The U.S. Court of Appeals for the Second Circuit has determined that a bankruptcy court may withdraw the derivative standing conferred on a statutory committee without that committee’s consent. Official Comm. of Equity Sec. Holders of Adelphia Communications Corp. v. Official Comm. of Unsecured Creditors of Adelphia Communications Corp. (In re Adelphia Communications Corp.), 544 F.3d 429 (2d Cir. 2008).  

During the pendency of the underlying bankruptcy case, the Official Committee of Equity Security Holders (the “Equity Committee”) obtained the right to commence and manage various claims of the estate against the debtor’s pre-petition lenders and investment bank. The Equity Committee continued to manage those actions to and through the date of confirmation of the debtor’s plan. The plan called for the transfer of all estate claims to a litigation trust. The Equity Committee objected and argued that the bankruptcy court did not have the authority to withdraw the derivative standing and transfer management of the claims without the Equity Committee’s consent.  

The bankruptcy court overruled the Equity Committee’s objection and found that the transfer was in the best interest of the bankruptcy estate. In accordance with the terms of the confirmed plan, the bankruptcy court withdrew the derivative standing conferred on the Equity Committee and transferred the underlying litigation to the litigation trust.  

Derivative Standing

On appeal, the Second Circuit analyzed its prior holdings relating to derivative standing. The court began with the premise that claims, although pursued derivatively by a statutory committee, remain property of the estate. Therefore, the bankruptcy court reserved the right to oversee the litigation. The court further concluded that it would be contrary to the court’s prior holdings on derivative standing to conclude that once derivative standing was vested in a statutory committee, that committee reserved a veto power over both the debtor-in-possession and the court concerning the ultimate determination of those claims.  

In a September opinion, the Second Circuit held that although the bankruptcy court reserves the right to withdraw a statutory committee’s derivative standing, the court should exercise discretion and should not withdraw standing, unless such a withdrawal is in the best interests of the estate. Here, the court determined that the bankruptcy court did not abuse its discretion.  

Primarily, the court relied on the conclusion that the underlying plan of reorganization provided the sole means of recovery for equity holders. Allowing the Equity Committee to pursue the cause of action would be inconsistent with the requirement that all junior creditors (including all unsecured creditors) receive payment in full prior to distributions to the debtor’s equity under the plan.  

The court understood that derivative standing retains a necessary place in the overall bankruptcy process: it permits the preservation and management of claims that the debtor refuses to pursue on behalf of the estate. The court, however, noted that the bankruptcy court retains the jurisdiction (and obligation) to ensure that the derivative standing conferred is exercised in the best interest of the estate. To hold otherwise would permit the party to whom derivative standing has been conferred to obtain and exercise a veto right over the bankruptcy court.  

This case provides important guidelines and limitations for statutory committees in the pursuit of litigation on behalf of the estate. It ensures a level playing field during the administration of a bankruptcy case to prevent one party in the case from obtaining a stranglehold over any estate asset without continuing bankruptcy court oversight. Statutory committees should understand that the derivative standing conferred remains subject to bankruptcy court review, and does not provide “carte blanche” authority for the overall management of those claims.