[DO NOT PUBLISH]
IN THE UNITED STATES COURT OF APPEALS
FOR THE ELEVENTH CIRCUIT FILED
________________________ U.S. COURT OF APPEALS
ELEVENTH CIRCUIT
No. 08-14346 APRIL 30, 2010
________________________ JOHN LEY
CLERK
D. C. Docket No. 07-20793-CV-ASG
BARRY E. MUKAMAL,
as Liquidating Trustee and Director and
Officer Trustee of Far & Wide Corporation, et al.,
Plaintiff-Appellant,
versus
PHIL BAKES,
ANDREW C. MCKEY,
CRAIG TOLL,
GEORGE GREMSE,
LOAN CAPITAL FUNDING, LLC, et al.,
Defendants-Appellees.
________________________
Appeal from the United States District Court
for the Southern District of Florida
_________________________
(April 30, 2010)
Before EDMONDSON and PRYOR, Circuit Judges, and CAMP,* District Judge.
CAMP, District Judge:
This appeal is from the district court’s partial final judgment in a proceeding
arising from the bankruptcy of Far & Wide enterprises (“Far & Wide”), a
conglomerate of travel companies (collectively, the “Debtors”). The Debtors filed
for bankruptcy in the United States Bankruptcy Court for the Southern District of
Florida in Miami in September 2003. The bankruptcy court confirmed a
liquidating plan of reorganization, which appointed Appellant, Barry Mukamal,
(“Appellant” or “Trustee”) as trustee of two trusts created to pursue claims on
behalf of the Debtors and Debtors’ creditors who had voted to accept the
liquidation plan. Appellees, the defendants in the district court proceeding, are
former directors and officers of Far & Wide (the “Individual Defendants”), as well
as Far & Wide’s majority shareholder, Wellspring Capital Management, LLC
(“Wellspring”).
The Trustee brought this action against Wellspring, the Individual
Defendants, and several other entities alleging a variety of claims. The claims on
this appeal are based on allegations that Wellspring and the Individual Defendants
________________
* Honorable Jack T. Camp, United States District Judge for the Northern District of
Georgia, sitting by designation.
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breached their fiduciary duties to the Far & Wide entities. Wellspring and the
Individual Defendants moved to dismiss these claims, and the district court found
that the Trustee failed to state a claim for the alleged breaches of fiduciary duty
and granted the motion to dismiss. Upon a review of the record, the parties’
briefs, and having the benefit of oral argument, we conclude the district court did
not err and we affirm.
I. BACKGROUND
A. The Parties to this Dispute
The principal Debtor, Far & Wide, is a Delaware corporation formed in
March 1999 to purchase travel companies. The Individual Defendants were
officers and/or served on the board of directors of Far & Wide. Even though Far
& Wide was incorporated in Delaware, the majority of its operations were in
Florida.
Wellspring is a Delaware corporation that manages private investment
partnerships, such as Loan Capital Funding, LLC, which focus on investing in or
acquiring companies.1 Wellspring and the Individual Defendants formed the
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Loan Capital Funding, LLC acted as a conduit between Wellspring and the Debtors.
Although the Trustee also named Loan Capital Funding, LLC as a defendant in the underlying
litigation, the Court refers to both Wellspring individually and Wellspring and Loan Capital
Funding, LLC collectively as “Wellspring”.
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Debtor companies by consolidating various travel companies. Wellspring
invested $45 million in the Debtors and acquired a majority of their stock.
Wellspring also required the Debtors to appoint four of its partners to Far &
Wide’s six-member board of directors. With a majority of the board, Wellspring
exercised a controlling interest in the Debtors.
From the time of the company’s creation, Far & Wide planned to purchase
and consolidate a number of smaller travel companies and to sell the resulting
conglomerate to the highest bidder for a profit. Appellant alleges that Wellspring
and the Individual Defendants violated their fiduciary duty of loyalty to Far &
Wide by pursuing a plan that maximized their own self-interest but was harmful in
the long-term to Far & Wide’s creditors.
Far & Wide established lines of credit with a number of banks to raise
capital. In 1999, the Debtors entered into a loan agreement with a group of banks
to infuse $70 million into the Debtors. The Debtors provided their assets as
collateral. A year later, the Debtors obtained an additional $20 million in
unsecured financing.
