Chapter 13 Trustee Liability and Indemnification

• Jurisdiction: United States

Chapter 13 Trustee Liability and Indemnification

This chapter provides an introduction to the critical concepts of trustee liability and indemnification. The scope of these risks and the protections offered to the trustee should be addressed in the governing documents of the trust.

Trustees have duties to the trust and its beneficiaries, but they also face potential liability for their actions as manager and operator of the debtor's estate. Potential liability can also arise from obligations to the government for tax and regulatory, as well as enforcement, obligations. The scope of these risks and the protections offered to the trustee should be addressed in the governing documents of the trust.

A. A Trustee's Risks and Responsibilities¹⁹⁸

Liquidation trustees face many potential risks of liability. They have duties to the liquidation trust itself and its beneficiaries. They face the risk of potential personal liability for the expenses of administering the liquidation trust or for acting outside of their official capacity or for breaching their fiduciary obligations. In addition, penalties or surcharges may be imposed to compensate the estate for violations by the trustee. They also face potential liability to the government for tax and regulatory, as well as enforcement, obligations. In order to avoid such personal liabilities, trustees must exercise great care in their duties.

Section 959 of Title 28 of the U.S. Code provides:

(a) Trustees, receivers or managers of any property, including debtors in possession, may be sued, without leave of the court appointing them, with respect to any of their acts or transactions in carrying on business connected with such property. Such actions shall be subject to the general equity power of such court so far as the same may be necessary to the ends of justice, but this shall not deprive a litigant of his right to trial by jury.
(b) Except as provided in Section 1166 of title 11, a trustee, receiver or manager appointed in any case pending in any court of the United States, including a debtor in possession, shall manage and operate the property in his possession as such trustee, receiver or manager according to the requirements of the valid laws of the State in which such property is situated, in the same manner that the owner or possessor thereof would be bound to do if in possession thereof.

The Bankruptcy Code defines the bankruptcy trustee's legal capacity in § 323(b): "The trustee in a case under this title has capacity to sue and be sued." The duties to be performed by trustees are listed in §§ 704, 1106 and 1302 of the Bankruptcy Code. Bankruptcy Rule 6009 states that the trustee's authority includes defending any pending action or proceeding by or against the debtor, or commencing and prosecuting any action or proceeding on behalf of the estate before any tribunal. Collier on Bankruptcy notes that "[t]he trustee appears in his or her legal capacity and is entitled to Derived Judicial Immunity."¹⁹⁹ Although trustees have been recognized to be protected by derived immunity, this is not a uniformly applied or recognized theory. Trustees must recognize and understand the extent to which they are not protected by immunity.

Trustees are fiduciaries who are authorized to act on behalf of the beneficiaries of the trust. Trustees routinely make decisions to either take action or not, such as filing a complaint, filing a motion to set aside a judgment, or filing a motion to assume or reject a lease or other contract. Trustees often have to decide whether to preserve and protect an intangible asset of the estate, or whether to close a business operating under chapter 11 or 7 or in a post-confirmation trust.

Trustees make decisions on whether to attempt to sell assets or surrender them to secured creditors, whether to administer or abandon causes of action, and myriad other decisions often based on conflicting information and professional opinions. As such, they can be sued by secured creditors who disagree with the trustee's actions affecting the creditor's collateral, by unsecured creditors who disagree with decisions made by the trustee, by third parties who believe they may have been injured by a trustee's actions, and by debtors engaged in openly adversarial relationships with trustees.

B. Responsible Parties and Immunity

Three principles of bankruptcy law control the interpretation of responsible parties. First, an estate is a distinct entity, but it is not a legal person. As such, it can only be sued in the name of its trustee. The trustee is a party to such a suit in his official capacity only. Second, the trustee is generally immune from suit for actions arising out of the operation of the estate. Third, the immunity is not unlimited. The trustee can be held liable under two circumstances: (1) when he operates ultra vires, and (2) when he...