Wednesday, October 17, 2007

Creditor Trust Fails to Revive Claims Brought by Debtor; Creditors Found to Have Derivative Standing Only

While plan trusts have many uses, overcoming res judicata is not one of them. In Medlin, Trustee v. Wells Fargo Bank, N.A., Adv. No. 04-5041 (Bankr. W.D. Tex. 7/31/07), the Bankruptcy Court considered whether claims contributed to a plan trust by investors could overcome a prior take nothing judgment entered in a suit by the debtor’s trustee. In this case, the motto try, try again proved unavailing.

In the initial action, Len Blackwell, Chapter 11 trustee for the Inverworld debtors brought claims against Wells Fargo Bank, N.A. and Wells Fargo Bank of Texas, N.A. Pursuant to a Cash Management Services Agreement, the claims were referred to arbitration. The arbitration resulted in a take nothing judgment.

Subsequently, the cases proceeded to confirmation. The plan allowed for creditors to contribute their claims to an investor claim trust. The investor claim trust then brought its own claims. Although the reference was withdrawn, the Bankruptcy Court retained preliminary matters. The Bankruptcy Court was asked to consider whether the creditor claims were barred by res judicata.

Drawing an analogy to Orson Welles who proclaimed that Gallo Wineries would sell no wine before its time, the Bankruptcy Court noted that this issue was now ripe for decision since a new opinion by the Delaware Supreme Court resolved the issue. In North American Catholic Educational Programming Foundation, Inc. v. Gheewalla, __ A.2d __, 2007 WL 1453705 (Del. Sup. 5/18/07), the Delaware Supreme Court held that creditors of an insolvent firm could assert breach of fiduciary claims; however, such claims were derivative claims just like those which could be asserted by shareholders. Because the creditor claims were derivative of the company’s claims, they were barred by res judicata based on the prior adverse ruling against the company. Thus, even though both the company and the creditors were allowed to assert clams, they were not considered to be separate parties for purposes of res judicata.

The derivative nature of these breach of fiduciary duty claims raises an interesting race to the courthouse problem. Because multiple parties have standing to pursue the same claim, it is possible that the first party to file might be the least qualified to pursue the claim or might have an actual incentive to sandbag the claims. For example, if debtor's management chooses to pursue claims against other members of management, it is possible that they might pursue the claims for the purpose of eliminating them. Thus, if management puts on a weak case and loses, the creditors would be barred. The same logic would seem to apply if management pursued the claims and then settled them on behalf of the company. There is some protection where the party sabotaging the claims is part of the debtor's management. In that case, the disingenuous pursuit of breach of fiduciary claims could give rise to new breach of fiduciary claims against the parties who caused the prior claims to be lost. However, if the claims are pursued by a small third party creditor who simply lacks the resources to put on a good case, there is no similar protection. Indeed, it is possible that a friendly creditor could bring claims for the express purpose of allowing them to go down to defeat. In that case, the creditor would not have a pre-existing fiduciary duty to the company (although it might acquire one by virtue of pursuing the claims)and its failure would bind both the debtor and its creditors.

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