Fiduciary Duties For Court Appointed, Court Approved, Code Created or Other Mythical Creatures in Bankruptcy

FIDUCIARY DUTIES FOR COURT APPOINTED,
COURT APPROVED, CODE CREATED OR

OTHER MYTHICAL CREATURES IN
BANKRUPTCY

State Bar of Texas Annual Meeting
Bankruptcy Law Section
San Antonio, Texas
J une 25, 2004

PANEL

Hon. Ronald B. King, Bankruptcy Judge, W.D. Texas, San Antonio
Charles A. Beckham, J r., Haynes and Boone, LLP, Houston
J ohn P. Melko, Gardere Wynne Sewell LLP, Houston

Fiduciary Duties For Court Appointed, Court Approved,
Code Created or Other Mythical Creatures in Bankruptcy i

FIDUCIARY DUTIES FOR COURT APPOINTED, COURT APPROVED,
CODE CREATED OR OTHER MYTHICAL CREATURES IN
BANKRUPTCY

Charles A. Beckham, J r., Haynes and Boone, LLP, Houston
J ohn P. Melko, Gardere Wynne Sewell LLP, Houston
Abigail Ottmers, Haynes and Boone, LLP, San Antonio

TABLE OF CONTENTS

I. INTRODUCTION...........................................................................................................................1
II. WHO OR WHAT: PARTIES IN BANKRUPTCY .........................................................................1
A. Debtors and Debtors-in-Possession...........................................................................................1
B. Appointed Trustees....................................................................................................................2
C. Examiners in Chapter 11 Cases.................................................................................................3
D. Committees................................................................................................................................3
E. Court Approved Counsel and Other Professionals for Trustees, Examiners and Committees..4
III. FIDUCIARY....................................................................................................................................5
A. What is a Fiduciary....................................................................................................................5
1. State....................................................................................................................................6
2. Bankruptcy..........................................................................................................................6
IV. FIDUCIARY DUTIES.....................................................................................................................7
A. DEBTORS.................................................................................................................................7
1. Fiduciary Duties Of Officers And Directors.......................................................................7
2. Basic Principles...................................................................................................................7
a. Duties Owed in a Solvent Corporation.........................................................................7
b. Business J udgment Rule...............................................................................................9
3. No Fiduciary Duty to Creditors in a Solvent Corporation..................................................9
4. Fiduciary Duties Upon Insolvency...................................................................................10
a. The Narrow View (Prohibition Against Self-Dealing and Insider Preferences)........11
b. Intermediate Views (Duty To Minimize Loss Upon Insolvency)..............................11
c. Expansive View (Duty To Maximize Long-Term Wealth Creating Capacity)..........15
5. Does the Fiduciary Duty Shift to Creditors, to the Exclusion of Shareholder Interests?..17
6. When is the Fiduciary Duty to Creditors Triggered?........................................................18
7. Fiduciary Duties Owed in Bankruptcy.............................................................................20
B. TRUSTEE ...............................................................................................................................21
C. EXAMINERS..........................................................................................................................22
D. COMMITTEES.......................................................................................................................23
1. Rights and Duties of a Committee....................................................................................24
2. Duties to Investigate the Debtors Business and Plan of Reorganization.........................26
3. Objections to Applications of Professionals.....................................................................26
4. Duty to Request Appointment of a Trustee or Examiner..................................................26
5. Standing Of Creditors Committees To Sue On Behalf of Debtors Estate......................27
6. Deference to Creditor Interest...........................................................................................28
7. Fiduciary Duty..................................................................................................................29
8. Committees and Committee Members Liability............................................................31
E. STANDARD OF REVIEW.....................................................................................................32
Code Created or Other Mythical Creatures in Bankruptcy ii

F. COURT APPROVED COUNSEL AND OTHER PROFESSIONALS FOR DEBTORS,
TRUSTEES, EXAMINERS, AND COMMITTEES..............................................................34
V. POTENTIAL USE OF SPECIAL CONFLICTS COUNSEL........................................................36

Code Created or Other Mythical Creatures in Bankruptcy 1

I. INTRODUCTION

A chapter 11 filing triggers many events, including the creation of offices or positions unique to
bankruptcy. Even before the filing of a bankruptcy petition, however, once a debtor wanders into the
vicinity of insolvency,
1
the fiduciary duties that an individual debtor or management of a entity-debtor
owe to the owners of the business expand to include the creditors of a debtor. The filing of a Chapter 7
petition, gives rise to the appointment of a trustee, who then becomes the fiduciary for the estate. But, in
Chapter 11 cases, a new estate is created whereby the Chapter 11 debtor becomes the debtor in
possession, unless supplanted by a Chapter 11 trustee. The Chapter 11 petition may also give rise to the
appointment or creation of an official committee of unsecured creditors, and depending upon the case,
other committees as well. Whether a debtor is in the vicinity of insolvency or in a filed bankruptcy
case, the debtors fiduciary duties have expanded, and not shifted as frequently described, to include not
only the equity owners of the debtor but also the other constituent groups with an interest in the
bankruptcy case. Accordingly, counsel for a debtor in possession, or a trustee, may owe fiduciary duties
to the same constituent group in a bankruptcy.
With respect to court-appointed committees, the obligations and responsibilities are more narrow.
Each committee owes fiduciary duties only to its constituent group. So, for example, the unsecured
creditors committee owes a fiduciary duty to the unsecured creditors as a whole, but owes no duty to the
debtors estate, nor equity security holders. And while the committee owes a fiduciary duty to the general
unsecured creditor class as a whole, they owe no duty to protect the interests of an individual creditor.

II. WHO OR WHAT: PARTIES IN BANKRUPTCY

A. Debtors and Debtors-in-Possession

Financially ailing entities or persons may choose to reorganize under chapter 11 of the
Bankruptcy Code or they may choose to liquidate under Chapter 7.
2
When a company cannot meet its
financial obligations, a company should envision protection under the Bankruptcy Code.
3
Having made
this decision, a debtor steps into the responsibilities and obligations required by the Bankruptcy Code,
while the Bankruptcy Code, in turn, protects the company by imposing an automatic stay
4
regarding all
efforts to recover assets or collect debts involving the bankrupt company. A debtor in bankruptcy has the
option to seek approval from the Bankruptcy Court to reorganize under chapter 11, or to liquidate the
company through chapters 7 or 11.
5

In a Chapter 11 proceeding, the term debtor in possession refers to the debtor, except when a
trustee has been appointed.
6
This term means that in the case of a corporate debtor, the debtor in
possession (the DIP) is the corporation, not the officers or directors of the corporation. For limited
purposes, however, under the Bankruptcy Rules, the bankruptcy court has the authority to order that the
term debtor will include one or more of the officers or directors of the corporation.
7
Such designation

1
Credit Lyonnais Bank Nederland, N.V. v. Pathe Communications Corp., No. 12150, 1991 WL 277613 (Del. Ch.
Dec. 30, 1991).
2
11 U.S.C. 1101, et seq.
3
11 U.C.C. 101, et seq.
4
11 U.S.C. 362.
5
11 U.S.C. 700, et seq. and 1101, et seq.
6
11 U.S.C. 1101(1).
7
FED. R. BANKR. P. 9001(5).

permits the bankruptcy court to require officers and directors to perform certain acts under the
Bankruptcy Rules, but does not make the officers and directors the DIP. A DIP has sometimes been
considered as a separate entity from the pre-petition debtor.
8
At other times the debtor and DIP have been
regarded as the same entity.
9
The DIP is required to perform all the functions and duties...of a
trustee,
10
and functions essentially in the role of a trustee. The DIP owes a fiduciary duty to all parties
that have an interest in the DIPs bankruptcy estate. It is critical for the DIP to adhere to its fiduciary
duties to all parties in interest.

B. Appointed Trustees

Under Chapter 7, a trustee is appointed to perform various functions.
11
At the filing of a Chapter
7 bankruptcy proceeding, a disinterested Chapter 7 trustee is appointed to oversee the debtors estate.
12
A
Chapter 7 trustee is obligated to perform nine enumerated tasks, including but not limited to collecting
monies, accounting for all property received, ensuring the debtor performs all necessary tasks,
investigating the debtors financial affairs, examining proofs of claim, and making reports to the court and
the United States Trustee.
13
A Chapter 7 trustee, has a fiduciary duty to all creditors.
14

The appointment of a trustee in a Chapter 11 case is governed by Section 1104 of the Bankruptcy
Code. Any party in interest or the United States Trustee may request for the appointment of a Chapter 11
trustee.
15
A party may request the appointment of a Chapter 11 trustee any time before plan confirmation
in a reorganization bankruptcy.
16
The court may appoint a Chapter 11 trustee if a party in interest can
show cause for the removal of the DIP or that the appointment of a Chapter 11 trustee would be in the
best interest of the creditors.
17
The Bankruptcy Code prefers a debtor to remain in possession of the
company while in bankruptcy, therefore, Chapter 11 trustees are typically appointed only upon a strong
showing of cause. Cause is statutorily defined to include fraud, dishonesty, incompetence, and gross
mismanagement of the DIPs business affairs.
18

If a Chapter 11 trustee is appointed, the Bankruptcy Code defines the Chapter 11 trustees duties
to include protecting the assets of the estate, making financial reports to the court, and operating the
debtors business.
19
The Chapter 11 trustee is also charged with investigating the debtor, the debtors
business practices and the feasibility of continuing the debtors operations.
20
The Chapter 11 trustee is

8
See In re Chapel Gate Apartments, Ltd., 64 B.R. 569, 576 (Bankr. N.D. Tex. 1986).
9
See NLRB v. Bildisco and Bildisco, 465 U.S. 513, 528 (1984) (viewing the DIP as the same entity which existed
before the filing of the bankruptcy petition but vested with certain powers and obligations by Bankruptcy Code).
10
11 U.S.C. 1107(a)
11
11 U.S.C. 701 and 704.
12
11 U.S.C. 701.
13
11 U.S.C. 704(1)-(9).
14
United Pacific Ins. Co. v. McClelland (In re Troy Dodson Construction Co., Inc.), 993 F.2d 1211, 1216 (5th Cir.
1993).
15
11 U.S.C. 1104(a).
16
11 U.S.C. 1104(a).
17
11 U.S.C. 1104(a)(1)-(2).
18
11 U.S.C. 1104(a).
19
11 U.S.C. 1106(a)(1) (stating that the trustee must perform the duties of a Chapter 7 trustee as specified in
sections 704(2), 704(5), 704(7), 704(8), and 704(9)); 11 U.S.C. 704(2), 704(8).
20
11 U.S.C. 1106(a)(3).

also responsible with filing a plan of reorganization.
21
The Chapter 11 trustee owes fiduciary duties like
that of a common law trustee and will be discussed more fully below.
22

C. Examiners in Chapter 11 Cases

An examiner, like a court-approved trustee, owes fiduciary duties to the bankruptcy estate. When
a trustee has not been appointed, the Bankruptcy Court may appoint an examiner.
23
The Bankruptcy
Code provides that the court shall order the appointment of an examiner if (1) such appointment is in
the interests of creditors . . .; or (2) the debtors fixed, liquidated, unsecured debts other than debts for
goods, services or taxes, or owing to an insider, exceed $5,000,000.00.
24

Courts have construed the language of section 1104(c) to mean the appointment of an examiner is
mandatory when the statutory requirements are present.
25
When the statutory requirements are not met, a
court has discretion to appoint an examiner when the equity security holders interest would be better
served and when the costs of the examiner is not disproportionately high. An examiner may perform
any of the duties of a trustee that the court orders the debtor in possession to perform.
26
More often, an
examiner is appointed for the limited purpose of investigating the debtor under Section 1104(b).
27

Examiners are also appointed to perform special tasks.
28
Examiners are often appointed in the context of
a compromise of a motion seeking the appointment of a Chapter 11 trustee.

D. Committees

Creditors and equity security holders committees are authorized under Section 1102 of the
Bankruptcy Code.
29
Shortly after the filing of a bankruptcy petition, the United States Trustee may
appoint a committee of unsecured creditors.
30
The court may order the United States Trustee to appoint
additional committees of creditors or equity security holders.
31

Section 1103 of the Bankruptcy Code describes the powers and duties of duly appointed
creditors and equity security holders committees. Section 1103(c) states that a committee may:
(1) consult with the trustee or debtor in possession concerning the
administration of the case;
(2) investigate the acts, conduct, assets, liabilities, and financial condition of
the debtor, the operation of the debtors business and the desirability of

21
11 U.S.C. 1106(a)(5).
22
Willoughby v. Howard, 302 U.S. 445, 451-52 (1983).
23
11 U.S.C. 1104(b).
24
11 U.S.C. 1104(c).
25
See In re Revco D.S., Inc. 898 F.2d 498, 501 (6th Cir. 1990) (appointment is mandatory under section
1104(c)(2)); In re 1243 20th Street, Inc., 6 B.R. 683, 685, n. 3 (Bankr. D.D.C. 1989) (same); In re Lenihan, 4 B.R.
209, 211 (Bankr. D.R.I. 1989) (same); see also L. King, 7 COLLIER ON BANKRUPTCY 1104.03 (15th ed. rev. 2000).
26
11 U.S.C. 1106(b).
27
11 U.S.C. 1104(b).
28
See, e.g., In re Fox, 232 B.R. 229 (Bankr. D. Kan. 1999) (examiner appointed for the limited purpose of preparing
a report for court to use at the disclosure statement hearing); In re Imperial Corp. of America, 181 B.R. 501 (Bankr.
S.D. Cal 1995) (examiner appointed to determine the amount available to disgorge).
29
11 U.S.C. 1102.
30
11 U.S.C. 1102(a)(1).
31
11 U.S.C. 1102(a)(2).

the continuation of such business, and any other matter relevant to the
case or to formulation of a plan;
(3) participate in the formulation of a plan, advise those represented by such
committee of such committees determination as to any plan formulated,
and collect and file with the court acceptances or rejections of a plan;
(4) request the appointment of a trustee or examiner under section 1104 of
this title; and
(5) perform such other services as are in the interest of those represented.
32

Although through exercise of these duties creditors committees do not control a debtor in
possession, they are able to exert significant leverage over a debtor. A significant area of leverage exists
for creditors committees in the form of actions to remove a DIP. Actions taken by a creditors committee
to remove a DIP, however, may be limited by policy considerations that tend to insulate the DIP from
external control. Usually, the rationale proposed by a creditors committee for the removal of a DIP stems
from a claim that the incumbent managers are acting in a wrongful manner or that their actions are not in
the best interest of the creditors.

The remedy for a creditors committee is to propose that a Chapter 11 trustee be appointed to
replace the management of a DIP. Section 1104 of the Bankruptcy Code requires the appointment of a
Chapter 11 trustee under either of two conditions: (1) for cause found, and (2) if such appointment is
in interest of creditors, equity holders and other interests of the estate.
33
Committees often become a
significant factor in the reorganization and, consequently, the unsecured creditors serving on such
committees have significant influence on corporate governance matters. As an alternative to the
appointment of a Chapter 11 trustee or the appointment of an examiner committees are also advocating
the appointment of an outside chief restructuring officer (CRO). Sometimes the CRO is appointed as
an officer, a director or a court appointed professional. Regardless of the title, the CRO will have
fiduciary duties to the entire bankruptcy estate.

