The United States Court of Appeals for the Sixth Circuit recently issued two opinions examining standing issues in bankruptcy proceedings. This article examines how those cases clarify bankruptcy practice and procedures in the Sixth Circuit related to: (1) obtaining standing to pursue causes of action on behalf of the bankruptcy estate, and (2) the standing of potential defendants to oppose orders granting authority to pursue causes of action against them.

I. Derivative Standing

The Sixth Circuit recently rendered an opinion in Hyundai Translead, Inc. v. Jackson Trust & Trailer Repair, Inc. (In re Trailer Source), 555 F.3d 231 (6th Cir. 2009) clarifying the rights of Bankruptcy Courts to permit derivative standing to creditors to pursue avoidance actions on behalf of the bankruptcy estate.

A. Facts and Background

The Trailer Source opinion was rendered in connection with a Chapter 7 case pending in the Bankruptcy Court for the Middle District of Tennessee. In that case, the Chapter 7 trustee elected not to pursue an avoidance action pursuant to Bankruptcy Code Sections 544(b) and 550(a) against Jackson Truck & Trailer Repair, Inc., as well as various individuals (the "JT & T Parties").

Following the trustee's decision not to pursue the avoidance action, a secured creditor in the case, Hyundai Translead, Inc., filed a motion seeking permission to pursue the avoidance action on behalf of the estate. Following a hearing, the Bankruptcy Court denied the motion. The Chapter 7 trustee then entered into a settlement agreement with the JT & T Parties resolving nearly $20 million in fraudulent transfer claims for $50,000. The settlement was approved by order of the Bankruptcy Court.

Hyundai appealed the denial of derivative standing and also appealed the order approving the settlement. The District Court reversed the Bankruptcy Court's rulings.

The JT & T Parties filed a motion to certify, among other things, the question of "whether derivative standing remains available in Chapter 7 proceedings after Hartford Underwriters." The Sixth Circuit granted permission for an interlocutory appeal on that question.

B. The Effect of Hartford Underwriters

In Hartford Underwriters Insurance Co. v. Union Planters Bank, N.A., 530 U.S. 1, 120 S.Ct. 1942 (2000), the Supreme Court held that an independent claimant does not have an independent right under Section 506(c) to pursue payment of its administrative claim from property encumbered by a secured creditor's lien. Id. at 13. In that case, the Supreme Court noted that the petition failed to ask the trustee to pursue the Section 506(c) claim and did not seek prior permission from the Bankruptcy Court to pursue the claim. In light of the foregoing and based on the language of Section 506(c), the Supreme court rejected the petitioner's claim that it held an "independent right" to pursue a remedy under Section 506(c). Id.

It was Hartford Underwriters that led the Bankruptcy Court in Trailer Source to question the viability of the derivative-standing doctrine. However, unlike Hartford Underwriters, in the Trailer Source case, the creditor seeking to pursue the avoidance action first requested the trustee to pursue the action, and once the trustee declined, the creditor sought court permission to pursue the action.

C. The Trailer Source Appeal and Holding

On February 6, 2009, the Sixth Circuit rendered its opinion in connection with the Trailer Source interlocutory appeal. The Court reaffirmed the "continued vitality after Hartford Underwriters of granting derivative standing to creditors to pursue avoidance actions on behalf of the estate." Trailer Source, 555 F.3d at 245.

The Sixth Circuit, like the Supreme Court in Hartford Underwriters, specifically held that derivative standing is not an independent right. However, even though an independent right does not exist, permission to pursue avoidance actions may be authorized by the Bankruptcy Court. Id. at 244. The creditor or party in interest seeking to pursue the claim must make a request of the Bankruptcy Court to do so. In considering any such request, the Sixth Circuit requires the Bankruptcy Court to apply the factors set forth in its holding in Canadian Pacific Forest Products, Ltd. v. J.D. Irving, Ltd. (In re The Gibson Group, Inc.), 66 F.3d 1436 (6th Cir. 1995).

In Gibson Group, the Sixth Circuit held that a party seeking to establish derivative standing must demonstrate that "(1) a demand was made on the trustee (or debtor-in-possession) to act, (2) the trustee (or debtor-in-possession) declined, (3) a colorable claim exists that would benefit the estate, and (4) the trustee's (or debtor-in-possession's) inaction was an abuse of discretion." Id. at 1446. Trailer Source reaffirms the Gibson Group holding, and also identifies factors such as conflict of interest and lack of funds to obtain competent counsel that may justify the approval of derivative standing to pursue causes of action. Trailer Source, 555 F.3d at 243-44.

In its review of the Bankruptcy Court's ruling in Trailer Source, the Sixth Circuit also considered whether a distinction should be made between derivative standing in Chapter 7 cases versus Chapter 11 cases in light of the JT & T Parties' argument that derivative standing is not necessary in Chapter 7 cases because the trustee is not "subject to such conflicts of interest." Trailer Source, 555 F.3d at 243. On this issue, the Sixth Circuit held that derivative standing is "available in both Chapter 11 and Chapter 7 proceedings." Id.

Ultimately, Trailer Source clarifies and reaffirms creditors' derivative standing to pursue avoidance actions in the Sixth Circuit. While the derivative standing is not an automatic right, when the Gibson Group prerequisites are met, it is a valuable tool available to creditors when the trustee or debtor-in-possession lacks either the willingness or the funds necessary to pursue potentially valuable causes of action for the benefit of the estate.

