Official Committee ex rel. Cybergenics v. Chinery

• Decision Date: 29 May 2003
• Docket Number: No. 01-3805.,01-3805.
• Citation: 330 F.3d 548
• Parties: The OFFICIAL COMMITTEE OF UNSECURED CREDITORS OF CYBERGENICS CORPORATION, on Behalf of CYBERGENICS CORPORATION, Debtor in Possession, Appellant v. <SMALL><SUP>*</SUP></SMALL>Kathleen CHINERY, Executrix of the Estate of Scott Chinery; L&S Research Corporation; Lincolnshire Management Inc.; Lincolnshire Equity Fund, L.P.
• Court: U.S. Court of Appeals — Third Circuit

330 F.3d 548

The OFFICIAL COMMITTEE OF UNSECURED CREDITORS OF CYBERGENICS CORPORATION, on Behalf of CYBERGENICS CORPORATION, Debtor in Possession, Appellant v. ^*Kathleen CHINERY, Executrix of the Estate of Scott Chinery; L&S Research Corporation; Lincolnshire Management Inc.; Lincolnshire Equity Fund, L.P.

No. 01-3805.

United States Court of Appeals, Third Circuit.

Argued February 19, 2003.

May 29, 2003.

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Gary D. Sesser (Argued), James Gadsden, Roxanna D. Nazari, Carter, Ledyard & Milburn, New York, for Appellant Official Committee of Unsecured Creditors of Cybergenics Corp.

Brian J. Molloy (Argued), Lauren D. Daloisio, Wilentz, Goldman & Spitzer, Woodbridge, for Appellees Chinery and L&S Research Corporation.

Bruce E. Fader (Argued), Scott A. Eggers, Proskauer Rose LLP, New York, for Appellees Lincolnshire Management, Inc.

Jonathan C. Lipson,^** Assistant Professor of Law, University of Baltimore School of Law, Baltimore, Amicus Law Professors in support of Appellant.

G. Eric Brunstad, Jr. (Argued), Julia Frost-Davies, Rheba Rutkowski, Bryan D. Short, Tanya Tymchenko, Melissa G. Liazos, Justin M. O'Sullivan, Seth A. Schwartz, Rachel A. Viscomi, Steven M. Ackley-Ortiz, Serena D. Madar, Bingham McCutchen LLP, Boston, Amicus in support of Appellant.

Teresa K.D. Currier, Eric Lopez Schnabel, Jeffrey R. Waxman, Klett Rooney Lieber & Schorling, Wilmington, Daniel H. Golden, David H. Botter, Robert J. Stark, Akin Gump Strauss Hauer & Feld LLP, New York, for Amicus Committee of Unsecured Creditors of Hayes Lemmerz International, Inc. in support of Appellant.

Luc A. Despins, Susheel Kirpalani, Roy C. Studness, Milbank, Tweed, Hadley & McCloy LLP, New York, for Amicus Official Committee of unsecured Creditors of Safety-Kleen Corp. in support of Appellant.

George R. Hirsch (Argued), Elyssa S. Kates, Bressler, Amery & Ross, P.C., Morristown, for Amicus Smurfit-Stone Corp. in support of Appellees.

Keith Sharfman, Associate Professor of Law, Rutgers University School of Law, Newark, Amicus in support of Appellees.

Before BECKER,^*** Chief Judge, SLOVITER, SCIRICA,^**** ALITO, ROTH, McKEE, RENDELL, BARRY, AMBRO, FUENTES and SMITH, Circuit Judges.

OPINION OF THE COURT

BECKER, Circuit Judge.

                CONTENTS
                  I.  Introduction..................................................................552
                 II.  Facts and Procedural History..................................................553
                III.  How Does Hartford Underwriters, Affect this Case? ............................555
                      A.  What happened in Hartford Underwriters? ..................................556
                      B.  Did Hartford Underwriters take place in an analogous context? ............557
                 IV.  Do Derivative Suits under § 544(b) Survive Hartford Underwriters? .......559
                      A.  The Code Itself...........................................................559
                          1.  The Need to Interpret Chapter 11 as a Whole...........................559
                          2.  Section 1109(b) ......................................................560
                          3.  Section 1103(c)(5) ...................................................562
                          4.  Section 503(b)(3)(B) .................................................563
                          5.  A Textual Conclusion..................................................566
                      B.  Bankruptcy Courts as Courts of Equity.....................................567
                  V.  Pre-Code Practice.............................................................569
                 VI.  Does Derivative Standing for Creditors' Committees Advance Congress's
                        Goals?  ....................................................................572
                      A.  The Salutary Effects of Derivative Standing for Creditors' Committees.....572
                      B.  Potential Drawbacks of Derivative Standing for Creditors' Committees......574
                          1.  Might derivative suits dissipate the value of the estate..............574
                          2.  Might bankruptcy courts be unable to identify meritorious claims......575
                          3.  Might derivative suits consume judicial resources.....................576
                      C.  Possible Substitutes for Derivative Standing for Creditors' Committees....576
                          1.  Appointment of a bankruptcy trustee...................................576
                          2.  Appointment of an examiner with authority to sue......................577
                          3.  Moving the court to order the debtor-in-possession to sue.............578
                          4.  Converting the bankruptcy case to Chapter 7 ..........................578
                          5.  Moving the bankruptcy court to authorize a committee to bring a
                                post-confirmation avoidance action..................................579
                          6.  Summary...............................................................579
                VII.  Conclusion...................................................................580
                