B. The Decline of Far & Wide
Time and circumstance, however, intervened in Far & Wide’s plan. Fewer
travelers took overseas trips after the September 11, 2001, terrorist attacks and the
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subsequent outbreak of the SARS virus in Asia. Far & Wide faced a liquidity
crises when the companies it owned and relied upon for operating funds faltered
because of the struggling travel market. As a result, Far & Wide defaulted on the
$70 million bank loan. After defaulting, Wellspring and the Individual
Defendants represented to the banks that a single purchaser could still be found to
purchase the consolidated travel enterprises. Based on these representations, the
banks, which could have foreclosed, instead entered into a forbearance agreement.
The banks, however, required the Debtors to hire consultants to aid in the daily
operations of the Debtors’ business.
In 2002, Far & Wide hired an outside company to solicit potential
purchasers. Pursuant to its agreement with the banks, Far & Wide also hired
KPMG and The Recovery Group (“TRG”), a firm specializing in turnaround and
crisis management. KPMG was retained to review Far & Wide’s records and to
advise the directors and officers on how better to keep the company’s books and
records. Far & Wide’s management neither implemented TRG’s
recommendations, nor implemented the bookkeeping and other advice it received
from KPMG.
The Trustee alleges that Wellspring and the Individual Defendants, in their
attempt to sell the travel enterprises for a sufficient price to obtain a return on their
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investment, used false and misleading indicators of the Debtors’ financial health.
In addition, the Trustee alleges that Wellspring and Far & Wide chose not to file
for bankruptcy or wind down the Debtors at that time because it would have
caused them to lose their $45 million investment. The Trustee alleged Far & Wide
was insolvent by April 2002.
In October 2002, the Debtors began a reorganization. Part of that
reorganization included two $10 million loans. The Debtors sought and obtained
consent to the loans and the restructuring from major creditors. One of the loans
came from Wellspring, which charged an interest rate of 10% over prime and not
less than 14.75%. Additionally, Wellspring insisted that its loan be repaid before
all the claims of the Debtors’ other creditors were paid. Wellspring and the
Individual Defendants also converted a portion of Wellspring’s equity position
into a debt claim, which would have higher priority in the event of a bankruptcy.
These loans allowed the Debtors to continue operating their businesses. Even
though the conditions were arguably unfairly favorable to Wellspring, the Debtors
do not allege that Wellspring received any benefit as a result of the loan
agreement, which was never repaid. Nor was there any allegation that the loan
could have been obtained on more favorable terms. Certain of the Trustee’s
claims in the district court, however, seek to subordinate the Wellspring loan to
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other creditors’ obligations and to recharacterize Wellspring’s $12 million dollar
debt claims as equity. The district court denied the motion to dismiss these claims,
and the Trustee continues to pursue them in district court.
In July 2003, when the two $10 million loans came due, the Debtors could
not repay the loans. Despite being insolvent, the Debtors continued operating the
travel businesses, selling trips to customers, and purchasing services from vendors
until September 23, 2003. Between July 2003 and September 23, 2003, the
Debtors used customers’ deposits to pay operating costs. Some of those customers
lost their deposits and did not receive their travel arrangements because of the
bankruptcy. These customers have priority bankruptcy claims of more than $5.6
million. After bankruptcy, assets for which the Debtors had paid $150 million
were sold for a net of $14 million.
C. The Trustee’s Allegations in the Complaint and Amended Complaint
The Trustee brought a number of claims against Wellspring and the
Individual Defendants based on their having exercised control of the Far & Wide
entities. The Trustee stated the following claims in the original Complaint:
1. The individual directors and officers of Far & Wide breached their fiduciary
duties to the Debtors.
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2. These individuals also breached their fiduciary duties to the Debtors’
creditors.
3. These individuals aided and abetted each other in breaching their fiduciary
duties to the Debtors and to Debtors’ creditors.
4. Wellspring aided and abetted the Individual Defendants’ breaches of their
fiduciary duties to both the Debtors and the Debtors’ creditors.
5. The claims of the Individual Defendants against the bankruptcy estate
should be equitably subordinated in the bankruptcy to the claims of other
creditors.
6. Wellspring misstated its purported debt claims in the bankruptcy and the
debt claims should be recharacterized as equity.
7. Wellspring’s claims against the bankruptcy estate should also be equitably
subordinated to the claims of the other creditors.
8. Ernst & Young, LLP (“Ernst & Young”), who prepared audited financial
statements for the Debtors, aided and abetted the breach of fiduciary duties
by Wellspring and the Individual Defendants, breached their duty of care to
the Debtors and the Debtors’ creditors, and committed professional
malpractice.
