W. Marion Wilson, Trust Me, I'm a Lawyer: Restoring Faith in Fiduciaries by Dumping "due Diligence" and Tolling the Statute of Limitations for Postpetition Breach of Fiduciary Duty in Chapter 11

• Publication year: 2011

TRUST ME, I'M A LAWYER:

RESTORING FAITH IN FIDUCIARIES BY DUMPING "DUE DILIGENCE" AND TOLLING THE STATUTE OF

LIMITATIONS FOR POSTPETITION BREACH OF

FIDUCIARY DUTY IN CHAPTER 11

INTRODUCTION

Imagine the following scenario: Corporation X files for bankruptcy under chapter 11 of the U.S. Bankruptcy Code ("Bankruptcy Code"). The directors of X, as the debtor-in-possession ("DIP"), propose what appears to be a feasible reorganization plan and the plan is confirmed. The plan, however, which depends on maintaining X's current business contracts for its success, was formulated under false pretenses. After confirmation of the plan, the DIP proceeds to divert the very business contracts that would have allowed Corporation X to successfully reorganize to Corporation Y, which is wholly owned by X's directors. As a result of the DIP's usurpation of Corporation X's business contracts, the reorganization fails. This is one example of how the

DIP can breach her fiduciary duty of loyalty in chapter 11.¹

As the above scenario demonstrates, the ability to enforce fiduciary duties in chapter 11 is crucial because breaches of fiduciary duty can cause a potentially successful reorganization to fail. There is a plethora of scholarly commentary concerning fiduciary duties in chapter 11.²Few scholars, however, have discussed the problems associated with enforcing those fiduciary duties.³

Statutes of limitations hinder one's ability to enforce fiduciary duties because of the nature of fiduciary relationships; a beneficiary will often fail to file a timely action because she has trusted the fiduciary was acting in her best interests. This is especially likely during a complex reorganization, which necessitates the beneficiary placing trust and reliance in others, especially those with fiduciary obligations. In this context, barring actions because the statute of limitations has run is detrimental-it effectively encourages, rather than deters, fiduciaries to breach their obligations.⁴

Further, the tolling provisions available in bankruptcy, which are intended to ameliorate the harsh application of the statute of limitations, are inadequate because they only prevent the running of the statute of limitations if a plaintiff has exercised due diligence to discover her claim.⁵It is inconsistent with the very nature of a fiduciary relationship to require the beneficiary to engage in

"aggressive oversight" of her fiduciary.⁶

This Comment argues Congress should create a federal "reliance on fiduciary" tolling provision under chapter 11 of the Bankruptcy Code that would automatically toll the statute of limitations if a plaintiff failed to file suit because of reliance on a fiduciary relationship. Part I of this Comment discusses the fiduciary duties of the DIP, the chapter 11 trustee, and reorganization committees. Part II discusses the rationale for statutes of limitations and the tolling provisions applied in chapter 11.

Part III collects and analyzes bankruptcy and non-bankruptcy cases that have discussed the effect of a fiduciary relationship on a tolling analysis. These decisions conflict on whether and to what extent a fiduciary duty should influence a decision to toll statute of limitations. Part IV discusses Burtch v. Ganz (In re Mushroom Transportation Co.), a recent Third Circuit opinion that considered the effect reliance on a fiduciary relationship should have on

Relationship Your Corporate Law Professor (Should Have) Warned You About, 8 AM. BANKR. INST. L. REV. tolling.⁷Although the Third Circuit applied a tolling provision that requires the plaintiff to act with due diligence,⁸this opinion is important because the court's reasoning supports the case for a federal fiduciary tolling provision.

In light of the conflicting case law and the Third Circuit's recent opinion, Part V calls upon Congress to create a federal fiduciary tolling provision because it would comport with the purposes and policies of both limitations law and bankruptcy law and empower plaintiffs to enforce the fiduciary duties in chapter 11. As a preliminary matter, this Part explains why a bankruptcy court can apply a federal tolling provision. Part V then argues a federal fiduciary tolling provision is justified because it promotes the policies and overall goals of chapter 11 by deterring breaches of fiduciary duty. Likewise, the fiduciary tolling provision is in accord with the policies of limitations law. Additionally, a fiduciary tolling provision would create uniformity and certainty for the major parties in chapter 11 reorganizations. Finally, creating a fiduciary tolling provision is imperative because the current tolling provisions fail to appreciate the nature of a fiduciary relationship.

