Finding the Still Small Voice: The Liability of Bankruptcy Trustees and the Work of the National Bankruptcy Review Commission
Posted: 28 Aug 2006
This article examines section 3.3.2 of the Report of the National Bankruptcy Review Commission. That section proposed altering the Bankruptcy Code to clarify the law governing the liability and fiduciary obligations of trustees in bankruptcy. The article was prepared in connection with a symposium evaluating the Commission's Report held at Dickinson Law School. The Commission issued its Report on October 20, 1997, following many months of controversy, heated hearings and significant public debate. The article argues that section 3.3.2 represents a failure of the drafter to understand and delineate the two basic doctrines of fiduciary law and derived judicial immunity. The article notes that cogent scholarship dating to the inception of the Code had correctly identified errors in the development of law governing the liability of trustees and directors of the DIP, but the drafter failed to acknowledge or incorporate this prior work. The article begins by analyzing the characteristics of the bankruptcy trustee, describing the trustee as a unique person, holding fiduciary obligations to a discrete set of beneficiaries, and liable to these persons for a failure to live up to necessary standards, while simultaneously serving as a functionary of the bankruptcy court entitled to a judge's judicial immunity from suit. The article carefully explains that fiduciary duty analysis should be kept separate and distinct from judicial immunity analysis. A trustee in bankruptcy (and by extension, directors of the DIP) should be always liable to beneficiaries of the bankruptcy trust for a breach of his fiduciary duties. The only exception to the trustee's liability to beneficiaries occurs where the trustee has received permission for an action from the bankruptcy court following complete disclosure of the trustee's intended action and its attendant risks. A contrary result should occur if non beneficiaries of the bankruptcy trust sue the debtor and the trustee. A trustee represents the estate in a variety of matters, and may in the course of his responsibility commit a tort or breach a contract. When the aggrieved party sues, the trustee is entitled to the benefit of derived judicial immunity. Tort victims and parties in contract disputes are not beneficiaries of the bankruptcy trust and the trustee does not owe these parties any fiduciary duties. In addition, section 3.3.2 proposed to subject chapter 7, 11, 12 and 13 trustees to suit in their individual capacities only for actions taken outside the scope of their duties. The section then proposed that chapter 7, 12 and 13 trustees be subjected to suit in their personal capacity to the extent they act in a grossly negligent manner. The section proceeds to explain that gross negligence should be defined as reckless indifference or deliberate disregard of the trustee's fiduciary duty. The article points out that 1) the duty of care is a fiduciary duty, 2) the duty of care is typically defined in terms of negligence, and therefore 3) defining gross negligence by referencing a disregard of a trustee's fiduciary duty is a circular definition. The article further ruminates on the possible meanings of and distinctions between the trustee's personal, individual and representative liability to suit described in section 3.3.2. This represents a confusing word choice. Finally, the article examines the manner in which section 3.3.2 proposed to alter the liability of chapter 11 trustees. Section 3.3.2 proposed that a chapter 11 trustee for a corporate debtor only should be subject to suit in the trustee's representative capacity and subject to suit in the trustee's personal capacity only to the extent that the trustee has violated the standard of care applicable to officers and directors of a corporation in the state in which the Chapter 11 case is pending. The article argues that this change in the Code, if adopted, would have completely altered rules governing chapter 11 trustees and directors of the debtor in possession, and for the worse. Creditors of chapter 11 companies reasonably expect care, as that term applies to trustees (and derivatively, to directors of the DIP) to mean the same thing whether the bankruptcy case is filed in New York, California, or any other jurisdiction. However, enactment of this new rule would create fifty different definitions of care corresponding to the fifty jurisdictions. The proposed section would also make permanent in the Code a flawed distinction between breaches of the duty of care and the duty of loyalty. A trustee should be liable for a breach of either duty.
Keywords: bankruptcy, trustee, director, DIP, debtor in possession, debtor, possession, liability, duty, fiduciary, commission, review, national, loyalty, care, negligence, 3.3.2
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