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Subsequently, Ernst & Young and the Trustee agreed to submit the claims
against Ernst & Young to arbitration, and the district court granted Ernst &
Young’s motion to compel arbitration. After Ernst & Young was removed,
Wellspring and the Individual Defendants moved to dismiss the Complaint in its
entirety pursuant to Rule 12(b)(6) of the Federal Rules of Civil Procedure. The
district court denied Wellspring’s and the Individual Defendants’ motion to
dismiss the claims for subordination and for recharacterization of debt (numbers
five, six, and seven above), which continue before the district court. The district
court dismissed the remaining claims (numbers one, two, three, and four above).
With the Court’s permission, Appellant filed an 82 page Amended Complaint on
December 5, 2007, which included the following claims:
a. Direct claims of the Debtors against Wellspring and the Individual
Defendants for breach of fiduciary duties.
b. Derivative claims of the Debtors’ creditors alleging that Wellspring and the
Individual Defendants breached fiduciary duties to the Debtors.
c. Direct claims of the Debtors against Wellspring and the Individual
Defendants for deceptive and unfair trade practices.
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d. Direct Claims by the Debtors against Wellspring and the Individual
Defendants for aiding and abetting each other’s breach of their fiduciary
duties.
e. Derivative Claims by the Debtors’ creditors against Wellspring and the
Individual Defendants for aiding and abetting each other’s breach of their
fiduciary duties.
Wellspring and the Individual Defendants moved to dismiss the Amended
Complaint. The district court granted the motion, dismissed the Amended
Complaint, and entered partial final judgment pursuant to Rule 54(b) of the
Federal Rules of Civil Procedure so that the Trustee could appeal the dismissal of
the breach of fiduciary duty claims while the claims for subordination and for
recharacterization of debt proceeded in the district court.
D. The Issues on Appeal
Appellant appeals the district court’s dismissal of the Debtors’ direct claims
for breach of fiduciary duty by Appellees, the dismissal of the Debtors’ creditors’
direct claims against Appellees for breach of fiduciary duty owed to them, and the
dismissal of the creditors’ derivative claims against Appellees. Appellant also
appeals the dismissal of the related aiding and abetting claims. Finally, Appellant
appeals the district court’s decision to apply Delaware rather than Florida law to
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the fiduciary duty claims. Appellant does not appeal the dismissal of the deceptive
trade practices claims (claim c. above) or the dismissal of the claims against Ernst
& Young (claim 8. above), which were compelled to arbitration. The equitable
subordination claims, the claim for recharacterization of Wellspring’s (claims 5.,
6., and 7. above) debt as equity, and a claim against Wellspring for disallowance
of a claim in bankruptcy continue in the district court.
II. JURISDICTION
The district court had jurisdiction over this case pursuant to 28 U.S.C. §
1334, which provides that district courts have original jurisdiction over civil
proceedings related to bankruptcy cases brought under Title 11. This Court has
jurisdiction over an appeal from the final judgment of the district court pursuant to
12 U.S.C. § 1291. See also Thigpen v. Smith, 792 F.2d 1507, 1516 n.15 (11th Cir.
1986) (federal appellate courts have jurisdiction to review partial final judgments
entered pursuant to Fed. R. Civ. P. 54(b)).
III. STANDARD OF REVIEW
This Court reviews the district court’s dismissal for failure to state a claim
de novo, accepting the allegations in the Complaint and Amended Complaint as
true and construing those facts in the light most favorable to the Trustee. Mills v.
Foremost Ins. Co., 511 F.3d 1300, 1303 (11th Cir. 2008). The Court reviews a
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district court’s order dismissing claims for lack of standing de novo. Miccosukee
Tribe of Indians v. Florida State Athletic Com’n, 226 F.3d 1226, 1228 (11th Cir.
2000). Finally, the district court’s decision to apply Delaware substantive law to
the Trustee’s claims is a legal question, which the Court also reviews de novo.
Grupo Televisa, S.A. v. Telemundo Comm. Group, Inc., 485 F.3d 1233, 1239
(11th Cir. 2007).
To survive a motion to dismiss, a complaint need not contain “detailed
factual allegations,” but it must contain sufficient factual allegations to suggest the
required elements of a cause of action. Bell Atlantic Corp. v. Twombly, 550 U.S.
