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Article of Interest

Director and Officer Fiduciary Duties to Creditors
By:  John A. Tancabel and Michelle C. Jacobs

I.  Introduction

    Corporate officers and directors ordinarily do not owe fiduciary duties to the corporation’s creditors. When a corporation becomes insolvent or is on the brink of insolvency, however, corporate fiduciaries must consider the interests of creditors, who may assert breach of fiduciary duty claims against them.

     Often one of the biggest assets of an insolvent corporation is the company’s D&O policy, which creditors can access if they successfully assert a breach of fiduciary duty claim. As a result, creditors must understand when this significant claim becomes available, and officers and directors must understand when the fiduciary duty arises to avoid having such a claim asserted against them.

II. Delaware Law—Gheewalla

     In 2007, the Delaware Supreme Court issued a seminal decision addressing this issue. See N. Am. Catholic Educ. Programming Found., Inc. v. Gheewalla, 930 A.2d 92 (Del. 2007). The Gheewalla decision established several doctrinal points on the kinds of suits creditors may bring against officers and directors under Delaware Law:

• When a corporation is solvent, creditors may not bring direct or derivative claims for a breach of fiduciary duty.
  
• When the corporation is insolvent, creditors may not bring a direct claim but may assert a derivative claim for a breach of fiduciary duty.
  
• When a corporation is in the “zone of insolvency,” officers and directors must operate the corporation “for the benefit of its shareholder owners.” This strongly suggests that officers and directors do not owe creditors fiduciary duties when the corporation has entered the zone of insolvency.

Id. at 100-03.

III. Texas Law—Three Approaches

     Although Gheewalla has influenced Texas decisions on this point, uncertainty still exists under Texas law regarding when officers and directors owe fiduciary duties to creditors. Texas courts have adopted at least three different positions on when a creditor may redress breaches of fiduciary duty under Texas law: (1) when the corporation is insolvent and has ceased doing business; (2) when the corporation is insolvent, regardless of whether it has ceased doing business; and (3) when the corporation is in the zone of insolvency.

     A. Insolvency and Ceased Operations

     In Floyd v. Hefner, No. H-03-5693, 2006 WL 2844245, at *10-24 (S.D. Tex. Sept. 29, 2006), the court held that under Texas law creditors can bring suit to redress corporate breaches of fiduciary duty only when the company is insolvent and has ceased doing business. See also In re Mega Sys., L.L.C., No. 03-60190, 2007 WL 1643182, at *6 n.13 (Bankr. W.D. Tex. June 4, 2007) (approving Floyd’s analysis).

     On account of the dearth of Texas state case law on the matter, the Floyd court relied primarily on a 1939 Fifth Circuit case applying Texas law and other Texas cases applying the trust fund doctrine to establish the proposition that creditors may only bring suit for breaches of fiduciary duty when the company is both insolvent and has stopped operations. Id. at *10-15. Floyd rejected dicta in Carrieri v. Jobs.com, 393 F.3d 508, 534 n.24 (5th Cir. 2004) (applying Texas law) indicating that directors owe fiduciary duties to creditors while a company is in the zone of insolvency. Floyd, 2006 WL 284424, at *11-13.

     B. Insolvency Without Ceased Operations

     Other courts have held that creditors obtain the right to redress corporate breaches of fiduciary duty when the corporation is insolvent. See In re Supplement Spot, LLC, 409 B.R. 187, 203 (Bankr. S.D. Tex. 2009); In re Advanced Modular Power Sys., 413 B.R. 643, 666 (Bankr. S.D. Tex. 2009). In neither case did the court state that the corporation was required to also cease doing business.

     In In re Supplement Spot, 409 B.R. at 203, the court considered whether the president of the debtor company had breached a fiduciary duty to the company’s creditors such that the court could impose a constructive trust to recover transferred funds. In concluding that officers owe fiduciary duties to the corporation’s creditors when the corporation is insolvent, the court cited a case stating that, under Delaware law, when a corporation becomes insolvent, its assets become a trust for the benefit of the corporation’s creditors. Id. at 203-04 (citing Jewel Recovery, L.P. v. Gordon, 196 B.R. 348, 354 (N.D. Tex. 1996). But Jewel Recovery also acknowledged that this equitable trust might spring into existence when the corporation is in the zone of insolvency. Jewel Recovery, 196 B.R. at 355 (citing In re Buckhead Am. Corp., 178 B.R. 956, 968-69 (D. Del. 1994)).

