Recovering for the wrongful death of a company: a dialogue on the rights and remedies available to individual and business victims of a corporate collapse.

Not long ago, three former clients came in to see Larry Lawyer, a sole practitioner in a small town. Although he'd successfully represented each before, he was surprised to see them again--and together. What could a banker, a garage owner, and a retired schoolteacher have in common?

The banker spoke first.

"We want you to sue the people who ran Grain Belt Computers into the ground. Just last month they borrowed $2 million from my bank, and now I see on the news that they've filed for bankruptcy under Chapter 11. My loan officer says they probably inflated the accounts receivable securing our loan. And they probably lied to us about the rest of their collateral, too."

The garage owner told a similar tale.

"GBC's into me for over $20,000 for fixing their tractor-trailer--the one they were supposedly using to deliver computers around the country. Turns out they didn't have any customers, so they sold the truck and stiffed me on the bill."

The teacher was the angriest of the three.

"I found out about all this only yesterday, when the three of us ran into each other at the grocery store. I've got half my life savings tied up in GBC stock. I bought into the initial public offering three years ago, and I've kept on buying shares since then. The general counsel goes to my church. When the stock first went on sale, he told me it couldn't miss. Said they were like a combination of Microsoft and Dell."

"OK," Larry said, "I think I get the picture. Now what can I do to help?"

"Well," the teacher said, "what do we have to do to get our money back? Or at least some of it? Isn't the law supposed to protect us?"

Although bankruptcy litigation was not Larry's specialty, he promised to help his former clients find basic answers to their questions and, if necessary, help them find counsel. A week later, he still hadn't found either, but he did learn that Tom Trustee had been named to oversee GBC's bankruptcy estate. (1) The same day, Larry went to an ATLA Education program at the local law school, where Paula Professor was speaking on corporate law for litigators.

After Paula's talk, Larry described his clients' various situations to her, and she suggested they go to her office for further discussion. "I can't begin to cover everything," she said, "but maybe I can give you some nutshell answers."

Weighing competing interests

Once in her office, Larry asked, "Can my guys recover their losses from anyone now that the company is in bankruptcy? Whom can they sue?"

"The first thing you have to understand," replied Paula, "is that none of them can directly sue the company--which is now called 'the debtor.' Under the Bankruptcy Code, almost all actions that were or could have been commenced against the debtor before the bankruptcy filing are automatically stayed. (2)

"As a practical matter," she continued, "your clients have no choice but to file proofs of claim against GBC in the bankruptcy proceeding. They may have some other options too, but no matter what, that's a step they have to take."

"What does that get them?" Larry asked skeptically. From what little he knew about bankruptcy, most people never collected much.

"Well," Paula said, "it depends on the nature of each claim and the amount of assets available to pay all the claims. If GBC is bankrupt, there won't be enough money to go around. In fact, after the costs of administering the debtor's estate have been paid, there often isn't anything left to distribute to creditors. And if there is, it's usually only pennies on the dollar." (3)

"That's what I was afraid of. So is the money just distributed based on the size of the individual claims?"

"Oh, no. Some claims have a higher rank in the Bankruptcy Code's priority-of-payment scheme and will be paid before others. Secured creditors' claims outrank those of unsecured creditors, and the claims of all types of creditors outrank the claims of shareholders. Some claims may even be put below the shareholder claims. 'Subordinated' is the bankruptcy word for that.

"All of which means your clients have very different and competing interests in the bankruptcy. The bank's secured claims outrank the claims of the garage owner. The garage owner's claims outrank those of the teacher/shareholder. Unless there are voluntary or court-ordered changes in the priority scheme, it's entirely possible the bank may be fully paid by the bankruptcy estate, while the garage owner and the teacher get nothing at all."

"Does that mean that I can't represent these guys?" asked Larry.

"You most likely can't represent them all," Paula replied. "Often, classes of claimants will fight each other over relative rank in the priority scheme, and that can create some pretty serious conflicts. You'd probably find yourself representing clients with very different interests."

"Sounds bad. But what else can I do? I mean, besides getting those conflict issues resolved (4) and getting proofs of claims filed with the bankruptcy court, are there any other steps my clients should consider?"

Creative thinking

Paula leaned forward and pointed her finger at him.

"Larry, you have to start thinking outside the bankruptcy box. If you do, you'll see that your clients may be able to sue nondebtors responsible for GBC's problems--people who caused your clients' losses in some other way."