544, 127 S. Ct. 1955, 1964-65 (2007); Watts v. Fla. Int’l Univ., 495 F.3d 1289,
1295-96 (11th Cir. 2007). “[A] formulaic recitation of the elements of a cause of
action will not do.” Twombly, 550 U.S. at 555-56. Nor will mere labels and legal
conclusions withstand a 12(b)(6) motion to dismiss. Id. This is a stricter standard
than the Supreme Court described in Conley v. Gibson, 355 U.S. 41, 45-46, 79 S.
Ct. 99, 102 (1957), which held that a complaint should not be dismissed for failure
to state a claim “unless it appears beyond doubt that the plaintiff can prove no set
of facts in support of his claim which would entitle him to relief.” Twombly, 550
U.S. at 577. Under the standard articulated by the Supreme Court in Twombly, the
12
complaint cannot suggest the existence of a claim; the complaint must contain
“enough facts to state a claim to relief that is plausible on its face.” Id. at 570.
IV. DISCUSSION
A. Choice of Applicable Law
The Trustee brought this case in Florida, alleging that the Individual
Defendants and Wellspring breached fiduciary duties owed to Far & Wide and its
creditors. Although the acts forming the basis of the Trustee’s claims occurred
largely in Florida, both Far & Wide and Wellspring were incorporated in
Delaware. The district court held that Delaware law, not Florida law, applied to
the substantive claims asserted by the Trustee. On Appeal, Appellant contends
that the district court erred by applying Delaware law.
The district court had jurisdiction of this matter pursuant to 28 U.S.C. §
1334. Federal courts sitting in diversity apply the forum state’s choice of law
rules. United States Fid. & Guar. Co. v. Liberty Surplus Ins. Corp., 550 F.3d
1031, 1033 (11th Cir. 2008); Grupo Televisa, 485 F.3d at 1240. Federal courts
have adopted this principle in cases arising under 28 U.S.C. § 1334, when the
underlying rights and obligations of the parties are defined by state law. See
Official Comm. of Unsecured Creditors v. Donaldson, Lufkin & Jenrette Sec.
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Corp., No. 00-8688, 2002 WL 362794, *5 (S.D.N.Y. Mar. 6, 2002). The Trustee
filed this action in Florida; therefore, Florida’s choice of law rules apply.
The fiduciary duties owed to a corporation by its officers and directors
concern the internal affairs of a corporation. See Edgar v. Mite Corp., 457 U.S.
624, 645, 102 S. Ct. 2629, 2642 (1982) (“matters peculiar to the relationships
among or between the corporation and its current officers, directors, and
shareholders” are a corporation’s internal affairs); see also Nagy v. Riblet Prods.
Corp., 79 F.3d 572, 576 (7th Cir. 1996) (applying the internal affairs doctrine to
claims of breach of fiduciary duty by a controlling shareholder). The Florida
Business Corporation Act provides that the internal affairs of a corporation are
governed by the laws of the state of incorporation. Fla. Stat. § 607.1505(3);
Chatlos Found., Inc. v. D’Arata, 882 So. 2d 1021, 1023 (Fla. 5th DCA 2004)
(applying the internal affairs doctrine as codified by the Florida Not for Profit
Corporation Act, which is identical to Fla. Stat. § 607.1505(3)).
[The Florida Business Corporation Act] does not authorize this state
to regulate the organization or internal affairs of a foreign corporation
authorized to transact business in this state.
Fla. Stat. § 607.1505(3). The Restatement (Second) of Conflict of Laws also
provides that the internal affairs of corporations are governed by the laws of the
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state of incorporation. See Restatement (Second) of Conflict of Laws §§ 302-9
(1971).
As claims concerning the internal affairs of Far & Wide, the fiduciary duty
claims asserted by the Trustee are governed by the law of Delaware, the state of
incorporation. Fla. Stat. § 607.1505(3); Chatlos, 882 So. 2d at 1023. An
exception to the internal affairs doctrine exists in the “unusual case” where the
forum state has a more significant relationship to the parties and the occurrence.
Restatement (Second) of Conflict of Laws §§ 302, 306, 309. The Trustee
contends that Florida has a more significant relationship to this dispute, and, thus,
the internal affairs doctrine should not apply to this case. As the district court
noted, however, the Trustee has not shown that Florida has the type of overriding
interest in applying its laws to this dispute so as to rebut the presumption that the
laws of the state of incorporation apply to claims for breach of fiduciary duty by
officers, directors, and a majority shareholder. See Restatement (Second) of
Conflict of Laws § 6 (1971) (setting forth factors to consider for determining
whether a forum other than the state of incorporation has a more significant
relationship to the parties or occurrence). Accordingly, the district court was
correct to apply Delaware law to the substantive claims in this dispute.