E. Court Approved Counsel and Other Professionals for Trustees, Examiners and
Committees

The debtor is entitled to employ professionals, including counsel, financial advisors, appraisers
and the like, to assist the debtor in reorganizing the debtors business. Although the debtors
professionals are subject to rules of professional responsibility and owe a fiduciary duty to their client, the
debtor, the debtors professionals also owe a fiduciary duty to all parties in interest to the bankruptcy
estate. The debtors counsel owes a fiduciary duty to the bankruptcy estate, including the debtors
creditors.

Many courts have authorized an examiner to employ professionals.
34
A trustee or an examiner in
a complex chapter 11 case may require attorneys, accountants, financial advisors and the like to complete
a court-approved investigation.
35

Any committee authorized under Section 1102 may employ legal counsel, accountants, other
agents, including financial advisors to assist the committee.
36
Any committee has the statutory authority

32
11 U.S.C. 1103(c).
33
11 U.S.C. 1104.
34
See, e.g., In re Southmark Corp., 113 B.R. 280 (Bankr. N.D. Tex. 1990) (allowing the examiner to employ
professionals under section 105(a)); In re Tighe Mercantile, Inc., 62 B.R. 995 (Bankr. S.D. Cal. 1986).
35
In re Southmark Corp., 113 B.R. at 282.

to investigate the acts, conduct, assets, liabilities and financial condition of the debtor, the operation of
the debtors business and the desirability of the continuance of such business, and any other matter
relevant to the case or to the formulation of a plan.
37
Any committee is also entitled to request the
appointment of a trustee or examiner under Section 1104 of the Bankruptcy Code.
38
The Fifth Circuit
stated [a] creditors committee not only has, with the courts approval, the power to employ attorneys,
accountants, and other agents to represent or perform services for the committee, it has the duty to
determine what assistance it requires in order to perform such duties, when such assistance is required,
and to select those best qualified to render such assistance.
39
The Fifth Circuit further stated that the
committee has the duty to use any tool available under Section 1103.
40

Counsel and advisors for a committee have the same fiduciary duty to the committees
constituency as the committee itself does.
41
Committee counsel has an independent duty to all unsecured
creditors and yet, is faced with taking instructions from either an unreasonably conservative or an
unreasonably aggressive committee majority. No bright-line rules exist in these circumstances and
counsel must be ever vigilant to assure that self-interested agendas of certain committee members do not
unreasonably put the committee and its counsel at risk. Further, neither the committee nor its counsel
have duties to any specific creditor.

III. FIDUCIARY

A. What is a Fiduciary

Fiduciary relationships are difficult to define.
42
Fiduciary relationships encompass trustee and
beneficiary, attorney and client, guardian and ward, and agent and principal relationships.
43
A fiduciary is
defined as [o]ne who owes to another the duties of good faith, trust, confidence, and candor [or] [o]ne
who must exercise a high standard of care in managing anothers money or property.
44
J ustice Felix
Frankfurters oft-cited discussion of fiduciary law in SEC v. Chenery Corp.
45
described the initial analysis
to determine a fiduciary relationship: To whom is he a fiduciary? What obligations does he owe as a
fiduciary? In what respect has he failed to discharge these obligations.
46

The Restatement (Second) of Trusts defines a fiduciary relation as:

A person in a fiduciary relation to another is under a duty to act for the benefit of
the other as to matters within the scope of the relation. A fiduciary is normally

36
11 U.S.C. 1103.
37
11 U.S.C. 1103(c)(2).
38
11 U.S.C. 1103(c)(4).
39
Advisory Committee of Major Funding Corp. v. Sommers (In re Advisory Committee of Major Funding Corp.),
109 F.3d 219, 224 (5th Cir. 1997) (quoting Irving Sulvmeyr, For Creditors Committees, 13.09 (Lawrence P.
King, ed., Matthew Bender 1996)) (emphasis added).
40
Id. at 225.
41
In re Mesta Mach. Co., 67 B.R. at 156; Pension Benefit Guaranty Corp., 42 B.R. at 963.
42
Stanley Pietrusiak, J r., Comment, Changing the Nature of Corporate Representation: Attorney Liability for Aiding
and Abetting the Breach of Fiduciary Duty, 28 ST. MARYS L.J . 213, n.100 (1996).
43
RESTATEMENT (SECOND) OF TRUSTS, 2 cmt. b (1959); Stanley Pietrusiak, Jr., Comment, Changing the Nature of
Corporate Representation: Attorney Liability for Aiding and Abetting the Breach of Fiduciary Duty, 28 ST. MARYS
L.J . 213, n.100 (1996).
44
BLACKS LAW DICTIONARY 640 (7th ed. 1999).
45
318 U.S. 80 (1943).
46
SEC v. Chenery Corp., 318 U.S. 80, 85-86 (1943).

under a duty not to delegate to a third person the performance of his duties as
fiduciary. As to matters within the scope of the relation he is under a duty not to
profit at the expense of the other and not to enter into competition with him
without his consent, unless authorized to do so by a proper court or by the
provisions under which the relation arose.
.
The scope of the transactions affected by the relation and the extent of the duties
imposed are not identical in all fiduciary relations.
47

A fiduciary is a person who stands in a special relation of trust. J ustice Cardozo described a
fiduciary duty as:

Many forms of conduct permissible in a workaday world for those acting at
arms length, are forbidden to those bound by fiduciary ties. A trustee is held to
something stricter than the morals of the market place. Not honesty alone but the
punctilio of an honor the most sensitive, is then the standard of behavior. As to
this there has developed a tradition that is unbending and inveterate.
Uncompromising rigidity has been the attitude of courts of equity when
petitioned to undermine the rule of undivided loyalty by the disintegrating
erosion of particular exceptions . . . only thus has the level of conduct for
fiduciaries been kept at a level higher than that trodden by the crowd.
48

1. State

State laws may define fiduciary differently. Depending on the jurisdiction, a fiduciary
relationship is defined by a narrow range. One Texas court has applied the classic definition of fiduciary
duty to mean uberrima fides or most abundant good faith.
49
Another Texas court defined a fiduciary
relationship as a legal relationship created by statute or contract, implying confidence and reliance.
50

Who may be a fiduciary and where fiduciary duties may run is often a product of state statute.

2. Bankruptcy

Under bankruptcy laws, it must first be determined to whom a party owes a fiduciary obligation.
51

The DIP owes a fiduciary obligation to the bankruptcy estate and all parties in interest to the bankruptcy
estate.
52
The DIP counsel owes a fiduciary duty to the client as well as a fiduciary duty to the bankruptcy
estate and to the creditors. A Chapter 11 trustee or examiner (depending on the scope of appointment)
owes a fiduciary duty to the estate and the creditors. A creditors committee owe a fiduciary duty to
unsecured creditors. The committee counsel owes a fiduciary duty to all creditors, not just committee
members.

47
RESTATEMENT (SECOND) OF TRUSTS, 2 cmt. b (1959).
48
Meinhard v. Salmon, 249 N.Y. 458, 464, 164 N.E. 545, 546 (1928); see also Lawrence v. Cohn, 197 F. Supp. 2d
16, 33 (S.D.N.Y. 2002).
49
Perez v. Kirk & Carrigan, 822 S.W.2d 261, 265 (Tex. App.Corpus Christi 1991, writ denied).
50
Peckham v. Johnson, 98 S.W.2d 408, 416 (Tex.Civ.App.Fort Worth 1936), affd, 132 Tex. 148, 120 S.W.2d
786 (1938).
51
See J ohn. T. Roache, Note, The Fiduciary Obligations of a Debtor in Possession, 1993 U. ILL. L. R. 133, 144.
52
See id. (citing In re N.S. Garrott & Sons, 63 B.R.189, 191 (Bankr. E.D. Ark. 1986)).

IV. FIDUCIARY DUTIES

A. DEBTORS
53

1. Fiduciary Duties Of Officers And Directors

The concept that the fiduciary duties of directors shift from shareholders to creditors in the event
of insolvency is not new; indeed, its origin has been traced by courts and commentators to the trust fund
doctrine promulgated 175 years ago by J ustice Story in Wood v. Dummer.
54
Under this theory, upon
insolvency of the corporation, the directors become trustees for creditors and hold corporate assets as a
trust fund for their benefit.
55
More recent leading decisions are Geyer v. Ingersoll Publications Co.,
56

and Credit Lyonnais Bank Nederland, N.V. v. Pathe Communications Corp.
57
Credit Lyonnais, in
particular, contains the now famous statement imposing broadened duties when a corporation is
operating in the vicinity of insolvency.
58

J udicial decisions in which a breach of fiduciary duty to creditors often is found to involve
diversion or disposition of assets from an insolvent or near insolvent entity for the benefit of insiders or
shareholders the type of conduct regulated by fraudulent transfer, preference, and illegal dividend
statutes. The fiduciary concept often functions to extend the reach of personal liability for such conduct,
and most specifically to impose personal liability on directors for fraudulent transfers by a corporate
entity.
59

2. Basic Principles

To analyze fiduciary duties that arise in the insolvency context, one must start with the base case,
a solvent, non-distressed corporation.

a. Duties Owed in a Solvent Corporation

State corporation statutes generally vest responsibility for management of the corporations
business and affairs in a board of directors.
60
The directors, in turn, owe fiduciary duties to stockholders
of a solvent corporation. It is the stockholders who own the corporation and who have entrusted the

53
Hon. Nancy Dreher, et al., Operating a Business in the Zone of Insolvency, ANNUAL MEETING OF THE AMERICAN
BAR ASSOCIATION (AUG 10, 2002) (with permission by author Robert Millner, Sonnenschein Nath & Rosenthal).
54
30 F. Cas. 435 (C.C.D. Me. 1824) (No. 17,944); see In re Mortgageamerica Corp., 714 F.2d 1266, 1268-69 (5th
Cir. 1983).
55
In re Mortgageamerica Corp., 714 F.2d at 1269; Clarkson Co., Ltd. v. Shaheen, 660 F.2d 506, 512 (2d Cir. 1991),
cert. denied, 455 U.S. 990 (1982).
56
621 A.2d 784 (Del. Ch. 1992).
57
No. 12150, 1991 WL 277613 (Del. Ch. Dec. 30, 1991).
58
Credit Lyonnais Bank Nederland, N.V. v. Pathe Communications Corp., No. 12150, 1991 WL 277613, *34 (Del.
Ch. Dec. 30, 1991).
59
Official Comm. of Asbestos Claimants of G-1 Holding, Inc. v. Heyman, 277 B.R. 20, 37 (S.D.N.Y. 2002)
(distribution to shareholders constituted not only fraudulent transfer but also breach of fiduciary duty to creditors by
debtors chairman, CEO and controlling shareholder); Hechinger Inv. Co. of Del. v. Fleet Fin. Group, 274 B.R. 71,
89-91 (D. Del. 2002) (even where payments to debtors shareholders in connection with LBO were insulated from
avoidance as settlement payments under section 546(e), directors could still be personally liable for transfer amounts
based on breach of fiduciary duty to creditors).
60
See, e.g., DEL. CODE ANN. tit 8, 141 (a).

directors with control and management of their property. Generally, directors and officers of a
corporation do not owe fiduciary duties to creditors of the corporation.
61

The duties owed by directors are principally duties of loyalty and care.
62
The duty of loyalty
requires that directors act in good faith and in the reasonable belief that the action taken is in the best
interests of the corporation. This duty prohibits self-dealing-type conduct, such as, misappropriation of
corporate opportunities, taking excessive compensation, and utilizing corporate assets or information for
personal gain.
63

The duty of care requires that directors exercise the care that an ordinarily prudent person would
exercise under similar circumstances.
64
Delaware, however, allows corporations, by provision in the
certificate of incorporation, to eliminate personal liability of directors to the corporation or its
stockholders for failure to act with due care (but not liability for breach of duty of loyalty or intentional
misconduct).
65
More than forty (40) other states have passed similar statutes.
66

Directors also owe the duties of courage and inquiry to the corporation and shareholders.
67
The
duty of courage requires the directors to ask the tough questions while facilitating a positive atmosphere
of pursuing the corporations best interest.
68
The duty of inquiry requires directors to ask questions and
inquire into financial statements, proposed business transactions and other business issues.
69
Directors are
required to fully analyze these business issues to determine the consequences to the corporation and the
shareholders.
70
Directors may hire experienced professionals to advise them on the consequences of these
business issues.
71

61
See, e.g., United States v. Jolly, 102 F.3d 46, 48 (2d Cir. 1996); Lorenz v. CSX Corp., 1 F.3d 1406, 1414 (3d Cir.
1993).
62
Section 8.30(a) of the Model Business Corporation Act provides:
A director shall discharge his duties as a director . . .
(1) in good faith;(2) with the care an ordinary prudent person in a like position would
exercise under similar circumstances; and (3) in a manner he reasonably believes to be in
the best interests of the corporation.
MODEL BUS. CORP. ACT 8.30(a) (1991).
63
See Ramesh K.S. Rao et al., Fiduciary Duty a la Lyonnais: An Economic Perspective on Corporate Governance
in a Financially-Distressed Firm, 22 J . CORP. L. 53, 60-61 (1996) (collecting cases to illustrate specific violations of
duty of loyalty); see also Pepper v. Litton, 308 U.S. 295, 306-07, 311 (1939) (The essence of the test is whether or
not under all the circumstances the transaction carries the earmarks of an arm's length bargain.... He who is in such
a fiduciary position cannot serve himself first and his cestuis second.)
64
MODEL BUS. CORP. ACT 8.30(a); see also Richard M. Cieri et al., The Fiduciary Duties of Directors of
Financially Troubled Companies, 3 J. BANKR. L & PRAC. 405, 406 (1994) (The duty of care requires that directors
act in an informed and considered manner, meaning that prior to making a business decision, the directors must have
informed themselves of all material information reasonably available to them and, [h]aving become so informed,
they must then act with requisite care in the discharge of their duties.) (quoting Aronson v. Lewis, 473 A.2d 805,
812 (Del. 1984)).
65
DEL. CODE. ANN. tit. 8 102(b)(7).
66
See Ramesh K.S. Rao et al., Fiduciary Duty a la Lyonnais: An Economic Perspective on Corporate Governance
in a Financially-Distressed Firm, 22 J. CORP. L. 53, 59 (1996).
67
Myron M. Sheinfeld & J udy L. Harris, Fiduciary Duties of Directors of a Corporation in the Vicinity of
Insolvency and After Initiation of a Bankruptcy Case, AMERICAN COLLEGE OF BANKRUPTCY FIFTH CIRCUIT
FELLOWS MEETING at 2-3 (February 7, 2004).
68
Id. at 2.
69
Id. at 3.
70
Id.
71
Id.