This was good news that Larry hadn't expected, and he began speculating about all the potential defendants: people who cheated the company, employees who didn't work hard enough. The possibilities were numerous.

"Not so fast," Paula warned. "It's not that easy. You have to be careful for at least three reasons."

"First and foremost," she said, "you need to recognize that not all business collapses and bankruptcies are caused by someone's bad behavior. Sometimes, a business will fail just because of economic forces beyond its control--forces no manager could master. But based on what you've told me, I don't think that's the case here."

"Lying to the bank couldn't be right," Larry said. "And surely it was wrong not to pay for the truck and to misrepresent the financial condition of the company and the value of the stock. There must be some strong claims here."

"Some of them may be. But you also have to understand that any litigation by creditors or shareholders against third-party nondebtors will almost always be long and expensive. That's true of shareholder and creditor class actions. It's also true if the third-party litigation is brought by individual plaintiffs like one of your clients or by a bankruptcy trustee.

"Finally," she said, "you have to keep in mind that there will often be competing claimants for any culpable third party's resources, just as there's competition for the remaining assets of the debtor. When a publicly traded company like GBC goes down suddenly, the third parties associated with the collapse are likely to attract not only the attention of individual shareholders and creditors, but also the attention of larger investors and secured creditors, bankruptcy officials like Tom Trustee, and federal and state regulatory agencies like the Securities and Exchange Commission and state attorney general offices. Sometimes there's criminal prosecution, too."

Larry pulled a pad of paper out of his briefcase and started to take notes. "Who do you think would be the parties most likely to be held liable?" he asked.

"As always, it depends on the facts. But think back to the potential defendants your clients could have properly sued before bankruptcy. Sounds like someone, maybe a GBC officer, made false statements or gave false financial statements to the banker. If so, the bank could probably make a claim directly against that person.

"The bank could probably also make a claim against those who helped the GBC person commit the fraud. If accountants helped cook the books, or knew of problems and still blessed the debtor's financial statements, there may be bank claims against them as well--maybe even if they negligently missed an obvious problem. The same may be true for GBC's lawyers, financial advisers, consultants, or even its other lenders if they assisted GBC in misrepresenting the financial condition of the company to the bank, to GBC's creditors or stockholders (individually or as a group), or to the marketplace generally."

"Sounds like we have a lot of potential defendants," said Larry. "Are my clients' claims equal now that they're not going against the debtor?"

"In theory, yes," said Paula. "Whether the third-party claims are the same or different, there will be no priority scheme that ranks the bank's, garage owner's, and teacher's claims as a matter of law. The practical realities are somewhat different, though. Each of your clients will have to realistically assess the costs and benefits of bringing lengthy and complex litigation against defendants like the potentially culpable officers and directors of GBC.

"What's more," she added, "your clients can't pursue that kind of litigation without understanding the role of Tom Trustee and how his actions or decision not to act might affect their litigation decisions."

By now, Larry's initial burst of enthusiasm had dimmed.

"I don't get it," he said. "How does the trustee affect us if we're not asking for money from the estate?"

Paula shook her head in dismay. "Do you know anything about how bankruptcy trustees operate?"

"Not really," Larry admitted. "But what I want to know is simple: Is he going to help my guys or not?"

"Maybe."

The trustee's actions as a factor to be weighed

Paula explained how Tom Trustee could bring an action against anyone who injured the debtor.

"And that could include the same directors and officers, the same accountants, the same lawyers, and the same financial advisers that creditors or shareholders might sue," she said. "Both the trustee and your clients share a common goal of finding culpable third parties, but he or she is also competing with you to collect from them."

"Does that mean any claim my clients might bring would also be a claim the trustee could bring? Would we be competing with the trustee no matter what we do?"

"Not necessarily. The trustee can assert only the claims of the debtor, including claims asserting a generalized injury to the debtor that ultimately affects all creditors. (5) A trustee can't assert claims that affect particular creditors individually. (6) So he or she couldn't, for example, claim the damages fraudulently suffered by the bank in lending money to the corporation. But a trustee like Tom might be able to bring a parallel claim for the damage that the corporation suffered by taking on too much debt. The measure there would be the resulting reduction in the value of the company."

"I don't get it," said Larry. "Where would a claim like that come from? The company received the money it borrowed, so where's the harm?"

