Opinion ID: 512405
Heading Depth: 1
Heading Rank: 3

Heading: bankruptcy perspective

Text: 52 The filing of a petition for reorganization under Chapter 11 of the Code creates an estate. 11 U.S.C. Sec. 541(a). That estate is comprised of all the property listed under section 541, wherever located and by whomever held, including all legal or equitable interests of the debtor in property as of the commencement of the case. Id. The scope of the term property of the estate is very broad. United States v. Whiting Pools, 462 U.S. 198, 205-06, 103 S.Ct. 2309, 2313-14, 76 L.Ed.2d 515 (1983); In re Louisiana World Exposition, Inc., 832 F.2d 1391, 1399 (5th Cir.1987). Section 541(a)(1)'s reference to all legal or equitable interests of the debtor in property includes causes of action belonging to the debtor at the time the case is commenced. In re S.I. Acquisition, Inc., 817 F.2d 1142, 1149 (5th Cir.1987); In re MortgageAmerica Corp., 714 F.2d 1266, 1274 (5th Cir.1983); In re Ozark Restaurant Equipment Co., Inc., 816 F.2d 1222, 1225 (8th Cir.), cert. denied, --- U.S. ----, 108 S.Ct. 147, 98 L.Ed.2d 102 (1987) (citing 4 Collier on Bankruptcy Sec. 541.10, at 541-62 (15th ed. 1986)). LWE's cause of action against its officers and directors, therefore, is property of the estate.
53 Until a corporation which is in Chapter 11 can be reorganized or liquidated pursuant to a plan under 11 U.S.C. Secs. 1121-29, a trustee or the debtor-in-possession is authorized to manage the property of the estate. See 11 U.S.C. Sec. 1108. Here, LWE was continued as the debtor-in-possession. See 11 U.S.C. Sec. 1101. With certain exceptions not relevant here, a debtor-in-possession performs the same functions as a trustee in a reorganization. See 11 U.S.C. Sec. 1107(a); Whiting Pools, 462 U.S. at 200 n. 3, 103 S.Ct. at 2311 n. 3; In re Hughes, 704 F.2d 820, 822 (5th Cir.1983). The debtor-in-possession, therefore, both enjoys the rights and must fulfill the duties of a trustee. In re Hughes, 704 F.2d at 822; see also Georgia Pacific Corp. v. Sigma Service Corp., 712 F.2d 962, 966 (5th Cir.1983). As one of its duties, a trustee is not only entitled to but must collect the property of the estate. 11 U.S.C. Sec. 704(1). 12 Moreover, as the Supreme Court has held, the trustee is 'accountable for all property received,' [11 U.S.C.] Secs. 704(2), 1106(a)(1), and has the duty to maximize the value of the estate, see [11 U.S.C.] Sec. 704(1). Commodity Futures Trading Comm'n. v. Weintraub, 471 U.S. 343, 352, 105 S.Ct. 1986, 1992, 85 L.Ed.2d 372 (1985) (emphasis added). Since LWE's cause of action was property of the estate, the debtor-in-possession was duty bound to assert it if doing so would maximize the value of the estate. 54 It is clear that a trustee--and, therefore, a debtor-in-possession--has the authority to bring an action for damages on behalf of a debtor corporation against corporate principals for gross negligence, mismanagement or breach of fiduciary duty where such an action could have been asserted by the debtor corporation, or by its stockholders in a derivative action, prior to bankruptcy. See Caplin v. Marine Midland Grace Trust Co., 406 U.S. 416, 428-29, 92 S.Ct. 1678, 1685-86, 32 L.Ed.2d 195 (1972); Pepper v. Litton, 308 U.S. 295, 307, 60 S.Ct. 238, 245, 84 L.Ed. 281 (1939) (interpreting section 70(a)(6) of the old Bankruptcy Act, a predecessor of sections 541(a)(1) and 704(1) of the Code) (While normally that fiduciary obligation is enforceable directly by the corporation, or through a stockholder's derivative action, it is, in the event of bankruptcy of the corporation, enforceable by the trustee.) (footnotes omitted); Dallas Cabana, Inc. v. Hyatt Corp., 441 F.2d 865, 868 (5th Cir.1971) (it is the trustee's right to prosecute all causes of action which could have been prosecuted by the bankrupt or debtor had bankruptcy not intervened); Hooper v. Mountain States Sec. Corp., 282 F.2d 195, 206-07 (5th Cir.1960), cert. denied, 365 U.S. 814, 81 S.Ct. 695, 5 L.Ed.2d 693 (1961); In re Ozark, 816 F.2d at 1225; Rochelle v. Marine Midland Grace Trust Co., 535 F.2d 523, 527 (9th Cir.1976) (reorganization trustee had standing to assert securities law claims on behalf of debtor corporation against corporation's officers and directors); Gochenour v. Cleveland Terminals Bldg. Co., 118 F.2d 89, 93 (6th Cir.1941) (corporation's right of action to recover damages because of corporate officer's misconduct and neglect of duty passes to trustee in bankruptcy); 4 Collier, Collier on Bankruptcy p 541.10 (15th ed. 1986) (The estate created pursuant to Sec. 541 succeeds to any right of action the debtor corporation may have to recover damages for misconduct, mismanagement, or neglect of duty by a corporate officer or director.). 