b. Business J udgment Rule

Directors are also protected by the business judgment rule, which is a judicially created
presumption that in making a business decision the director of a corporation acted on an informed basis,
in good faith and in the honest belief that the action taken was in the best interest of the company.
72
The
protection of the business judgment rule will be lost upon a showing of improper director interest in a
transaction (if the transaction is not approved by a majority of disinterested directors) or that the director
has not adequately informed himself.
73
If the protection of the business judgment rule is lost, the burden
shifts to the director to prove the fairness of the challenged transaction.
74
Some courts rely on the general
fairness of a transaction rather than relying on the fairness of a transaction under the business judgment
rule.
75

3. No Fiduciary Duty to Creditors in a Solvent Corporation

Another basic rule is that directors of a solvent company do not owe fiduciary duties to creditors.
A leading case, Simons v. Cogan,
76
holds that no fiduciary duties are owed to holders of a corporations
convertible debentures.
77
Federal decisions have upheld this principle in change of control situations,
when debtholders assert (unsuccessfully) that the transaction (an LBO or other acquisition) will impair
their ability to be paid.
78
There are limited exceptions to the general rule of course, if a solvent
corporation is rendered insolvent, the decisions giving rise to the insolvency can be re-examined under the
harsher light described below.
79

72
In re Healthco Int'l, Inc., 208 B.R. at 306 (quoting Aronson, 473 A.2d at 812). The protection of the business
judgment rule is modified in the takeover context, in Delaware and certain other jurisdictions, to require that
directors make a threshold showing of the reasonableness of their actions before receiving the protection. Richard
M. Cieri et al., Breaking Up Is Hard to Do: Avoiding the Solvency-Related Pitfalls in Spinoff Transactions, 54 BUS.
L. 533, 544 n.37 (1999).
73
In re Healthco Int'l, Inc., 208 B.R. at 306; see Richard M. Cieri et al., Breaking Up Is Hard to Do: Avoiding the
Solvency-Related Pitfalls in Spinoff Transactions, 54 BUS. L. 533, 547-49 (1999) (discussing actions leading to loss
of business judgment rule protection).
74
See Richard M. Cieri et al., Breaking Up Is Hard to Do: Avoiding the Solvency-Related Pitfalls in Spinoff
Transactions, 54 BUS. L. 533, 549 n.47 (1999) (citing Weinberger v. UOP, Inc., 457 A.2d 701, 711 (Del. 1983) for
proposition that under entire fairness standard of review, directors must establish that the transaction in question
was the product of both fair dealing and a fair price).
75
Welt v. Sasson (In re Dollar Time Group, Inc.), 223 B.R. 247 (Bankr. S.D. Fla. 1998) (reviewing the intrinsic
fairness of a transaction); Official Committee of Subordinated Bondholders v. Integrated Resources, Inc. (In re
Integrated Resources, Inc.), 147 B.R. 650 (S.D.N.Y. 1992) (reviewing the entire fairness of a transaction, not the
business judgment on one portion of the transaction).
76
549 A.2d 300, 302-04 (Del. 1988).
77
Accord Lorenz v. CSX Corp., 1 F.3d 1406,1417 (3d Cir. 1993) (Even if the debentures are convertible, the
debentureholder is merely a creditor who is owed no fiduciary duty until conversion takes place). See generally
WEIL, GOTSHAL & MANGES, REORGANIZING FAILING BUSINESSES, ch. 16, 5-9 (1998) (also noting several cases
finding that directors do not owe duties to creditors).
78
C-T of Virginia, Inc. v. Barrett, 124 B.R. 689, 692-93 (W.D. Va. 1990); Metropolitan Sec. v. Occidental
Petroleum Corp., 705 F. Supp. 134, 141 (S.D.N.Y. 1989); Metropolitan Life Ins. Co. v. RJR Nabisco, Inc., 716 F.
Supp. 1504, 1525 (S.D.N.Y. 1989).
79
Directors of banking institutions owe fiduciary duties to depositors, and directors of non-banking corporations that
hold funds in trust owe fiduciary to the owners of the funds held in trust. See WEIL, GOTSHAL & MANGES,
REORGANIZING FAILING BUSINESSES, ch. 16, p.9 (1998). An exception also arises out of constituency statutes,
enacted in the mid 1980s largely in response to takeover activities. See Richard M. Cieri et al., Breaking Up Is Hard
to Do: Avoiding the Solvency-Related Pitfalls in Spinoff Transactions, 54 BUS. L. 533, 540 n. 31 (1999) (collecting

4. Fiduciary Duties Upon Insolvency

In the bankruptcy context, most reported cases in which a court has found that a breach of
fiduciary duty to creditors has taken place involve diversion or disposition of assets from an insolvent
entity or from an entity rendered insolvent, for the benefit of insiders or shareholders. This conduct is the
type of behavior that fraudulent transfer, preference, and illegal dividend statutes are intended to prohibit.
In the case of fraudulent transfers, the fiduciary concept may extend the reach of personal liability for
such behavior and may impose personal liability on directors for fraudulent transfers by a corporate
entity.
80
Directors, officers, and, in most jurisdictions, all those who aid, abet, or conspire may be
personally liable for breach of fiduciary duty to creditors.
81

When a corporation becomes insolvent, the fiduciary duty of directors shifts from the
stockholders to the creditors.
82
[I]t is universally agreed that when a corporation approaches insolvency
or actually becomes insolvent, directors fiduciary duties expand to include general creditors.
83
In one
courts view, upon insolvency the rights of creditors become paramount.
84

The reason for this shift in duties, as articulated in recent cases, is easily understood. Creditors
deal with corporations by entering into contracts or recovering on tort liability. As long as the corporation
is solvent, satisfaction of creditors claims requires only compliance with their contracts, and maintenance
of adequate insurance and cash flow to pay tort claims. The business decisions of managers will ... have
no affect [sic] on the income of creditors.
85
Shareholders, in contrast, are residual claimants on the
corporations assets and cash flow. So long as the corporation is solvent, business decisions made by
managers directly affect the income of shareholders.
86
As set forth in In re Ben Franklin Retail Stores,
Inc.:

The economic rationale for the insolvency exception is that the value
of creditors contract claims against an insolvent corporation may be

statutes). These statutes generally authorize but do not require director consideration of non-shareholder
constituencies.
80
See, e.g., Heyman, 277 B.R. at 37 (distribution to shareholders constituted not only fraudulent transfer but also
breach of fiduciary duty to creditors by debtor's chairman, CEO, and controlling shareholder); Hechinger Inv. Co. of
Del., 274 B.R. at 89-91 (even where payments to debtors shareholders in connection with a leveraged buyout are
insulated from avoidance as settlement payments under section 546(e) of the Bankruptcy Code, directors may still
be personally liable for transfer amounts based on breach of fiduciary duty to creditors).
81
See, e.g., In re Healthco Intl, Inc., 208 B.R. at 309 (recognizing an action under Delaware law for aiding and
abetting a breach of fiduciary duty).
82
FDIC v. Sea Pines Co., 692 F.2d 973, 976-77 (4th Cir. 1982), cert. denied, 461 U.S. 928 (1983).
83
In re Kingston Square Assoc., 214 B.R. 713, 735 (Bankr. S.D.N.Y. 1997) (holding that an "independent" director
of several "bankruptcy proofed" entities whose consent was needed for a bankruptcy filing breached his fiduciary
duty to creditors and limited partners by failing to ratify involuntary filings).
84
In re Healthco Int'l., 208 B.R. at 300 (applying Delaware law). Credit Lyonnais, a leading case, states the rule a
bit differently. "At least where a corporation is operating in the vicinity of insolvency, a board of directors is not
merely the agent of the residue risk bearers, but owes its duty to the corporate enterprise." 1991 WL 277613, at *34.
It is clear, however, from the court's discussion, that it had protection encompassing the interests of creditors in
mind.
85
In re Ben Franklin Retail Stores, Inc., 225 B.R. 646, 653 (Bankr. N.D. Ill. 1998), aff'd. in relevant part, No. 97 C
7904 (N.D. Ill. Oct. 20, 1999).
86
Christopher W. Frost, The Theory, Reality and Pragmatism of Corporate Governance in Bankruptcy
Reorganizations, 72 AM. BANKR. L.J . 103, 107 (1998).

affected by the business decisions of managers. At the same time, the
claims of the shareholders are (at least temporarily) worthless. As a result
it is the creditors who now occupy the position of residual owners.
87

In short, in an insolvency situation, the directors are playing with the creditors money. Since the
liability of shareholders is limited to their investments, anything the managers do to increase or decrease
shareholder equity is primarily to the benefit or detriment of the creditors, rather than the shareholders,
until the corporation regains solvency.
88
When there is no equity in the company (and assuming that
secured claims are covered), the unsecured creditors actually own the entity.

a. Scope of the Duty

There is no single formulation, or set of clearly articulated competing formulations, defining the
fiduciary duty (or duties) owed creditors upon insolvency. Courts tend, simply, to invoke undefined trust
duties.
89
To obtain an understanding of how courts have actually understood the fiduciary duty to
creditors, one must look closely at specific cases.

b. The Narrow View (Prohibition Against Self-Dealing and Insider
Preferences)

In St. James Capital Corp. v. Pallet Recycling Assoc. of North America, Inc.,
90
the court ruled that
directors and officers owe no duty of care to the creditors of an insolvent corporation, and that their
fiduciary duty does not extend beyond a prohibition against self-dealing and insider preferences.
91

c. Intermediate Views (Duty To Minimize Loss Upon Insolvency)

New York Credit Mens Adjustment Bureau v. Weiss,
92
articulates a duty to obtain the best results
for creditors in a non-bankruptcy liquidation. New York Credit was an action by a bankruptcy trustee
against the directors (and owners) of a corporation, a wholesaler of electrical supplies, that had liquidated
its assets through public auction sale. There was no allegation of self-dealing or insider preference, and
the auction proceeds were turned over to the bankruptcy trustee upon an involuntary filing shortly after
the auction.

The complaint against the directors was that they had failed to supervise personally the
liquidation sale. They had instead put the liquidation in the hands of a licensed auctioneer. The
cornerstone of plaintiffs case was that the sale proceeds were too little ($23,262.33), given that the book

87
225 B.R. at 653 (footnote omitted).
88
In re Ben Franklin Retail Stores, Inc., 225 B.R. at 653 n. 13.
89
The typical state-court case involves a closely-held corporation in which the directors are also significant
shareholders. The alleged breaches of duty generally involve self-dealing. Cases in which fiduciary liability to
creditors has been found are collected and catalogued by commentators. See Bruce A. Markell, The Folly of
Representing Insolvent Corporations: Examining Lawyer Liability and Ethical Issues Involved in Extending
Fiduciary Duties to Creditors, 6 J . BANKR. L. & PRAC. 403, 413-14 (1997); Laura Lin, Shift of Fiduciary Duty Upon
Corporate Insolvency: Proper Scope of Directors Duty to Creditors, 46 VAND. L. REV. 1485, 1513-22 (1993); see
also Bovay v. H.M. Byllesby & Co., 38 A.2d 808 (Del. 1944).
90
589 N.W.2d 511 (Minn. App. 1999).
91
Accord Helm Fin. Corp. v. MNVA RR., Inc., 212 F.3d 1076, 1082 (8th Cir. 2000) (Under Minnesota law, spinoff
of subsidiary to shareholders is not actionable as breach of fiduciary duty to creditors because defendant debtors
were not creditors of debtors and hence did not receive insider preferences.).
92
New York Credit Men's Adjustment Bureau v. Weiss, 110 N.E.2d 397 (N.Y. 1953).

value of the assets was $73,492.21, and their cost was $60,000. The trustee specifically contended that a
larger return could have been obtained in a proper sale or orderly liquidation.
93
Yet, there was no
allegation of irregularity in the auction or that the sale constituted a fraudulent transfer (or any other
fraud).

The court closely scrutinized the directors conduct and focused, in particular, on the fact that
creditors were not given notice of the sale. The court rejected any notice requirement. [D]espite the fact
that the creditors were primarily concerned with defendants [sic] activities in this respect, defendants
were under no obligation to give notice to each creditor of their intention to convert the assets into
cash.
94
Nevertheless, the court put the burden on defendants to prove that they had obtained full value
under the circumstances. The court did not define what it meant by full value under the
circumstances. The court remanded for a new trial to afford defendants an opportunity to account for
their handling of the res in the matter of the sale and to show that full value was realized for the assets
upon the sale.
95

In re Ben Franklin Retail Stores, Inc.,
96
is difficult to categorize. The bankruptcy court decision,
which dismisses a fiduciary claim based on fraudulent misrepresentation to creditors, endorses a narrow
view of the fiduciary duty to creditors. Yet, core dicta in the case (perhaps reflecting the impact of Credit
Lyonnais) shows that the court would impose liability for conduct other than transfers resembling insider
preferences and fraudulent transfers.

Ben Franklin involved a failed chapter 11 of a holding company and subsidiaries that comprised a
wholesale and retail variety store business. Upon conversion, the chapter 7 trustee brought suit for breach
of fiduciary duty against the debtors officers and directors. The charge was that the defendants had
wrongfully prolonged the debtors lives through fraudulent valuation of receivables:

They are accused of wrongfully prolonging the Debtors corporate lives
beyond the point of insolvency by misrepresenting the true value of the
Debtors accounts receivable. Specifically, they refreshed or redated
the due dates of millions of dollars of receivables to make it appear that
they were current when, in fact, they were seriously past due. As a result,
receivables that should have been written down were recorded at full
value. Based on that overvaluation, the Defendants induced creditors to
lend money and supply inventory and other value to the Debtors, even
after the Debtors were insolvent. Creditors were harmed because the
Debtors sank deeper into insolvency as their liabilities grew.
97

As the court recognized, the trustee had made a tactical decision to dress fraud claims, based on
individual reliance of specific creditors, as a breach of fiduciary duty (undoubtedly to enhance the

93
Id. at 399.
94
Id. at 398.
95
Id. at 400.
96
225 B.R. 646 (Bankr. N.D. Ill. 1998), affd in part and revd in part, 2000 WL 28266 (N.D. Ill. 2000).
97
In re Ben Franklin Retail Stores, Inc., 225 B.R. 646, 649 (Bankr. N.D. Ill. 1998), affd in part and revd in part,
2000 WL 28266 (N.D. Ill. 2000).

prospect of insurance recovery).
98
Indeed, in order to assure the trustees standing and ability to prove
damages based on creditor losses, the creditors expressly assigned their claims to the trustee.
99

The bankruptcy court in Ben Franklin focused on the theory of law advanced by the trustee and
carefully analyzed whether the conduct alleged constituted a breach of the duty of care, as the trustee
contended. The court dismissed the complaint, stating that the trustee has attempted to allege a breach of
fiduciary duty. He has failed to do so.
100

The principal basis for the bankruptcy courts ruling in Ben Franklin is the view that fiduciary
duties to creditors should be limited to something like a prohibition on directors denuding the entity of
assets for the benefit of insiders and shareholders:

On this theory, creditors have a right to expect that directors will not
divert, dissipate or unduly risk assets necessary to satisfy their claims.
That is the appropriate scope of a duty that exists only to protect the
contractual and priority rights of creditors.
101

The concept of unduly risk[ing] assets in the above quotation is significant. Although dictum
(because not necessary to this decision), the articulation of the concept is a part of an attempt by the
bankruptcy court to distill a coherent theory based on the case law and academic writing to date. The
court continued:

This is not to say that the duty could not be violated by causing the
corporation to incur unnecessary debt to or for the benefit of
shareholders. Subjecting assets to unwarranted claims is a way of
diverting them from legitimate corporate uses. In an appropriate case,
therefore, directors who cause their corporation to incur debt may be in
breach of duties enforceable by creditors. This is not such a case.
102

Moreover, the bankruptcy court viewed the duty of care as very much operative in the area of
fiduciary duty to creditors. As authorized by Delaware law, the debtors certificate of incorporation
eliminated liability for failure to act with due care.
103
The directors urged, and the court rejected, the
certificate as a defense:

It is also true, however, that shareholders elect directors; creditors do
not. Creditors should not be bound by limitations on the scope of the
duties of fiduciaries they had no part in selecting because, unlike
shareholders, they cannot protect themselves by being careful in their
selection of managers.

