In a 6 page decision denying a motion to dismiss, released September 21, 2015, Judge Gross of the Delaware Bankruptcy Court considered the legal argument of whether a bankruptcy trustee could legally pursue a recovery against a company’s directors for allowing a WARN claim to arise. Judge Gross’ opinion is available here (the “Opinion”).
Because this was a decision on a motion to dismiss, the legal analysis is not as fulsome as is normal for an opinion of the Delaware Bankruptcy Court. Should the parties fail to settle this issue and an opinion be issued after a trial, I will be sure to provide an update. For now, it is enough to know that this type of case CAN survive a motion to dismiss.
Judge Gross’ Opinion
In response to the Trustee’s complaint that the directors breached their fiduciary duty, the defendants in this case made two arguments: (1) This was a ‘deepening insolvency” claim, which is unrecognized under Delaware law, and (2) the Trustee is the improper party to bring this claim (i.e., he lacks standing). Opinion at *3.
Judge Gross responded to these arguments in the opposite order – which seems reasonable as standing is always a gating issue. Judge Gross opined that “The Trustee in this Chapter 7 proceeding is ‘the sole representative of the estate with the authority to sue and be sued.’” Opinion at *4, citing In re USDigital, 443 B.R. 22, 43 (Bankr. D. Del. 2011). And that the Trustee has the duty to pursue the estate’s interests whether the claims are direct or derivative. Opinion at *4-5, citing Claybrook v. Morris (In re Scott Acquisition Corp.), 344 B.R. 283, 290-91 (Bankr. D. Del 2006) and Brandt v. Hicks, Muse & Co., Inc. (In re Healthco Int’l, Inc.), 208 B.R. 288 (Bankr. D. Mass. 1997). Thus, the Trustee has standing.
Judge Gross then opined that exposing the Debtor to claims under the WARN Act was a breach of their fiduciary duty. Opinion at *5. Because the complaint alleged facts that support a finding that the directors breached their fiduciary duties, Judge Gross denied the motion to dismiss. Opinion at *5.
As previously held by Judge Walsh, retired, and as quoted by Judge Gross, “Where directors fail to act in the face of a known duty to act, demonstrating a conscious disregard for their responsibilities, they breach their duty of loyalty by failing to discharge that fiduciary obligation in good faith.” In re Bridgeport Holdings, Inc., 388 B.R. 548, 564 (Bankr. D. Del 2008).
As is clear from the Opinion, there is a difference between deepening insolvency claims, and claims of breach which arise out of separate causes of action (like WARN Act violations). Based on this Opinion, it seems likely that in cases in which WARN Act violations are alleged, D&O insurers are going to start fielding far more calls from their insured.