55 In the instant case, once LWE filed a petition for Chapter 11 relief, its cause of action against the appellees--which was property of the estate--passed to the debtor-in-possession as representative of the estate. Since the cause of action belonged to LWE, the debtor-in-possession had the authority to pursue it in bankruptcy proceedings. See In re Ozark, 816 F.2d at 1225. Moreover, under section 704(1) of the Code, the debtor-in-possession was required to pursue the cause of action if it would be beneficial to the estate to do so. Due to a conflict of interest on the part of its officers and directors, however, the debtor-in-possession, in effect, refused to assert the cause of action. As a result, the Committee sought to bring the action on the corporation's behalf. Our discussion must now turn, therefore, to whether the Committee has the authority to pursue the matter on the debtor-in-possession's behalf.
56 The law is well-settled that in some circumstances, a creditors' committee has standing under Title 11, United States Code, section 1103(c)(5) and/or section 1109(b) 13 to file suit on behalf of a debtor-in-possession or a trustee. See In re Louisiana World Exposition, 832 F.2d at 1397; Coral Petroleum, Inc. v. Banque Paribas-London, 797 F.2d 1351, 1363 (5th Cir.1986) (suggesting that section 1109(b) provides a basis for the standing of a creditors' committee); Fuel Oil Supply & Terminaling v. Gulf Oil Corp., 762 F.2d 1283, 1287 (5th Cir.1985) (expressing approval of bankruptcy cases such as In re Toledo Equipment Co., 35 B.R. 315 (Bankr.N.D.Ohio 1983), and In re Joyanna Holitogs, Inc., 21 B.R. 323 (Bankr.S.D.N.Y.1982), which have conceded that a creditors' committee may sue in certain situations); In re Nicolet, Inc., 80 B.R. 733 (Bankr.E.D.Pa.1987); see also In re MortgageAmerica, 831 F.2d 97, 98 (5th Cir.1987) (creditors' committee may, in some circumstances, have the right to initiate an avoidance action); In re STN Enterprises, 779 F.2d 901, 904 (2d Cir.1985) (We agree with these bankruptcy courts that 11 U.S.C. Sec. 1103(c)(5) and 1109(b) imply a qualified right for creditors' committees to initiate suit with the approval of the bankruptcy court.). 57 While the circumstances under which a creditors' committee may sue are not explicitly spelled out in the Code, the bankruptcy courts have generally required that the claim be colorable, that the debtor-in-possession have refused unjustifiably to pursue the claim, and that the committee first receive leave to sue from the bankruptcy court. In re Louisiana World Exposition, 832 F.2d at 1397 (citing cases). 14 We agree that these are relevant considerations, though not necessarily a formalistic checklist. Id. Here, as discussed earlier in this opinion, the Committee is pursuing a colorable claim. The Committee asked LWE to bring the action; LWE in effect refused, apparently being unable to act due to the conflict of interest presented to its decision makers. See id. Finally, the bankruptcy court granted the Committee's request to bring suit on behalf of LWE. Under the circumstances, we can find no fault with the Committee's authority to bring this lawsuit. 15 We must address in greater detail, however, the appellees' argument that LWE's refusal to bring the lawsuit was not unjustified.
58 While conceding, as they must, that a creditors' committee has a qualified right to sue on behalf of a debtor-in-possession or a trustee, the appellees argue that the Committee lacks standing to maintain this action because the debtor-in-possession did not unjustifiably refuse to pursue it. We are able to discern what are, in essence, three distinct yet related arguments.