I. FIDUCIARY DUTIES IN CHAPTER 11

A fiduciary relationship contains "a unique degree of trust and confidence between the parties, one of whom has superior knowledge, skill or expertise and is under a duty to represent the interests of the other."⁹The Supreme Court has warned the "whole body of law" imposes "the most rigorous responsibilities for fair dealing" on fiduciaries that represent the rights of others.¹⁰According to Justice Frankfurter, "[T]o say that a man is a fiduciary only begins [the] analysis; it gives direction to further inquiry. To whom is he a fiduciary? What obligations does he owe as a fiduciary? In what respect has he failed to discharge these obligations?"¹¹This section will use Justice Frankfurter's analysis to discuss the fiduciary duties chapter 11 imposes upon a DIP, a chapter 11 trustee, and a reorganization committee.

A. Fiduciary Duties of the DIP

As an alternative to liquidation, an insolvent debtor-corporation may file under chapter 11 of the Bankruptcy Code and attempt to reorganize.¹²The debtor immediately becomes the DIP upon filing for chapter 11.¹³Generally, the DIP remains in control of the estate for the duration of the chapter 11 proceedings; however, a court may remove the DIP and appoint a trustee "for cause."¹⁴

Section 1107 of the Bankruptcy Code governs the rights, powers, and duties of the DIP.¹⁵Pursuant to this provision, the DIP is entrusted with the rights and powers of a chapter 11 trustee under Sec. 1106.¹⁶The DIP must also perform most of the duties of a chapter 11 trustee.¹⁷Most importantly, the DIP is authorized to continue operating the business during the reorganization proceedings.¹⁸In chapter 11, the directors and officers of the corporation control the corporate DIP, therefore, it is the directors and officers of the DIP who owe fiduciary duties.¹⁹

The DIP is a fiduciary of the bankruptcy estate and all parties who have an interest in it.²⁰Parties who have an interest in the estate include secured creditors, unsecured creditors, and stockholders of the debtor-corporation.²¹

Therefore, courts have held the DIP owes fiduciary duties to these three parties.²²

Id.

The DIP's officers and directors continue to owe the same fiduciary duties in bankruptcy that officers and directors owe a corporation and its stockholders outside of bankruptcy.²³These fiduciary duties are generally referred to as the duty of care²⁴and the duty of loyalty.²⁵

1. The Duty of Care

A DIP in chapter 11 owes the same fiduciary duty of care to its beneficiaries that any corporate officer or director owes to his corporation.²⁶

The standard corporate fiduciary duty of care mandates corporate officers and directors perform their duties with the level of care that an ordinarily prudent person would exercise under similar circumstances.²⁷Moreover, corporate officers and directors must exercise those duties in a manner they reasonably believe to be in the best interests of the corporation.²⁸The DIP is held to these same standards.²⁹

Many facets of a DIP's role in a chapter 11 proceeding give rise to fiduciary duties.³⁰The DIP has a duty to "protect and maximize the return on estate assets" as it manages the estate.³¹A DIP has a fiduciary duty not to waste assets by continuing to operate or incurring additional debt if it becomes apparent there is no reasonable chance for a successful reorganization.³²

Additionally, the duty of care "requires the debtor-in-possession to 'furnish

[financial information and records] concerning the estate and the estate's administration as is requested by a party in interest.'"³³Finally, when drafting a reorganization plan, the DIP must exercise reasonable diligence and care in formulating a feasible plan that maximizes the value of the estate.³⁴

Bankruptcy courts often apply the business judgment rule and refuse to hold the DIP liable for breach of fiduciary duty arising out of its business decisions.³⁵The business judgment rule assumes, "in making a business decision the directors of a corporation acted on an informed basis, in good faith and in the honest belief that the action taken was in the best interests of the company."³⁶Therefore, a court will not second-guess a DIP's business decisions unless they were made by an uninformed DIP without diligence.³⁷

Courts are generally concerned with the decision making process rather than the substantive decision itself.³⁸

In most circumstances, a court will not hold a DIP liable under the business judgment rule if the DIP articulates a business justification for its decisions.³⁹

Under the business judgment rule, a DIP is not liable for merely negligent business decisions.⁴⁰Rather, a DIP has only breached the duty of care if the "corporate decision lacks a business purpose, is tainted by a conflict of interest, is so egregious as to amount to a no-win decision, or results from an obvious and prolonged failure to exercise oversight or supervision."⁴¹

2. The Duty of Loyalty

In chapter 11, a DIP continues to owe the fiduciary duty of loyalty that binds the management of a solvent corporation.⁴²Broadly speaking, the duty of loyalty requires the DIP to conduct itself with a "view towards promoting the interests of the corporation."⁴³Thus, the duty of loyalty prohibits a DIP from...