Dear constituency list members of the Insolvency Law Committee, the following is a case update written by John N. Tedford, IV, a partner at Danning, Gill, Israel & Krasnoff, LLP, analyzing a recent case of interest:
In Bear Creek Trail, LLC v. BOKF, N.A. (In re Bear Creek Trail, LLC), 35 F.4th 1277 (10th Cir. 2022), the U.S. Court of Appeals for the Tenth Circuit (the “Court”) held that a debtor’s former management lacks authority to file an appeal, on behalf of the debtor, of an order converting the debtor’s case from chapter 11 to chapter 7. According to the Tenth Circuit, only the chapter 7 trustee has authority to challenge such an order on behalf of the debtor.
This case bulletin provides extensive commentary to the contrary. The Ninth Circuit has not yet ruled on the issue.
To read the full published decision, click here.
In July 2020, Bear Creek Trail, LLC (the “Debtor”), filed a chapter 11 petition for relief. A few months later, a creditor filed a motion for conversion of the case to chapter 7. A second creditor joined in the motion. In April 2021, the bankruptcy court granted the motion and converted the case to chapter 7. On behalf of the Debtor, a notice of appeal was filed by the attorney (“McCartney”) who represented the Debtor prior to conversion of the case.
The two creditors moved to dismiss the appeal, arguing that only the chapter 7 trustee had authority to bring the appeal on the Debtor’s behalf. Following binding Tenth Circuit authority (In re C.W. Mining Co., 636 F.3d 1257 (10th Cir. 2011)), the district court agreed. According to the district court, only the trustee had capacity to prosecute the appeal on the Debtor’s behalf. Since the parties who filed the appeal lacked the legal capacity to act on behalf of the Debtor, the district court dismissed the appeal.
McCartney filed a notice of appeal of the district court’s order on behalf of the Debtor. The Court affirmed the district court’s dismissal of the appeal.
The Court stated that when a corporate bankruptcy case is converted from chapter 11 to chapter 7, a sea change takes place. After the case is converted, “the debtor’s former management’s only role is to turn over the corporation’s property to the trustee and to provide certain information to the trustee and creditors. Authority to make legal decisions, like all other business decisions, passes to the Trustee alone. Corporate officers are ‘completely ousted’ once the trustee is appointed.” Bear Creek, 35 F.4th at 1280-81 (quoting C.W. Mining, 636 F.3d at 1263) (cleaned up).
In C.W. Mining, the Tenth Circuit held that once a chapter 7 trustee was appointed, the corporate debtor’s former management could no longer appeal the conversion order on the debtor’s behalf. According to C.W. Mining, the chapter 7 trustee was the only person authorized to bring the appeal on behalf of the debtor. Former management could still appeal, but only in their own right (and only if they had suffered pecuniary harm). Following C.W. Mining, the Court in Bear Creek determined that the district court properly dismissed the appeal filed by McCartney on the Debtor’s behalf.
Because C.W. Mining is binding authority in the Tenth Circuit, the Court properly affirmed the district court’s dismissal of the appeal. But in this author’s opinion, C.W. Mining and cases outside of the Tenth Circuit that follow it are wrong. No other circuit court—including the Ninth Circuit—has ruled on the question.
This issue typically arises in two contexts: (1) a corporate debtor appeals an order for relief entered in an involuntary case (e.g., C.W. Mining; South Edge LLC v. JPMorgan Chase Bank, N.A., 2011 WL 1626567 (D. Nev. Apr. 28, 2011)); or (2) a corporate debtor appeals from an order converting its case from chapter 11 to chapter 7 (e.g., Bear Creek). When dismissing these appeals, courts rely heavily upon C.W. Mining because the Tenth Circuit is the only circuit-level court to have squarely addressed this issue.
In C.W. Mining, the Court identified some of the powers and duties of chapter 7 trustees. See 11 U.S.C. §§ 323, 704(a). The Court also relied heavily on the Supreme Court’s decision in Commodity Futures Trading Com’n v. Weintraub, 471 U.S. 343, 352-53 (1985). The question in Weintraub was whether a chapter 7 trustee had the power to waive the debtor’s attorney-client privilege with respect to communications that took place pre-petition. The Supreme Court concluded that in light of the Code’s allocation of responsibilities between a trustee and the debtor’s former management, a trustee plays the role most closely analogous to that of a solvent corporation’s management. And since a debtor’s directors “retain virtually no management powers,” the Supreme Court concluded that they should not exercise the traditional management function of controlling the corporation’s attorney-client privilege.
