In many chapter 11 cases, creditors’ committees can play a vital role in maximizing the recoveries of unsecured creditors. But the powers of creditors’ committees are circumscribed by both the Bankruptcy Code and case law.

One way committees try to enhance recoveries is by seeking “derivative standing” to commence adversary proceedings challenging the validity of a secured lender’s pre-petition liens. A recent decision shows how one court analyzed if a committee had standing to bring such actions. In re Platinum Corral, LLC, No. 21-00833-5-JNC, 2021 WL 4695327 (Bankr. E.D.N.C. Oct. 7, 2021).

The debtor operated 28 franchise restaurants primarily in the Sun Belt region. The debtor encountered financial problems related to the onset of the COVID-19 pandemic, resulting in a chapter 11 filing in April 2021.

Post-petition, the debtor operated as a debtor-in-possession and, with the consent of one its largest pre-petition lenders, used cash collateral from its retail locations to continue operating. After the formation of a creditors’ committee in the early stages of the case, the committee sought to challenge the validity of the lender’s pre-petition liens. The committee initiated an adversary proceeding seeking: (1) to avoid the lender’s liens against certain collateral pursuant to Bankruptcy Code section 544(a), (2) a judicial determination of the validity of those liens, and (3) the disallowance of the lender's claims and security.

The lender moved to dismiss the complaint by arguing that the committee lacked standing to bring a lien avoidance action under section 544. The lender asserted that only a chapter 11 trustee or a debtor-in-possession could bring such an action on behalf of the debtor’s estate. Therefore, the lender sought a ruling that the court lacked subject matter jurisdiction over the case pursuant to Federal Rule of Bankruptcy Procedure 7012(b)(1).

In response, the committee contended that: (1) the debtor could not sue the lender for lien avoidance because of its dependence on the lender for ongoing operational funding and an alleged conflict arising from its controlling member’s personal guaranty of the loans, and (2) no trustee had been appointed in the case to bring the lien avoidance challenge in lieu of the debtor-in-possession.

Bankruptcy Judge Joseph N. Callaway noted that bankruptcy courts occasionally recognize derivative standing for third parties (including creditors’ committees) to pursue an adversary proceeding. The U.S. Circuit Court of Appeals for the Fourth Circuit has said, however, that derivative standing should be granted only under "strict conditions”:

"In discussing the ‘strict conditions’ under which courts have allowed derivative standing, the Fourth Circuit approvingly cited the Commodore Test from the Second Circuit, which provides: ‘A creditors’ committee [or secured creditor] may acquire standing to pursue the debtor's claims if (1) the committee [or creditor] has the consent of the debtor in possession or trustee, and (2) the court finds that suit by the committee [or creditor] is (a) in the best interest of the bankruptcy estate, and (b) is necessary and beneficial to the fair efficient resolution of the bankruptcy proceedings.’" Id. at *4 (citing In re Baltimore, 432 F.3d at 561, quoting In re Commodore Int'l, Ltd., 262 F.3d 96, 100 (2d Cir. 2001)).

Here, Judge Callaway held that the creditors’ committee had failed to obtain the debtor’s consent to file the lien avoidance action and also did not seek prior court approval. Therefore, Judge Callaway dismissed the committee’s adversary complaint without prejudice, thus leaving open the possibility that the committee could obtain derivative standing in the future if the applicable strict conditions are met.