Actions Against Former Committee Members Alleged Breach of Fiduciary Duty for Support of a Plan and Ramifications

Journal Issue

Apr 2005

Column Name

Bankruptcy Code

Topic Tags

Plan Confirmation

Journal HTML Content

Creditors' committees serve an important
role in chapter 11 cases. Notwithstanding the fact that committee
members are not compensated, they are tasked with serving as
representatives and fiduciaries for the general unsecured creditor body
as a whole. Among the important functions, and one that is specifically
enumerated in §1104(c)(3) of the Bankruptcy Code, is the
formulation of a reorganization plan. Committees provide input and are
often co-sponsors of a plan. A committee's support, or lack thereof, can
determine whether a plan gets confirmed.

<h4>Action Against Former Committee Members</h4>

Robert A. Mark, Chief Judge of the U.S. Bankruptcy Court
for the Southern District of Florida, recently decided Tae Il Media
Co. Ltd. v. Maxtor Corp., et al. (the "Tae Il action"). A
disgruntled creditor, Tae Il Media Co. Ltd. commenced the Tae Il action
in state court against each of the former committee members just a few
days short of four years after a plan was confirmed in the main chapter
11 case of Future Tech International, Case No. 99-14707-BKC-RAM.
The Tae Il action alleged that the former committee members breached
their fiduciary by supporting a plan that was confirmed by the
bankruptcy court over Tae Il's objection. More specifically, the
complaint alleged that the committee members approved and
enthusiastically supported a reorganization plan that (1) impermissibly
classified claims, (2) unfairly discriminated against Tae Il and (3) did
not satisfy the best-interests-of-creditors test. Based on these
allegations, Tae Il asserted that (1) the former committee members owed
Tae Il a fiduciary duty, which was breached because the members did not
honestly and fairly make determinations giving rise to their support for
the debtor's plan and because the committee members made inaccurate and
incorrect determinations negligently, and (2) as a result of the alleged
breaches of fiduciary duties to Tae Il, the former committee members
substantially enriched themselves to the detriment and loss of Tae Il
(as well as certain of the several unsecured creditors), entitling Tae
Il to damages. The defendant/former committee members removed the Tae
Il's action to bankruptcy court.

<hr>
<big><center>
A committee's support or lack thereof can determine whether a plan gets
confirmed.
</center></big>
<hr>
</blockquote></blockquote>

<h4>Confirmation of Plan Four Years Earlier</h4>

Four years before Tae Il sued the former committee members, it
actively participated in the confirmation proceedings and objected to
confirmation of the debtor's plan, asserting (1) improper classification
of its claim and (2) that the plan (a) discriminated unfairly and was
not fair and equitable in respect of its claim, (b) did not meet the
best-interests-of-creditors test and (c) was not proposed in good faith.

After a multi-day contested evidentiary confirmation hearing, the
bankruptcy court confirmed the debtor's plan. The court specifically
found that (1) although creditors in two of the classes voted against
and were impaired under the plan, the plan did not unfairly discriminate
against those classes of creditors and the treatment of those classes
was fair and equitable, as required by the Code; (2) the plan complied
with the applicable provisions of the Code; (3) the debtor, as proponent
of the plan, complied with the applicable provisions of the Code; (4)
the plan was proposed in good faith and not by any means forbidden by
law; (5) although the plan discriminated as to certain creditors,
including the objecting creditor, the classification scheme had a
reasonable basis and was appropriate under the facts and circumstances
of the case and therefore the plan satisfied §1122 of the Code; (6)
as to each impaired class under the plan, either each holder of a claim
in such class has accepted the plan or would receive on account of such
claims property of a value, as of the effective date, that is not less
than the amount that such holder would receive or retain if the debtor
were liquidated under chapter 7 of the Code on such date; and (7) the
objecting creditor voted against the plan; however, the plan could still
be confirmed because the plan was fair and equitable with respect to the
objecting class of creditors and did not discriminate unfairly against
these classes of creditors.

Tae Il appealed the confirmation order, but the appeal was dismissed
as moot, and Tae Il failed to assert any additional appellate rights.

