Alerts

Breach of Fiduciary Duty by Insiders of Chapter 11 Debtors

March 12, 2008

The U.S. Court of Appeals for the Eighth Circuit recently held that insiders who control the operations of a debtor owe a duty, as fiduciaries, to refrain from self-dealing. In re Brook Valley VII, Joint Venture (Lange v. Schropp), 496 F.3d 892 (8th Cir. 2007). The controlling insiders of two Chapter 11 debtors had thus breached their fiduciary duties to the debtors when they caused the debtors to consent to a foreclosure sale of estate properties and then secretly purchased the properties for themselves at the sale. Because the properties had substantial equity and had been operating profitably even after the bankruptcy filing, the insiders “should have been making efforts to obtain financing on behalf of the Debtors to salvage the properties,” rather than consenting to a foreclosure and searching for financing for their own purchase of the assets. Id. at 901. The court upheld the lower court’s imposition of a constructive trust in favor of the estate on the net proceeds of the foreclosure sale and awarded the bankruptcy trustee all profits that the insiders had earned from operating the properties after the foreclosure sale.