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The Authority of a Debtor to Settle Estate
Claims Brought by a Committee
Written by:
Elliot Moskowitz
Davis Polk & Wardwell LLP; New York
[email protected]
Gerald M. Moody, Jr.
Davis Polk & Wardwell LLP; New York
[email protected]
T
his article examines whether a
debtor in possession (DIP) may
unilaterally settle estate causes of
action brought by a creditors’ committee
where the committee was previously
granted standing to bring the claims.
Recent trends in the law strongly suggest
that under the right circumstances, a DIP
retains the authority to settle such claims.
The Lyondell Chemical Co. chapter 11
case in the Southern District of New York
has focused a spotlight on this issue.
Creditor Standing to Bring
and Settle Claims
Many federal circuits
allow, in certain
circumstances,
creditors to prosecute
an d s e t t l e c l a i m s
derivatively on behalf
of the estate.1 In the
Second Circuit, there
are three types of
Elliot Moskowitz
derivative standing.
The most well-known
is STN standing, in which the bankruptcy
court grants derivative standing to a
creditor where the DIP “unjustifiably fails”
to bring “colorable claims” that are “likely
to benefit the reorganization estate.”2
Commodore3 standing authorizes a creditor
to bring claims where the DIP has expressly
1 Federal Rule of Bankruptcy Procedure 9019 authorizes a trustee or DIP,
after notice and a hearing, to settle adversary proceedings on behalf
of the estate. Fed. R. Bankr. P. 9019. Creditor derivative standing,
however, has no explicit statutory basis.
2 See In re STN Enterprises, 779 F.2d 901, 904 (2d Cir. 1985), remanded,
73 B.R. 470 (Bankr. D. Vt. 1987).
3 Commodore Int’l Ltd. v. Gould (In re Commodore Int’l Ltd.), 262 F.3d 96
(2d Cir. 2001).
About the Authors
Elliot Moskowitz and Gerald Moody are
associates in the Litigation Department
at Davis Polk & Wardwell LLP in New
York. Their practices include complex
civil litigation, and they represent
debtors and agent banks in adversary
proceedings and contested matters.
consented, while Housecraft4 standing
permits a creditor to act as a co-plaintiff with
the DIP or trustee. This line of authority is
often referred to as the “STN Trilogy.”5
While it is clear that a committee may settle
claims that it is prosecuting on behalf of the
estate pursuant to authority granted under
creditors (none of whom had previously
been granted standing). The court held
that the creditors could not settle the
estate’s claims without the consent of
the DIP, because “it is the debtor in
possession, as legal representative of the
estate, who is vested with the power to
settle the estate’s claims.”6
The court explained
that, as the “estate’s
only fiduciary,”
the DIP alone
“bears the burden
of ‘maximizing
the value of the
estate....’” 7 This is
because a DIP owes
Gerald M. Moody, Jr.
Feature
the STN Trilogy, courts have only recently
considered whether, and under what
circumstances, the DIP retains the right
unilaterally to settle such claims without the
committee’s consent.
The Leading Cases: Smart
World and Adelphia
Two cases from the Second Circuit—
Smart World and Adelphia—suggest that
a DIP may unilaterally settle derivative
claims if doing so is in the best interests
of the estate. In Smart World, the
Second Circuit reversed a bankruptcy
court’s approval of a settlement that
was brokered exclusively by the DIP’s
4 Glinka v. Murad (In re Housecraft Industries USA Inc.), 310 F.3d 64 (2d
Cir. 2002).
5 There is often a blurring of lines among the different forms of creditor
derivative standing. For example, a grant of “STN standing” may
not implicate any “unjustifiable” behavior by the DIP, but instead
an inability by the DIP to prosecute claims for innocuous reasons.
As described later in this article, for purposes of analyzing a DIP’s
authority to settle, the particular variant of derivative standing—
whether designated as STN, Commodore or Housecraft—matters less
than whether the DIP in fact engaged in “unjustifiable” behavior or had
improper motives in failing to bring the claims that led the court to
grant standing in the first instance.
a fiduciary duty to the entire estate, while
“a creditors’ committee owes a fiduciary
duty to the class it represents.”8 The court
noted that this conclusion is “hardly
surprising in light of the numerous
provisions of the Bankruptcy Code
establishing the debtor-in-possession’s
authority to manage the estate and its
legal claims.”9
Adelphia involved the inverse
scenario—namely, a DIP seeking to
manage claims where authority to
prosecute those claims was previously
granted to a third-party pursuant to
STN.10 In Adelphia, the bankruptcy court
had previously granted STN standing to
an equity committee to pursue certain
claims.11 Later, the DIP proposed a plan
6 Smart World Techs. LLC v. Juno Online Servs. (In re Smart World Techs.
LLC), 423 F.3d 166, 175 (2d Cir. 2005).
