06-3390
In re AppliedTheory Corp.



                              UNITED STATES COURT OF APPEALS

                                      FOR THE SECOND CIRCUIT

                                       __________________

                                         August Term, 2006

   (Argued: March 22, 2007                                           Decided: July 9, 2007)

                                      Docket No. 06-3390-bk

                                       __________________

                            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.

                                       __________________

                                            Before:

                                  WALKER, SACK , and B.D. PARKER,

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                                          Circuit Judges.

                                         _____________

        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.
                                      __________________

       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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