II. Appellate Standing – The "Person Aggrieved" Doctrine

In addition to derivative standing, the Trailer Source holding also touches on the "person aggrieved" doctrine as it applies to the question of appellate standing. The Trailer Source ruling was quickly followed by Glenn J. Moran v. LTV Steel Company, Inc. and Official Committee of Administrative Claimants (In re LTV Steel Company, Inc.), 560 F.3d 449 (6th Cir. 2009), which further examines the question of appellate standing.

Specifically, Trailer Source and LTV Steel explain that once the Bankruptcy Court has authorized a party to pursue litigation, potential defendants have no standing to appeal the order granting that right absent a showing that the potential defendant is directly and adversely affected pecuniarily. If the harm is merely the harm of becoming a defendant in threatened or actual litigation, the Court will likely hold that the potential defendant has no standing to appeal the order at issue.

A. To Whom Does the "Person Aggrieved" Doctrine Apply?

On March 23, 2009, the Sixth Circuit applied the "person aggrieved" doctrine in LTV Steel and held that the former officers and directors of the debtor did not have standing to challenge a Bankruptcy Court order authorizing the Official Committee of Administrative Claimants (the "ACC") to pursue litigation against those parties.

In that case, the Bankruptcy Court issued an order permitting the ACC to pursue causes of action against certain officers and directors of the debtor. The former CEO appealed the order to the District Court and the ACC moved to dismiss the appeal for lack of jurisdiction. The District Court dismissed the appeal for lack of finality and lack of standing. The CEO appealed to the Sixth Circuit which ultimately ruled that based on the "person aggrieved" doctrine, the CEO lacked standing to appeal the Bankruptcy Court's order. LTV Steel, 560 F.3d 453-54.

Specifically, the Sixth Circuit explained that a party is not a "person aggrieved" unless that party is "directly and adversely affected pecuniarily by the order." Id. at 452, quoting Marlow v. Rollins Cotton Co. (In re Julien Co.) 146 F.3d 420, 423 (6th Cir. 1998). The pecuniary interest must be a "direct financial stake in the order," and the unpleasant or onerous burden of defending a lawsuit does not reach the level of immediate harm required to trigger the "person aggrieved" doctrine. Id. at 453.

The Court also rejected arguments by the CEO that because the lawsuit against him had already been filed, the harm was an actual harm as opposed to a potential harm. In rejecting this argument, the Court explained that the order in question did not in any way impair the CEO's right to defend himself. As such, the authorization of a lawsuit did not "directly 'diminish [his] property, increase [his] burdens, or detrimentally affect [his] rights.'" Id. at 454, quoting In re El San Juan Hotel, 809 F.2d 151, 155 (1st Cir. 1987).

Furthermore, the CEO's status as an administrative claimant was not sufficient to confer appellate standing. In making this determination, the Court referenced the dissenting opinion in Trailer Source and explained that "simply holding a claim of any type against the estate does not automatically confer appellate standing under the 'person aggrieved' doctrine". Id. at 454, citing Trailer Source, 555 F.3d at 250 (Rogers, J., dissenting). Again, the holder of the claim must have a direct and adverse pecuniary interest in the order challenged in order to have appellate standing.

B. When Does the "Person Aggrieved" Doctrine Apply?

As explained above, the "person aggrieved" or "appellate standing" doctrine states that "standing to appeal a bankruptcy order is limited to "parties directly and adversely affected pecuniarily." Trailer Source, 555 F.3d at 235. In Trailer Source, the Sixth Circuit considered at what stage in the appeals process that doctrine must be applied.

Specifically, the Sixth Circuit considered whether the doctrine of appellate standing was limited to initial appeals from the Bankruptcy Court, or whether the doctrine may be applied to appeals from the District Court to the Court of Appeals. Appeals from the District Court to the Court of Appeals are referred to in Trailer Source as the "second layer of appeal."

In Trailer Source, the Sixth Circuit determined that the person aggrieved doctrine is "not applicable to the second layer of appeal…when it is uncontested that the party who appealed the Bankruptcy Court's order to the District Court had appellate standing." Id. at 237. In other words, if the first layer appeal – the appeal from the Bankruptcy Court to the District Court, was authorized, then the appellate standing doctrine need not be applied at the "second layer" appeal.

The Sixth Circuit further explained that so long as there is no dispute as to whether the party who appealed the Bankruptcy Court's order had standing, the general rule as to "second layer" appeals is the more relaxed standard that "a party must be aggrieved by the judicial action from which it appeals." Id. at 237-38, citing City of Cleveland v. Ohio, 508 F.3d 827, 836 (6th Cir. 2007).

III. Conclusion

Following the Sixth Circuit's recent holdings in Trailer Source and LTV Steel, creditors and parties in interest have new clarity with respect to standing in bankruptcy litigation and appeals.

The Trailer Source opinion clarifies that, in the wake of Hartford Underwriters, Bankruptcy Courts in the Sixth Circuit retain their equitable powers to authorize creditors to pursue litigation that may benefit the estate following application to the Bankruptcy Court and a showing regarding the Gibson Group factors.

Meanwhile, based on LTV Steel, once a party has been authorized to pursue litigation, only those parties that are directly and adversely affected pecuniarily have standing to appeal the Bankruptcy Court order authorizing the litigation. Appeals from such orders based merely on the harm of becoming a defendant will likely fail absent some other demonstrable pecuniary harm.

Source:MGLAW.net