Exposure of officers and directors in bankruptcy to having to pay back their salaries and expenses arising from their alleged breaches of their fiduciary duties

 

 

   As more and more officers and directors of insolvent companies are being sued for their alleged breaches of fiduciary duties in adversary proceedings brought by the company’s bankruptcy trustee, it is becoming more common to see additional counts brought by the Trustee, as a means to exert additional leverage, against former management and boards, seeking to avoid and recover all purported earnings and expense reimbursements paid by the debtor companies to them during the four years preceding the filing of the bankruptcy utilizing a combination of state and federal constructive and intentional fraudulent conveyance theories. The core rational of the argument is that by virtue of having breached their fiduciary duties to the company, they likewise did not provide reasonably equivalent value to the company either. It is a technique often times used quite successfully against a company’s former professionals, to wit, accountants and lawyers, to extend shorter state statute of limitations by casting their professional negligence as a mere avoidance action, based upon that person’s failure to do their job, or engagement, properly.

 

There is not much reported case law on the issue, but there are some decisions that should provide some comfort to former management and boards of directors that their regularly paid salaries and expenses will not have to be disgorged. In Official Comm. Of Unsecured Creditors v. Foss (In re Felt Mfg. Co.), 371 B.R. 589, 651 (Bankr. D.N.H. 2007) the Court held that to plead less than reasonably equivalent value, a complaint against a former officer for the services provided, the trustee must allege bad faith, a failure to undertake to perform their duties, and/or compensation that is excessive for the undertaking. In dismissing the constructive fraudulent transfer claim, the Court held that bad business decisions without more cannot form the basis for a fraudulent transfer conveyance action seeking recovery of compensation to an officer or a director.

 

Similarly, in Boyd v. Sachs, 153 B.R. 457, 498-99 (Bankr. W.D. Mich. 1993) the Court found that for the purposes of fraudulent transfer pleadings, in a case brought by a trustee against management that their efforts were qualitatively deficient, that the distinction between the quality and quantity of services rendered is critical, and that where the compensation is commensurate with the undertaking and the employee attempts in good faith to fulfill the undertaking, fair consideration has been given, and such a count could not stand. The mere fact that the services the defendants performed increased the debtors’ insolvency did not preclude a determination that they gave value.

 

So long as the officer or director did not act in bad faith, fail to perform the services for which they were paid, or that they were not paid excessive compensation in relation to the services rendered, such salary and expense recoupment claims should not survive. While a trustee may disagree with the decisions made by the board and management, that does not give the trustee the right to claw back the hard-earned compensation paid to them in the ordinary course of their services.