Officer and Director Negligence and Malfeasance

The bankruptcy litigators at Mark Anchor Albert and Associates are experienced litigators and skillful trial advocates who successfully handle complex claims involving officer and director negligence and malfeasance.

A corporation’s directors, officers, and controlling shareholders are fiduciaries of the corporation. See In re Hechinger Investment Co. of Delaware (D. Del. 2002) 274 B.R. 71, 91; Enterra Corp. v. SGS Associates (E.D. Pa. 1985) 600 F. Supp. 678, 684. Additionally, under Delaware law—which is the law of incorporation of a majority of publicly-traded corporations—a fiduciary relationship develops between the officers, directors, and controlling shareholders of a corporation and creditors of the corporation, when the corporation enters the “zone of insolvency.” Hechinger Investment Co. of Delaware, 327 B.R. at 547; Main, Inc. v. Blatstein (E.D. Pa. 1999) 1999 WL 424296, at *14; Production Resources Group, LLC v. NCT Group, Inc. (Del. Ch. 2004) 863 A.2d 772, 788; Credit Lyonnais Bank Nederland, N.V. v. Pathe Communications Corp. (D. Del. 1991) 1991 WL 277613, at *34 & fn. 55.

“As an officer, director and principal stockholder of an insolvent corporation ... [a] defendant [is] duty bound to act with absolute fidelity to both creditors and stockholders.” Brown v. Presbyterian Ministers Fund (3d Cir.1973) 484 F.2d 998, 1005. “As such, any dealings that the officer, director or dominant shareholder has with the corporations for which they are fiduciaries are subjected to rigorous scrutiny.” In re Main, Inc. v. Blatstein (1999) 1999 WL 424296, at *14; see Pepper v. Lipton, (1939) 308 U.S. 295, 306 (rigorous scrutiny of a fiduciary); Zahn v. Transamerica Corp. (3d Cir. 1947) 162 F.2d 36, 42 (same).

Indeed, directors of insolvent corporations “hold their powers ‘in trust’ for all creditors of the corporation.” In re Insulfoams, Inc. (Bankr. W.D. Pa. 1995) 184 B.R. 649, 703-04, aff’d (3d Cir. 1997) 104 F.3d 547 (citing Sicardi v. Keystone Oil Co. (Pa. 1892) 24 A. 163, 164 ); see Bovay v. H.M. Byllesby & Co. (Del. 1944) 38 A.2d 808, 813 (“An insolvent corporation is civilly dead in the sense that its property may be administered in equity as a trust fund for the benefit of creditors.”). Fiduciaries “may not use their powers for their own benefit and to the detriment of creditors.” Committee of Unsecured Creditors v. Doemling (Bankr. W.D. Pa. 1991) 127 B.R. 945, 951.

“A person in a fiduciary relationship with a bankrupt corporation cannot serve himself first and his cestuis second. He cannot manipulate the affairs of his corporation to their detriment and in disregard of the standards of common decency and honesty. ... He cannot by the use of the corporate device avail himself of privileges normally permitted outsiders in a race of creditors. He cannot utilize his inside information and his strategic position for his own preferment. ... He cannot use his power for his personal advantage....” Pepper v. Litton (1939) 308 U.S. 295, 311.

The test for determining the fiduciary integrity of any transaction between a corporation and one of its officers, directors, and/or dominant or controlling shareholders is whether “the transaction carries the earmarks of an arm’s length bargain.” Pepper, 308 U.S. at 306-07. Additionally, “Persons who knowingly join a fiduciary in an enterprise which constitutes a breach of his fiduciary duty of trust are jointly and severally liable for any injury which results.” Laventhol, Krekstein, Horwath and Horwath v. Tuckman (Del. 1976) 372 A.2d 168, 170.

Delaware applies the standard of gross negligence in determining the validity of a director’s decision which falls under the protection of the business judgment rule. See Smith v. Van Gorkom (Del. 1985) 488 A.2d 858, 874 (holding that a board of directors was grossly negligent in approving a merger where the facts indicated that the board’s decision was made in a hurried manner, without reading all of the reports or considering alternatives).

Officer and director misfeasance or negligence in the bankruptcy context is far from unusual, but the business judgment rule still provides a powerful defense in actions not involving insider trading or other self-dealing, or at minimum gross negligence if not intentional wrongdoing.