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B. Appellant’s Attempt to Bring Creditors’ Claims Directly Against Wellspring
and the Individual Defendants
In the original Complaint, the Trustee sought to bring claims against the
Individual Defendants and Wellspring for breaching a fiduciary duty owed directly
to the creditors after the Debtors became insolvent. See supra Part I.C.claims 2-4.
In the Amended Complaint, the Trustee attempted to bring derivative claims on
behalf of the creditors based on the Individual Defendants’ and Wellspring’s
breaches of fiduciary duties owed to the Debtors. See supra Part I.C. claims b,d.
The district court dismissed the direct creditor claims in the original Complaint,
holding Delaware law did not recognize direct creditor claims under North
American Catholic Educational Programming Foundation, Inc. v. Gheewalla, et
al., 930 A.2d 92, 101 (Del. 2007). The district court alternatively held that the
Trustee did not have standing to bring direct creditors’ claims on behalf of less
than all creditors under Caplin v. Marine Midland Grace Trust Co., 406 U.S. 416,
92 S. Ct. 1678 (1972), and E.F. Hutton & Co. v. Hadley, 901 F.2d 979, 986 (11th
Cir. 1990). The district court dismissed the derivative claims as duplicative and a
waste of judicial resources. We find that the district court was correct for the
following reasons.
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1. Delaware Law Does Not Recognize Direct Claims for Breach of Fiduciary
Duty by the Debtors’ Creditors.
The original Complaint asserted three direct claims on behalf of the
Debtors’ creditors against Wellspring and the Individual Defendants for breach of
fiduciary duty. The Trustee argued that both the Individual Defendants and
Wellspring owed fiduciary duties directly to the Debtors’ creditors once Far &
Wide became insolvent. The district court dismissed the creditors’ direct claims
for breach of fiduciary duty under Delaware law. Appellant appeals the dismissal
as error.
Delaware law recognizes that officers and directors are given wide latitude
to run a corporation as they see fit for the benefit of shareholders. Michelson v.
Duncan, 407 A.2d 211, 217 (Del. 1979). Appellant argues, therefore, that the
directors’ and officers’ duties change once a corporation becomes insolvent
because Delaware courts have long recognized that, when a corporation becomes
insolvent, its property must be administered as a trust fund for the benefit of
creditors. See Credit Lyonnais Bank Nederland, N.V. v. Pathe Communications
Corp., 1991 WL 277613, at *1155 n.55 (Del. Ch. 1991) (describing the “curious”
17
incentives and divergence of interests creditors and directors face during
insolvency); Bovay v. H.M. Byllesby & Co. 38 A.2d 808, 813 (Del.1944).
Appellant contends that, upon insolvency, the officers and directors owe a
fiduciary duty directly to creditors, which requires them to maximize the
company’s value for the creditors, as the corporation’s residual value holders.
See, e.g., Geyer v. Ingersoll Publications Co., 621 A.2d 784, 787-88 (Del. Ch.
1992) (suggesting that a fiduciary duty to creditors arises at insolvency); see
generally Richard M. Cieri & Michael J. Riela, Protecting Directors and Officers
of Corporations That Are Insolvent: Important Considerations, Practical
Solutions, 2 DePaul Bus. & Comm. L.J. 295, 301-02 (2004) (drawing the
inference from prior Delaware authority that insolvency alters the nature of
fiduciaries’ duties); Laura Lin, Shift of Fiduciary Duty Upon Corporate
Insolvency: Proper Scope of Directors’ Duty to Creditors, 46 Vand. L. Rev. 1485,
1512 (1993) (same).
The Delaware Supreme Court provided clear guidance on this issue in
Gheewalla, 930 A.2d at 101. In Gheewalla, a creditor of a Delaware corporation
brought direct claims for breach of fiduciary duty against three of the
corporation’s directors. Id. at 94. The complaint alleged that three directors used
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their control of the corporation to favor Goldman Sachs in violation of their
fiduciary duties to the corporation. Id. The directors moved to dismiss the
complaint for failure to state a claim. Id.
The Delaware Supreme Court held that creditors of an insolvent company
do not have a direct claim against directors or managers for breach of fiduciary
duty. Id. The Court explained that under Delaware law, “[d]irectors owe their
fiduciary obligations to the corporation and its shareholders.” Id. at 99. Because
directors and officers do not owe a fiduciary duty to creditors, even after
insolvency, the district court correctly dismissed the Debtors’ creditors’ direct
claims for breach of fiduciary duty.
