When Congress passed the Small Business Reorganization Act of 2019 (the SBRA), [1] they made two important changes to chapter 11. [2] First, Congress created the subchapter V trustee. [3] Second, Congress eliminated the mandatory appointment of a committee of unsecured creditors. [4]
Historically, creditors’ committees have played an important role in conventional chapter 11 reorganizations. When a debtor-in-possession unjustifiably refuses to bring a cause of action because of a conflict of interest or otherwise, a creditors’ committee can step in to assert the claim for the benefit of all creditors. Also known as derivative standing, [5] this practice plays an important role in ensuring that a chapter 11 estate is not diminished by a DIP’s potential conflicts of interest.
But with creditors’ committees effectively eliminated in subchapter V cases, who then steps in when a small business debtor unjustifiably refuses to bring a colorable cause of action? The answer is the subchapter V trustee.
Subchapter V trustees are unique because they are the only bankruptcy trustees charged with the duty to facilitate consensual plans of reorganization. [6] However, they are similar to chapter 12 and 13 trustees because small business debtors remain in possession of property of the estate. [7] Subchapter V trustees do not take possession of property of the estate unless the debtor is removed. [8] It is widely understood that subchapter V trustees occupy a mediator-like role within subchapter V cases. [9]
Yet Congress intended that subchapter V trustees act as fiduciaries for creditors in the absence of creditors’ committees. [10] Indeed, when a subchapter V debtor is removed, the powers of a subchapter V trustee expand. [11] However, these expanded powers do not include a key source of a committee’s authority for asserting derivative standing. Courts typically cite, among other statutes, 11 U.S.C. § 1103(c)(5) as allowing a committee’s derivative standing. [12] This section provides that “[a] committee appointed under section 1102 of this title may — … perform such other services as are in the interest of those represented.” [13] This section is not included in a subchapter V trustee’s duties. [14] However, there are at least three sources of statutory authority for extending derivative standing to subchapter V trustees when a small business debtor unjustifiably refuses to assert a cause of action: §§ 704(a)(2), 1183(b)(7) and 1185.
Section 704(a)(2) is an incorporated subchapter V trustee duty. [15] This section provides that “[t]he trustee shall — … be accountable for all property received….” [16] “‘[A]ccountable’ is best defined as ‘responsible’ or ‘liable to be called to account or to answer for responsibilities and conduct.’” [17] Because a subchapter V trustee is obligated to be accountable for property received, regardless of whether the debtor is removed from possession, § 704(a)(2) contemplates that subchapter V trustees are likely to possess estate property at some time during the course of a small business case. Moreover, § 704(a)(2) is not limited to any type of property, and thus is broad enough to include causes of action against third parties.
Section 1183(b)(7) is an express subchapter V trustee duty, providing that “[t]he trustee shall — … facilitate the development of a consensual plan of reorganization.” [18] “[T]he subchapter V trustee is the only trustee directed to ‘facilitate the development of a consensual plan of reorganization.’” [19] “This duty is assigned to no other trustee in bankruptcy.” [20] Although the use of “facilitate” in § 1183(b)(7) is cited as giving subchapter V trustees a mediator-like role, [21] the term is not limited and is broad enough to include any activity that makes the advancement of a consensual plan easier. It is reasonable to conclude that the duty to facilitate includes that ability to assert estate causes of action when a debtor unjustifiably refuses to do so.
Section 1185 deals with removal of a DIP: “On request of a party in interest, and after notice and a hearing, the court shall order that the debtor shall not be a debtor in possession for cause, including fraud, dishonesty, incompetence, or gross mismanagement of the affairs of the debtor….” [22] Although § 1185(a) lists three examples of cause for removal, this list is not exclusive. An interested party could assert that the debtor should be removed for failure to assert potentially valuable causes of action. This would give a subchapter V trustees derivative standing.
While subchapter V trustees are less adversarial than committees and their residual powers are less broad, there are at least three sources of statutory authority that grant subchapter V trustees derivative standing when a small business debtor unjustifiably refuses to assert a cause of action. Subchapter V trustees are charged with being accountable for estate property and facilitating consensual plans of reorganization. An interested party could also seek removal of the DIP. Accordingly, subchapter V trustees have statutory authority to obtain derivative standing.
[1] In re Ventura, 615 B.R. 1, 12 (Bankr. E.D.N.Y. 2020) (“On August 23, 2019, the President signed the SBRA into law, which became effective on February 19, 2020.”) (citing Pub. L. No. 116-54 § 5, 133 Stat. 1079, 1087).
[2] See 11 U.S.C. §§ 1101-1195.
[3] See In re 218 Jackson LLC, 631 B.R. 937, 946–47 (Bankr. M.D. Fla. 2021) (“Subchapter V also introduces a new player — the subchapter V trustee.”).
[4] See 11 U.S.C. § 1181(b) (“Unless the court for cause orders otherwise, paragraphs (1), (2), and (4) of section 1102(a) and sections 1102(b), 1103, and 1125 of this title do not apply in a case under this subchapter.”). Section 1102 provides for the appointment of creditors’ committees automatically in conventional chapter 11 cases. See 11 U.S.C. § 1102(a)(1).
[5] See Lepene & Gordon, The Case for Derivative Standing in Chapter 11: “It’s the Plain Meaning, Stupid”, 11 AM. BANKR. INST. L. REV. 313, 315 (2003) (“[T]his practice is known as the grant of ‘derivative standing,’ whereby a creditor or a creditors’ committee is designated by the bankruptcy court to take action in the trustee’s stead.”).
[6] 218 Jackson, 631 B.R. at 947 (citing 11 U.S.C. § 1183(b)(7)).
[7] See id. (“A chapter 12 trustee is perhaps the most similar here — not taking possession of estate property and occupying a similar oversight role.”).
[8] Id. (citing 11 U.S.C. § 1183(a)(5)).
[9] Id. (citing In re Seven Stars on the Hudson Corp., 618 B.R. 333, 346 n.81 (Bankr. S.D. Fla. 2020) (“A substantial part of the Subchapter V trustee’s pre-confirmation role, therefore, should be to serve as a de facto mediator between the debtor and its creditors.”)).
[10] See Ventura, 615 B.R. at 13.
[11] See 11 U.S.C. § 1183(b)(5) (incorporating by reference the subchapter V trustee’s expanded duties upon removal of a DIP).
[12] See In re Roman Catholic Church of the Archdiocese of Santa Fe, 621 B.R. 502, 507 (Bankr. D.N.M. 2020) (citation omitted).
[13] 11 U.S.C. § 1103(c)(5).
[14] See 11 U.S.C. § 1183(b) (describing the subchapter V trustee’s general duties).
[15] See 11 U.S.C. § 1183(b)(1).
[16] 11 U.S.C. § 704(a)(2).
[17] Seven Stars, 618 B.R. at 345 (citation omitted).
[18] 11 U.S.C. § 1183(b)(7).
[19] 218 Jackson, 631 B.R. at 947 (citing 11 U.S.C. § 1183(b)(7)) (italics in original).
[20] Id.
[21] See id. (discussing the mediator-like qualities and duties of subchapter V trustees).
[22] 11 U.S.C. § 1185(a).