Enforcing Prebankruptcy Governance Obligations During Bankruptcy

Enforcing Prebankruptcy Governance Obligations During Bankruptcy

by Christopher W. Frost

In this Emerging Issues Analysis, Professor Christopher Frost examines two contentious corporate governance issues that arise during bankruptcy: (1) actions by the bankruptcy trustee that seek to pierce the corporate veil and allow recovery from shareholders; and (2) the authority of the court to grant derivative standing to a creditors' committee to pursue actions that the debtor in possession or the trustee is unwilling, or unable, to pursue.

Excerpt:

This Emerging Issues Analysis has been adapted from material appearing in Collier Monograph: Corporate Governance in Insolvency and Bankruptcy (May 2011).

The financial failure of a corporation often gives rise to claims that managers and others have breached duties owed to the corporation itself. Typically these claims are brought in the bankruptcy case of the failed firm and a substantial body of bankruptcy law has developed to address breach of duty claims that arose prior to bankruptcy.

Courts sometimes have difficulty translating nonbankruptcy doctrines to the bankruptcy process. Two issues have been particularly troublesome. First, actions by the bankruptcy trustee based on alter ego theory that seek to pierce the corporate veil and allow recovery from shareholders have resulted in controversy. In general, courts look to state law to determine whether such claims belong to the creditors, individually, or to the corporation itself. Where the action is owned by the corporation, the trustee may bring the action under its power to manage property of the estate.

A second area of contention concerns the authority of the court to grant derivative standing to a creditors' committee to pursue actions that the debtor in possession or the trustee is unwilling, or unable, to pursue. Despite some decisions to the contrary, where conflicts of interest or other impediments interfere with the trustee's or debtor in possession's pursuit of the action, most courts have permitted derivative standing.

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