C. The Creditors’ Derivative Claims Are Mirror Images of the Debtors’ Claims
and Cannot be Brought in the Same Action.
In the Amended Complaint, the Trustee also brought derivative claims by
the Debtors’ creditors. These claims attempt to assert derivatively the identical
direct claims of the Debtors for breaches of fiduciary duty and depend on the
same factual allegations. The district court referred to them as “mirror images” of
the Debtors’ claims and, in a well-reasoned analysis, dismissed these derivative
claims as duplicative of the Debtors’ direct claims.
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A plaintiff may only recover from a defendant once for a single claim. See
St. Luke’s Cataract & Laser Inst., P.A. v. Sanderson, 573 F.3d 1186, 1203 (11th
Cir. 2009). If the Debtors succeed on the direct claims against the Individual
Defendants then the creditors’ derivative claims must fail because the Individual
Defendants cannot be liable twice for the same claim. See Gen. Tel. Co. v.
EEOC, 446 U.S. 318, 333, 100 S. Ct. 1698, 1708 (1980) (“courts can and should
preclude double recovery by an individual”); White v. United States, 507 F.2d
1101, 1103 (5th Cir. 1975) (“no duplicating recovery of damages for the same
injury may be had”).2 If, however, the Debtors’ direct claims fail to state a claim
then the creditors’ derivative claims must also fail because the claims are based
on the same factual allegations. Accordingly, this Court affirms the district
court’s dismissal of Counts III, IV, V, VI, and VII of the Amended Complaint.
D. Appellant’s Complaint and Amended Complaint Failed to State a Claim for
Breach of Fiduciary Duty by Defendants.
The Trustee does have standing to bring direct claims for breach of
fiduciary duty on behalf of the Debtors. The Amended Complaint alleges that
Wellspring and the Individual Defendants breached both the fiduciary duty of
2
Fifth Circuit decisions rendered on or before September 30, 1981, are binding precedent
on this court. See Bonner v. City of Prichard, 661 F.2d 1206, 1209 (11th Cir. 1981) (en banc).
20
loyalty and the fiduciary duty of care owed to the Debtors. The claims are based
on allegations that the Individual Defendants and Wellspring operated Far &
Wide with the goal of continuing its operations until it could be sold for a profit
and refused to take other measures that may have better preserved its value for the
creditors. The Trustee specifically focuses on the secured loan transaction
between the Debtors and Wellspring in October 2002 as a primary example of
this breach of duty.
The Trustee contends that Wellspring was preferred over other
shareholders, and that the Individual Defendants, as interested inside directors,
are not entitled to the protection of the business judgment rule. The Trustee
contends that because the Individual Defendants are not protected by the business
judgment rule, the burden shifts to the Individual Defendants and Wellspring to
demonstrate that the loan was “entirely fair.” For the following reasons, this
Court finds that the district court did not err in dismissing the breach of fiduciary
duty claims asserted against the Individual Defendants and Wellspring since the
Complaint failed to state sufficient facts “to state a claim to relief that is plausible
on its face.” Twombly, 550 U.S. at 570.
1. The Duty of Loyalty
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Under Delaware law, “[t]he essence of the duty of loyalty is that ‘corporate
officers and directors are not permitted to use their position of trust and
confidence to further their private interests.’” 1-4 Corporate Governance: Law
and Practice § 4.03 (quoting Guth v. Loft, 5 A.2d 503, 510 (Del. 1939)). The
duty of loyalty requires a fiduciary to act in the best interests of the corporation.
Cede & Co. v. Technicolor, Inc., 634 A.2d 345, 361 (Del. 1993) (“the duty of
loyalty mandates that the best interest of the corporation and its shareholders take
precedence over any interest possessed by a . . . controlling shareholder and not
shared by the stockholders generally.”) A claim for breach of the duty of loyalty
under Delaware law exists where (1) the company is harmed or (2) a fiduciary
personally profits from a corporate opportunity. See Oberly v. Kirby, 592 A.2d
445, 463 (Del. 1991) (holding a breach of the fiduciary duty of loyalty can exist
where either the beneficiary is harmed or the fiduciary uses knowledge gained
from his position to advance his independent interests).
