By: Donald L Swanson
In In re Cyberco Holdings, Inc., 431 B.R. 404 (Bankr. W.D. Mich. 2010), the Bankruptcy Court holds that the statutory basis for substantive consolidation is the Bankruptcy Code’s turnover provision (§ 542)—not the equitable powers provision of § 105(a). [See this linked article, which was the first in this series of five articles.]
In re Cyberco also holds that the only person with standing to seek substantive consolidation in bankruptcy:
- is the bankruptcy estate representative—i.e., either the bankruptcy trustee or the debtor in possession; and
- does not include a creditor, absent court authorization to exercise derivative standing.
That’s because statutory standing to pursue turnover claims under § 542 is confined to “the trustee.” And the “trustee” in § 542 includes a debtor in possession—see, § 1107, § 1184, § 1203, § 1303 & § 1304.
Derivative Standing—Legal Standards
An illustrative opinion on a creditor seeking and obtaining derivative standing to exercise rights and powers belonging to the bankruptcy estate is In re Racing Services, Inc., 540 F.3d 892 (8th Cir. 2008).
According to In re Racing Services, the creditor must show that:
- it petitioned the trustee/DIP to bring the claims, and the trustee/DIP refused;
- the claims to be pursued are colorable;
- it sought permission from the bankruptcy court to initiate an adversary proceeding; and
- the trustee/DIP unjustifiably refused to pursue the claims.
In most cases, says the Eighth Circuit, creditors will easily satisfy the first three elements—which elements ought to be mere formalities.
Derivative Standing—Unjustifiable Refusal
The real challenge, says the Eighth Circuit, is to persuade the bankruptcy court that the trustee/DIP unjustifiably refuses to bring the claims. In this regard:
- the creditor has the onus of establishing that the trustee/DIP unjustifiably refuses to bring the creditor’s proposed claims;
- to satisfy its burden, the creditor must provide specific reasons why it believes the trustee’s refusal is unjustified; and
- circumstances making a decision unjustified in one bankruptcy may not necessarily support the same conclusion in another.
The universe of circumstances making a refusal unjustified is limited. Factors to be considered include:
- a refusal is not justified when the creditor’s claim, if successful, would benefit the estate;
- a refusal is justified when the proposed claim would yield insignificant benefits to the estate; and
- a creditor’s willingness to shoulder the costs of litigation, with no burden on the bankruptcy estate, would be a significant factor in the analysis.
At bottom, the determination on whether to grant a request for derivative standing requires the bankruptcy court to perform a cost-benefit analysis that includes, (i) probability of success and recovery, (ii) the proposed fee arrangement, and (iii) anticipated delay and expense to the bankruptcy estate.
But a mini-trial is not needed.
Ultimately, the bankruptcy court’s decision on whether to grant a creditor derivative standing will be reviewed for an abuse of discretion.
Conclusion
Derivative standing authorization by the bankruptcy court is required for a creditor to pursue a request for substantive consolidation. That’s according to the In re Cyberco Holdings opinion identified above, which opinion is based on the proposition that the Bankruptcy Code’s § 542 turnover provision are the source of authority for substantive consolidation–not § 105(a).
The In re Racing Services opinion described above illustrates and explains the legal standards for evaluating a creditor’s request for derivative standing.
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