59 As an initial matter, the appellees maintain that the debtor-in-possession's refusal to initiate this lawsuit was not unjustified because the creditors' interests--as opposed to the debtor's interests--were not impaired by that refusal. Relying on Coral Petroleum and Fuel Oil Supply, the appellees argue that there was no unjustified refusal here because Louisiana law precludes injured creditors of an insolvent corporation from bringing the suit themselves. The appellees contend that [t]he interests and rights of LWE creditors are not impaired by the refusal to grant them a right of action that they are not entitled to under substantive State law. Therefore, they conclude, the Committee has no right to maintain the instant action. 60 In Fuel Oil Supply, we had occasion to address the intervention rights of a creditors' committee. In that case, we held that section 1109(b) of the Code does not create an automatic right to intervention; rather, it places intervention under the Code on the same footing as Federal Rule of Civil Procedure 24(a)(2), which permits intervention when a party with an interest in the proceeding would have its rights impaired if it were not allowed to intervene and those rights are not protected by the parties in the suit. Coral Petroleum, 797 F.2d at 1363; Fuel Oil Supply, 762 F.2d at 1285-87. We expressly stated in Fuel Oil Supply that bankruptcy cases concerning a creditors' committee's right to intervene are analogous to cases concerning its right to initiate adversary proceedings. Fuel Oil Supply, 762 F.2d at 1287; see also Coral Petroleum, 797 F.2d at 1363. In both Fuel Oil Supply and Coral Petroleum, we noted that the creditors' committee's right to initiate adversary proceedings depends on whether the trustee or the debtor-in-possession has failed to act to protect the creditors' interests. Id. 61 It is at this point in the analysis, however, that we must part ways with the appellees. The appellees assert that Fuel Oil Supply and Coral Petroleum bar the Committee's suit here. They assert that the creditors' rights are fully protected if the debtor-in-possession only asserts those causes of action which creditors could have maintained prior to bankruptcy. 16 Neither case stands for that proposition, however, and the appellees' reliance on them is misplaced. A creditor's interests in a Chapter 11 context are not protected where the debtor-in-possession fails to fulfill its obligation to collect property of the estate. If a valid--and potentially profitable--cause of action exists under state law which the debtor-in-possession may assert on behalf of the corporation, all creditors are harmed when the debtor-in-possession refuses to pursue it. The value of the estate is not maximized and the ultimate recovery of all creditors is diminished. As we noted in Coral Petroleum: 62 Here, Coral refused to sue, yet the Committee desired to bring an action. If a preference were to exist, then under section 547 the unsecured creditors' interests (which the Committee represents) are not protected. See 5 Collier, supra, Sec. 1109.-0213) (a general right to be heard would be an empty grant unless those who had such rights were allowed to act when those who should act did not). 63 797 F.2d at 1363. 64 The appellees' argument seems premised on the bizarre notion that a debtor-in-possession is under no obligation to act in the best interests of the creditors. The appellees' position ignores the fact that bankruptcy causes fundamental changes in the nature of corporate relationships. See Weintraub, 471 U.S. at 355, 105 S.Ct. at 1994. As the Court noted in Weintraub: 65 Respondents also ignore that if a debtor remains in possession--that is, if a trustee is not appointed--the debtor's directors bear essentially the same fiduciary obligation to creditors and shareholders as would the trustee for a debtor out of possession. Wolf v. Weinstein, 372 U.S. 633, 649-652 [83 S.Ct. 969, 979-981, 10 L.Ed.2d 33] (1963). Indeed, the willingness of courts to leave debtors-in-possession is premised upon an assurance that the officers and managing employees can be depended upon to carry out the fiduciary responsibilities of a trustee. Id., at 651 [83 S.Ct. at 980]. 66 471 U.S. at 355, 105 S.Ct. at 1994; see also In re Hughes, 704 F.2d at 822 (debtor-in-possession holds its powers in trust for the benefit of creditors; creditors have the right to require the debtor-in-possession to exercise those powers for their benefit); Ford Motor Credit Co. v. Weaver, 680 F.2d 451, 462 n. 8 (6th Cir.1982) (A trustee in bankruptcy or a debtor-in-possession, as a fiduciary, represents both the secured and unsecured creditors of the debtor.). Here, the debtor-in-possession effectively could not act to maximize the value of the estate. As a result, the creditors' interests were not protected. Far from barring the Committee's action, as the appellees assert, Coral Petroleum and Fuel Oil Supply command this action to go forward. 17