The Amended Complaint alleges that the Individual Defendants and
Wellspring breached the duty of loyalty by favoring the interests of Wellspring
over those of the Debtor. In short, the Amended Complaint alleges that the
Individual Defendants managed Far & Wide for the benefit of a majority
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shareholder and that Far & Wide obtained a loan from Wellspring in October
2002, which allowed the company to continue to run its troubled businesses
rather than preserving its value for the creditors.
As a threshold matter, the conclusory allegations concerning breach of the
duty of loyalty in both complaints are not supported by the necessary factual
allegations “to state a claim to relief that is plausible on its face.” Twombly, 550
U.S. at 570. Moreover, the Trustee alleges injury only to the Debtors’ creditors.
For example, the Amended Complaint alleges that the decision to accept the loan
from Wellspring in 2002 and continue operating the business “resulted in the
diminution in value of Far & Wide’s assets to a point where Far & Wide did not
have any ability to pay its liabilities to its creditors when bankruptcy protection
was finally sought....”
In order to state a claim for breach of the duty of loyalty, the Trustee must
allege facts that indicate either Far & Wide or its minority shareholders, not Far &
Wide’s creditors, were injured by the action of the Individual Defendants. See
Cede & Co., 634 A.2d at 361 (stating that a breach of the duty of loyalty can exist
where a fiduciary pursues his own interest over that of the shareholders). Neither
the Complaint nor the Amended Complaint contain sufficient factual allegations
to support such a claim. The Trustee does not allege facts demonstrating that the
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majority shareholders were preferred in any way over the minority shareholders.
No allegations indicate that the loan could have been obtained on more favorable
terms, that the Individual Defendants personally benefitted, or that Wellspring
benefitted at all since the loan was never repaid.
The only injury alleged in the Amended Complaint was to the Debtors’
creditors as a result of Far & Wide staying in business longer and deepening its
insolvency, when it would have been in the best interest of the creditors for Far &
Wide to cease business and liquidate. Delaware law, however, does not
recognize a cause of action for “deepening insolvency.” Trenwick Am. Litig.
Trust v. Ernst & Young, LLP, 906 A.2d 168, 174, 204 (Del. Ch. 2006).
Even when a firm is insolvent, its directors may, in the appropriate
exercise of their business judgment, take action that might, if it does
not pan out, result in the firm being painted in a deeper hue of red.
The fact that the residual claimants of the firm at that time are
creditors does not mean that the directors cannot choose to continue
the firm's operations in the hope that they can expand the inadequate
pie such that the firm's creditors get a greater recovery.
Id. at 174.
The Trustee alleges that the actions taken by the board of directors were
done so that the company could continue operating in an attempt to facilitate a
sale of the corporation to a third party. The sale, however, would have
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maximized the value to all shareholders. Recent Delaware cases hold that
officers and directors do not breach the duty of loyalty by exercising their
business judgment and continuing to operate an insolvent corporation rather than
entering bankruptcy and preserving assets to pay creditors. Trenwick, 906 A.2d
at 174; Gheewalla, 930 A.2d at 99 (explaining that the general rule is that
directors of a corporation do not owe creditors duties beyond the relevant
contractual terms).
In fact, Gheewalla presents an analogous factual situation. In Gheewalla, a
creditor of Clearwire Holdings, Inc. (“Clearwire”) sued several directors of
Clearwire for breach of fiduciary duty. Gheewalla, 930 A.2d at 94. The creditors
alleged that the directors breached their fiduciary duties once Clearwire became
insolvent and effectively went out of business because the directors allowed the
corporation to continue holding certain licenses. Id. at 97-99. Holding onto these
licenses required large expenditures of cash each month, which otherwise would
have been available for creditors had the corporation liquidated. Id. at 97-99 The
Delaware Supreme Court stated:
It is well established that the directors owe their fiduciary obligations
to the corporation and its shareholders. While shareholders rely on
directors acting as fiduciaries to protect their interests, creditors are
afforded protection through contractual agreements, fraud and
fraudulent conveyance law, implied covenants of good faith and fair
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dealing, bankruptcy law, general commercial law and other sources of
creditor rights.
Id. at 99. All these remedies are available to the creditors in the present situation,
and they continue to pursue some in the district court. If they were wronged, they
have ample recourse, but the remedies do not include bringing a claim for breach
of fiduciary duty where the only alleged injury is a deepening insolvency which
harmed only creditors.
Since Delaware law does not recognize a duty to liquidate, and the
Amended Complaint fails to allege sufficient facts to demonstrate the necessary
elements of a claim for breach of the duty of loyalty to the Debtors, the district
court did not err in dismissing Appellant’s claim for breach of the fiduciary duty
of loyalty.