     In In re Advanced Modular Power Systems, 413 B.R. at 654, the trustee in bankruptcy brought suit against the officer of the debtor corporation for breach of fiduciary duty. In finding that officers owe fiduciary duties to the corporation’s creditors when the corporation is insolvent, the court cited one case indicating that the duty is owed when the corporation is insolvent and another case indicating that creditors are owed fiduciary duties in the zone of insolvency. Id. at 666 (citing ASARCO LLC v. Ams. Mining Corp., 396 B.R. 278, 415 (S.D. Tex. 2008) (construing Delaware law and applying duty when corporation is insolvent), and In re Mirant Corp., 326 B.R. 646, 651 (Bankr. N.D. Tex. 2005) (applying Delaware law and imposing duty when corporation is in zone of insolvency)). Although In re Supplement Spot and In re Advanced Power Systems state that the duty is owed when the corporation is insolvent, the cases they cite for this proposition make it unclear if the duty should also apply when the corporation is in the zone of insolvency.

C. Zone of Insolvency

     Other Texas courts have specifically held that creditors can bring suit for breach of fiduciary duty when the corporation is in the zone of insolvency. See In re I.G. Servs. Ltd., No. 04-5041-C, 2007 WL 2229650, at *3 (Bankr. W.D. Tex. July 31, 2007); In re Vartec Telecom, Inc., 04-81694HDH7, 2007 WL 2872283, at *2 (Bankr. N.D. Tex. Sept. 24, 2007). In concluding that under Texas law creditors may bring a suit for breach of fiduciary duty while the company is in the zone of insolvency, the In re I.G. Services court relied on Delaware law, including the Gheewalla decision. In re I.G. Servs., 2007 WL 2229650, at *3. Without much analysis, however, the court construed Gheewalla as permitting creditor derivative suits when the company is in the zone of insolvency. Id. (“[C]reditors had the right to bring actions for breach of fiduciary duties ... at least when the corporation has entered the zone of insolvency.”). Similarly, In re Vartec relied on both Gheewalla and the dicta from the Fifth Circuit’s Carrieri decision in concluding, “Both Texas and Delaware law recognize [that] a cause of action for breach of fiduciary duty against the directors and officers of a corporation may be brought by the creditors of a corporation when the company is either insolvent or in the ‘zone’ or ‘vicinity’ of insolvency.’” In re Vartec, 2007 WL 2872283, at *4.

IV. Responding to the Uncertainty

     The disparate holdings of these cases create uncertainty in this area of Texas law, particularly considering: (1) Floyd’s holding relied in part on the view that Delaware law did not recognize a cause of action by creditors, Floyd, 2006 WL 2844245, at *16-18, but this has since changed with Gheewalla, (2) the Delaware cases cited by In re Supplement Spot and In re Advanced Power Systems that indicate the duty is owed when the corporation is in the zone of insolvency were decided before Gheewalla, and Gheewalla appears to overrule this conclusion, and (3) both In re I.G. Services and In re Vartec appear to misread Gheewalla, as nothing in the Gheewalla decision authorizes suits by creditors while the company is in the zone of insolvency.

     Thus, Gheewalla may be the key to resolving this conflict of authorities. Gheewalla may: (1) undermine the holding of Floyd, (2) affirm that In re Supplement Spot and In re Advanced Power Systems only provide a creditor right to sue when the corporation is insolvent, and (3) convince later courts applying Texas law not to follow In re I.G. Services and In re Vartec. Until In re I.G. Services and In re Vartec are clearly rejected, however, directors and officers of a Texas corporation should be attuned to the interests of creditors as the company nears insolvency, and creditors should be alert to potential breach of fiduciary duty claims they might assert on behalf of the corporation.