In Re AppliedTheory Corp.

06-3390
In re AppliedTheory Corp.
UNITED STATES COURT OF APPEALS
FOR THE SECOND CIRCUIT
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August Term, 2006
(Argued: March 22, 2007 Decided: July 9, 2007)
Docket No. 06-3390-bk
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IN RE : APPLIED THEORY CORPORATION , DEBTOR
APPLIED THEORY CORPORATION ,
Debtor,
OFFICIAL COMM ITTEE OF UNSECURED CREDITORS
OF APPLIED THEORY CORPORATION ,
Appellant,
— v .—
HALIFAX FUND , L.P., PALLADIN PARTNERS I, L.P., PALLADIN OVERSEAS FUND LTD ., HATTERAS
PARTNERS , L.P., “FILING FOR” DE AM CONVERTIBLE ARBITRAGE FUND , LTD ., SPECTRUM
INVESTMENT S PARTNERS , LP, ELLIOTT INTERNATIONAL, L.P., ELLIOTT ASSOCIATES , L.P.,
Appellees.
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Before:
WALKER, SACK , and B.D. PARKER,
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Circuit Judges.
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Appeal from an order of the United States District Court for the Southern District of New
York (Cote, J.), affirming an order of the United States Bankruptcy Court for the Southern
District of New York (Gerber, J.).
Affirmed.
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ANDREW I. SILFEN (Leah M. Eisenberg and Heike M. Vogel, on the brief), Arent Fox,
LLP, New York, NY, for Appellant.
KIRK L. BRETT, New York, NY, for Appellees Halifax Fund, L.P., Palladin Partners I,
L.P., Palladin Overseas Fund Ltd., Hatteras Partners, L.P. (filing for DeAm Convertible
Arbitrage Fund, Ltd.), and Spectrum Investments Partners, LP (David Parker, Kleinberg,
Kaplan, Wolff, & Cohen, P.C., New York, NY, on the brief, for Appellees Elliott
International, L.P., and Elliott Associates, L.P.).
PER CURIAM:
Appellant Official Committee of Unsecured Creditors of AppliedTheory Corporation (the
“Committee”), appeals from an order of the United States District Court for the Southern District
of New York (Cote, J.), affirming an order of the United States Bankruptcy Court for the
Southern District of New York (Gerber, J.) denying the Committee authorization to assert a
claim of equitable subordination under Section 510(c) of the Bankruptcy Code, 11 U.S.C. §
510(c), against various lenders (“Lenders”) to AppliedTheory (“Debtor”).
In its proposed equitable subordination claim, the Committee sought to set aside a
transaction in which the Lenders, as insiders of the Debtor, are said to have used their control
over AppliedTheory to transform $30 million in convertible unsecured debt obligations into
secured debt to the detriment of other creditors. The Committee contended that the transaction
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occurred at a time when AppliedTheory was insolvent, undercapitalized, and experiencing large
losses, and that consideration for the transaction was an advance of an additional $4 million,
which was both inadequate and fully secured. According to the Committee, the advance was not
a loan but, in reality, a risk investment that should be recharacterized as equity or subordinated to
the claims of other creditors.
After the Debtor’s Chapter 11 Trustee investigated the claim and concluded it lacked
merit, the bankruptcy court denied the Committee permission to pursue the claim. That court
concluded, among other things, that, because the proposed claim was not directed toward any
particularized injury suffered by any specific creditor, it could not be pursued by the Committee
and constitute property of the estate. Because the Trustee had the exclusive authority to assert
such a claim and doubted its merit, the court denied the Committee authority to pursue it.
The Committee appealed to the district court, which affirmed. Judge Cote concluded
that, while the powers granted to creditors’ committees under the Bankruptcy Code have been
read to support a qualified right for such committees to sue, this right, under our decision in In re
STN Enterprises, 779 F.2d 901, 904 (2d Cir. 1985), is contingent upon the Committee obtaining
the approval of the bankruptcy court. In addition to court approval, the district court noted that a
committee’s right to sue is limited to a narrow set of situations, such as where the trustee or
debtor-in-possession unreasonably failed to bring suit or where the trustee or debtor-in-
possession consents. Commodore Int’l Ltd. v. Gould (In re Commodore Int’l Ltd.), 262 F.3d 96,
100 (2d Cir. 2001).
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In determining whether to allow the Committee to sue, the district court concluded that
the bankruptcy court had properly applied the factors we identified in STN, looking to whether
the claim is colorable and whether it is likely to benefit the estate. The district court also
affirmed the bankruptcy court’s finding that the Committee’s proposed claim would not be
directed toward a particularized injury suffered by any specific creditor.
DISCUSSION
On appeal, the Committee maintains that it is not obligated to seek the court’s approval to
bring its equitable subordination claim because STN does not apply. We exercise plenary review
over a district court’s affirmance of a bankruptcy court’s decision. Superintendent of Ins. v. Ochs
(In re First Cent. Fin. Corp.), 377 F.3d 209, 212 (2d Cir. 2004). We review the bankruptcy
court’s conclusions of law de novo and its findings of fact for clear error. Id.The Bankruptcy Code provides for the appointment of official committees of unsecured
creditors in Chapter 11 cases, and sets forth their powers and duties. See 11 U.S.C. §§ 1102,
1103. While the Bankruptcy Code authorizes a creditors’ committee to “raise and . . . appear and
be heard on any issue in a case under” Chapter 11, 11 U.S.C. § 1109(b), this provision does not
allow the committee “to usurp the trustee’s role as a representative of the estate with respect to
the initiation of certain types of litigation that belong exclusively to the estate,” Hartford
Underwriters Ins. Co. v. Union Planters Bank, N.A., 503 U.S. 1, 8-9 (2000) (quoting 7 Collier on
Bankruptcy ¶ 1109.05 (Lawrence P. King et al. eds., rev. 15th ed. 1999)). Moreover, the
Bankruptcy Code “contains no explicit authority for creditors’ committees to initiate adversary
proceedings.” STN, 779 F.2d at 904.
