Derivative standing of creditors and official committees has been an issue for some time, and the law is far from settled. Some courts have declined to allow any other parties the authority to file lawsuits the Code leaves to the Debtor or Trustee.
In a story released today, "Delphi Corp. creditors [committee] are seeking the right to sue General Motors Corp. to retrieve billions of dollars in costs they said were transferred to Delphi when it was spun off in 1999."
In papers filed with the U.S. Bankruptcy Court in Manhattan Tuesday, Delphi’s creditors blamed the spin-off for much of Delphi’s current financial troubles. Delphi has made the same contention in court papers, but the creditors said it has lately shown signs of wanting to let GM off the hook.
Under the circumstances, Delphi’s creditors committee asked a judge to authorize it to pursue GM on Delphi’s behalf. The committee said they saw "means of recovering from GM billions of dollars in payments" potentially owed to Troy, Mich.-based Delphi as a result of the spin-off. It said it identified those means to Delphi more than six weeks ago and was reluctant to let much more time go by.
Coincidentally, the District Court in the Southern District of New York (the venue of the Delphi case), just issued an opinion on committee standing. In In re Applied Theory Corp., 2006 U.S. Dist. LEXIS 41481 (E.D. N.Y. June 22, 2006), the unsecured creditors committee sought approval to assert an equitable subordination claim against lenders of the debtor corporation.
The committee sought approval from the Bankruptcy Court to assert the claim after the Chapter 11 Trustee determined that the claim lacked merit. The court denied permission to the committee and it appealed.
The District Court affirmed, but left open the possibility that the committee (or creditors) may obtain approval to assert a claim if the facts are stronger —
The powers explicitly granted to committees under the Bankruptcy Code have been read to support a "qualified right for creditors’ committees to initiate suit" but this right is contingent upon the committee obtaining "the approval of the bankruptcy court." In re STN Enters., 779 F.2d 901, 904 (2d Cir. 1985). The right to bring suit may be exercised in a limited set of situations, including when the trustee or "debtor in possession unreasonably fails to bring suit" and "where the trustee or debtor in possession consents." In re Commodore Intern. Ltd., 262 F.3d 96, 100 (2d Cir. 2001). In determining whether to allow a committee to bring litigation the bankruptcy court considers two factors: 1) whether the claim is colorable and 2) whether the claim is "likely to benefit the reorganization estate." STN, 779 F.3d at 905. These two factors, which were introduced by the Second Circuit in STN Enterprises, 779 F.2d at 901, are referred to as the STN factors.
Equitable subordination is a judge-made doctrine that predates Congress’s revision of the Bankruptcy Code. United States v. Noland, 517 U.S. 535, 538, 116 S. Ct. 1524, 134 L. Ed. 2d 748 (1996). The purpose of equitable subordination is to undo wrongdoing by an individual creditor in the interest of the other creditors. See In re Lockwood, 14 B.R. 374, 380-81 (Bankr. E.D.N.Y. 1981) ("The fundamental aim of equitable subordination is to undo or offset any inequality in the claim position of a creditor that will produce injustice or unfairness to other creditors in terms of bankruptcy results."). It affects the order in which creditors will be paid. Id. at 381. Given equitable subordination’s purpose, many courts have concluded that where a trustee has been appointed, it is the proper party to raise claims of equitable subordination. See e.g. In re KDI Holdings, Inc., 277 B.R. 493, 507 (Bankr. S.D.N.Y. 1999); Lockwood, 14 B.R. at 381. n1 Those courts that have allowed creditors to bring claims for equitable subordination, have done so where an individual creditor sought to bring the equitable claim for its own benefit. See In re Vitreous Steel Prods. Co., 911 F.2d 1223, 1231 (7th Cir. 1990); In re Hoffinger Indus., 327 B.R. 389, 394 (Bankr. E.D.Ark. 2005).
The Bankruptcy Court has already made factual determinations in the Authority Order that the Committee’s equitable subordination claim would seek to redress injuries "allegedly inflicted upon the Debtors and their creditors generally" and that any claim "would not be directed toward any particularized injury suffered by any creditor."