More broadly, shareholders investments in corporations are subject to
the rights and limitations of the certificate of corporation. Creditors
investments are not; they are subject to specific contracts. The

98
Id. at 656.
99
Id. at 649.
100
Id. at 656.
101
Id. at 655.
102
Id. at 656 (footnote omitted).
103
Id. at 652.

Defendants duties to creditors arose, if at all, to protect the value of
those contract claims from diminution by reason of improper conduct.
Those duties cannot be reduced by a provision in a certificate that forms
no part of the creditors contracts or the inducement for their
investments. Indeed, the provision itself is limited to the Corporation
or its stockholders. It makes no mention of creditors.
104

All in all, the bankruptcy courts decision in Ben Franklin is one of the most thoughtful
expositions to date of fiduciary duty to creditors. The lasting significance of the case may be its warning
that ill-planned turnaround efforts, based on unrealistic or excessive new debt obligations, will expose
directors to fiduciary liability.

d. Deepening Insolvency

In Official Committee of Unsecured Creditors v. R.F. Lafferty & Co., Inc.,
105
the court recognized
a cause of action for deepening insolvency under Pennsylvania law. Lafferty involved a Ponzi scheme
by two related and closely-held corporate debtors. Allegedly, the debtors principal and related insiders
orchestrated a scheme with two outside professionals, Lafferty (accountant) and Cogan (underwriter)
whereby the debtors issued and marketed debt securities while insolvent. The action was brought by a
creditors committee on behalf of the debtors estates. The claims against the principal and insiders were
not at issue, having been upheld by the district court on a motion to dismiss and not being subject to the
appeal. The appeal dealt exclusively with the claims against the outside professionals (Lafferty and
Cogan), who were in essence aiders and abettors.

Although the Third Circuit decision affirmed dismissal of the claims against the professionals on
pari delicto grounds, the decision is explicit in recognizing a deepening insolvency tort akin to breach
of fiduciary duty. The court made clear, in upholding the committees standing on behalf of the estate,
that expansion of corporate debt out of all proportion to ability to pay, and consequent prolongation a
corporate life, constitutes a tortious injury to the corporate entity itself, not merely an injury to creditors
(for which a bankruptcy trustee could not sue).
106
The harm includes forcing an entity into bankruptcy,
thus inflicting legal and administrative costs, as well as interference with customers and operations.
107

The dismissal of Lafferty on in pari delicto grounds arises because the wrongdoing of the entitys
principals is imputed to the corporate debtors, and therefore to the bankruptcy trustee which stands in the
shoes of the Debtors.
108
While it is possible that the conduct of directors adverse to the corporate entity
would not be imputed, when the insider wrongdoers are the sole representatives of the corporate entity,
the imputation may be made. The result of this analysis is that the trustee can sue the principals and
directors, while third party participants in the fraud or breach of duty must be sued by creditors -- a result
similarly reached in In re Mediators, Inc.,
109
and prior Second Circuit cases.

104
Id. (footnote omitted); accord Pereina v. Cogan, 2001 WL 243537, at *9-10 (S.D.N.Y.) (directors liable for
failure to exercise due care to prevent principal from taking large loans from corporation and excessive
compensation while corporation insolvent); cf. In re Healthco Int'l, Inc., 208 B.R. at 308-09 (such provisions are
effective as to directors but grant "no protection to third parties who aid and abet directors" in their breach of duty).
105
267 F.3d 340 (3d Cir. 2001).
106
Official Committee of Unsecured Creditors v. R.F. Lafferty & Co., Inc., 267 F.3d 340, 347-48 (3d Cir. 2001).
107
Id. at 349-50.
108
Id. at 355.
109
105 F.3d 822 (2d Cir. 1997).

In re Toy King Distributors, Inc.,
110
is another recent decision of significance. The court in Toy
King, in a thorough and well researched opinion, covered the full panoply of fiduciary issues confronting
insolvent entities. Toy King involved serial chapter 11 cases. In the second case, the creditors committee
sued debtors principals (directors and officers)
111
for breach of fiduciary duty relating to fraudulent
transfer and other alleged wrongs. The corporate debtor in Toy King was insolvent at all times relevant.
Among other transgressions, the insider officers and directors in Toy King authorized borrowings from
the corporate parent at excessive interest rates and charges, which the court held to constitute a violation
of the duty of care.
112
In addition, two of the directors were held to have violated the duty of loyalty
during the first Toy King bankruptcy by acquiring a significant creditors claims, without advance
disclosure to the court or the committee.
113

e. Expansive View (Duty To Maximize Long-Term Wealth Creating
Capacity)

Credit Lyonnais Bank Nederland, N.V. v. Pathe Communications Corp.,
114
presents a different,
and more expansive, view of directors duties in insolvency situations. Credit Lyonnais involved a
dispute as to control of MGM-Pathe Communications Co. (MGM). Plaintiff, Credit Lyonnais, was a
major lender to MGM; the principal defendant, Giancarlo Parretti, was the indirect controlling
shareholder of MGM. The action sought a judicial determination of the persons who constituted the
lawfully elected board of MGM.

The case arose out of a leveraged buyout of MGM by a Parretti entity. Five months after the
leveraged buyout, MGMs creditors forced it into bankruptcy. Credit Lyonnais financed MGMs
emergence from Chapter 11 with substantial new bank debt. As part of that transaction, Credit Lyonnais
obtained significant governance restrictions which ceded control to the lender (through an executive
committee of the board controlled by the lender). The applicable governance contract provided that the
controlling (98.5%) shareholder (a Parretti entity) would regain control (and the executive committee be
dissolved) when the debt was paid down to a certain amount.

When MGM emerged from bankruptcy, the controlling shareholder demanded that the executive
committee sell certain assets to pay down the loan sufficiently to restore control to Parretti. The executive
committee rejected the demand out of concern as to adequacy of the price. Ladd [bank nominee] and his

110
256 B.R. 1 (Bankr. M.D. Fla. 2000).
111
There is an issue (not often addressed) concerning the extent that fiduciary duties extend to officers. The court
made clear in Toy King that at least under Florida law the fiduciary duties extend to both directors and officers.
Although the statute is not specifically directed to corporate officers, the case law makes clear that
both officers and directors of a corporation owe fiduciary duties to the corporation. See, e.g., Sea
Pines, 692 F.2d at 977; Tinwood v. Sun Banks, Inc., 570 So.2d 955, 959 (Fla. 5th DCA 1990);
Snyder Electric, 305 N.W.2d at 869. Cf. Steinberg v. Kendig (In re Ben Franklin Retail Stores,
Inc.), 2000 WL 28266 (N.D. Ill.) [Although Delaware courts have found that officers owe
fiduciary duties to the corporation, this Court has found that the only instances where such a duty
is found are where the circumstances involved self-dealing.].
In re Toy King Distributors, Inc., 256 B.R. 1, 165 n18 (Bankr. N.D. Fla. 2000).
112
Id. at 169.
113
Id. at 170-173 (relying on In re Papercraft Corp., 187 B.R. 486, 500 (Bankr. W.D. Pa. 1995)).
114
1991 WL 277613 (Del.Ch. Dec. 30, 1991).

team could reasonably suspect that he [Parretti] might be inclined to accept fire sale prices.
115
At all
relevant times, MGM was in the vicinity of insolvency.
116

Each side claimed that the other had breached its contractual governance obligations and
purported to remove the others board representatives. Parretti further alleged that the bank nominees
breached their fiduciary duty to the controlling shareholder.
117
The chancellor ruled for plaintiffs and held
that the executive committee decisions were valid and did not represent a breach of duty.
118
[T]he
Ladd management group acted prudently with respect to these transactions from the point of view of
MGM.
119
The court explained:

In these circumstances where the company was in bankruptcy until May
28 and even thereafter the directors labored in the shadow of that
prospect, Mr. Ladd and his associates were appropriately mindful of the
potential differing interests between the corporation and its 98%
shareholder. At least where a corporation is operating in the vicinity of
insolvency, a board of directors is not merely the agent of the residue risk
bearers, but owes its duty to the corporate enterprise. [FN55]
.
Ladd and his team could reasonably suspect that he [Parretti] might be
inclined to accept fire-sale prices. But the MGM board or its executive
committee had an obligation to the community of interest that sustained
the corporation, to exercise judgment in an informed, good faith effort to
maximize the corporations long-term wealth creating capacity.
120

In footnote 55, the chancellor emphasized the need to protect creditors. The possibility of
insolvency can do curious things to incentives, exposing creditors to risks of opportunistic behavior, and
creating complexities for directors.
121
In footnote 55, the chancellor posed a hypothetical in which a
corporations sole asset is a claim against a solvent entity for $51 million, with a value (taking into
consideration the likelihood of success) of $15.55 million; and the corporations debt is only $12 million.
In the hypothetical, the stockholders (whose equity is worth only $3.55 million) have a 1 in 4 chance of
realizing $39 million for themselves ($51 million less $12 million to debtholders) if the claim is not
settled, but would receive little if the claim were settled in the range of its market value, $15.55 million.
The shareholders, accordingly, might well prefer to reject a fair market value settlement and gamble for a
win at trial. If they lose, it is mostly all creditors money that will be lost, and if the stockholders win,
they will get all the reward. In the chancellors view, the directors may incur personal liability if they
take such high risk action for the benefit stockholders. Instead, as fiduciaries to the enterprise, they should
choose the best settlement over $15.55 million:

If we consider the community of interests that the corporation represents
it seems apparent that one should in this hypothetical accept the best
settlement offer available providing it is greater than $15.55 million, and

115
Credit Lyonnais Bank Nederland, N.V. v. Pathe Communications Corp., 1991 WL 277613, at *34 (Del.Ch. Dec.
30, 1991).
116
Id.
117
Id. at *33.
118
Id.
119
Id.
120
Id. at *34 (emphasis supplied).
121
Id. at n.55.

one below that amount should be rejected. But that result will not be
reached by a director who thinks he owes duties directly to shareholders
only. It will be reached by directors who are capable of conceiving of the
corporation as a legal and economic entity.
122

The upshot of the courts analysis is (a) to subordinate the interests of shareholders to the interests
of creditors in an insolvency situation when they conflict and (b) to impose an open-ended duty of care to
maximize the corporations long-term wealth creating capacity.
123
One might try to limit Credit
Lyonnais to situations involving potential disposition of assets for the benefit of stockholders on terms
unfair to creditors, since that is what Parretti wanted to do.
124
But the reasoning of the court in Credit
Lyonnais is clearly not tied to such situations and footnote 55 has nothing to do with asset disposition and
everything to do with directors undertaking undue risk to achieve a return for stockholders whose equity
is with little or nothing.

5. Does the Fiduciary Duty Shift to Creditors, to the Exclusion of Shareholder
Interests?

The majority of cases state or contemplate that upon insolvency, fiduciary duties are owed to both
creditors and stockholders, although certain duties to creditors may predominate under certain
circumstances (as Credit Lyonnais contemplates).
125
It has been held, however, that when a corporation
becomes insolvent ... the officers and directors no longer represent the stockholders . . . .
126

The majority view would appear to be the more sound. The fact of insolvency (either in a
bankruptcy or an equity sense) does not preclude rehabilitation of the enterprise and restoration of
positive net worth and cash flow. It has been argued persuasively that even post-petition, in a corporate
chapter 11 case, until it is clear that there will be no going concern (or liquidation) value available for
stockholders, the directors continue to owe fiduciary duties to stockholders.
127
The rule should be no
different prepetition.

122
Id.
123
Id. at *34.
124
See In re Ben Franklin Retail Stores, Inc., 225 B.R. at 655.
125
See, e.g., Ed Peters Jewelry Co., Inc. v. C&J Jewelry Co., Inc., 124 F.3d 252, 276 (1st Cir. 1997); Geyer v.
Ingersoll Publications Co., 621 A.2d 784, 789 (Del. Ch. 1992) (The existence of the fiduciary duties at the moment
of insolvency may cause directors to choose a course of action that best serves the entire corporate enterprise rather
than any single group interested in the corporation at a point in time when shareholders' wishes should not be the
director's only concern.); Pepper v. Litton, 308 U.S. 295, 307 (1939) (For that standard of fiduciary obligation is
designed for the protection of the entire community of interests in the corporation).
126
Fed. Deposit Ins. Corp. v. Sea Pines, 692 F.2d at 977 (citation omitted). Sea Pines ruled on duties of directors of
a South Carolina corporation, although no South Carolina cases are cited. 692 F.2d at 977; see also In re Hoffman
Assoc., Inc., 194 B.R. 943, 964 (Bankr. S.C. 1995) ([W]hen the Debtor became insolvent, the fiduciary duty owed
by [the defendant] as a director of the Debtor, shifted from the stockholders to all of the creditors of the Debtor);
First Options v. Polonitza, 1990 WL 114740, at *4 (N.D. Ill. J uly 31, 1990) (applying California law and upholding
verdict based on instruction that [a]n officer and director of an insolvent corporation has a duty to the corporation's
creditors to be loyal, to act solely for the financial benefit of the creditors in all matters, and to enhance the financial
interest of the insolvent corporation).
127
Harvey R. Miller, Corporate Governance in Chapter 11: The Fiduciary Relationship Between Directors and
Stockholders of Solvent and Insolvent Corporations, 23 SETON HALL L. REV. 1467, 1468, 1514-15 (1993). It is the
gray area between liquidation value and going concern value which may be realized because of a chapter 11
reorganization that provides a potential interest for existing stockholders . . . . The interests of stockholders should
not prolong a chapter 11 case when it is patent that there is not, and there never will be, sufficient value to provide
any consideration for the stockholders. However, so long as a debtor has a good faith belief that the corporation can

The practical effect of this dual (creditor/shareholder) obligation is to weaken or defeat any
argument that the directors have a duty upon insolvency to arrange an orderly sale or liquidation for the
benefit of creditors.
128
A significant part of the courts analysis was its view that, given the existence of
duties to both creditors and shareholders, there simply was no duty (on the allegations presented) to
liquidate the company:

[T]heir [directors] duty is to serve the interests of the corporate
enterprise, encompassing all its constituent groups, without preference to
any. That duty, therefore, requires directors to take creditor interests into
account, but not necessarily to give those interests priority. In particular,
it is not a duty to liquidate and pay creditors when the corporation is near
insolvency, provided that in the directors informed, good faith judgment
there is an alternative.
129

6. When is the Fiduciary Duty to Creditors Triggered?

The fiduciary duty to creditors is triggered at or about the point of insolvency. The fact which
creates the trust is the insolvency . . . .
130
Insolvency, however, is a term with more than one meaning.
As set forth in In re Healthco Intl, Inc.:

Insolvency has a settled meaning under fraudulent transfer law, whether
the relevant statute be section 548 of the Bankruptcy Code, the Uniform
Fraudulent Transfer Act or the Uniform Fraudulent Conveyance Act. Its
statutory definition is, in essence, an excess of liabilities over the value
of assets. This is sometimes referred to as insolvency in the bankruptcy
sense.