7 Id. (citation omitted).
8 Id. at 175 n.12.
9 Id. at 174.
10 See In re Adelphia Comm’n Corp., 368 B.R. 140, 271-72 (Bankr.
S.D.N.Y. 2007).
11 Id.
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of reorganization that would transfer
the claims to a litigation trust. 12 The
bankruptcy court confirmed the plan
over the equity committee’s objection,
effectively allowing the DIP to reassert
control over the bankruptcy estate’s
claims.13 In so doing, the court rejected
the argument that the equity committee
“owned” the claims that it had been
granted standing to prosecute.14
The district court affirmed the
decision of the bankruptcy court, noting
that the DIP’s continuing authority over
the committee’s claims is a natural
consequence of th e S ma rt W o rl d
decision: “[N]owhere does Smart World
suggest that...where derivative standing
does exist, a debtor in possession is
irreversibly stripped of its authority to
settle that litigation absent the consent
of the standing committee... Smart
World confirms repeatedly that it is the
fundamental responsibility of the debtor
in possession to manage the estate.”15
The Second Circuit, in a decision
authored by Judge Sonia Sotomayor,
concurred: “It would be contrary to the
reasoning of this Circuit’s precedent to
hold that the bankruptcy court’s grant
of derivative standing vested the Equity
Committee with a veto over both the
court and the debtor in possession.” 16
The circuit court concluded that “a court
may withdraw a committee’s derivative
standing and transfer the management
of its claims, even in the absence of
that committee’s consent, if the court
concludes that such a transfer is in the
best interests of the bankruptcy estate.”17
Smart World and Adelphia do not
conclusively answer the question of
whether a DIP may settle claims brought
by a committee. Adelphia involved the
transfer of claims to a trust, not a final
settlement of those claims. Nonetheless,
the logic that permits a DIP to transfer
claims to a trust—i.e., the primacy of
the DIP’s role in managing the estate—
should apply with equal force to a DIP
that appropriately seeks to settle those
claims instead.18
12 Id.
13 Id. at 284.
14 Id. at 272 (stating that derivative standing did not confer “ownership” of
claims to equity committee, and DIP therefore need not “obtain the Equity
Committee’s consent to transfer those claims to the [litigation trust]”).
15 Official Comm. of Equity Security Holders of Adelphia Comm’n Corp. v.
Adelphia Comm’n Corp. (In re Adelphia Comm’n Corp.), 371 B.R. 660,
670 (S.D.N.Y. 2007).
16 Official Comm. of Equity Security Holders of Adelphia Comm’n Corp. v.
Official Comm. of Unsecured Creditors of Adelphia Comm’n Corp. (In re
Adelphia Comm’n Corp.), 544 F.3d 420, 425 (2d Cir. 2008).
17 Id. at 423.
18 The issue of a DIP’s authority to settle was also examined in In re
Exide, 303 B.R. 48, 67-71 (Bankr. D. Del. 2003). In this case, the court
appeared to endorse the concept of a DIP settling a committee’s claims
as a general matter, but rejected the proposed settlement as not “in the
best interests of the estate.” Id. at 71.
Settlement, Motives of the DIP
The DIP must present settlements
to the bankruptcy court for approval
pursuant to Rule 9019 of the
Bankruptcy Code, the rule governing
bankruptcy court settlements. 19 As
with any bankruptcy settlement, a
settlement in which the DIP settles
the claims of the committee must
satisfy the so-called “TMT factors”—
the series of factors set forth by the
U.S. Supreme Court in Protective
Comm. for Indep. Stockholders of
TMT Trailer Ferry, Inc. v. Anderson,
391 U.S. 414, 424 (1968). 20 In the
Second Circuit, bankruptcy courts
also consider a related set of factors
described in In re Texaco Inc., 84 B.R.
893 (Bankr. S.D.N.Y. 1988). As part of
this examination, the bankruptcy court
must consider “the extent to which the
settlement is truly the product of armslength bargaining, and not of fraud
or collusion.”21
Intercreditor disputes have played a
significant role in a number of major
chapter 11 cases in recent years.
