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Judge Carey (Bankr. D. Del.) Grants Motion to Dismiss Derivative Breach of Fiduciary Duty Claim Because Creditors of Insolvent Limited Partnerships and Limited Liability Companies Lack Standing Under Applicable State Law

Written by: Gregory J. Flasser

Does a creditors’ committee have standing to pursue derivative breach of fiduciary duty claims on behalf of debtor entities formed as either a limited partnership or limited liability companies? Looking to applicable state law governing such entities, Judge Carey answered a resounding “no” in the case of Gavin/Solmonese LLC v. Citadel Energy Partners, LLC (In re Citadel Watford City Disposal Partners, L.P.), Case No. 17-50024 (KJC).

By way of background, on June 19, 2015, four limited partnership and limited liability companies formed under Delaware, North Dakota, and Wyoming law, respectively, filed petitions for relief under chapter 11 of the Bankruptcy Code.

Before effectiveness of the debtors’ chapter 11 plan and in accordance with an order granting standing, the creditors’ committee commenced an adversary proceeding asserting derivative breach of fiduciary duty claims on behalf of the debtors. The plan provided for the creation of a liquidation trust to administer certain assets and to pursue, prosecute, settle, or abandon causes of action involving said assets. The plan and liquidation trust agreement included therewith, also contemplated that the liquidation trustee would be substituted in as the real party in interest in causes of action commenced by or against the debtors, the debtors’ estates, or the creditors’ committee.

Shortly after effectiveness, the caption in the adversary proceeding was amended to reflect that the liquidation trustee would succeed the creditors’ committee as plaintiff. Thereafter, a defendant filed a motion to dismiss for lack of standing.

Applying the internal affairs doctrine, the Court found that the state laws of Delaware, North Dakota, and Wyoming governed in determining the standing of creditors to bring derivative breach of fiduciary duty claims. Section 17-1002 of the Delaware LP Act provides, in relevant part, “[i]n a derivative action, the plaintiff must be a partner or an assignee of a partnership interest at the time of bringing the action.” 6 Del. C. § 17-1002 (emphasis added). Finding the statutory language to be unambiguous, the Court held that the creditors’ committee did not have standing to assert derivative claims on behalf of the Delaware based debtor. To bolster his decision, Judge Carey cited well-developed precedent on this issue with respect to Delaware LLC law. See In re HH Liquidation, 590 B.R. 211, 283-85 (Bankr. D. Del. 2018) (holding that under the plain language of 6 Del. C. § 18-1002, a committee lacked standing to bring a breach of fiduciary duty claim on behalf of a Delaware LLC); see also In re PennySaver USA Publishing, LLC, 587 B.R. 445, 466-67 (Bankr. D. Del. 2018) (dismissing a chapter 7 trustee’s derivative claims for breach of fiduciary duties allegedly owed to a Delaware LLC).

Similarly, with respect to the North Dakota and Wyoming based debtors, the Court noted that the applicable statutes limit standing to members at the time an action is commenced. Accordingly, the Court held that the creditors’ committee’s derivative claims on behalf of those debtors must also be dismissed.

The liquidation trustee also argued that the confirmed plan provided the liquidation trustee standing because the plan assigned the liquidation trust assets—including the causes of action—to the liquidation trustee. The Court disagreed, finding that under the doctrine of assignment, the liquidation trustee could not receive more than its predecessor (the creditors’ committee) which, for the reasons set forth above did not have standing to begin with.

Last, the Court ruled that Rule 17(a)(3) regarding dismissal for failure to join the real party in interest did not cure the standing issue. The purpose of Fed. R. Civ. P. 17(a)(3) is to “prevent forfeiture of an action when determination of the right party to sue is difficult or when an understandable mistake has been made.” See Gardner v. State Farm Fire & Cas. Co., 544 F.3d 553, 563 (3d Cir. 2008) (citing U.S. for Use & Benefit of Wulff v. CMA Inc., 890 F.2d 1070, 1074 (9th Cir. 1989)). Here, the Court found that the parties were clearly identified, and the liquidation trustee presented no evidence of excusable mistake. For all these reasons, the Court granted the defendant’s motion to dismiss the derivative breach of fiduciary duty claims.

The liquidating trustee appealed the opinion on May 16, 2019.

A copy of the opinion can be found here.

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