"Well, by improperly taking on too much debt at a critical time, the company may sink deeper into insolvency, expose itself to creditor liability, and eventually be forced into bankruptcy. That debt also may create operational limitations for the company, undermining its relationships with customers, suppliers, and employees." (7)

"Interesting. So when will Tom Trustee bring these claims?"

"It depends. The Bankruptcy Code extends any statute of limitations on a trustee's claims for at least two years after the bankruptcy filing. (8) During much of that two-year period, the trustee will probably focus on simply rounding up the debtor's assets and deciding whether to confirm a plan of reorganization. As a result, he or she usually waits to assert litigation claims until later in the case. Or the trustee may never assert those claims, especially if the estate doesn't have the assets to fund the litigation, which can be very expensive."

Choosing realistic options

"OK," Larry said, "I think I'm starting to get the big picture. But where does all this lead?"

"Different places for each of your clients," said Paula. "Let's consider the banker's situation first."

The banker's options. "The banker has several options," she said. "First, he could move to lift the automatic stay and foreclose on the bank's collateral, especially if that collateral is rapidly depreciating or isn't necessary for the debtor's reorganization. (9) That move, however, probably won't fully pay off the bank debt and might even trigger claims against the bank by Tom Trustee."

"Claims against the bank," Larry repeated. "What kind of claims could those possibly be?"

"Keep in mind that the trustee's primary duty is to maximize the recovery for unsecured creditors, sometimes at the expense of secured creditors like the bank. So, if the bank moves to foreclose on its collateral, Tom Trustee might challenge its liens on the collateral."

"Sounds like foreclosure could be a risky move for the bank," said Larry. "What are its other options?"

"Given the large amount of its loan, the bank, perhaps more than your other clients, may be economically justified in bringing its own separate lawsuit against third parties. It just has more at stake here. So it should probably devote some resources to investigating those claims right away. On the basis of that investigation, the bank may decide to file suit and get a jump on the trustee in collecting from the third parties."

Larry frowned. His banker client was very risk-averse, he noted.

"Here's another approach it could take," Paula said. "The bank could cut its losses and assign its claims to Tom Trustee, so that he could recover for the benefit of all creditors of the estate, including the bank. In exchange, it could negotiate a court-approved settlement resolving any questions about the nature and extent of the bank's claims against the estate." (10)

"But the trustee already has similar claims to assert. Why would he want the bank claims, too?"

"Because the bank claims may be immune from certain defenses that defendants might raise to the trustee's claims. Some defendants, for example, argue that the trustee is imputed with the bad acts of the debtor's management and, therefore, cannot recover for those acts.

"Dubious as it might be, that defense would not apply to the bank's assigned claims, even if it were the trustee who was asserting them. (11) Obviously, the bank's claims are substantial in size, and the assignment of such claims would give the trustee heavy-duty weaponry that he wouldn't otherwise have."

The garage owner's options. "What about the garage owner?" Larry asked. "He's a creditor too. Can't he just bring his own action like the bank or assign his cause of action to the trustee?"

"Maybe, but it's unlikely," replied Paula. "His fundamental problem is that the prospective cost of any litigation he might bring individually would far outweigh even his maximum possible return. So unless you know some way in which he can individually finance and prosecute lengthy and complex third-party tort litigation and recover something in excess of what he might get in distributions from the bankruptcy estate, your garage owner client should most likely not file any individual litigation--at least of the type that we've been discussing."

"I get the point," Larry said. "I certainly wouldn't take that sort of case on a contingency basis, and I don't suppose the trustee would want to spend much time on it, either. But isn't there something my garage guy can do, after doing all that work for that company?"

"I really do sympathize with people like the garage owner," said Paula. "But you need to understand that every bankruptcy begins because there is already a long list of genuinely innocent human and business casualties, like the garage owner, who gave the debtor money, goods, and services and didn't get what they were owed. The question is whether the bankruptcy process can heal their injuries or at least provide some salve for their wounds. We can hope that through Tom Trustee's management of the bankruptcy's litigation and nonlitigation assets, that will happen.

"Instead of the garage owner starting a war with the people who ran the company into the ground, I'd suggest a few things. First, he should determine whether he has a mechanic's or materialman's lien on the tractor-trailer, which would make him a secured creditor. If so, he can try to use it to get the truck back and/or improve his ranking in the bankruptcy priority-of-payment list. If he gets higher on the list, he'll get more of whatever Tom Trustee can collect and distribute.