In reaching this conclusion, the Supreme Court wrote that “the powers of the debtor’s directors are severely limited. Their role is to turn over the corporation’s property to the trustee and to provide certain information to the trustee and to the creditors. . . . Congress contemplated that when a trustee is appointed, he assumes control of the business, and the debtor’s directors are ‘completely ousted.’” Weintraub, 471 U.S. at 352-53 (quoting H.R. Rep. No. 95-595, 220 (1977)).
Parties pounce on the Supreme Court’s statement that when a trustee is appointed the debtor’s directors are “completely ousted.” However, as the Supreme Court recognized in a footnote, the Judiciary Committee’s report was referring to chapter 11 trustees appointed to operate a debtor’s business:
An initial question in a reorganization case is whether the management of the debtor should be left in possession to operate the business, or whether an independent trustee, representing the creditors’ and equity security holders’ interests, should be appointed to replace the management. If a trustee is appointed, the management is completely ousted, although occasionally a trustee hires former management to handle day-to-day operations. The trustee is put completely in control of the business. If a trustee is not appointed, then business continues as usual, subject, however, to court supervision over the debtor’s actions.
H.R. Rep. No. 95-595, at 220-21.
But there is nothing in the Code (or the Judiciary Committee’s report) to suggest that a trustee’s authority to operate a debtor’s business exterminates existing management’s authority to exercise rights retained by the debtor. Indeed, the Code says that the trustee “is the representative of the estate,” 11 U.S.C. § 323(a) (emphasis added), not the representative of the debtor. Further, it is clear that the “debtor” retains some rights and obligations independent of the trustee and the estate. For example:
- If a chapter 11 trustee is appointed during the exclusivity periods, the debtor (as well as the trustee and other parties) may file a plan. 11 U.S.C. § 1121(c).
- A chapter 7 debtor may convert its case to chapter 11. 11 U.S.C. § 706(a).
- The debtor must appear at the section 341(a) meeting of creditors, at which the trustee may examine the debtor. 11 U.S.C. § 343.
- The debtor must cooperate with the trustee as necessary to enable the trustee to perform his or her duties. 11 U.S.C. § 521(a)(3).
- Generally, property abandoned by the trustee re-vests in the debtor. See 11 U.S.C. § 554.
These and other rights and obligations of an “out of possession” debtor, separate from the rights and obligations of a trustee acting as the representative of the estate, can be exercised and performed only by the debtor’s separate management. Thus, while a debtor’s management may be “completely ousted” with respect to control over operations of the debtor’s business, it retains the authority to exercise rights the debtor still has after a trustee is appointed.
C.W. Mining and Bear Creek correctly recognize that debtors have the right to appeal orders for relief in involuntary cases and orders converting chapter 11 cases to chapter 7. See C.W. Mining, 636 F.3d at 1266 (“We do not hold that [the debtor] has no right to appeal the bankruptcy court’s § 303(b) determination.”); Bear Creek, 35 F.4th at 1282 (question is not whether debtor has standing to appeal, but whether former management has authority to appeal on debtor’s behalf). But they incorrectly hold that “the only natural person who can control the right is the trustee” whose appointment is being challenged. Id.
Some respond that a debtor’s owners can appeal in their own right if they are “persons aggrieved.” See C.W. Mining, 636 F.3d at 1266. And one court has stated that if a debtor believes that a trustee is breaching his or her fiduciary duties by not pursuing an appeal of an order for relief in an involuntary case (or an order converting a chapter 11 case to chapter 7), “the proper remedy is to seek removal of the Trustee, not to pursue an appeal on [the debtor’s] behalf.” South Edge, 2011 WL 1626567, at *6. These remedies are impracticable in most cases, disregard the fact that the debtor itself is the person most aggrieved, and effectively insulate orders from review. Appellate courts should therefore reject C.W. Mining’s holding and hear corporate debtors’ appeals of such orders on the merits.
These materials were written by former ILC co-chair John N. Tedford, IV, of Danning, Gill, Israel & Krasnoff, LLP, in Los Angeles, California (jtedford@DanningGill.com). Editorial contributions were provided by Kit J. Gardner of Law Offices of Kit J. Gardner in San Diego, California (email@example.com).