By Kate Scherling (Quinn Emanuel Urquhart & Sullivan, LLP)
Until recently, the judges of the Delaware bankruptcy court were in apparent agreement that Delaware state law acted to prohibit creditors from obtaining derivative standing to prosecute breach of fiduciary duty claims on behalf of the bankruptcy estate of a Delaware limited liability company. But in February 2024, Judge Craig T. Goldblatt broke ranks with his fellow judges in In re Pack Liquidating, LLC, No. 22-10797 (CTG), 2024 WL 409830 (Bankr. D. Del. Feb. 2, 2024), holding that the Delaware Limited Liability Company Act did not preclude the bankruptcy court from granting the official creditors’ committee standing to pursue estate causes of action (assuming it otherwise met the established standards for granting that relief).
Under Delaware law, a member of a Delaware LLC (like a shareholder of a corporation), may sue derivatively for breach of fiduciary duties. The Delaware LLC Act limits who can be a plaintiff in such an action to members or certain assignees of an LLC interest. The Delaware Chancery Court examined the plain meaning of the statute in 2010 in CML V, LLC v. Bax, 6 A.3d 238 (Del. Ch. 2010) and held that only members or assignees of LLC interests have standing to bring derivative actions. Thus, the court concluded, creditors of an LLC never have standing to bring derivative actions on behalf of an LLC.
Judge Goldblatt’s fellow judges focused their opinions on state law (i.e., the Delaware LLC Act and the Bax decision) not on the Bankruptcy Code or the Third Circuit Court of Appeals’ ruling in Cybergenics. In this seminal case—which is binding precedent for Delaware Bankruptcy Courts—the Third Circuit held that the bankruptcy court could authorize the committee to pursue certain estate claims and that such authority was implicit in the Bankruptcy Code. Official Comm. Of Unsecured Creditors of Cybergenics Corp. ex rel. Cybergenics Corp. v. Chinery, 330 F.3d 548 (3d Cir. 2003).
Breaking with the other judges, Judge Goldblatt held that Cybergenics controlled in the bankruptcy context. In his view, there is no conflict between Cybergenics and Bax, but even if there were, the U.S. Constitution’s Supremacy Clause would require the authority that the Third Circuit found implicit in the Bankruptcy Code to preempt any contrary state law.
But just as the other Delaware Bankruptcy Judges’ decisions were not binding on Judge Goldblatt, his Pack Liquidating ruling similarly not binding. As a result, there is significant uncertainty as to the state of the law in the District of Delaware. Until a higher court decides the issue, creditors may be well-advised to negotiate for provisions in financing, cash collateral, or similar orders, or other so-ordered stipulations, prospectively granting standing to pursue claims on behalf of debtors notwithstanding any issue regarding whether creditors have the ability to file derivative suits on behalf of any debtor that is a Delaware LLC or LP.
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