<h4>Committee Members Seek Dismissal of Action</h4>

The former committee members filed (or filed joinders to) several
motions to dismiss the complaint for failure to state a claim upon which
relief can be granted pursuant to Rule 12(b)(6) of the Federal Rules of
Civil Procedure. The motions to dismiss collectively made the following
arguments: (1) the doctrine of res judicata,<a href="#1" name="1a">1</a> also known as "claim
preclusion," barred the claims asserted by the disgruntled creditor; (2)
the doctrine of collateral estoppel,<a href="#2" name="2a">2</a> also known as "issue preclusion," barred
the claims asserted by the disgruntled creditor; and (3) committee
members have immunity for actions taken in their role as committee
members.

<h4>Res Judicata (Claim Preclusion)</h4>

Similar to the standards in other circuits, in the Eleventh Circuit,
where this action was commenced, a party seeking to invoke the doctrine
of res judicata must establish the following elements: (1) the
prior decision must have been rendered by a court of competent
jurisdiction, (2) there must have been a final judgment on the merits,
(3) both cases must involve the same parties or their privies and (4)
both cases must involve the same causes of action.<a href="#3" name="3a">3</a>

In this case, the first three elements were conceded. The fourth
element, whether the matters involved the same cause of action, was
disputed. Tae Il argued that its claim for alleged breach of fiduciary
duty was distinguishable from the objections it asserted to confirmation
of the plan. The former committee members argued that the creditor's
cause of action was premised upon the same legal theories Tae Il
advanced in support of its confirmation objections and arose out of the
same nucleus of operative facts.

<h4>Collateral Estoppel (Issue Preclusion)</h4>

In the Eleventh Circuit, a party seeking to invoke the doctrine of

collateral estoppel must show that (1) the issue was decided
pursuant to a final judgment; (2) the issue at stake is identical to the
one involved in the prior proceeding; (3) the issue was actually
litigated in the prior proceeding; (4) the determination of the issue in
the prior litigation must have been a critical and necessary part of the
judgment; and (5) the party against whom the doctrine is asserted must
have had a full and fair opportunity to litigate the issue in the prior
proceeding. Christo v. Padgett, 223 F.3d 1324, 1338-39 (11th Cir.
2000) (citation omitted).

In this case, the former committee members argued that Tae Il's
complaint was nothing more than a collateral attack on the long final
order confirming the plan. Tae Il argued that collateral estoppel did
not apply since the issue of whether the committee members breached
their fiduciary duty was not litigated or decided at confirmation and
was therefore not a critical or necessary part of the confirmation
order.

<h4>Qualified Immunity of Committee Members</h4>

The former committee members argued that the acts by the former
committee members of which Tae Il complained and their support of the
debtor's plan were within the scope of their duties under §1103 of
the Code. Section 1103 authorizes a committee appointed under §1102
to "participate in the formulation of a plan [and] advise those
represented by such committee of such committee's determinations as to
any plan formulated...." 11 U.S.C. §1103. Second, the former
committee members argued that the complaint did not and could not allege
that the former members' support of the plan constituted misconduct, let
alone "willful misconduct," where the plan was confirmed over numerous
objections to confirmation asserted by Tae Il and where Tae Il failed to
and could not allege that the committee members knew that confirmation
of the plan would probably result in an injury to Tae Il. To highlight
this point, the former committee members argued that since the court
determined that the plan met the best-interest-of-creditors test under
§1129(a)(7) of the Code, Tae Il could not be injured by
confirmation of the plan (or by the committee's support thereof) because
it received at least as much under the plan as it would have received in
a case under chapter 7. In addition, the former committee members argued
that Tae Il's complaint did not and could not allege that the
committee's support of the plan was an "ultra vires activity,"
since §1103 of the Code expressly authorized the committee to take
a position on a plan and to advise its constituents of its position on
such a plan.

<h4>Bankruptcy Court Dismisses Action with Prejudice</h4>

After extensive oral argument and briefing, the court granted the
motions to dismiss on the three bases asserted by the former committee
members: (1) the doctrine of res judicata, (2) the doctrine of
collateral estoppel and (3) qualified immunity.