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In STN, we recognized that a committee has standing to bring an adversary suit in the
context of a bankruptcy proceeding in only two limited instances. There, an unsecured creditors’
committee sought leave from the bankruptcy court to sue the president and director of a debtor-
in-possession for fraudulent conveyances. We held that “11 U.S.C. §§ 1103(c)(5) and 1109(b)
imply a qualified right for creditors’ committees to initiate suit with the approval of the
bankruptcy court” when the trustee or debtor-in-possession has unjustifiably failed to bring suit
or abused its discretion in not suing to avoid a preferential transfer. STN, 779 F.2d at 904. We
explained that this inquiry would involve a determination as to whether the claim the committee
wishes to assert “is likely to benefit the reorganization estate.” Id. at 905.
Later, in Commodore, we held that a committee may sue, with the debtor’s consent and
the bankruptcy court’s approval, so long as the court finds that the suit is “(a) in the best interest
of the bankruptcy estate, and (b) is necessary and beneficial to the fair and efficient resolution of
the bankruptcy proceedings.” 262 F.3d at 100 (internal quotation marks and citation omitted); cf.
Glinka v. Murad (In re Housecraft Indus. USA, Inc.), 310 F.3d 64, 71 n.7 (2d Cir. 2002)
(applying the same analysis to a fraudulent transfer claim brought by an individual secured
creditor with the consent of a bankruptcy trustee).
Both cases doom the Committee’s appeal. They make clear that claims such as those the
Committee wishes to pursue depend on a judicial determination that they are likely to benefit the
estate. Here both the trustee and the bankruptcy court concluded that they were not. The
Committee advances no reasons for us to disturb these conclusions. Moreover, sound reasons
underlie the requirement of court authorization that STN and Commodore insist upon.
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Reorganizations would routinely spin out of control if decisions that would commit the time and
limited resources of the estate could be taken without the consent of the bankruptcy court, the
entity charged by law with controlling and regulating such matters. Requiring bankruptcy court
approval conditioned upon the litigation’s effect on the estate helps prevent committees and
individual creditors from pursuing adversary proceedings that may provide them with private
benefits but result in a net loss to the entire estate. Cf. Commodore, 262 F.3d at 99 (“[I]mpartial
judicial balancing of the benefits of a committee’s representation better serves the bankruptcy
estate.”) (quoting Liberty Mutual Ins. Co. v. Official Unsecured Creditor’s Comm. of Spaulding
Composites Co. (In re Spaulding Composites Co.), 207 B.R. 899, 904 (B.A.P. 9th Cir. 1997)).
Therefore, beyond the absence of benefit to the estate, approval to litigate is an independent
justification for dismissal of this appeal.
Nevertheless, the Committee argues that STN and Commodore are inapplicable because
they involved “derivative” claims brought on behalf of a trustee or debtor-in-possession, whereas
its claim for equitable subordination is “direct.” According to the Committee, section 510(c)
indicates that an equitable subordination claim is a direct claim that can be commenced by parties
in interest other than the trustee without first seeking court approval. Unlike other sections of the
code, § 510(c), the Committee contends, does not provide that only the trustee may bring
equitable subordination claims. See, e.g., 11 U.S.C. §§ 547, 548 (preference and fraudulent
conveyance claims). Citing only out-of-circuit authority – In re Vitreous Steel Prods. Co., 911
F.2d 1223 (7th Cir. 1990) – the Committee urges us to adopt a bright-line rule, under which
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equitable subordination claims “may be brought directly by a creditor, creditors, or a creditors’
committee, without Bankruptcy Court approval.” We are not persuaded.
In Vitreous, the Seventh Circuit held that an individual unsecured creditor had standing to
assert a claim for equitable subordination, because, unlike a trustee, the individual creditor
seeking equitable subordination “is not acting in the interests of all the unsecured creditors” and
“individual creditors have an interest in subordination separate and apart from the interests of the
estate as a whole.” Id. at 1231. We have observed, however, that “[a]n unsecured creditors’
committee has a close identity of interests with” the debtor-in-possession insofar as the latter is
obligated to pursue all actions that are in the best interest of the creditors and the estate.
Commodore, 262 F.3d at 99 (quoting Spalding, 207 B.R. at 904). It is clear to us, as it was to the
district court and the bankruptcy court, that the Committee’s proposed equitable subordination
claim would not be directed toward any particularized injury suffered by any creditor. The
Committee has demonstrated no interest of its own in subordination separate and apart from the
interests of the estate as a whole, and has failed to demonstrate why it should be permitted to step
into the shoes of the trustee. Cf. St. Paul Fire & Marine Ins. Co. v. PepsiCo, Inc., 884 F.2d 688,
700-03 (2d Cir. 1989).
In any event, regardless of how the Committee characterizes it, any equitable
subordination claim brought by the Committee would allege harm to the Debtor generally and
would seek to subordinate the Lenders to other creditors. Since the Committee is not itself a
creditor, it does not have any rights held by any creditor to assert such a claim against another
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creditor. In other words, the Committee has not sustained an injury for which a “direct” claim
might otherwise be available.
CONCLUSION
For the foregoing reasons, we AFFIRM the judgment of the district court.
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