2. The Duty of Care
“The fiduciary duty of care requires that directors of a Delaware
corporation use that amount of care which ordinarily careful and prudent men
would use in similar circumstances, and consider all material information
reasonably available in making business decisions.” In re Walt Disney Co., 907
A.2d 693, 749 (Del. Ch. 2005) (internal quotation and citation omitted). A
deficiency in the process employed by the directors is only actionable as a breach
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of the duty of care if the director’s actions are “grossly negligent.” Id. Gross
negligence includes a director’s failure to inform him or herself of available
material facts when making a decision on behalf of the corporation. See In re
Walt Disney Co., 906 A.2d 27, 64-64 (Del. Super. Ct. 2006); Smith v. Van
Gorkhom, 488 A.2d 858, 874 (Del. 1985) (holding that board members who
voted to approve a merger without reviewing any documentation regarding the
adequacy of the proposed purchase price violated the duty of care), overruled on
other grounds by Gantler v. Stephens, 965 A.2d 695, 713 n.45 (Del. 2009); Cede
& Co. v. Technicolor, 634 A.2d 345, 367-68 (Del. 1993) (holding that the duty of
care requires directors to act on an informed basis). Simply put, the standard is
procedural, rather than substantive. In fact, Delaware law allows a company’s
board to even make an “irrational” decision, so long as the decision-making
process employed by the board “was either rational or employed in a good faith
effort to advance corporate interests.” In re Caremark Int’l Derivative Litig., 698
A.2d 959, 967 (Del. Ch. 1996) (emphasis in original). Thus, directors who make
a decision after employing a rational decision-making process and considering the
pertinent information will not be liable for a breach of the fiduciary duty of care.
In re Caremark, 698 A.3d at 967; Cede & Co., 634 A.2d at 367-68. Moreover,
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even upon insolvency, the duty of care to the corporation remains the same.
Gheewalla, 930 A.2d at 101.
The Amended Complaint fails to allege that the Individual Defendants did
not employ a rational decision-making process or did not consider material
information when making the decision to obtain additional loans and continue
operating Far & Wide rather than proceed into bankruptcy. The Amended
Complaint alleges only that the Individual Defendants “refused or failed to follow
[the] advice” of the two independent consultants hired by Far & Wide’s
management. To state a claim for breach of the duty of care under Delaware law,
a plaintiff must allege more than that the directors and officers of a corporation
received information from outside consultants, but decided not follow this advice.
Cede & Co., 634 A.2d at 367-68. Here, the Individual Defendants discharged
their obligations under the duty of care by hiring consultants and by considering
the consultants’ advice, even if they did not follow the advice. Id. Accordingly,
the district court properly dismissed Counts VI and XI of the Amended
Complaint.
E. The Amended Complaint Failed To State A Claim for Aiding and Abetting a
Breach of Fiduciary Duty.
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In order to state a claim for aiding and abetting a breach of fiduciary duty
under Delaware law, a plaintiff must allege: (1) the existence of a fiduciary
relationship, (2) that the fiduciary breached its duty, (3) that a defendant, who is
not a fiduciary, knowingly participated in the breach, and (4) that damages to the
plaintiff resulted from the concerted action of the fiduciary and the non-fiduciary.
Gotham Partners L.P. v. Hallwood Realty Partners, et al., 817 A.2d 160, 172 (Del.
2002) (quoting Wallace v. Wood, 752 A.2d 1175, 1180 (Del. Ch. 1999)). The
Amended Complaint alleges that the Individual Defendants and the Wellspring
Defendants aided and abetted each others’ breaches of fiduciary duties.
The underlying breaches of fiduciary duty that form the basis for the
Debtors’ claims for aiding and abetting are the same breaches of fiduciary duty
that the Court finds fail as a matter of law. See supra Part IV.D.1-2. Because the
underlying breach of fiduciary duty claims fail, the claims that Wellspring and the
Individual Defendants aided and abetted those breaches must follow suit. See
Gotham Partners, 817 A.2d at 172 (a claim for aiding and abetting a breach of
fiduciary duty requires that the fiduciary breach its duty). The district court
correctly dismissed the aiding and abetting claims, and this Court affirms the
district court’s dismissal of Counts IV, VII, IX, and XII.
V. CONCLUSION
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For the foregoing reasons, this Court AFFIRMS the judgment of the
district court.
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