Airlines, Inc., 219 B.R. 575, 577-78 (D.Colo.1998) (discussing a creditors' committee's watchdog role). This deterrent effect remains important even after commencement of the bankruptcy case itself. 8 97