In a recent ruling on In re Land Securities Investors, Ltd., the United States Bankruptcy Court for the District of Colorado ruled that trust beneficiaries do not have standing to appear in a bankruptcy case even when the beneficiaries are seeking to remove the trustee of the trust in a separate state court action. As a result, the beneficiaries cannot challenge the trustee’s decisions affecting the trusts’ interests in the bankruptcy.

The movants in this case were the beneficiaries of two separate trusts with the same trustee. The sole asset of each trust was a 49.5% membership interest in the debtor, Land Securities Investors, Ltd., which was managed by the trustee. During the course of the bankruptcy, the beneficiaries became concerned about the nature and amount of claims made by the trustee and related parties against the bankruptcy estate, as well as the terms of the proposed plan of reorganization. The beneficiaries sought leave from the Bankruptcy Court to participate in the plan approval process, object to creditor claims against the estate, and seek appointment of a bankruptcy trustee to operate the debtor.

The Bankruptcy Court denied the beneficiaries’ motion. First, the Bankruptcy Court found beneficiaries could not demonstrate an actual injury traceable to the alleged misdeeds of the trustee and his affiliates because the beneficiaries were not creditors or equity holders in the debtor, and the alleged future mismanagement of the debtor by the trusts and the trustee was speculative at best.

Second, the Bankruptcy Court found the beneficiaries did not fulfill the criteria for “prudential standing.” Prudential standing holds that even “[w]hen the plaintiff has alleged injury sufficient to meet the case or controversy requirement, . . . the plaintiff generally must assert his own legal rights and interests, and cannot rest his claim to relief on the legal rights or interests of third parties.” The Bankruptcy Court noted that in most instances, a trustee has the exclusive authority to sue third parties who injure the beneficiaries’ interest in the trust, including any legal claim the trustee holds in trust for the beneficiaries.

Third, the Bankruptcy Court found the beneficiaries were not “parties in interest” under 11 U.S.C. § 1109(b). While the statute’s non-exhaustive list of parties in interest includes a debtor, the trustee, a creditors’ committee, an equity security holders’ committee, a creditor, an equity security holder, or an indenture trustee, and although the Bankruptcy Court held that“[t]he general theory behind the section is that anyone holding a direct financial stake in the outcome of the case should have an opportunity . . . to participate in the adjudication of any issue that may ultimately shape the disposition of his or her interest,” The Court found that because the beneficiaries did not have a direct interest in the debtor, they did not have standing to participate in the bankruptcy proceeding.

The Bankruptcy Court found that the sole remedy available to the beneficiaries was to sue the trustee in state court. “If they or others are ultimately appointed as trustees for the trusts, then they will be able to pursue legal rights as equity holders in [Land Securities Investors, Ltd.]”

This opinion highlights the problems faced by trust beneficiaries. Generally their only recourse is to sue the trustee in state court to seek his removal. However, if the trustee contests the removal, the beneficiaries have little recourse to prevent the trustee from acting in other forums to their potential detriment.