"He could also look for simple claims that either he or the trustee might bring against other defendants; several possibilities might provide some recovery. For instance, he might look into potential fraudulent-transfer actions regarding the sale of the tractor-trailer (if he actually did have any rights in that truck and solvent third parties can be held liable for the fraudulent transfer).

"He might also consider asserting a claim for impairment of collateral. Or he could object to the treatment of his claim in the bankruptcy proceedings. All of those options are cheaper than litigation. Notice I said cheapen. None of them is cheap. No matter how angry he may be now, your garage owner client probably doesn't want to throw good money after bad."

"My guess is that he will have to hope that the trustee's work ultimately produces distributions that reduce his losses," Larry said.

That's my guess, too," Paula agreed.

The teacher's options. "And I suppose a shareholder like the teacher would have even fewer claims," Larry said. "Shareholder claims come last, after all."

"Actually, although they're at the bottom of the pile for repayment out of bankruptcy estate assets, shareholders like the teacher may have one of the best options for seeking compensation from folks other than the debtor," Paula said. "But that's true only if a valid shareholder class action can be mounted.

"Using that vehicle, which eliminates or minimizes the shareholder's personal cost, shareholders like the teacher may be able to sue the company's directors and officers as well as any professionals who helped them misrepresent the company's health. They may seek compensation for all of the damages incurred by the class members.

"In fact, it is now rare to have a public company bankruptcy without a parallel shareholder class action, usually aimed at the officers and directors of the debtor and sometimes at professionals alleged to have assisted them in their misconduct. Such actions are typically simple to construct legally, but they are factually dense, like other kinds of shareholder class actions. There's well-established law (12) that can be invoked to support the shareholder victims of a corporate collapse if some of the lawyers who do this kind of work take an interest in the particular case and prosecute it vigorously. Of course, the teacher's securities transactions would have to fall within the definition of the 'class.'

"If neither condition applies, then the teacher and the rest of the shareholders are in dire straits. If there isn't a successful class action, and if Tom Trustee doesn't recover more than what is needed to pay all the creditors (and he probably won't), people like the teacher are out of luck--unless actions by the Securities and Exchange Commission or a state attorney general produce money for shareholders. Most individual shareholders just don't have the wherewithal to bring successful complex litigation of the type required in this case."

"What about the trustee?" Larry asked. "Won't he help the shareholders, just as he helps creditors like the bank and the garage owner?"

"Not really," said Paula. "While the trustee will have no antipathy to shareholders generally, his first loyalties, as a matter of law, are to the creditors. And only after he has fully satisfied their needs will he look to the relief that might be provided to individual shareholders. If there is a shareholder class action, however, and it threatens to deplete the third-party resources available to pay the damages he is claiming in his own cases, (13) the trustee may have a far less charitable attitude toward shareholders and their claims.

"In any case, unlike the bank and the garage owner, the teacher should not expect much help from the trustee. If she recovers anything at all, it will be because one of the trustee's rivals--a class action, the Securities and Exchange Commission, or a state attorney general--beats the trustee to the third-party resources."

Timing

"OK, Paula," said Larry, "it can be a mess. But if my clients want to file suit to preserve their rights and remedies, when and where should they do it?"

"Again, there's no single answer. In a situation like this one, you can expect a lengthy and competitive, multipronged attack on the same, usually scarce, third-party resources by shareholder and/or creditor class actions, by individual creditors or shareholders, and by the bankruptcy trustee. Those who file first--these days, typically the shareholder class action lawyers (14)--may well have an edge in selecting the forum, defining the issues, and obtaining settlements or judgments against third parties with the greatest liability and the greatest ability to satisfy a judgment against them.

"In short, it will pay for your clients to make their litigation decisions responsibly but quickly. That is also true for the trustee and for the shareholder class action attorneys, though for reasons I've mentioned, trustees all too often get involved with the estate's nonlitigation matters at the expense of its litigation matters and so fall behind the other plaintiff groups in advancing their litigation agendas."

Larry suddenly realized that his crash course in protecting the interests of those injured by a corporate bankruptcy had taken all afternoon. Nevertheless, he now understood that even if his clients theoretically enjoyed the same range of options--from doing nothing to filing individual third-party litigation in addition to claims in the bankruptcy--they still were not similarly situated. Each had different claims and different real-world mechanisms and capabilities for prosecuting them. His clients could be in active competition with others for the same resources. Each could and absolutely would have different views of the trustee and his work.