67 The appellees argue that the debtor-in-possession's refusal to initiate this lawsuit was not unjustified because only the creditors represented by the Committee would benefit from it; in effect, the appellees have reframed their earlier argument that the Committee is merely attempting to recover the debts of the corporation from LWE's officers and directors. The appellees complain that [a]lthough the Creditors' Committee disingeniously asserts that it filed the instant action on behalf of the LWE, defendants herein submit that various LWE creditors represented by the Creditors' Committee are the only persons who would benefit from any recovery in this action. They also note that the Committee has unabashedly characterized this lawsuit as a 'quest to get money for the creditors of the Debtor.'  While we are uncertain as to why such a quest would be either unlawful or immoral, we most assuredly reject their proposition that this lawsuit will only benefit the Committee. 68 There can be no serious dispute that the Committee and its member creditors are not the only creditors with a conceivable interest in seeing the value of the estate maximized. The appellees have admitted that there are other interested parties with a pecuniary interest in the estate. These include: lending institutions which have extended funds to LWE; corporate sponsors/guarantors; city, state and federal tax authorities; and creditors holding priority claims arising from the operation of the business as well as for professional fees arising in a Chapter 11 case. See, e.g., 11 U.S.C. Secs. 504, 507, 1129. In addition, we must disagree with the appellees' intimation that any recovery will flow directly to the Committee. As the Committee has noted, if there is any money that is produced as a result of this lawsuit it will go not to the creditors who are represented by the Creditors' Committee but to LWE itself which will distribute those funds in accordance with the usual bankruptcy principles and after a plan of reorganization has been filed. 69 Insofar as the appellees argue that we should adopt as a matter of law the peculiar proposition that a debtor-in-possession need never pursue property of the estate which will ultimately go only to satisfy the claims of creditors, their argument deserves short shrift. In the vast majority of reorganization cases, the debtor corporation is insolvent and, upon confirmation of a plan of reorganization or liquidation, equity holders will receive nothing. In almost every case, all of the property of the estate will ultimately go to the creditors. Indeed, in an analogous situation, the Supreme Court recognized that: 70 One of the painful facts of bankruptcy is that the interests of shareholders become subordinated to the interests of creditors. In cases in which it is clear that the estate is not large enough to cover any shareholder claims, the trustee's exercise of the corporation's attorney-client privilege will benefit only creditors, but there is nothing anomalous in this result; rather, it is in keeping with the hierarchy of interests created by the bankruptcy laws. See generally 11 U.S.C. Sec. 726(a). 71 Weintraub, 471 U.S. at 355, 105 S.Ct. at 1994. The appellees' argument would free Chapter 11 trustees and debtors-in-possession from their express duty to collect the property of the estate whenever the corporation's debts are greater than its assets. That stands the Bankruptcy Code on its head. 72 Finally, we note that where a debtor-in-possession possesses a cause of action--and, because the estate will benefit as a result, must assert that cause of action--yet is unable, because of a conflict of interest, to bring that action, allowing a creditors' committee to pursue the suit on the debtor-in-possession's behalf will often prove beneficial to the estate. Inherent conflicts in the debtor-in-possession's relationship with its management and creditors may constitute a basis for the appointment of a trustee. It takes but little imagination to discern the benefits of permitting a creditors' committee to proceed in lieu of appointing a trustee for that purpose: 73 In cases in which the debtor-in-possession is conducting its affairs without objection but for its failure to prosecute a handful of claims against insiders, granting leave to the creditors' committee to pursue these actions may be less expensive than the appointment of a trustee and the awarding of his commission ... and it is also less disruptive than conversion of a Chapter 11 proceeding to Chapter 7. 74 In re Philadelphia Light Supply Co., 39 B.R. 51, 52 (Bankr. E.D.Penn.1984) (citation omitted); see also In re Nicolet, 80 B.R. at 739 (allowing a Committee to maintain an action on behalf of a [debtor-in-possession] is [a] less drastic and hence we believe initially preferable course to that of requiring appointment of a trustee simply to prosecute a meritorious cause of action which the [debtor-in-possession] chooses not to pursue). 18