These disputes can result in fullfledged litigation that involves many,
if not all, of an estate’s stakeholders.
As with any litigation among
sophisticated parties, the prospect of
settlement is a strategic and practical
consideration for the litigants.
Accordingly, a DIP that is free of
conflicts of interest or improper motives
is best positioned to settle claims
previously brought by a committee. In
Adelphia, all three courts—bankruptcy,
district and circuit—stressed that the
equity committee had not been granted
STN standing because of any “improper
motive” (e.g., a desire to forego claims
against insiders) on the part of the DIP.22
19 Supra n.1.
20 According to TMT Trailer, the bankruptcy court must examine whether
the settlement is “fair and equitable” and “in the best interests of the
estate.” TMT Trailer, 391 U.S. at 424. In making this determination, the
court must consider the following factors: “the probabilities of ultimate
success should the claim be litigated,” and “an educated estimate
of the complexity, expense, and likely duration of such litigation, the
possible difficulties of collecting on any judgment which might be
obtained, and all other factors relevant to a full and fair compromise.”
Id. at 424-25.
21 Id. at 901.
Rather, the DIP did not object to the
equity committee’s motion for standing
because it was unable to bring the claims
itself as a result of standard waivers by
it of claims against the lender defendants
contained in the DIP financing order.23
Indeed, the courts noted that although
the committee had sought standing
pursuant to STN, which involves a DIP’s
“unjustifiable failure” to bring claims, the
situation was more akin to “Commodore
standing”—i.e., one involving the DIP’s
express consent.24
If there are conflicts of interest
between the DIP and the defendants, or
if the committee can adduce evidence
of improper motives on the part of the
DIP, the committee may challenge the
settlement as collusive and inconsistent
with Texaco.
A Case Study:
In re Lyondell Chemical Co.
The issue of the DIP’s authority to settle
was recently at the forefront of an adversary
proceeding in In re Lyondell Chemical
Company, a chapter 11 proceeding before
Bankruptcy Judge Robert E. Gerber in
the Southern District of New York.25 In
December 2007, Lyondell Chemical Co., the
third-largest independent, publicly-traded
petrochemicals company in the world, was
acquired by Basell AF S.C.A. through a $22
billion leveraged buyout (LBO). The newlyformed company, LyondellBasell Industries
AF S.C.A., filed for chapter 11 protection
in January 2009. Amid near-frozen credit
markets, the DIP obtained the then-largest
non-governmental DIP financing in history.
The DIP facility was financed by many
of the same financial institutions that had
previously financed the LBO.
In July 2009, the unsecured creditors’
committee appointed in the Lyondell
Chemical Co. bankruptcy cases sought
22 See In re Adelphia Comm’n Corp., 368 B.R. at 272 n.319 (noting that
decision to grant standing was “not based on a perception that the
Debtors or their counsel had failed to bring the additional claims for
any reason that might have been deemed to be inappropriate”); 371
B.R. at 670-71 (same); 544 F.3d at 424-25 (“the bankruptcy court
emphasized that it had not found any improper motive on the part of the
Debtors in failing to pursue the claims”). The bankruptcy court left open
the possibility that a DIP might lose the ability to manage the claims
of the estate if the DIP were to engage in misconduct: “I don’t need to
decide, and don’t now decide, whether a debtor might lose the power to
discontinue or settle litigation brought on its behalf under STN authority
where STN authority was granted because the Debtor had improper
motive or couldn’t be relied upon to act responsibly, or where a court,
when issuing STN authority, chose to take the debtor’s control away.
Here we have neither of those scenarios.” See In re Adelphia Comm’n
Corp., 368 B.R. at 272 n.319.
23 In granting the original standing motion, the bankruptcy court
specifically noted: “It was necessary (and typical) for the Debtors to
accede to such a provision, and for the Court to approve it. Provisions
of that character are common in DIP financing orders in chapter 11
cases.” In re Adelphia Comm’n Corp., 330 B.R. at 373.
24 Adelphia Comm’n Corp. v. Bank of America (In re Adelphia Comm’n
Corp.), 330 B.R. at 368 n.2; 544 F.3d at 425.
25 Judge Gerber also presided over the Adelphia chapter 11 proceedings.
The information set forth in this section was taken from pleadings
available on the public docket in the Lyondell adversary proceeding,
Official Committee of Unsecured Creditors v. Citibank NA, Adv. Proc. No.
