Courtesy of associate Carl Neff is a summary of a decision from the U.S. Bankruptcy Court for the District of Delaware in a case styled: In re Troll Communications, LLC , 385 B.R. 110, 113 (2008). This Bankruptcy Court in Delaware is often called upon to apply Delaware corporate law and frequently applies it in the context of a claim brought by a trustee for a bankrupt corporation against the former directors and officers. This is such a case.
In this Bankruptcy Court decision, a Chapter 7 trustee (the “Trustee”) brought adversary proceedings for breach of fiduciary duty, and fraudulent and preferential transfers. The Trustee filed an amended complaint and the defendants moved to dismiss. The motions to dismiss were granted in part and denied in part.
A. Count One: Claims for Breach of Fiduciary Duty Against Individual Defendants.
Count One of the amended complaint alleged claims for breach of fiduciary duty against Troll Communications directors and officers. See id. at 113. In support of these claims, the Trustee cited: (1) the board and officers’ suspect authorization of the use of proceeds from an equity transaction to pay debts owed by Quad Ventures Partners SBIC (“Quad”); and (2) the board and officers’ failure to prevent Troll’s deepening insolvency. See id. at 117. Supporting their motions to dismiss, the defendants cited: (1) the Trustee’s failure to plead around the business judgment rule; (2) the amended complaint’s lack of specificity regarding the officers’ knowledge and participation; and (3) the invalidity of a “deepening insolvency” cause of action. See id. at 119-122.
First, the court held that the business judgment rule was not a basis for dismissal of a breach of loyalty claim against the board of directors. See id. at 119. Count One alleged that certain members of Troll’s board of directors breached the duty of loyalty when they authorized the use of proceeds from an equity transaction in September 2002 to pay debts owed by Quad. See id. at 117. The complaint alleged that a majority of the directors had a financial interest in both Troll and Quad and one director failed to perform an independent review of the decision. See id. at 119. The defendants argued that the Trustee failed to plead around the business judgment rule and therefore the count should be dismissed. See id. at 118. The court rejected this argument because the complaint sufficiently pled facts questioning the disinterestedness of a majority of the directors. See id. at 119. Accordingly, the motion to dismiss was denied. See id. at 120.
Also under Count One, the court dismissed claims against Troll’s officers for breach of fiduciary duty because the complaint failed to allege specific details about the officers’ knowledge and participation. See id. at 120-21. To state a valid claim for breach of fiduciary duty, the Trustee must demonstrate: “(1) the existence of a fiduciary relationship; (2) a breach of that relationship; and (3) knowing participation by the defendant in the fiduciary’s breach.” See id. at 120. The complaint failed to allege with sufficient detail the officers’ knowing participation in the payments to Quad. See id. at 120. Therefore, the court dismissed the allegations, gave the Trustee leave to amend and directed him to specify which officers breached, or aided and abetted in the breach, of the fiduciary duty. See id. at 120-21.
Finally, the court dismissed Count One’s request for relief based on deepening insolvency, because deepening insolvency is not a valid cause of action under Delaware law. See id. at 121. Count One alleged that by failing to take prompt corrective action in the face of the company’s financial decline, the directors and officers “caused the corporate life of the debtors to be artificially extended beyond the point of economic viability.” See id. at 121. Although the Trustee did not explicitly assert this as an action for deepening insolvency, the court interpreted it as such. See id. Noting that the Delaware Supreme Court had rejected deepening insolvency as a cause of action, the court dismissed Count One’s request for relief based on this theory. See id. at 121 (citing Trenwick Am. Litig. Trust v. Billett, 931 A.2d 438 (Del. 2007), aff’g Trenwick Am. Litig. Trust v. Ernst & Young, LLP, 906 A.2d 168, 204-07 (Del.Ch. 2006)).
B. Counts Two and Three: Avoidance and Recovery of Fraudulent and Preferential Transfers
Both counts Two and Three of the amended complaint sought avoidance and recovery of three specific payments from Troll to Quad. See id. at 122. Count Two sought avoidance and recovery of the payments under the theory that they were fraudulent transfers. See id. Count Three sought avoidance and recovery of the same three transfers under the theory that they were preference payments. See id. at 123. The defendants moved to dismiss these counts arguing that (1) the Trustee did not sufficiently allege facts establishing Troll’s insolvency at the time of the transfers; and (2) the Trustee failed to plead the fraud claim with the requisite specificity. See id. The court denied the motions to dismiss.
The Trustee adequately alleged Troll’s insolvency at the time of the challenged payments. See id. at 124. To state a valid fraudulent transfer claim, the complaint must allege that the debtor was insolvent at the time of transfer. See id. The amended complaint, referencing Troll’s internal financial statements, alleged that at the time of the transfers Troll had “a negative net worth and was unable to meet maturing obligations.” Id. The court accepted the allegations as true and rejected the defendants’ argument that the facts alleged only a “mere suspicion” of insolvency. See id. The Trustee sufficiently alleged Troll’s insolvency, therefore the court denied the defendants’ motion to dismiss. See id. The amended complaint sufficiently pled fraud with the specificity required by Federal Rule of Civil Procedure 9(b). See id. at 125. The defendants argued that the Trustee’s pleading was deficient because it failed to identify a creditor and other factual information. See id. at 124. The court rejected the defendants argument holding that courts do not “require a trustee to plead the existence of an unsecured creditor by name.” See id. at 125. Additionally, the court held that the amended complaint contained sufficient factual information including: (1) the applicable statutory language; (2) the date and amounts of each transfer; (3) a claim that the transferees were insiders; and (4) specifics regarding Troll’s financial status. See id. The amended complaint sufficiently pled fraud with the requisite specificity, therefore the court denied the defendants’ motion to dismiss. See id.
C. Trustee’s Request to Further Amend the Amended Complaint.
The Trustee requested the opportunity to add certain corporate entities to Count One, Two and Three. See id. at 125. The defendants objected to the addition of one business entity to Count One arguing that the Trustee could not meet the requirements for relation back under Federal Rule of Civil Procedure 15(c). See id. The court scheduled a hearing to address the issue of whether the Trustee may further amend the complaint as requested. See id.