The court found, among other things, that "[f]atal to Tae Il's claims
is the fact that the plan and those portions of i[t], which...supported
an alleged breach of [the committee's] fiduciary duty to Tae Il, were
vigorously objected to by Tae Il, litigated in front of this court and
considered in the confirmation process."<a href="#4" name="4a">4</a> The court went on to recount findings of
fact and conclusions of law made in the order confirming the plan as
well as its oral ruling on confirmation and found that "[i]n sum, the
plan was confirmed after full and fair consideration of all of Tae Il's
objections and the confirmation order is final."<a href="#5" name="5a">5</a>

The bankruptcy court also found "it to be absurd to believe that [Tae
Il] could pursue a claim against committee members for supporting a plan
that included [the elements required under the Code] and find it to be a
breach of fiduciary duty without [Tae Il] arguing for and seeking to
obtain a finding that [Tae Il] was collaterally estopped from seeking,
namely a finding that the liquidation analysis was faulty, and so it was
not in the best interest of creditors."<a href="#6" name="6a">6</a> The court went on to state, "[b]efore I
reject [Tae Il's] argument that the cause of action alleged here could
be brought because there is some distinction between wrongdoing based on
negotiation efforts as distinct from the confirmation process itself,
again, I don't believe that [Tae Il] could prove misconduct in the
negotiation which led to the support of these objectionable elements
without seeking a finding that they are collaterally estopped from
seeking with respect to the elements of the plan."<a href="#7" name="7a">7</a>

The court's final basis to dismiss the action was based on a finding
that "creditor committee members have qualified immunity for acts within
the scope of their duties. In order to overcome this immunity and hold
the committee or any of its members liable, a party must show either
willful misconduct or ultra vires activity by a committee
member...."<a href="#8" name="8a">8</a> The
court noted that "[t]he complaint on its face clearly does not allege
any willful misconduct or ultra vires acts."<a href="#9" name="9a">9</a> The court went on to adopt the
definition of willful misconduct used by the district court in the case
of Pan Am Corp. v. Delta Air Lines Inc. (In re Pan Am Corp.), 175
B.R. 438 (S.D.N.Y. 1994), finding that "[w]illful misconduct requires a
showing of either the intentional performance of an act with knowledge
that the performance of that act will probably result in injury' or 'the
intentional performance of an act in such a manner as to imply reckless
disregard of the probable consequences' (citation omitted)... Ultra
vires actions require a showing that the conduct was engaged in
without any authority whatever (citation omitted)." Pan Am, p.
175 B.R. at 514, fn. 66.

The bankruptcy court also cited Collier on Bankruptcy,
¶1103.05[4], p. 1103-32-33 (15th ed. rev. 1996), which states:

<blockquote>
Actions against committee members in their capacity as such should be
discouraged. If members of the committee can be sued by persons unhappy
with the committee's performance during the case or unhappy with the
outcome of the case, it will be extremely difficult to find members to
serve on an official committee... An active and involved committee is an
important part of a chapter 11 case, and if a committee can be
intimidated by the threat of legal action seeking personal liability of
its members, it will not be able to play its role in the case."
</blockquote>

Collier on Bankruptcy, ¶1103.05[4], p. 1103-32-33 (15th ed.
rev. 1996).<a href="#10" name="10a">10</a> Tae
Il appealed the bankruptcy court's dismissal of its action. The district
court affirmed the bankruptcy court on all three grounds, and on March
4, 2005, Tae Il further appealed to the Eleventh Circuit, where it is
currently pending.

<h4>Ramifications and Teaching Points</h4>

After prevailing in their efforts to get the Tae Il action against
them dismissed with prejudice, the former committee members filed a
consolidated application for reimbursement of the fees and costs they
incurred in the defense of Tae Il's action, and they sought such fees
and costs as administrative expenses of the chapter 11 case. The
application was premised on §§503(b)(3)(F) and (b)(4) of the
Code as well as the principle of fundamental fairness, which stems from
the U.S. Supreme Court case of Reading Co. v. Brown, 391 U.S. 471
(1968), and the line of cases following it.<a href="#11" name="11a">11</a> Future Tech Liquidating Corp. (FTLC),
the successor to the debtor under the debtor's confirmed plan, argued
that the fees and expenses were not "incurred in the performance of the
duties of the committee" as contemplated in §503(b)(3)(F) of the
Code because the fees and expenses were incurred in connection with
litigation arising from the performance of the duties of the
committee.

The bankruptcy court recognized that this case presented unusual
circumstances<a href="#12" name="12a">12</a>
and was most troubled by the fact that the committee members were sued
with respect to actions taken prior to confirmation and almost four
years after the debtor's plan was confirmed and after the committee had
been dissolved. The court was also troubled by the fact that, to the
extent that an administrative expense claim was awarded to the former
committee members, the distribution to general unsecured creditors other
than Tae Il would be diminished.

