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Delaware Bankruptcy Court Grants Derivative Standing to Creditors’ Committee to Sue Members and Officers of Delaware LLC

In early February, a Delaware bankruptcy judge set new precedent by granting a creditors’ committee derivative standing to pursue breach of fiduciary duty claims against a Delaware LLC’s members and officers. At least three prior Delaware Bankruptcy Court decisions had held that creditors were barred from pursuing such derivative claims by operation of Delaware state law, specifically under the Delaware Limited Liability Company Act (the “DLLCA”). 

Generally speaking, under bankruptcy law, a creditor can step into the shoes of the debtor to pursue debtor claims (referred to as derivative standing).  Such derivative claims can be a valuable source of recovery for a bankruptcy estate and its creditors, especially claims against directors and officers which often times have insurance coverage.  However, Delaware state law limits a creditor’s ability to bring these derivative claims on behalf of a Delaware LLC debtor, and, until this recent decision, Delaware bankruptcy courts had upheld such limitation. 

In prior Delaware bankruptcy court decisions,[1] courts applied the plain language of the DLLCA, which provides that in a derivative action, the plaintiff must be a member or an assignee of the limited liability company.[2]   These decisions also followed the seminal Delaware case CML V, LLC v. Bax[3], in which the Delaware Supreme Court denied derivative standing to the creditors of the Delaware limited liability company and held that Section 18–1002 of the DLLCA, by its plain language, limits derivative standing to members or assignees of the LLC.[4] 

In this most recent opinion, Judge Craig T. Goldblatt issued a lengthy 52-page opinion in In re Pack Liquidating LLC,[5] finding that federal law, not state law, sets forth the procedures that govern derivative actions in federal court.[6] Although the opinion notes that the Court is “loath to break” with the prior opinions to have addressed this topic, it found that the Third Circuit Court of Appeal’s decision In re Cybergenics was controlling.  Cybergenic treated “the authority to grant a committee derivative standing to pursue an estate claim as one that stems from the Bankruptcy Code rather than state law.”[7] The Cybergenics Court reasoned that, among other things, the power to grant a creditors’ committee standing is implied from three specific provisions of the Bankruptcy Code, 11 U.S.C. §§ 1109(b), 1103(c)(5), and 503(b)(3)(B).[8] In applying the Constitution’s Supremacy Clause, Judge Goldblatt reasoned that ordinary principles of federal supremacy would require the Bankruptcy Code to preempt contrary Delaware state law that limits derivative standing to creditor committees.[9] 

As a result of the In re Pack decision, creditors’ committees, and potentially secured creditors, may now have a tool to pursue fiduciary duty claims against members and officers of a Delaware LLC in bankruptcy proceedings.  As mentioned, these claims may be a valuable source of recovery for the bankruptcy estate and its creditors. 

[1]In re Citadel Watford City Disposal Partners, L.P., 603 B.R. 897 (Bankr. D. Del. 2019); In re HH Liquidation, LLC, 590 B.R. 211 (Bankr. D. Del. 2018); In re PennySaver USA Publishing, LLC, 587 B.R. 445 (Bankr. D. Del. 2018).

[2]See 6 Del. C. § 18-1002 (“In a derivative action, the plaintiff must be a member or an assignee of a limited liability company interest at the time of bringing the action . . . .”); see also 6 Del. C. § 18-1001 (“A member or an assignee of a limited liability company interest may bring an action in the Court of Chancery in the right of a limited liability company to recover a judgment in its favor if managers or members with authority to do so have refused to bring the action or if an effort to cause those managers or members to bring the action is not likely to succeed.”). 

[3] 28 A.3d 1037 (Del. 2011). 

[4]Id. at 1046.

[5] No. 22-10797 (CTG), 2024 WL 409830 (Bankr. D. Del. Feb. 2, 2024)

[6]Id. at *4.

[7]Id. at *2 (citing Official Comm. of Unsecured Creditors of Cybergenics Corp. ex rel. Cybergenics Corp. v. Chinery, 330 F.3d 548 (3d Cir. 2003)).

[8]Cybergenics, 330 F.3d at 560-67.

[9]In re Pack Liquidating, LLC, at *2.

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Jacklyn M. Branby is an Associate at Mintz who focuses her practice on bankruptcy, financial restructuring, and commercial litigation matters. She has experience with Chapter 11 and other litigation and advising clients on out-of-court restructurings, including providing guidance on divisive mergers, loan workouts, and forbearance agreements.