The Trustees claims against the directors are based on principles of
fiduciary obligations rather than fraudulent transfer law. Here another
form of insolvency is equally relevant-insolvency in the equity sense.
This is an inability to pay debts as they mature. Even though not
insolvent in the bankruptcy sense, a business is insolvent in the equity
sense if the assets lack liquidity.
131

be rehabilitated and that going concern value will be preserved and enhanced, the debtor and its directors have a
duty to attempt to achieve a consensual plan of reorganization incorporating plan treatment for stockholder interests
and junior creditor claims as contemplated by the Bankruptcy Code. Id.
128
See In re Ben Franklin Retail Stores, Inc., 225 B.R. 646.
129
225 B.R. at 655.
130
Bovay, 38 A.2d at 813.
131
208 B.R. at 301-02 (footnotes omitted). In Geyer v. Ingersoll, the court mixed the two concepts:
An entity is insolvent when it is unable to pay its debts as they fall due in the usual course
of business. Webster's Ninth New Collegiate Dictionary 626 (1988). That is, an entity is
insolvent when it has liabilities in excess of a reasonable market value of assets held.
Geyer, 621 A.2d at 789.

Insolvency under either definition should trigger the duty. If a corporation is insolvent in either the
bankruptcy or equity sense, creditors are at risk of nonpayment and the value of their debt claims is
dependent on the business decisions of the corporations managers.

The practical problem here is that it is hard to determine when, exactly, a corporation becomes
insolvent. The court in Geyer rejected the position that the trigger should be a bright line test,
specifically, the institution of bankruptcy or other statutory insolvency proceedings:

While it is true, as Mr. Ingersoll argues, that defining the exception as
arising when statutory proceedings have begun would give directors a
clear and objective indication as to when their duties to creditors arise,
there are other policy concerns which suggest that I interpret the
insolvency exception to arise when insolvency exists in fact. That is, it is
efficient and fair to cause the insolvency exception to arise at the
moment of insolvency in fact rather than waiting for the institution of
statutory proceedings. [Citations omitted.] The existence of the
fiduciary duties at the moment of insolvency may cause directors to
choose a course of action that best serves the entire corporate enterprise
rather than any single group interested in the corporation at a point in
time when shareholders' wishes should not be the directors only concern.
Furthermore, the existence of the duties at the moment of insolvency
rather than the institution of statutory proceedings prevents creditors
from having to prophesy when directors are entering into transactions
that would render the entity insolvent and improperly prejudice creditors'
interests.
132

Compounding the difficulty is the dictum from Credit Lyonnais which would trigger a fiduciary
duty to creditors in the vicinity of insolvency.
133
There is no test or definition for vicinity of
insolvency.
134
In a similar vein, the court in Healthco suggests that fiduciary duties are triggered when a
transaction leaves the company with unreasonably small capital (a fraudulent transfer concept), which
connotes a condition of financial debility short of insolvency (in either the bankruptcy or equity sense)
but which makes insolvency reasonably foreseeable.
135

The upshot of all this is a great deal of uncertainty. Directors, and those assisting them, must
exercise great care to demonstrate (and document) that creditor interests are being taken into account
whenever they believe the company is in financial difficulty.

132
Id. at 789; see Fagan v. La Gloria Oil & Gas Co., 494 S.W.2d 624, 628-29 (Tex. Civ. App.Houston [14th
Dist.] 1973, no writ) (under Texas law, fiduciary duty to creditors is triggered only when a corporation is insolvent
and has ceased doing business altogether or without reasonable prospect of success).
133
1991 WL 277613 at 34; accord In re Buckhead America Corp., 178 B.R. 956, 968 (D. Del. 1994).
134
Given that the courts footnote hypothetical involves a balance sheet solvent entity and risk to creditors of
nonpayment through dissipation of an asset, it would seem that "vicinity of insolvency" refers to risk of
nonpayment. See Credit Lyonnais, 1991 WL 277613 at *34 n.55.
135
In re Healthco, 208 B.R. at 302.

7. Fiduciary Duties Owed in Bankruptcy

In Chapter 11 cases, the debtor ordinarily remains in possession of the estate and operates the
business.
136
Bankruptcy courts have viewed a DIPs standard as analogous to the standard imposed by the
business judgment rule.
137
In a footnote, the Curlew Valley court stated:

An analogy may be drawn to suits by shareholders against directors who,
like trustees, in the exercise of business judgment, make decisions of
policy for corporations: Corporate management is vested in the board
of directors. If in the course of management, directors arrive at a
decision, within the corporations powers (intra vires) and their authority,
for which there is a reasonable basis, and they act in good faith, as the
result of their independent discretion and judgment, and uninfluenced by
any consideration other than what they honestly believe to be the best
interests of the corporation, a court will not interfere with internal
management and substitute its judgment for that of the directors to enjoin
or set aside the transaction or to surcharge the directors for any resulting
loss. H. Henn, Law of Corporations 482 (2d ed. 1970).
138

A DIP owes a fiduciary duty to its creditors similar to the duty a corporate fiduciary owes the
corporation. In Fulton State Bank v. Schipper (In re Schipper),
139
the duty was analyzed in the context of
a DIP selling assets pursuant to Section 363 of the Bankruptcy Code. A prospective purchaser made a
pre-petition offer to purchase the debtors land for $45,830. The deal fell through however and shortly
thereafter, the debtor filed a Chapter 11 petition. As the DIP, the debtor sold the land to his parents for
the price of $7,791. An appraisal ordered by the bank had valued the property at this amount. After this
transaction, the third party purchaser reappeared and offered to purchase the property from the debtors
parents for the same price of $45,830.
140
A creditor who learned of the sale brought an adversary
proceeding alleging that the debtor had breached his fiduciary duty by not informing the creditors of the
earlier offer when the property was sold.
141

The bankruptcy court ruled that the debtor had not breached his fiduciary duty to the creditors by
not informing them of the unconsummated, pre-bankruptcy negotiations. The district court affirmed. On
appeal, the Seventh Circuit stated that the issue on appeal was the nature of the fiduciary duty the DIP
owed to his creditors.

The bankruptcy court had recognized and discussed the DIPs general fiduciary duty and the
specific requirements of Section 363. The bankruptcy court applied the duties and applicable law to the
debtors sale of property to his parents. The bankruptcy court held that the DIP did not breach his
fiduciary duty under either standard.
142
In analyzing the general fiduciary duty to creditors, the
bankruptcy court reviewed, by analogy, the duties of a corporate fiduciary under state law and found that

136
11 U.S.C. 1108.
137
See In re Curlew Valley Associates, 14 B.R. 506 (Bankr. D. Utah 1981) (court will not entertain objections to
trustees conduct of estate where conduct involves business judgment made in good faith, upon a reasonable basis,
and within scope of his authority under Code).
138
In re Curlew Valley, 14 B.R. at 514, n.12.
139
933 F.2d 513 (7th Cir. 1991).
140
Fulton State Bank v. Schipper (In re Schipper), 933 F.2d 513, 514 (7th Cir. 1991).
141
Id. at 515.
142
Id.

the DIP had some business reasons for making the sale (the price was based on an independent appraisal)
and that the transaction met the general standard of inherent fairness because the sale was made in good
faith and met all the earmarks of an arms length transaction.

In appealing the decision, the plaintiff suggested that the debtor should be held to the higher
standard of duty of a trustee under common law. The Seventh Circuit held that the corporate fiduciary
standard was appropriate, stating that the protections afforded creditors under that standard are sufficient
without engrafting as well the duties of care and loyalty reserved by the common law for trustees.
143
A
finding that the common law trustee standards of duty applied rather than the more traditional corporate
law fiduciary duties would result in a more rigorous standard for evaluating the discharge of a DIPs
actions.

The United States Supreme Court has also indicated that the DIP also owes a fiduciary duty to
stockholders.
144
The implications of this fiduciary duty are unclear since the DIP at the same time owes a
fiduciary duty to creditors, and the interest of creditors and stockholders often conflict. Consequently, it
is difficult to define exactly how the DIP can properly act as a fiduciary for both the stockholders and the
creditors.

B. TRUSTEE

A bankruptcy trustee has a fiduciary duty to exercise care and diligence as an ordinary prudent
person would exercise in similar circumstances.
145
A bankruptcy trustee has the fiduciary duty to
conserve assets of the estate and to maximize distribution to creditors.
146
Chapters 7, 11 and 13
trustees have a fiduciary duty to all creditors.
147
A trustee is liable for intentional and negligent violations
of fiduciary duties.
148
In In re Ridgen, the majority of the Ninth Circuit held that the reasonable due
diligence standard is the one by which we judge the conduct of the trustee, regardless of whether the
debtor is an individual or a corporation.
149

The Fifth Circuit stated that the bankruptcy trustee is charged with the duty to collect and
reduce to money the property of the estate for which such trustee serves, and close such estate as
expeditiously as is compatible with the best interests of parties in interest.
150
The Fifth Circuit also
stated that bankruptcy trustees are required to comply with state law, as ordered by federal statute.
151

Regarding a trustees potential liability, the Supreme Court has held that a trustee should be held
personally liable for willfully and deliberately breaching his/her fiduciary duty of loyalty.
152
The Fifth

143
Id. at 516.
144
Commodity Futures Trading Commn v. Weintraub, 471 U.S. 343, 355, 105 S. Ct. 1986, 85 L. Ed. 2d. 372
(1985).
145
In re Cochise College Park, Inc., 703 F.2d 1339, 1357 (9th Cir. 1983).
146
United States v. Aldrich (In re Rigden), 795 F.2d 727, 730 (9th Cir. 1986).
147
See 11 U.S.C. 704, 1106, 1302; see, e.g., United Pacific Ins. Co. v. McClelland (In re Troy Dodson
Construction Co., Inc.), 993 F.2d 1211, 1216 (5th Cir. 1993); Hildebrand v. Hays Imports (In re Johnson), 279 B.R.
218, 225 (Bankr. M.D. Tenn. 2002).
148
United States v. Aldrich (In re Rigden), 795 F.2d at 730.
149
Id. at 731 n.1.
150
Dodson v. Huff (In re Smyth), 207 F.3d 758, 761 (5th Cir. 2000) (quoting 11 U.S.C. 704(1) (1994)).
151
Texas v. Lowe (In re H.L.S. Energy Co., Inc.), 151 F.3d 434, 438 (5th Cir. 1998) (citing 28 U.S.C. 959(b)).
152
In re Smyth, 207 F.3d at 761.

Circuit refined this ruling in Dodson v. Huff (In re Smyth) and held that trustees are not subject to personal
liability unless the trustee is found to have acted with gross negligence.
153

C. EXAMINERS

Like a bankruptcy trustee, an examiner has a fiduciary duty to exercise care and diligence as an
ordinary prudent person would exercise in similar circumstances and to maximize distribution to
creditors.
154
Recently, examiners have been used in otherwise unconventional ways, clouding the scope
of the examiners fiduciary duties. Examiners with expanded powers or limited budgets raise new issues
of where fiduciary duties may lay for examiners.

In In re Enron Corp., the court appointed two examiners. One examiner investigated Enrons
complex set of off balance sheet transactions (the Enron Corp. Examiner). The second examiner was
appointed to investigate the relationship between Enron Corp. and Enron North America, Inc., an Enron
Corp. subsidiary (the ENA Examiner). While the Enron Corp. Examiner conducted examinations and
prepared reports on the off balance sheet transactions, the ENA Examiner initially revised the relationship
between Enron Corp. and Enron North America, Inc. but subsequently adopted a role as a plan facilitator
and actively engaged in plan negotiations on behalf of the ENA creditors.

Expanding the powers of an examiners duties raise questions regarding the scope of the
examiners fiduciary duties, the rules of engagement regarding the examiners extra curricular activities,
as well as how the examiner is to be compensated for expanded duties. The scope of the examiner with
expanded powers fiduciary duties are not well defined and it is unclear whether the examiner owes a
fiduciary duty to all creditors or merely a fiduciary duty to parties effected by his or her role.

Furthermore, the rules of engagement for examiners are ever changing. Is an examiner
authorized to have ex parte communications with the court? Is an examiner restricted to communicating
with all parties through the official examiner report? Is an examiner entitled to have ex parte
communications with all parties? Other large bankruptcies have employed special examiners to
investigate certain areas in a bankruptcy case. Examiners have been appointed in the WorldCom
bankruptcy, the Enron bankruptcy and even several Texas bankruptcies such as Mirant, Tri-Union and El
Paso Electric Company.

D. OTHER CREATURES

Sometimes parties in bankruptcy will find themselves dealing with persons or entities not
described or defined in the Bankruptcy Code. Since the Bankruptcy Code clearly defines the roles and
tasks of most of the participants in a bankruptcy, how to deal with a court created creature can be
problematic. A recent example is the appointment of advisors by the Bankruptcy Court in five asbestos
bankruptcy cases, Owens Corning, W.R. Grace & Co., USG Corp., Armstrong World and Federal Mogul
pending in the United States District Court for the District of New J ersey. District J udge Wolin appointed
the advisors to assist him with the complicated asbestos cases and he had frequent ex parte meetings with
the advisors. J udge Wolin authorized the advisors to mediate disputes, hold case management

153
In re Smyth, 207 F.3d at 762.
154
United States v. Aldrich (In re Rigden), 795 F.2d at 730; In re Cochise College Park, Inc., 703 F.2d 1339, 1357
(9th Cir. 1983).

conferences, consult with counsel, hear matters, and advise the court.
155
Eventually, several parties
questioned the propriety of the use of the advisors. The Third Circuit required J udge Wolin to recuse
himself from four of the cases. The recusal was required not on a finding of unethical or biased conduct,
but rather the Third Circuit found that the district judges conduct carried an air of impropriety.

To avoid the air of impropriety for trustees with limited powers, examiners with expanded powers
and other special creatures, the parties in a bankruptcy should play a more active role in defining an
examiners or advisors scope of engagement and participation in a bankruptcy case.