The bankruptcy court ruled, however, that the former committee
members were entitled to an award of attorneys' fees and expenses as an
administrative expense claim in the chapter 11 case pursuant to
§§503(b)(3)(F) and 503(b)(4) of the Code. More specifically,
the court, focusing on when the actions giving rise to the alleged
breach of fiduciary duty occurred, reasoned that the actions complained
of by Tae Il stemmed from the execution of the former committee members'
duties during the administrative period, and had the action been brought
prior to confirmation, the court-appointed counsel for the committee
would have defended them and would have been paid by the estate. Tae Il
argued that the former committee members were not entitled to an
administrative expense claim for the attorneys' fees and costs they
incurred in defending the Tae Il Action for two primary reasons. First,
Tae Il argued that no administrative expense claim should be awarded
because former committee members' defense of Tae Il action did not
benefit the debtor's estate. Second, Tae Il argued that the former
committee members were not entitled to an administrative expense claim
as a matter of law because the expenses they incurred and for which they
sought an administrative expense claim occurred post-confirmation. The
court rejected both of Tae Il's arguments. As to Tae Il's second
argument, the court focused on when the actions giving rise to the
claims against the former committee members were taken—in this
case, during the administrative period and prior to confirmation, not on
when the legal fees and costs were actually incurred.

The bankruptcy court rejected the argument that administrative
expenses should be awarded based on the principle of fundamental
fairness. The court found that the Reading line of cases was
inapplicable, since the cases involved transactions with, or conduct by,
a debtor-in-possession (DIP)or trustee.

In the chapter 11 case discussed herein, the court determined that
the bankruptcy estate was liable for the fees and costs incurred by the
former committee members in defense of Tae Il's lawsuit—nearly four
years after the debtor's plan was confirmed. However, the ruling left
open the determination of reasonableness of the fees and expenses
sought. In addition, the bankruptcy court found that the bankruptcy
estate may have a claim (or claims) against Tae Il for the damage caused
by it in diminishing the dividend to general unsecured creditors.

In this case, it was fortuitous for the former committee members that
the bankruptcy estate was still open and had unencumbered assets four
years after confirmation of the debtor's plan. The Future Tech
case teaches that it would be wise for committee members and their
counsel to insure that the plan and the confirmation order (1) expressly
provide for reimbursement to individual committee members that are
forced to defend themselves against lawsuits alleging breach of
fiduciary duty and the like for actions taken during the administration
of the case where there is an ultimate determination that such committee
members were not liable; (2) shorten of the statute of limitations (or
establish a bar date) for bringing actions against the committee members
and require that any such actions be brought in the bankruptcy court; as
well as (3) require that lawsuits against committee members must be
commenced prior to the making of final distributions in the case. While
the suggested plan provisions may not prevent a creditor from suing
former committee members, they could save former committee members the
expense of defending the litigation if it is brought.

<hr>
<h3>Footnotes</h3>

<a name="1">1</a> Res judicata bars
parties to a prior action from re-litigating causes of action that were
or could have been raised in prior litigation. See Allen v.
McCurry, 449 U.S. 90, 94 (1980). A bankruptcy court order confirming
a plan is res judicata as to all matters that were or could have
been raised in connection with plan confirmation. See Wallis v.
Justice Oaks II Ltd. (In re Justice Oaks II Ltd.), 898 F.2d 1544,
1550 (11th Cir. 1990) (citations omitted); see, also, CoreStates Bank
N.A. v. Huls America Inc., 176 F.3d 187, 194 (3rd Cir. 1999)
(citing Justice Oaks ("The principle of claim preclusion applies
to final orders overruling objections to a reorganization plan in
bankruptcy proceedings just as it does to any other final judgment on a
claim"); see, also, In re Szostek, 886 F.2d 1405, 1408 (3d Cir.
1989) ("[A] confirmation order is res judicata as to all issues
decided or which could have been decided at the hearing on
confirmation"); see, also, Crop-Maker Soil Servs. v. Fairmount State
Bank, 881 F.2d 436, 440 (7th Cir. 1989) ("Public policy supports

res judicata generally, but in the bankruptcy context in
particular"). <a href="#1a">Return to article</a>

<a name="2">2</a> Collateral estoppel
"prohibits relitigation of any factual or legal issue that was actually
decided in previous litigation between the parties, whether on the same
or on different claim." Richards v. Public Service Co. of N.H. (In re
Public Service Co. of N.H.), 848 F. Supp. 318, 325 (D. R.I. 1994)
(citation and quotation omitted). <a href="#2a">Return to article</a>