I. Introduction

This is an appeal from an Order of the District Court, which set aside an Order of the Bankruptcy Court authorizing a creditors' committee ("the Committee") to sue on the estate's behalf to avoid a fraudulent transfer in a Chapter 11 proceeding. Before seeking derivative standing, the Committee had unsuccessfully petitioned the debtor-in-possession to pursue the avoidance claim. In granting derivative standing, the Bankruptcy Court determined that such a suit would be in the estate's best interest. The question on appeal is whether the decision of the United States Supreme Court in Hartford Underwriters Ins. Co. v. Union Planters Bank, 530 U.S. 1, 120 S.Ct. 1942, 147 L.Ed.2d 1 (2000), a Chapter 7 case which interpreted the text of 11 U.S.C. § 506(c) to foreclose anyone other than a trustee from seeking to recover administrative costs on its own behalf, operates to prevent the Bankruptcy Court from authorizing the suit described above.

We conclude that it does not. While the question in Hartford Underwriters was one of a nontrustee's right unilaterally to circumvent the Code's remedial scheme, the issue before us today concerns a bankruptcy court's equitable power to craft a remedy when the Code's envisioned scheme breaks down. We believe that Sections 1109(b), 1103(c)(5), and 503(b)(3)(B) of the Bankruptcy Code evince Congress's approval of derivative avoidance actions by creditors' committees, and that bankruptcy courts' equitable powers enable them to authorize such suits as a remedy in cases where a debtor-in-possession unreasonably refuses to pursue an avoidance claim. Our conclusion is consistent with the received wisdom that "[n]early all courts considering the issue have permitted creditors' committees to bring actions in the name of the debtor in possession if the committee is able to establish" that a debtor is neglecting its fiduciary duty. 7 Collier on Bankruptcy ¶ 1103.05[6][a] (15th rev. ed. 2002).

Accordingly, we will reverse the judgment of the District Court and remit the case to the original Panel so that it may consider the other grounds for the District Court's reversal of the Bankruptcy Court's Order, which were not argued before the en banc Court.

II. Facts and Procedural History

Scott Chinery founded L&S Research Corporation ("L&S") in 1985.¹ L&S, with Chinery as its sole shareholder, marketed nutritional food supplements for body-building and weight loss under the brand name "Cybergenics." In 1994, Lincolnshire Management, Inc. ("Lincolnshire") initiated negotiations with Chinery to buy L&S, and the parties reached an agreement for an aggregate consideration of approximately $110.5 million.² Lincolnshire established Cybergenics Acquisition, Inc., an equity investment affiliate, which later became Cybergenics Corporation ("Cybergenics"), to acquire substantially all of L&S's assets. Lincolnshire's equity investment affiliate provided the largest equity stake and became the majority shareholder in Cybergenics, although several banks and various other lenders ("the Lenders") helped to finance the asset purchase. These financiers also agreed to provide working capital for Cybergenics after the acquisition. The buyout was memorialized in a writing dated October 13, 1994.

Cybergenics's financial outlook soon worsened. Despite increased equity investments by Lincolnshire and the Lenders, in August 1996, Cybergenics filed a voluntary petition for relief under Chapter 11 of the Bankruptcy Code. As is customary in Chapter 11 reorganizations, the bankruptcy court allowed Cybergenics to remain in control of its assets as a debtor-in-possession, so that no bankruptcy trustee was appointed. As is also customary, the United States trustee appointed a creditors' committee ("the Committee") to represent the interests of Cybergenics's unsecured creditors.

Although the traditional Chapter 11 case involves a business reorganization rather than a liquidation, Cybergenics soon determined that its situation was unsalvageable, and it chose to sell its assets through a court-supervised auction. At the auction, a third party successfully bid $2.65 million for all of Cybergenics's assets, and the Bankruptcy Court approved the sale in October 1996. Cybergenics then moved to dismiss the bankruptcy case, but the Committee objected, asserting that certain transactions relating to the leveraged buyout could give rise to substantial fraudulent transfer actions and that a debtor-in-possession has a fiduciary duty to maximize the value of the estate.

In June 1997, Cybergenics notified the bankruptcy court that it would not pursue any fraudulent transfer claims, arguing that the probability of recovery was sufficiently low that the costs of litigation would likely outweigh any benefits. The Committee responded by volunteering to bear all of the costs so that the avoidance action would go forward, but when Cybergenics still refused to pursue the claims, the Committee sought leave from the Bankruptcy Court to bring a derivative action to avoid the transfers for the benefit of the estate....