The Bottom Line
Recently, in In re Dura Automotive Systems, No. 19-12378 (Bankr. D. Del. June 9, 2020), the Bankruptcy Court for the District of Delaware held that granting the Official Committee of Unsecured Creditors (the Committee) derivative standing on behalf of the debtors – a Delaware limited liability company – was precluded by the Delaware Limited Liability Company Act (the Delaware LLC Act).
What Happened?
The Committee filed a motion for standing to pursue certain claims and causes of action of the bankruptcy estate against certain of the debtors’ prepetition lenders, the debtors’ former CEO Lynn Tilton and other Tilton-affiliated entities that provided purported management and consulting services to the debtors. The Committee’s proposed complaint contemplated state law claims, as well as preference claims under Section 547, recharacterization under Section 502(a) and equitable subordination under Section 510.
The court held that the Committee could not be granted derivative standing, focusing on the following provision of the Delaware LLC Act: “In a derivative action, the plaintiff must be a member or an assignee of a limited liability company interest at the time of bringing the action and: (1) At the time of the transaction of which the plaintiff complains; or (2) The plaintiff’s status as a member or an assignee of a limited liability company interest had devolved upon the plaintiff by operation of law or pursuant to the terms of a limited liability company agreement from a person who was a member or an assignee of a limited liability company interest at the time of the transaction.” According to the court, since the Committee was not a “member of the LLC debtors or an assignee of an LLC interest,” it could not be granted derivative standing.
In so holding, the court rejected the Committee’s argument that federal, not state, law should control the question of derivative standing in bankruptcy, in particular where the claims at issue are federal law claims (e.g., equitable subordination). The court held that to determine whether a third party may bring a derivative claim, the court must look to the law of the debtors’ state of incorporation – in this case, Delaware, which is clear that members or assignees of an LLC interest have the exclusive authority to sue derivatively. The Committee failed to identify any Bankruptcy Code provision to the contrary. Additionally, the court rejected the Committee’s attempt to distinguish a derivative action brought in bankruptcy on behalf of an estate, rather than outside of bankruptcy on behalf of an LLC.
The court recognized that its ruling could create certain issues, such as undermining the Committee’s role or rendering its investigation rights illusory, if the Committee is unable to sue derivatively. However, the court noted that even without standing, other remedies exist to ensure compliance with fiduciary duties and the Bankruptcy Code. For example, “potential claims and causes of action could be assigned to a trust and a plan or conversion or the appointment of a Chapter 11 Trustee or examiner could be requested.”
Why This Case Is Interesting
Notably, in The McClatchy Company, Case No. 20-10418-mew (Bankr. S.D.N.Y. July 6, 2020), the Bankruptcy Court for the Southern District of New York reached a different conclusion. There, the court determined that the committee had authority to pursue claims on behalf of the estate as a matter of federal bankruptcy law, not state law – an argument rejected by the Dura court. These decisions create uncertainty for debtors, creditors’ committees and other parties in interest regarding who has standing to pursue certain claims. It is unclear how courts will rule in cases involving debtor entities from various jurisdictions, as well as how courts will reconcile these two conflicting decisions.