<a name="3">3</a> In re Piper Aircraft
Corp., 244 F.3d 1289, 1296 (11th Cir. 2001), cert. denied,

534 U.S. 827 (2000); see, also, Israel Discount Bank Ltd. v.
Entin, 951 F.2d 311, 314 (11th Cir. 1992); see, also, Justice
Oaks, 898 F.2d at 1550. The court must then determine whether the
claim in the new suit was or could have been raised in the prior action;
if the answer is "yes," res judicata applies. See Piper
Aircraft, 244 F.3d at 1296; see, also, Justice Oaks, 898 F.2d
at 1552 (bankruptcy court's order of confirmation "is an absolute bar to
the subsequent action or suit between the same parties...in respect of
every matter which was actually offered and received to sustain the
demand, but also as to every [claim] which might have been presented.")
(citation omitted). <a href="#3a">Return to article</a>

<a name="4">4</a> Transcript of oral ruling
on motions to dismiss (hereinafter "transcript"), pp. 81-82. <a href="#4a">Return to article</a>

<a name="5">5</a> Transcript, p. 89. <a href="#5a">Return to article</a>

<a name="6">6</a> Transcript, p. 98. <a href="#6a">Return to article</a>

<a name="7">7</a> Transcript, p. 99. <a href="#7a">Return to article</a>

<a name="8">8</a> The bankruptcy court
cited to Pan Am Corp. v. Delta Air Lines Inc., 175 B.R. 438, 514
(S.D.N.Y. 1994). See, also, Ludeke v. Delta Air Lines Inc., 159
B.R. 385, 392 (S.D.N.Y. 1993); Philip v. L.F. Rothschild Holdings
Inc. (In re L.F. Rothschild Holdings Inc.), 163 B.R. 45, 49
(S.D.N.Y. 1994); ABF Capital Management v. Kidder Peabody Co. Inc.
(In re Granite Partners LP), 210 B.R. 508, 516 (Bankr. S.D.N.Y.
1997); In re PWS Holding Corp., 228 F.3d 224, 246 (3rd Cir.
2000); In re Dow Corning Corp., 255 B.R. 445, 485 (E.D. Mich.
2000); In re WCI Cable Inc., 282 B.R. 457, 476-77 (Bankr. D. Ore.
2002). <a href="#8a">Return to article</a>

<a name="9">9</a> Transcript, p. 101. <a href="#9a">Return to article</a>

<a name="10">10</a> See, also, Picciotto
v. Schreiber, 260 B.R. 242, 246 (D. Mass. 2001) (noting that
"holding an unsecured creditor and member of an unsecured creditors
committee personally liable for breach of fiduciary duty to another
unsecured creditor would violate public policy, as it would discourage
creditors from serving on the committee and would interfere with the
committee's activities"). <a href="#10a">Return to article</a>

<a name="11">11</a> The Reading line
of cases have recognized the bankruptcy court's inherent power to award
administrative expenses against the bankruptcy estate based on the
principle of fundamental fairness, even where there is no actual benefit
to the estate. See, e.g., In re Healthco Int'l. Inc., 310 F.3d 9,
12 (1st Cir. 2002) (awarding litigation costs incurred by successful
defendant as administrative expense claim); Yorke v. NLRB, 709
F.2d 1138 (7th Cir. 1983) (damages from failure to bargain with union as
required by federal law awarded as administrative expense); In re
Met-L-Wood Corp., 115 B.R. 133 (Bankr. E.D. Ill. 1990)
(administrative claim awarded for attorneys' fees incurred in successful
defense of meritless litigation brought by trustee). <a href="#11a">Return to article</a>

<a name="12">12</a> The unique
circumstances presented included (1) the passage of time between
confirmation of the plan and the commencement of the lawsuit by Tae Il,
(2) request for administrative expenses in the main bankruptcy case by
former committee members stemming from an action commenced by a creditor
and (3) counsel for the creditor was simultaneously acting as chief
executive officer of Future Tech Liquidating Corp., the successor to the
debtor under the plan. <a href="#12a">Return to article</a>

Journal Authors

Grace Robson

Paul Steven Singerman

Journal Date

Friday, April 1, 2005 - 12:00

Bankruptcy Rule

2005

none