E. COMMITTEES

Committee members are deemed to have a fiduciary relationship with those whom the committee
members represent.
156
As a result of its fiduciary relationship, committee members may not use their role
solely for their own personal advantage.
157
Fiduciary duties are also owed by counsel to the committee
that the committee represents.
158

Committee members must act in good faith and exercise reasonable care in their decisions and
recommendations. For example, In re Tucker Freight Lines, Inc.,
159
the creditors committee was found to
have violated its fiduciary duties by issuing a letter recommending against a proposed reorganization plan
and asserting reasons the committee knew to be false. The court held that the committee may be entitled
to limited immunity, pursuant to Bankruptcy Code Section 1103(c) but this limited immunity did not
shield the creditors committee from dishonest or reckless acts.

However, implied in this grant of authority must also be a concurrent
fiduciary duty to all unsecured creditors. At a minimum, this fiduciary
duty requires that the committees determination must be honestly
arrived at, and, to the greatest degree possible, also accurate and correct.
For a Creditors Committee to urge rejection of a plan for reasons they
knew, or would have known but for the recklessness, to be false would
violate this duty and deprive them of any limited immunity they might
otherwise hold under 1103(c)(3).
160

In Krafsur v. UOP (In re El Paso Refinery, L.P.), a Western District of Texas bankruptcy court
found that a committee member is not expected to subordinate its own interest to the interest of the
creditors committee.
161
In In re El Paso Refinery, the trustee brought suit against a committee member

155
Advisors, ex parte meetings led to questions of impartiality, WEEKLY NEWS, BANKRUPTCY COURT DECISION,
Vol. 42, Issue 26 at 5 (June 1, 2004).
156
In re Mid-Island Hosp., Inc., 276 F.3d 123 (2d. Cir. 2002); In re Caldor, Inc., 193 B.R. 165 (Bankr. S.D.N.Y.
1996); Pan Am Corp. v. Delta Airlines, Inc., 175 B.R. 438 (S.D.N.Y. 1994) (committee held fiduciary duty to
creditors, but not to debtor or other parties); Locks v. United States Trustee, 157 B.R. 89 (W.D. Pa. 1993); Pension
Benefit Guar. Corp. v. Pincus, Verlin, Hahn, Reich & Goldstein Professional Corp., 42 B.R. 960 (E.D. Pa 1984).
157
In re Natl Equip. & Mold Corp., 33 B.R. 574 (Bankr. N.D. Ohio 1983) (a committee member may not act
through the committee where the only benefit would be to place the committee member in a more favorable light to
creditors).
158
In re Mesta Mach. Co., 67 B.R. 151 (Bankr. W.D. Pa. 1986); see also In re J.F.D. Enter., Inc., 223 B.R. 610
(Bankr. D. Mass. 1998) (held that counsel to creditors' committee was not fiduciary of debtor or estate generally).
159
62 B.R. 213 (Bankr. W.D. Mich. 1986).
160
In re Tucker Freight Lines, Inc., 62 B.R. 213, 216 (Bankr. W.D. Mich. 1986) (citations omitted).
161
Krafsur v. UOP (In re El Paso Refinery, L.P.), 196 B.R. 58, 74 (Bankr. W.D. Tex. 1996).

both objecting to its proof of claim and alleging breach of fiduciary duties to the committee.
162
The
bankruptcy court reasoned that while a committee member has the responsibility to deal fairly with the
other committee members, the individual committee members were entitled to look out for their own
interest.
163
The court ruled that a committee member that had a conflict with the committee did not
breach its fiduciary duties to the committee when the member acted out of its own legitimate business
interests.
164

[The committee member] thus experienced the conflict that
accompanies a creditors both continuing to do business and serving on a
creditors committee. This it was (and must be) permitted to do, else the
liability associated with committee membership would effectively chill
participation on such committees. Liability ought not attach whenever
there is a conflict. Nor should courts decree that, whenever there is such
a conflict, the duty to the committee ought always prevail. Such a rule is
simply too harsh and unrealistic, and would only lead to a mass exodus
from committee participation.
165

1. Rights and Duties of a Committee

Section 1103 empowers and vests the creditors committee with substantial power and an equally
substantial responsibility. On the one hand, a committee is empowered to do virtually anything that has a
prospect for furthering the interests of its constituency. This mandate could include everything from
investigation of litigation against the debtors management to negotiation of a transaction for the sale of
the debtors assets. The broad powers of the committee, coupled with the committees fiduciary duties,
undivided loyalty and due care to the unsecured creditor constituency, seemingly impose on the
committee not just the power but also the duty to leave no stone unturned in the pursuit of creditor
interests.

The Fifth Circuit explored the tension between committee powers and duties in Advisory
Committee of Major Funding Corp. v. Sommers (In re Advisory Committee of Major Funding Corp.).
166

In Major Funding, a confirmed liquidating plan of reorganization provided for the formation of an
advisory committee that was to carry out duties under 11 U.S.C. 1103 . . . .
167
The expenses incurred
by the advisory committee in carrying out its duties under the plan were to be reimbursed on an
administrative priority basis. The advisory committee moved to retain counsel to investigate questionable
behavior on the part of the liquidating trustee. The liquidating trustee objected, arguing that the advisory
committee was not authorized under the plan of reorganization to retain counsel. According to the
liquidating trustee, the plan of reorganization charged the advisory committee with the statutory duties
imposed on official creditors committees under Section 1103, but did not confer on the advisory
committee the powers granted to official committees under Section 1103. The liquidating trustee argued
that the use of may rather than shall with reference to the activities listed under Section 1103(c)

162
Id. at 63, 73.
163
Id. at 74.
164
Id. at 75.
165
Id.
166
109 F.3d 219 (5th Cir. 1997).
167
Advisory Committee of Major Funding Corp. v. Sommers (In re Advisory Committee of Major Funding Corp.),
109 F.3d 219, 221 (5th Cir. 1997).

indicates that those activities constitute powers rather than duties of creditors committees and that the
plan of reorganization did not confer those powers on the advisory committee.
168

The Fifth Circuit held that the plan of reorganization did authorize the advisory committee to
retain counsel, determining that Section 1103(c) describes both powers and duties of creditors
committees and that the two are inexorably intertwined.
169
A creditors committee has one overriding
duty: to act in the best interest of the creditors it represents.
170
When a power granted under Section
1103 is needed for the committee to fulfill its overriding duty of protecting the creditors interest, the
committee is obliged to employ that power.
171
When the advisory committee learned of the liquidating
trustees questionable behavior, it had the duty under Section 1103(c)(5) to perform such other services
as in the interest of those represented.
172
Since Section 1103(a) and (b) empower committees to retain
counsel, the advisory committee was required to use this tool, if such retention would further the
interests of creditors. Thus, by conferring on the advisory committee the duties imposed under Section
1103, the plan of reorganization authorized the advisory committee to retain counsel in order to carry out
its duties.

In the Sommers opinion, the Fifth Circuit depicted the powers and duties of creditors committees
in the broadest possible terms. A creditors committee is obligated to use any of its statutory powers to
further the interest of the creditors. Sommers can be read as a mandate to committees to pursue every
lead, to turn over every rock, and to fully prepare for every contingency on pain of being second-guessed
by their creditor constituency, and potentially being exposed to liability for a breach of their duties of
diligence and due care. In reality, few bankruptcy cases can financially support a creditors committee to
act on such a broad front which would involve much duplication of effort and, ultimately, unnecessary
cost to the estate. Committees and their members have a qualified immunity and if it and they are
reasonably diligent and honest, the business judgment rule should apply to their acts or failures to act.
173

The tension between powers and duties runs squarely into considerations of waste of estate assets.
On the one hand, the committee must be diligent and zealous in pursuit of creditor interests while, on the
other, the committee has a duty to preserve estate assets. On the other hand, Section 1103 is not a license
for excess and inefficiency. If anything, there seems to be a bias against creditors committees pursuing
aggressive due diligence and contingency planning. A leading treatise suggests:

[E]fforts should be directed toward facilitating discussions and resolutions of plan issues
instead of preparing numerous committee draft plans and objections to debtor plans and
disclosures. Generally, the committees professional should not involve themselves in
every minute aspect of the DIPs business, incurring excessive fees that inappropriately
drain the estate, nor should they act as mere spectators, however, contributing nothing to
the benefit of the creditors while reaping the estates cash for their fees.
174

168
Id. at 223 .
169
Id. at 224-25.
170
Id. at 224.
171
Id.
172
Id. at 225.
173
See, e.g., In re Tucker Freight Lines, Inc., 62 B.R. 213.
174
NORTON BANKRUPTCY LAW & PRACTICE 2d, 27:20 at 27-52 (1994).

2. Duties to Investigate the Debtors Business and Plan of Reorganization

A creditors committee has investigative duties regarding a plan of reorganization. In In re
Western Management, Inc.,
175
the court, in denying confirmation of the Debtors proposed plan of
reorganization, chastised the creditors committee for failing to fulfill its investigative duties, stating:

There is no indication in the record that the unsecured creditors committee has met,
investigated, monitored or in any other manner attempted to fulfill its statutory
responsibility. It was envisioned by the drafters, when they removed the bankruptcy
judge as overseer of a Chapter 11 case, that the committee would fill the void. Without
the recommendations and findings of the creditors committee, the court, in a ruling on a
plan of reorganization, is confronted with a difficult, if not impossible, task in fulfilling
its statutorily prescribed duties. It is vitally important that the Court be fully and
accurately informed by independent, reliable evidence. Neither the Court, nor the
creditors should be required to rely entirely on the evidence produced by the proponents
of the plan.
176

Dismay over ineffectual creditors committee has come from other courts.
177
A committee should take
its responsibility very seriously.

A committee is also given broad powers to oversee and investigate the business of the debtor.
The Bankruptcy Code authorizes the committee to investigate the business and financial condition of the
debtor and gives the committee the power to examine any entity as a party in interest upon filing a
rule 2004 motion with the court.
178

3. Objections to Applications of Professionals

Creditors committees should also object to a debtors application to hire professionals if the
committee believes that a conflict of interest exists,
179
and to the fees of professionals, if not necessary
and reasonable. As articulated by the court in In re Western Management, Inc.,
180
a committee must
exercise its powers wisely to prevent the imposition of liability for failing to fulfill its statutory
obligations. An additional duty for an objection that should be raised by a creditors committee is when
the committee or its counsel become aware that another professional in the case has developed a conflict
after the approval of the initial retention pleadings.

4. Duty to Request Appointment of a Trustee or Examiner

Frequently in chapter 11 cases, there will be allegations of mismanagement, insider dealings and
perhaps fraud. The creditors in such cases very properly would be skeptical of existing management and
may seek to oust existing management. Creditors committees have the authority to request appointment
of a trustee, examiner, or retention of a chief restructuring officer. By virtue of its broad investigative

175
6 B.R. 438 (Bankr. W.D. Ky. 1980).
176
In re Western Mgmt., Inc., 6 B.R. 438, 440 (Bankr. W.D. Ky. 1980).
177
In re B&W Tractor Co., 38 B.R. 613, 615 (Bankr. E.D. N.C. 1984) (most creditors committees are totally
inactive and ineffective).
178
See FED. R. BANKR. P. 2004.
179
See In re Sharon Steel Corp., 19 F.3d 138 (3d Cir. 1994) (accountants with pre-petition claim disqualified from
representing debtor-in-possession).
180
In re Western Mgmt., Inc., 6 B.R. 438.

authority, a creditors committee may be in the best position to assess the need for a trustee or an
examiner and bring such need to the attention of the court.

5. Standing Of Creditors Committees To Sue On Behalf of Debtors Estate

It widely acknowledged that, under Sections 1103(c)(3),(5) and 1109(b), a committee has
standing to bring an action to recover preferences, fraudulent transfers or otherwise, when the DIP or
trustee unjustifiably fails to initiate the action and when the claims are shown to be colorable.
181
The
statutory authority for this power is inferred from Section 1103(c)(2) relating to investigation of the
debtor.

The Fifth Circuit has ruled that a creditors committee has the authority to bring a colorable
action on behalf of the debtor-corporation.
182
In Louisiana World Exposition v. Federal Insurance Co.,
the Fifth Circuit found that because a claim was property of the estate, the DIP was bound to assert the
claim against the debtors board and officers for gross negligence, mismanagement and breach of
fiduciary duty.
183
The debtors board, however, citing a conflict of interest, did not pursue the claim;
therefore the creditors committee sought court approval to institute the suit on the debtors behalf.
184
The
Fifth Circuit held that while the Bankruptcy Code did not explicitly authorize a creditors committee to
bring suit on behalf of the debtors, the fact that the DIP unjustifiably refused to pursue the claim, this
action entitled the creditors committee to bring the derivative lawsuit.
185
The Fifth Circuit stated that
[w]here the debtor-in-possession is unable or unwilling to fulfill its obligation [to bring a derivative
suit]due, for instance, to a conflict of interestthe Committee may assert the cause of action on behalf
and in the name of [debtor] if authorized to do so by the bankruptcy court.
186

In recent years, other courts have further analyzed the authority of a creditors committee to bring
an adversary proceeding on behalf of the bankruptcy estate. In 2002, the Third Circuit in Official Comm.
of Unsecured Creditors of Cybergenics Corp. v. Chinery, found that the creditors committee did not have
the authority to bring an adversary proceeding on behalf of the bankruptcy estate.
187
The bankruptcy
court found the debtors refusal to bring a derivative claim unreasonable and authorized the creditors
committee to proceed with the derivative claim. The district court dismissed the committees derivative
suits finding that under Section 544 of the Bankruptcy Code, the committee could not bring suit. A Third
Circuit panel upheld the district courts ruling finding that the committee could not bring suit under
Section 544 of the Bankruptcy Code.
188
Upon rehearing, the Third Circuit sitting en banc found that
alone, Sections 503(b)(3)(B), 544, 1103(c)(5) and 1109(b) of the Bankruptcy Code did not authorize the
court to empower a creditors committee with derivative standing. The en banc Third Circuit, however,

181
See, e.g., Canadian Pacific Forest Products Ltd. v. J.D. Irving, Ltd. (In re The Gibson Group, Inc.), 66 F.3d 1436
(6th Cir. 1995) (stating that alternative basis for committee standing may be judicially-created derivative standing);
Louisiana World Exposition v. Fed. Ins. Co., 858 F.2d 233 (5th Cir. 1988); In re STN Enterprises, 779 F.2d 901
(2d Cir. 1985).
182
Louisiana World Exposition v. Fed. Ins. Co., 858 F.2d 233 (5th Cir. 1988).
183
Id. at 235, 246.
184
Id. at 235.
185
Id. at 247.
186
Id. at 252.
187
Official Comm. of Unsecured Creditors of Cybergenics Corp. v. Chinery, 304 F.3d 316 (3d Cir. 2002). The
initial Third Circuit opinion was vacated when the Third Circuit granted the Committees motion for rehearing en
banc. Official Comm. of Unsecured Creditors of Cybergenics Corp. v. Chinery, 330 F.3d 548 (3d Cir. 2003).
188
Official Comm. of Unsecured Creditors of Cybergenics Corp. v. Chinery, 330 F.3d 548.

held that the bankruptcy courts equitable powers enabled the court to authorize a creditors committee to
bring a claim on behalf of the debtors.
189

In 2004, a Tenth Circuit Bankruptcy Appellate Panel in United Phosphorus, Ltd. v. Fox (In re
Fox) held that only the trustee or debtor had the authority to pursue avoidance actions.
190
Although the
court considered the Cybergenics case and other cases that held a creditors committee has derivative
standing, the Tenth Circuit BAP found that an otherwise interested party (i.e. creditors committee) did
not have standing to bring a derivative suit to benefit the estate.
191
The Tenth Circuit BAP in Fox found
that the language of Section 548 was absolute and therefore allowed no other party to pursue avoidance
actions other than the trustee or debtor.
192
The Fox BAP found that although there may be good policy
reasons to enable a creditors committee to bring an avoidance action, the Fox BAP nevertheless adhered
to the strict language of the statute and denied the creditors committee derivative standing.
193

6. Deference to Creditor Interest

The creditors committee is a party-in-interest and has standing to be heard in all matters arising
in the case.
194
There are some situations in which the committee gets out of step with its constituency
and finds its position being rejected by the court.
195
Except in those rare situations involving a committee
taking steps contrary to the expressed will of the creditor constituency as a whole, the courts generally
give great weight to the position taken by the committee whether it is in support of the debtors action or
in opposition to it.
196
From time to time, matters arise which involve considerable exercise of discretion
by the court. On those occasions, for example in connection with approving a compromise of
controversy, the court has to consider a whole range of factors to determine whether a particular requested
action should be approved. One of the tests for approving a compromise is all other factors bearing on
the wisdom of the compromise.
197
In a situation when the court is balancing a number of factors, the
committees views can be decisive.