75 The appellees maintain that allowing the Committee to pursue LWE's cause of action against its officers and directors for gross negligence, mismanagement and breach of fiduciary duty--in lieu of a trustee or the debtor-in-possession--would give LWE's creditors substantive property rights which they are not entitled to under Louisiana law, in contravention of the United States Supreme Court's opinion in Butner v. United States, 440 U.S. 48, 99 S.Ct. 914, 59 L.Ed.2d 136 (1979). Butner involved a dispute between a bankruptcy trustee and a second mortgagee over the right to rents collected during the period between a mortgagor's bankruptcy and the foreclosure sale of mortgaged property. The Court was forced to determine if a particular question--whether a security interest in property extends to rents and profits derived from the property--should be resolved by reference to state law. Recognizing that Congress has generally left the determination of property rights in the assets of a bankrupt's estate to state law, id. at 54, 99 S.Ct. at 918, the Court refused to adopt a federal rule of equity affording a mortgagee an automatic security interest in the rents even if state law would not recognize any such interest until after foreclosure, id. at 53-54, 99 S.Ct. at 917-18. 76 In doing so, the Court clarified the relationship between state property laws and the equity powers of the bankruptcy court. As the Court explained: 77 Property interests are created and defined by state law. Unless some federal interest requires a different result, there is no reason why such interests should be analyzed differently simply because an interested party is involved in a bankruptcy proceeding. Uniform treatment of property interests by both state and federal courts within a State serves to reduce uncertainty, to discourage forum shopping, and to prevent a party from receiving a windfall merely by reason of the happenstance of bankruptcy. 78 Id. at 55, 99 S.Ct. at 918 (quoting Lewis v. Manufacturers Nat'l Bank, 364 U.S. 603, 609, 81 S.Ct. 347, 350, 5 L.Ed.2d 323 (1960)); see also In re Waldron, 65 B.R. 169, 170 (Bankr.N.D.Tex.1986). In Butner, therefore, the Supreme Court stressed that federal bankruptcy law should not be used to work a substantive change in the ordering of property interests under state law. The appellees argue that allowing the Committee to maintain this action effectively creates a new cause of action on the part of creditors, thereby working a substantive change in property interests under Louisiana law. We reject that proposition and conclude that Butner in no way forbids the committee from maintaining this action in lieu of a trustee or the debtor-in-possession. 79 Here, it is clear that LWE's cause of action against its officers and directors for gross negligence, mismanagement and breach of fiduciary duty arises under Louisiana law. The named plaintiff, LWE, is the party to whom the action belongs under state law; moreover, any recovery from successful litigation flows directly to that same party. State law property interests are not disturbed--indeed, state property interests would be disturbed if we were to accept the appellees' argument--and no substantive interests are created by allowing the Committee to pursue LWE's state law created cause of action. The only change lies in the identity of the agent that actually pursues that state law cause of action on behalf and in the name of LWE. That change is, at most, a procedural device, authorized by the Code, which does not affect state created property interests. To the extent that Louisiana has any interest whatsoever in the identity of the agent who actually asserts LWE's state law rights where LWE is unable to do so, that interest must yield to the procedural needs and dictates of federal bankruptcy law. Butner is simply not implicated.
80 To summarize: LWE's state law cause of action against its officers and directors is clearly property of the estate. It is equally clear that as property of the estate, that cause of action is enforceable by a trustee or, in this case, the debtor-in-possession. Moreover, if pursuing the action would maximize the value of the estate, the debtor-in-possession is obligated to do so. Where the debtor-in-possession is unable or unwilling to fulfill its obligation--due, for instance, to a conflict of interest--the Committee may assert the cause of action on behalf and in the name of LWE if authorized to do so by the bankruptcy court. 19 In light of our analysis, we find that the debtor-in-possession's refusal to pursue LWE's cause of action against its officers and directors for negligent management was indeed unjustified. 20 The Committee outlined a colorable claim which, if pursued successfully, could have greatly increased the value of the estate. While the debtor-in-possession's refusal was understandable given the grave conflict of interest implications, we cannot ignore the fact that the creditors' interests in seeing the property of the estate collected were not protected. Where the interests of an estate and its creditors are impaired by the refusal of a trustee or a debtor-in-possession to initiate adversary proceedings to recover property of the estate, we must consider that refusal unjustified.