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

Heading: Potential Drawbacks of Derivative Standing for Creditors' Committees

Text: 98
99 Despite these clear benefits stemming from derivative standing, amicus Professor Sharfman identifies reasons why it might be harmful from a policy perspective. He first argues that, although the purpose of derivative suits is presumably to maximize the value of the estate, academic research has shown that such suits frequently result in awards only large enough to pay the litigants' legal bills. See Roberta Romano, The Shareholder Suit: Litigation Without Foundation?, 7 Journal of Law, Economics and Organization 55 (1991); Jonathan R. Macey & Geoffrey P. Miller, The Plantiffs' Attorney's Role in Class Action and Derivative Litigation: Economic Analysis and Recommendations for Reform, 58 U. Chi. L.Rev. 1 (1991). Sharfman submits that creditors' derivative suits are even less likely to add value than are shareholders' derivative suits, for the possibility of setting aside transfers as fraudulent would make it riskier for financially distressed firms to persuade potential lenders and suppliers to do business. (Sharfman Brief at 14.) The Supreme Court recognized this concern in Hartford Underwriters, where it stated that [t]he possibility of being targeted ... by various administrative claimants could make secured creditors less willing to provide postpetition financing. 530 U.S. at 13, 120 S.Ct. 1942. 100 We are untroubled by this argument. To be sure, there are situations where derivative suits recover only enough to pay the lawyers, but that concern is lessened by the need to obtain bankruptcy court approval before pursuing an action. There is no inherent reason why a debtor would be able to prosecute an avoidance claim more cheaply than a creditors' committee could, so there is no reason why a creditor suing derivatively would dissipate more value than would a debtor suing directly. Likewise, although the possibility of an avoidance action might trouble a prospective supplier or lender, that is an argument not against derivative standing, but against avoidance actions generally. Congress, however, has clearly decided that such actions are valuable to the Chapter 11 process, and we will not second-guess that judgment. The concern that derivative suits might be value-dissipating is adequately served by affording a debtor the deference normally accorded pursuant to the business judgment rule. When a debtor's action is beyond the scope of that deference, however, Congress's intent is best served by ensuring that an action is filed, even if by a creditors' committee. At all events, the Bankruptcy Court in this case concluded that the estate ought to have brought the avoidance claim in question. 101
102 Professor Sharfman also takes issue with the idea that a bankruptcy court can serve as a competent gatekeeper for the purpose of deciding when to authorize derivative standing. He submits that the idea that judges in bankruptcy cases will permit only value enhancing derivative litigation to go forward (rather than all litigation that is merely colorable) is more wishful thinking than serious argument. It is often hard to tell at the outset when permission to prosecute derivative litigation is sought whether a claim is meritorious, and judges understandably can make mistakes. (Sharfman Brief at 15) (citing Frank H. Easterbrook & Daniel R. Fischel, The Economic Structure of Corporate Law 102 (1991)). From this observation, he concludes that creditors could well recover more in the aggregate if creditor derivative suits were impermissible across the board. ( Id. at 16.) 103 It is doubtless true that judges, like trustees or debtors, sometimes lack sufficient information to determine ex ante whether a claim is value-enhancing or merely colorable. But it does not follow that creditors would likely recover more if derivative suits were impermissible. First, this assumes that the debtor-in-possession would be better able to identify valuable claims than a bankruptcy court would be. There is no reason this should be true, for, as discussed above, conflicts of interest can often cloud debtors' judgment — it is difficult objectively to determine whether a potential action is meritorious when one would be a defendant in that action. 104 Second, this argument assumes that creditors' committees are rather unsophisticated, for it predicts that the estate, and hence its creditors, would be better off if no avoidance actions took place. If that were true, presumably creditors' committees would know it, and would not seek to bring the sort of action at issue today. Third, this critique overlooks the fact that the choice at hand is not between derivative actions and no actions. Instead, if a bankruptcy court cannot authorize a derivative suit when it concludes that a debtor is unreasonably refusing to pursue an action, it will likely take the alternative step of ordering the debtor itself to pursue that action. That step is unlikely to yield a vigorous prosecution of the claim, yet it would incur all of the costs of a derivative suit. 105 Most fundamentally, however, the problem with the courts cannot identify meritorious claims critique is that it is one of futility. The proposition that a bankruptcy court cannot reliably determine when a debtor is not maximizing value is, at bottom, an argument that bankruptcy courts are not capable of doing many of the things we depend on them to do. They are, for example, instrumental in approving the bankruptcy plan itself and determining whether to appoint an examiner or trustee, and they are frequently called upon to weigh the merits of proposed first-day orders. It seems to us that we have no choice but to presume the competency of bankruptcy courts throughout the process, and we are therefore unwilling to place much stock in the claim that they are unable to determine when a debtor is unreasonably refusing to pursue an avoidance action. 106
107 Lastly, amicus Professor Sharfman warns that determining whether a derivative suit should be maintained and, if so, who should maintain it, takes time and effort on the part of the court. The Court in Hartford Underwriters was concerned about this cost, observing that the possibility of multiple [] claimants created by [a]llowing recovery to be sought at the behest of parties other than the trustee could [] impair the ability of the bankruptcy court to coordinate proceedings, as well as the trustee to manage the estate. 530 U.S. at 12-13, 120 S.Ct. 1942. Professor Sharfman points out that in the case at bar, the issue of whether the Committee could pursue a derivative claim consumed significant judicial time and effort that would not have been necessary if creditors lacked derivative standing. We disagree. Rather, we believe that the cost that Sharfman laments arises from uncertainty regarding the propriety of derivative suits, a matter resolved by this appeal. If derivative standing is unambiguously permissible, it is not unduly burdensome to determine whether any particular creditor or committee should have that standing. 108 In general, although we agree that derivative standing does not come without costs, we are satisfied that on the whole it is an immensely valuable tool for bankruptcy courts and creditors alike. It helps to deter fraudulent transfers in the first instance, and it provides courts with a viable remedy when those transfers nonetheless occur. 109