The critical importance of the position of the committee is clearly illustrated in In re Foster
Mortgage Corporation.
198
In Foster Mortgage, the debtor proposed to enter into a compromise of
controversy.
199
Although there was no creditors committee, representatives of ninety-five percent (95%)
of the creditors strongly opposed the proposed action. The court weighed thefactors and concluded that
the debtors proposed compromise of controversy should be approved over the strong objection of the
creditors. The Fifth Circuit held the bankruptcy court abused its discretion in not giving due
consideration to the will of the vast majority of the creditors. The court noted that:

A bankruptcy court may not ignore creditors overwhelming opposition to a settlement.
We believe a bankruptcy court should consider the amount of creditor support for a

189
Id. at 580.
190
United Phosphorus, Ltd. v. Fox (In re Fox), 305 B.R. 912 (10th Cir. B.A.P. 2004).
191
Id.
192
Id. at 917.
193
Id. at 914-17.
194
11 U.S.C. 1109(b).
195
See, e.g., In re Cara Corp., No. 90-15397S, 1992 WL 88189 (Bankr. E.D. Pa. April 27, 1992); In re Mortgage
Investment Co. of El Paso, Texas, 111 B.R. 604 (Bankr. W.D. Tex. 1990).
196
Tex. Extrusion Corp. v. Lockheed Corp. (In re Tex. Extrusion Corp.), 844 F.2d 1142, 1159 (5th Cir. 1988) (in
the bankruptcy context the interests of the creditors not the debtors are paramount).
197
In re AWECO, Inc., 725 F.2d 293, 298 (5th Cir. 1984).
198
68 F.3d 914 (5th Cir. 1995)
199
In re Foster Mortgage Corp., 68 F.3d 914 (5th Cir. 1995).

compromise settlement as a factor bearing on the wisdom of the compromise as a way
to show deference to the reasonable views of creditors.
200

7. Fiduciary Duty

The members of a committee assume a fiduciary relationship to those creditors or interest holders
whom they represent. These duties are fundamentally the same duties a director of a solvent corporation
holds to the shareholder, i.e., the duty of loyalty and the duty of due care.
201
In In re Johns-Manville, the
court opined on the importance of these fiduciary duties in a chapter 11 case as follows:

In the case of reorganization committees, these fiduciary duties are crucial because of the
importance of committees. Reorganization committees are the primary negotiating
bodies for the plan of reorganization. They represent those classes of creditors from
which they are selected. They also provide supervision of the debtor and execute an
oversight function in protecting their constituents interests.
. . . .
Accordingly, the individuals constituting a committee should be honest, loyal,
trustworthy and without conflicting interests, and with undivided loyalty and allegiance
to their constituents.
202

The members must put aside their own personal, parochial and economic self-interest and
evaluate the debtor and its prospects in light of the interests of the collectivity of unsecured creditors.
Thus, for instance, a committee member may not act through the committee to seek an order of the court
correcting a statement issued by the debtor to its creditors, which statement suggested that legal actions
taken by the committee member had precipitated the chapter 11 case, when the only benefit to be gained
by correction would be to place the committee member in a more favorable light to other creditors.
203

Committee members dealings with the debtor will be scrutinized, as, for instance, when a group to which
the member belongs speculates in securities of the debtor.
204
If a committee member violates its fiduciary
duties to creditors, a court may remove the creditor from a committee.
205
Committee members are not
immune to personal liability for breach of fiduciary duty.

In In re Seaescape Cruises, Ltd, it was not a breach of fiduciary duty, however, when members of
the creditors committee sought relief from the automatic stay to enforce their liens and moved to convert

200
Id. at 918.
201
See, e.g., Woods v. City Natl Bank, 312 U.S. 262 (1941); Bohack Corp. v. Gulf & Western Indust. (In re Bohack
Corp.), 607 F.2d 258, 262 n.4 (2d Cir. 1979); In re Mountain States Power Co., 118 F.2d 405 (3d Cir. 1941);
Pension Benefit Guaranty Corp. v. Pincus, Verlin., 42 B.R. 960 (E.D. Pa. 1984) (committee owes undivided loyalty
and allegiance to group it represents); In re Realty Assoc. Sec. Corp., 56 F. Supp. 1007 (E.D.N.Y. 1944); In re
Quality Beverage Co., Inc., 181 B.R. 887 (Bankr. S.D. Tex. 1995); In re County of Orange, 179 B.R. 195 (Bankr.
C.D. Cal. 1995) (an indenture trustee serving on a committee must act in the best interest of all creditors represented
by the committee while working on the creditors committee); In re Natl Liquidators, Inc., 171 B.R. 819 (Bankr.
S.D. Ohio 1994) (committees do not act in best interest of the individual members, but serve to protect all creditors),
affd in part, revd in part, 182 B.R. 186 (S.D. Ohio 1985); In re Mesta Machine Co., 67 B.R. 151
(Bankr. W.D. Pa. 1986); In re Johns-Manville Corp., 26 B.R. 919 (Bankr. S.D.N.Y. 1983).
202
In re Johns-Manville Corp., 26 B.R. at 925.
203
In re Natl Equip. & Mold Corp., 33 B.R. 574 (Bankr. N.D. Ohio 1983).
204
See, e..g., In re Mountain States Power Co., 118 F.2d at 407; In re Standard Commercial Tobacco Co., 34 F.
Supp. 304, 310 (S.D.N.Y. 1940); In re Philadelphia & W. Ry. Co., 64 F. Supp. 738 (E.D. Pa. 1946).
205
In re Haskell-Dawes, Inc., 188 B.R. 515, 522 (Bankr. E.D. PA. 1995).

the case to chapter 7.
206
The court held these acts indicated the committee was not breaching its duty, but
playing a productive role as a watchdog in the case.

Committees and their members do not owe a duty to constituencies either above or below them in
the debtors capital structure. Manville Corp. v. Committee of Equity Security Holders (In re Johns-
Manville Corp.).
207
Committee members have no responsibility to push the value envelope of the estate
so that the equity security holders can receive a recovery. The bankruptcy system presumes that equity
security holders will zealously advocate their own interest if, in fact, there is a realistic opportunity for
value to be recovered at that level. Similarly, a creditors committee has no duty to creditors with rights
or priorities senior to the committees unsecured constituency.

Even though the committee can aggressively and zealously promote its interests even at the risk
of jeopardizing the interest of those not in its constituency, numerous circumstances can arise in the
course of the committees operations which create perplexing problems for the committee members and
their counsel. Frequently committees are composed of both trade creditors and unsecured creditors who
have contractually subordinated their claims either to another group of unsecured creditors or to some
form of senior debt. The potential for conflicts and casualties even within the creditors committee
constituency may not be readily apparent. On the one hand, senior unsecured creditors have the potential
for voting the interests, not only of their senior debt, but also the interests of the junior debt. In most of
the larger cases, the combined funded debt of senior and junior subordinated debt will constitute the vast
majority (frequently 90+%) of the total unsecured debt in the case. The senior debtholders, taking
advantage of their subordination rights, may elect to pursue a quick conservative resolution of the case
even though that result may pose little or no recovery to the subordinated debt and a diminished recovery
to the trade. By the same token, typically committees are initially organized by holders of subordinated
debt who recognize early that most impairment will occur at their level. By early aggressive action, the
subordinated debtholders are frequently able to get control of a pre-petition unofficial committee and
translate that control into control of an official committee. In many cases, the subordinated debt ends up
selecting counsel and financial advisors and becoming chairman of the committee. The approach to the
case of a committee controlled in this fashion will be a virtual mirror image of the approach taken in a
case in which senior debt controls. Under these circumstances, when the sub-debt essentially is playing
with senior constituencys money, the committee may adopt an extremely aggressive, very high risk
strategy involving such things as attempts to subordinate senior debt, assertion of speculative lender
liability claims against secured creditors and pursuit of litigation strategies of questionable pedigree
against third-parties. Again, trade creditors are frequently caught in the middle and their opportunity to
realize a meaningful dividend may be put into play by the adoption of an aggressive roll-the-dice
strategy by a sub-debt dominated committee.

The fiduciary duties of members of a committee in a reorganization case have generally not been
considered to extend to the estate or any other interested party, other than constituents. As the court
recognized in Johns-Manville,:

No doubt, a committee and its members are fiduciaries for each of the parties that it
represents . . . but neither a committee nor its members has any underlying duty to the
debtor or to the estate. Rather, a committees only duty is to pursue the interests of its
members. That pursuit, together with the representation of other committees, collectively
furthers the reorganization process.
208

206
In re Seaescape Cruises, Ltd., 131 B.R. 241 (Bankr. S.D. Fla. 1991).
207
60 B.R. 842, 853-54 n.22 (S.D.N.Y. 1986), revd on other grounds, 801 F.2d 60 (2d Cir. 1986).
208
In re Johns-Manville Corp.,60 B.R. at 853-54 n.22.

Not surprisingly, it has been held that a creditors committee cannot cram down a plan of
reorganization on its own constituency.
209
The court stated that to do so would be to not only allow, but
also to encourage the committee to neglect its fiduciary duties.
210

Committee members have a duty to fully inform their constituency of proceedings in the case
impacting the financial interest of the committee members and their counsel. In In re Mesta Machine
Co.,
211
the court held that failure of the members of a subclass of unsecured creditors (who had formed a
committee) to give notice of a proposed plan modification which would reduce distributions to the class
and benefit committee members, was a breach of fiduciary duty.
212

8. Committees and Committee Members Liability

Because creditors committees have fiduciary duties to the creditors they represent, they can also
incur liability for actions breaching those duties in a bankruptcy case. There is no specific grant of
immunity from liability for committee members in the Bankruptcy Code except for Section 1125(e),
which protects a committee member from violation of the securities laws for good faith solicitations of
acceptances or rejections of a plan in a chapter 11 bankruptcy case.

One of the first and most far-reaching cases interpreting the fiduciary duties of a creditors
committee is In re Tucker Freight Lines, Inc.
213
In Tucker Freight, the plaintiff, sole shareholder and
unsecured creditor of the debtor, sued certain of the members of the official unsecured creditors
committee, alleging that the defendants unlawfully and intentionally or recklessly committed tortious acts
which resulted in denial of confirmation of the debtors chapter 11 plan and the conversion of debtors
case to a case under chapter 7.
214
Specifically, the committee, by permission of the court, included in the
ballot package a letter giving the committees recommendations. The letter, which had not been reviewed
by the court, recommended rejection of the plan of reorganization. The letter also made statements
concerning the debtors good faith, the debtors multi-employer pension plan withdrawal liability, and
purported tax benefits to the plaintiff. Subsequently, the class of unsecured creditors rejected the plan.
215

The plaintiff claimed that the committees letter made false and misleading statements. The
plaintiff further alleged that the letter resulted from a fraudulent scheme in violation of the committees
fiduciary duties. The defendants claimed that, as members of a statutory creditors committee, they
enjoyed an absolute immunity against lawsuits such as the one brought by the plaintiff.
216
The
bankruptcy court refused to read an implicit grant of absolute immunity into Section 1103 of the
Bankruptcy Code. Rather, the court stated that implicit in the authority vested in the committee by
Section 1103 must also be a concurrent fiduciary duty to all the unsecured creditors:

At a minimum, this fiduciary duty requires that the committees determinations must be
honestly arrived at, and, to the greatest degree possible, also accurate and correct. For a
creditors committee to urge rejection of a plan for reasons they knew, or would have

209
In re Cara Corp., No. 90-15397S, 1992 WL 88189 (Bankr. E.D. Pa. April 27, 1992).
210
Id. at *14987
211
67 B.R. 151 (Bankr. W.D. Pa. 1986).
212
In re Mesta Mach. Co., 67 B.R. 151 (Bankr. W.D. Pa. 1986)
213
62 B.R. 213 (Bankr. W.D. Mich. 1983).
214
In re Tucker Freight Lines, Inc., 62 B.R. 213.
215
Id. at 215.
216
Id. at 215-16.

known, but for their recklessness, to be false would violate this duty and deprive them of
any limited immunity they might otherwise hold under section 1103(c)(3).
217

The court also rejected the defendants contention that if the Code is to function, the members of
the creditors committee must have the same absolute immunity that Trustees do.
218
Instead, the court
recognized that trustees do not have absolute immunity, but may be held liable for intentional
wrongs.
219
Furthermore, the court stated, the assumed tortious acts are not with [sic] the scope of
authority of a Trustee, a debtor in possession, or a creditors committee.
220
In Sowerwine v. Air Canada
(In re REA Holding Corp.),
221
the court found that the trustee stated a claim for relief in alleging that
individual committee members had breached their fiduciary duty when they diverted business to the
debtors competition.

