Fifth Circuit Differentiates Between Derivative Claims and Claims Belonging to a Creditor

Even if a third party’s actions harm both the debtor and a creditor, the creditor can sometimes sue the third party, according to the Fifth Circuit.

The January 4 opinion by Circuit Judge Gregg Costa explained the difference between a derivative claim belonging only to the debtor and an independent claim that a creditor can pursue.

Shortly before filing chapter 11, a corporation fired its chief executive officer, allegedly breaching the CEO’s long-term employment agreement and failing to pay severance benefits. The CEO contended he was fired at the insistence of the dominant secured creditor, who held a lien on all assets. The CEO filed a claim against the debtor but later withdrew the claim.

In chapter 11, the debtor released all claims it held against the lender in return for $10 million.

The former CEO then sued the lender in state court, alleging tortious interference with contract. The lender removed the suit to federal court, contending that the tortious interference claim belonged to the debtor and was released in return for the $10 million.

Ruling that the claim belonged to the former CEO and that the CEO’s claim was not released, the bankruptcy court remanded the suit to state court. The district court affirmed, prompting the lender to appeal to the Fifth Circuit.

Whether a creditor or the bankruptcy estate can pursue a claim against a third party “is a recurring issue in bankruptcy law,” Judge Costa said. Citing the leading Fifth Circuit authority, In re Seven Seas Petroleum Inc., 522 F.3d 575 (5th Cir. 2008), he said that a claim is “derivative” and is property of the estate if “harm to the creditor comes about only because of harm to the debtor.” In those circumstances, only the trustee can sue.

On the other hand, claims “cannot be part of the estate” if “the claim does not involve any harm to the debtor,” Judge Costa said.

The third category involves claims where there was harm to the debtor and the creditor, both emanating from the same conduct by the third party.

“But even when the conduct harms the debtor,” Judge Costa said, “the creditor may also have a claim if its asserted injury does not flow from the injury to the debtor.” This means, he said, “that the estate and a creditor may have separate claims against a third party arising out of the same events,” citing opinions from the Second, Seventh and Eleventh Circuits.

To pursue a claim, Judge Costa said, the “creditor must show this direct injury is not dependent on injury to the estate.”

Judge Costa upheld the lower courts because, he said, “the harm to [the former CEO] from any improper firing without required severance does not depend on any harm to the debtor.” The injury to the CEO “flowed through” the lender’s actions “but not through injury to the debtor.” Indeed, he said, firing the CEO may have benefitted the debtor.

Even if the lender’s action also harmed the debtor, Judge Costa said that “a debtor and creditor can have separate claims arising from the same conduct.”

For a similar but more complicated case involving the Bernard Madoff Ponzi scheme, see A&G Goldman Partnership v. Picard (In re Bernard L. Madoff Investment Securities LLC), 739 Fed. Appx. 679 (2d Cir. June 27, 2018). In Madoff, the claims brought by creditors belonged to the trustee because the creditors were alleging the same harm that befell the estate. For ABI’s discussion of Madoff, click here.