09-01375 (Bankr. S.D.N.Y. 2009).
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STN standing to bring various avoidance
and other claims against the pre-petition
lenders. Among other things, the committee
sought to avoid as fraudulent transfers the
liens granted and obligations incurred in
favor of the pre-petition lenders during
the LBO. The DIP was unable to bring the
claims because the DIP and DIP lenders
had negotiated for, and the bankruptcy
court’s DIP order included, a waiver of
such claims as against the DIP lenders. The
committee’s STN motion was granted in
July, and soon after the committee filed a
complaint asserting the claims.
Months of contentious litigation
followed.26 After two failed mediation
sessions, the DIP negotiated a settlement
directly with the pre-petition lenders,
without the involvement or consent of
the committee. The settlement would
have provided unsecured creditors with
$300 million in cash and other substantial
benefits. While the committee’s
constituents would have recovered
under the settlement, the committee was
not a signatory to the agreement and
vigorously opposed it.
The DIP filed a motion pursuant
to Bankruptcy Rule 9019 seeking
approval of the settlement. The DIP
argued that pursuant to Smart World
and Adelphia, it was authorized to settle
the committee’s claims if doing so was
in the best interests of the bankruptcy
estate. The DIP further explained that
the dispute between the committee and
the secured lenders was the principal
impediment to reorganization and that it
was necessary to resolve the litigation to
permit the DIP to emerge from chapter
11 as soon as possible.
The committee argued, among other
things, that the DIP was beset by conflicts
of interest and that the settlement was the
product of collusive behavior among the
DIP and other parties. The committee
also argued that the settlement provided
inadequate consideration to unsecured
creditors given the strength of the
committee’s claims against the pre-petition
lenders. The committee thus urged the
bankruptcy court to reject the settlement as
failing to satisfy the standards for approval
set forth in TMT and Texaco.
The bankruptcy court reserved
several days in February 2010 to try the
matter. In the weeks leading up to the
hearing, the committee took extensive
discovery. Much of the discovery was
focused on the question of whether the
26 At a hearing on Oct. 26, 2009, Judge Gerber noted that the parties
were exchanging “accusations” the likes of which he had not seen in
“10 years on the bench and 38 years since [he] first started working in
bankruptcy.” Oct. 26, 2009 Hearing Tr. at 36:12-15.
settlement was negotiated in good faith
and at arm’s length.
Days before the hearing was set
to begin, the committee, DIP and prepetition lenders entered into a new, global
settlement that involved all constituencies.
Under the revised settlement, the core
consideration afforded to unsecured
creditors was increased to $450 million,
and various avoidance actions and other
causes of action were to be transferred
to trusts for their benefit. The parties
cancelled the contested hearing to consider
the settlement, and the bankruptcy court
approved the revised settlement some
weeks later after definitive documentation
was completed. The DIP emerged from
bankruptcy on April 30, 2010.
Accordingly, while the Lyondell
Chemical Co. case did not ultimately
resolve the question of a DIP’s
standing to settle a lawsuit brought by
a committee, the extensive record of the
case stands as a precedent and resource
for future proceedings where this issue
may be litigated to conclusion.
Future Considerations
Intercreditor disputes have played
a significant role in a number of major
chapter 11 cases in recent years. These
disputes can result in full-fledged litigation
that involves many, if not all, of an estate’s
stakeholders. As with any litigation
among sophisticated parties, the prospect
of settlement is a strategic and practical
consideration for the litigants. The ability
of a DIP to negotiate directly with the
defendants and settle claims brought by a
committee may well affect the dynamics
of intercreditor negotiations in future
chapter 11 cases. Creditors may negotiate
differently and with greater flexibility if
there is a possibility that the DIP will step
in and settle the claims. In addition, as the
fiduciary for the entire estate, the DIP may
be well positioned to propose a settlement
that is in the best interest of all creditors. As
the Lyondell Chemical Co. example shows,
however, a settlement without the consent
of the committee may give rise to additional
litigation before the underlying intercreditor
dispute can be resolved with finality. n
Reprinted with permission from the ABI
Journal, Vol. XXIX, No. 5, June 2010.
The American Bankruptcy Institute is a
multi-disciplinary, nonpartisan organization
devoted to bankruptcy issues. ABI has
more than 12,500 members, representing
all facets of the insolvency field. For more
information, visit ABI World at www.
abiworld.org.
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