Bankruptcy courts have also sanctioned committee members and committee counsel for violating
the automatic stay and Rule 9011 by filing a suit for improper purposes.
222
A bankruptcy court initiated a
civil contempt proceeding sua sponte against the committee and committee counsel.
223
After an
evidentiary hearing, the court found that the committee and committee counsel were each fifty percent
(50%) culpable for violating the automatic stay and Rule 9011 of the Federal Rules of Bankruptcy
Procedure in authorizing special counsel to the committee to file an action challenging transfers by the
debtor to another group of creditors.
224
The court held the committee members jointly and severally liable
for fifty percent (50%) of the awarded sanctions.
225

When parties pursue state court actions against committee members for actions taken in the
context of a bankruptcy case, a bankruptcy court may have the power to enjoin those actions.
226

E. STANDARD OF REVIEW

What standard must a committee satisfy to avoid liability for breaching a fiduciary duty?
Basically, the committee will have the benefit of the business judgment rule. If the committee is careful,
attentive and loyal to its constituency, it should be able to avoid liability. At least one bankruptcy court
has held that committees as fiduciaries are subject to more rigorous scrutiny.
227
Mesta Machine basically
put the burden of proof on the committee to prove its non-liability. If any transactions are challenged, the

217
Id. at 216.
218
Id. at 217.
219
See Mosser v. Darrow, 341 U.S. 267 (1951).
220
In re Tucker Freight, 62 B.R. at 217-18.
221
8 B.R. 75 (Bankr. S.D.N.Y 1980)
222
Official Unsecured Creditors Committee of General Homes Corp. v. American Savings & Loan Assn of Florida
(In re General Homes Corp.), 181 B.R. 870 (Bankr. S.D. Tex. 1994); Robert S. Blanc, Putting a Limit on Unlimited
Creditors Committee Liability, 13 BANKR. DEV. J . 359 (Spring 1997).
223
In re General Homes Corp., 181 B.R. at 877.
224
Id. at 876.
225
Id. at 883.
226
See, e.g., In re Burstein-Applebee Co., 63 B.R. 1011 (Bankr. W.D. Mo. 1986). A bankruptcy court has
permanently enjoined a state court libel and defamation suit filed against committee members in state court for
statements made by the committee members to a trade publication. The bankruptcy court found that not only were
the members statements made in good faith, but may have been required to fulfill their fiduciary duties to inform
the creditors they represented the debtors condition. The bankruptcy court found it not only necessary but the
inescapable duty of the court to issue a permanent injunction. Id. at 1019-20.
227
In re Mesta Mach. Co., 67 B.R. 151, 157 (Bankr. W.D. Pa. 1986).

committee as a fiduciary must not only prove its good faith but also show that the transaction was
inherently fair.

In Mesta Machine the committee was a special unsecured creditors committee representing the
hourly employees of the debtor. The committee members took actions, pursuant to a plan modification,
that was not served on the committees constituents which, for the benefit of the members and committee
counsel, lowered the amount the class members would receive under the plan. The bankruptcy court
found that this was a breach of the fiduciary duties the committee owed to their class.
228
For the
breaching of their fiduciary duties, the court ordered that all money received by both the committee
members and counsel were to be repaid to the bankruptcy court clerk. Further, the court found them
jointly and severally liable when they acted together in a breach of their duties.
229

Other courts have set a somewhat higher threshold of willful misconduct, which must be proven
before a committee can be held liable for its actions. Several courts that have considered the issue have
applied the willful misconduct standard before the court will find the committees qualified or limited
immunity should be set aside for the actions it took.
230

Misconduct allegations were raised against the creditors committee in the Pan Am bankruptcy.
In Pan Am I, Delta Airlines (Delta) had asserted a claim for relief against the Pan Am creditors
committee.
231
Delta asserted that the committee and its members were principal wrongdoers contributing
to the failure of the Pan Am plan of reorganization. In particular, Delta alleged that the committee acted
beyond the scope of its statutory duties by de facto becoming a joint proponent of the plan of
reorganization and then by manipulating the reorganization process without regard to the viability of the
reorganized Pan Am or the feasibility of a proposed plan of reorganization solely to improve, at any cost,
their potential recovery. The committee asserted entitlement to qualified immunity from suit because
their actions were committed within the scope of their statutory authority under Section 1103. The court
acknowledged the existence of qualified immunity for creditor committee members conduct. Relying
upon the Drexel Burnham case, Pan Am court adopted a standard granting fairly broad immunity:

Based upon this case law concerning the qualified immunity of creditors committees and
their members, any such immunity must be limited to actions taken within the scope of
the committees authority as conferred by statute or the court and may not extend to
willful misconduct of the committee or its members.
232

Pan Am II is the courts decision on the merits of Deltas claim against the creditors
committee.
233
The court found that Delta could not prove that any of its damages were a consequence of
the admittedly obstructive and disruptive conduct of the committee as it related to Deltas attempts to
fund certain aspects of the Pan Am reorganization. The Pan Am II court initially observed that the
committee had a substantial responsibility to assure that unsecured creditors views are heard and their
interests promoted and protected. The court went on to observe that no duty ran from the committee to
anyone other than its constituency, not Delta and not the debtor. The committee, therefore, enjoyed a

228
Id. at 159-60.
229
Id. at 166.
230
In re Drexel Burnham Lambert Group, Inc. 138 B.R. 717 (Bankr. S.D.N.Y. 1992), affd, 140 B.R. 347
(S.D.N.Y. 1992); see Pan Am Corp. v. Delta Airlines Inc., 175 B.R. 438 (S.D.N.Y. 1994) (Pan Am II); Luedke v.
Delta Air Lines, Inc., 159 B.R. 385 (S.D.N.Y. 1993) (Pan Am I).
231
Pan Am I, 159 B.R. 385.
232
Pan Am I, 159 B.R. at 392-93.
233
Pan Am II, 175 B.R. 438.

qualified immunity that corresponds to and is intended to further the committees exercise of its statutory
duties and powers. That immunity extends to conduct within the scope of the committees statutory
authority. The Pan Am II court held that in order for the creditors committee to have liability, its
qualified immunity must be overcome by Delta and that Delta would have to prove that the committee
engaged in willful misconduct or ultra vires activity.
234

The lesson of Tucker Freight, Drexel Burnham, Pan Am I and Pan Am II seems to be that
creditors committees enjoy a fairly broad qualified immunity to aggressively pursue single-mindedly the
interest of unsecured creditors. So long as the committee is acting within the scope of its authority, and
does not self-deal, it should enjoy immunity from suit.

In General Homes one Texas bankruptcy court has applied the willful conduct standard to actions
of a creditors committee for violations of the automatic stay.
235
The creditors committee filed an
adversary proceeding for a cause of action belonging to the debtor without prior bankruptcy court
approval. The committee had discussed the Louisiana World
236
case, but had concluded that Louisiana
World did not impose an absolute requirement of prior court authorization for a committee to file an
action that was property of the estate. The bankruptcy court found that the committee had not complied
with Louisiana World and this constituted a violation of the automatic stay, was willful misconduct
outside of the committees limited immunity and subjected the committee members personally to
sanctions. The court suggested that the debtors and certain secured creditors attorneys fees and costs
would be the appropriate sanction against the committee members and its counsel. The committee
members and counsel vigorously contested the bankruptcy courts ruling and ultimately the reported
decision was modified somewhat by an unreported decision entered in 1996.

Committee members may gain protection from liability in a confirmed plan, which they are
unable to receive from the Bankruptcy Code. Often a Chapter 11 plan contains a provision releasing
committee members from any liability for actions they took while serving on the committee.
237

F. COURT APPROVED COUNSEL AND OTHER PROFESSIONALS FOR
DEBTORS, TRUSTEES, EXAMINERS, AND COMMITTEES

Court approved counsel and professionals owe a fiduciary duty to their clients. DIP counsel and
professionals also owe a fiduciary duty to the creditors and parties-in-interest to the bankruptcy estate.
Committee counsel and professionals owe a fiduciary duty to all creditors, not merely the creditors
comprising the committee. Trustees and examiners and professionals employed by trustees and
examiners, owe a fiduciary duty to bankruptcy estate and to maximize returns for the unsecured creditors.

The trustee or DIP attorneys have a high fiduciary duty to the represented estate.
238
The
trustee/DIP counsel owes a fiduciary duty to the bankrupt corporate estate and not the interest of the

234
Pan Am II, 175 B.R. at 514-15.
235
Official Unsecured Creditors Committee of Gen. Homes Corp. v. Am. Savings & Loan Assn of Fla. (In re Gen.
Homes Corp.), 181 B.R. 870 (Bankr. S.D. Tex. 1994).
236
Louisiana World Exposition v. Fed. Ins. Co., 858 F.2d 233 (5th Cir. 1988).
237
See In re L.F. Rothschild Holdings, Inc., 163 B.R. 45 (S.D.N.Y. 1994); In re Drexel Burnham Lambert Group,
Inc., 138 B.R. 717.
238
See, e.g., In re Evangeline Refining Co., 890 F.2d 1312, 1323 (5th Cir. 1989); In re Consol. Bancshares, 785
F.2d 1249, 1255 (5th Cir. 1986).

corporate principals.
239
The trustee/DIP counsel has a fiduciary duty to the bankruptcy estate, including
the beneficiaries and the creditors.
240

One bankruptcy court summarized DIP or trustees counsels fiduciary duties as:

An attorney retained by the trustee, or debtor in possession, who assists with the
collection of the assets of the estate, must abide by the highest professional
standards. Not honesty alone, but the punctilio of an honor the most sensitive, is
he standard of behavior.
241
An attorneys duty goes beyond not merely putting
false evidence before the court; the duty is greaterthe lawyer has a duty to not
make misrepresentations to the court.
242

Several courts have ruled that DIP counsel does not owe a fiduciary duty to specific creditors.
243

Some courts, such as In re Sidco, Inc. and Hansen, Jones & Leta, P.C. v. Segal have found that DIP
counsel does not owe a fiduciary duty to the bankruptcy estate, its beneficiaries or its creditors.
244
In
Hansen, Jones & Leta, P.C., the court found that DIP counsel did not owe a fiduciary duty to the
beneficiaries of estate because the beneficiaries were not the clients.
245
The Sideco and Hansen, Jones &
Leta, P.C. decisions relied on the fact that the Bankruptcy Code does not contain a provision imposing a
fiduciary duty of DIP counsel; rather, the Bankruptcy Code imposes a duty on the DIP itself.

The Southern District of Texas in ICM Notes, Ltd. v. Andrews & Kurth, L.L.P, ruled that DIP
counsel owed a general fiduciary duty to preserve the bankruptcy estate, however, this duty did not extend
to a particular creditor.
246
In ICM Notes, ICM Notes purchased the debtors outstanding notes and
elevated to the position as secured lender.
247
ICM Notes then sued the debtors counsel, Andrews &
Kurth for breach of its fiduciary duties and tortious interference related to a foreclosure of ICM Notes
holdings.
248
The district court acknowledged that DIP counsel owed a fiduciary duty to the debtor-client
and the bankruptcy court, and recognized that many courts have employed a fiduciary duty to the
bankruptcy estate as a whole.
249
The district court ruled that the DIP counsel did not owe a fiduciary duty
to a specific creditor, ICM Notes, and reasoned: finding that debtors counsel owes a particular duty to
an individual creditor in a Chapter 11 bankruptcy proceeding would prevent counsel from representing his
client in accordance with the provisions of the Bankruptcy Code.
250
The district court noted that ICM
Notes was represented by independent legal counsel and that a ruling that DIP counsel owes a fiduciary
duty to a particular creditor is contrary to the tenet of the Bankruptcy Code mandating that debtors

239
See ,e.g., In re Grabill Corp., 113 B.R. 966, 970 (Bank. N.D. Ill. 1990).
240
In re Wilde Horse Enterprises, Inc., 136 B.R. 830, 840 (Bankr. C.D. Cal. 1991).
241
Id. at 840 (quoting In re Thompson, 54 B.R. 311, 315 (Bankr. N.D. Ohio 1985) (quoting J udge Cardozo in
Meinhard v. Salmon, 249 N.Y. 458, 464 (1928)) and In re Disciplinary Action Curl, 803 F.2d 1004, 1005-06 (9th
Cir. 1986)).
242
Id. at 840.
243
See, e.g., ICM Notes, Ltd. v. Andrews & Kurth, L.L.P., 278 B.R. 117 (S.D. Tex. 2002), affd, In re ICM Notes
Ltd., 324 F.3d 768 (5th Cir. 2003); Hansen, Jones & Leta, P.C. v. Segal, 220 B.R. 434 (D. Utah 1998).
244
In re Sidco, Inc., 173 B.R. 194 (E.D. Cal. 1994); Hansen, Jones & Leta, P.C. v. Segal, 220 B.R. 434 (D. Utah
1998).
245
Hansen, Jones & Leta, P.C., 220 B.R. at 457.
246
ICM Notes, Ltd. v. Andrews & Kurth, L.L.P., 278 B.R. at 123.
247
Id. at 119.
248
Id.
249
Id. (citing Brown v. Gerdes, 321 U.S. 178, 182, 64 S. Ct. 487 (1944) and In re JLM, Inc., 210 B.R. 19, 25 (2d Cir.
BAP 1997)).
250
Id. at 126.

S-FiduciaryDuties06-04.DOC
counsel be disinterested.
251
The ICM Notes case was affirmed, without written opinion, by the Fifth
Circuit in 2003.
252

V. POTENTIAL USE OF SPECIAL CONFLICTS COUNSEL

A relatively new creature in bankruptcy is the use of special conflicts counsel. In several large
bankruptcies, the courts have approved the use of special conflicts counsel to represent creditors and
debtors in bankruptcy. Often times, a partys law firm of choice has conflicts that prevent the law firm
from representing the party in bankruptcy. In order not to deprive a party of effective legal counsel, the
courts are approving the employment of two sets of counsel one primary counsel and a conflicts counsel
to represent the party when the primary counsel has a conflict of interest.
253
In the Enron bankruptcy,
primary counsel for the creditors committee was Milbank, Tweed, Hadley & McCloy, LLP, while Squire
Sanders & Dempsey, LLP served as conflicts counsel.
254
Although a creditor challenged the retention of
Milbank, Tweed, Hadley & McCloy, LLP, the court ultimately employed the firm as primary counsel
with the use of conflict counsel.

Although conflict counsel has been used in several large bankruptcies, questions arise as the
appropriateness of special conflict counsel. The use of conflicts counsel in large bankruptcies may be
appropriate for certain circumstances, however, the effectiveness of primary counsel and conflicts counsel
must be monitored. The use of several law firms in one case can be expensive and duplicative.
Furthermore, law firms may differ on tactics to take in a case, therefore causing internal conflict and
weakening the position of the represented client. Conflict counsel has a place in bankruptcy practice;
however, other remedies and solutions should be explored with more detail before the bankruptcy
industry adopts this practice as standard procedure.

251
Id.
252
ICM Notes, Ltd. v. Andrews & Kurth, L.L.P., 278 B.R. 117 (S.D. Tex. 2002), affd, In re ICM Notes Ltd., 324
F.3d 768 (5th Cir. 2003).
253
Mega-Case Conflict Issues: Enron Committee Counsel, 21 Sept. AM. BANKR. INST. J . 20 (2002); David B.
Young, Counsel as Preference Defendant and Conflicts Counsel: The Problems Posed by Pillowtex, Enron, and
Other Cases, STATE BAR OF TEXAS 22
ND
ANNUAL ADVANCED BUSINESS BANKRUPTCY COURSE, Chpt. 14.3 at 5
(May 6-7, 2004).
254
In re Enron Corp., 279 B.R. 671 (Bankr. S.D.N.Y.2002).

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