Larry also understood that time was of the essence, that he needed to get together with his clients, needed to quickly sort out any conflicts of interest that could limit his ability to represent any of them, and possibly needed to help them get other lawyers. He also knew that he or their new lawyers needed to make decisions that the bankruptcy process and any collateral litigation could soon force on them.

Thus armed, Larry departed, thanking Paula on the way out.

"I owe you big time," he said.

"You do," she replied, "but it's a contingent, unsecured, and probably unenforceable claim. Just buy me a drink at the next ATLA meeting, and we'll call it even."

Business Torts Section eases the way into business litigation

Plaintiff lawyers who recognize that business litigation offers many opportunities to expand their practices are taking advantage of ATLA's best resource in this area of the law: the Business Torts Section.

"There are lots of opportunities in business torts for trial lawyers," said the section's chair, Elizabeth Ann (Betty) Morgan of Atlanta. It's "the wave of the future for ATLA members."

Section membership is vital for ATLA members who want to learn the fundamentals of this practice area and network with other business torts lawyers. For example, in July, the section will host a continuing legal education (CLE) seminar at ATLA's Annual Convention in Seattle to teach trial lawyers the basic building blocks of business litigation.

"Our education program is geared to help lawyers transition into business torts," Morgan said. It will include discussions on potential claims like tortious interference with a business relationship, fraud, and RICO act violations. Speakers also will address examining a company's finances, offer case-selection tips, and review ethics rules on the treatment of contingent fees in business cases.

After the seminar, section members can purchase recordings of the program at a 25 percent discount. They can also download the CLE reference materials online for free.

Other benefits include a quarterly newsletter, which keeps members abreast of the developments in the field, and access to the section's list server, where members can converse with each other anytime.

The section has five subcommittees that actively monitor hot topics in securities, antitrust and unfair competition, intellectual property, bankruptcy, and class actions.

The section's other officers are Chair-Elect Kirk Reasonover of Lafayette, Louisiana; Vice Chair Matthew Cartwright of Wilkes-Barre, Pennsylvania; Secretary and Newsletter Coeditor Colleen Duffy Smith of San Jose, California; Newsletter Coeditor Jacquelyn Wright of Ventura, California; and Immediate Past Chair Bruce Simon of Burlingame, California.

Annual membership dues are $45. To join or for more information, contact ATLA Sections at [phone], ext. 290, or visit the Business Torts Section home page at www.atla.org/ sections/businesstorts/.

BERT BLACK practices law with Lockridge Grindal Nauen in Minneapolis. JAMES D. MCCARTHY and ERIC D. MADDEN are with Diamond McCarthy in Dallas.

Notes

(1.) The appointment of Tom Trustee, especially this early in the case, indicated problems with GBC's management. Normally, the debtor will continue to operate and manage the business during a Chapter 11 bankruptcy case. A trustee, however, will be appointed by the court either "for cause, including fraud, dishonesty, incompetence, or gross mismanagement of the affairs of the debtor by current management" or if such appointment is in the best interests of the creditors and the estate. (11 U.S.C. [section] 1104 (a) (2000 & Supp. 2005).) Alternatively, the court will often appoint an official committee of unsecured creditors to consult with, investigate, and supervise the debtor and its management of the bankruptcy. (11 U.S.C. [subsection] 1102 & 1103 (2000 & Supp. 2005).)

(2.) 11 U.S.C. [section] 362(a) (2000 & Supp. 2005).

(3.) Litigation by trustees and creditor committees can produce larger returns for creditors than a mere liquidation of the debtor's "hard" assets, as in the Chapter 7 bankruptcy of Southeast Banking Corp. In that case, the bankruptcy trustees and estate lawyers recovered sufficient funds to pay all the creditors' approved claims in full, and even to pay some interest on them. See In re Southeast Banking Corp., No. 91-1451-BRC-SMW (Bankr. S.D. Fla. filed Sept. 20, 1991). Partial payment is more typical, but the percentage payout is generally still higher than if litigation were not pursued.

(4.) Not every situation in which two or more of a lawyer's clients are seeking to collect from the same party constitutes a conflict. However, where a lawyer for one potential claimant may be obligated to take actions in the bankruptcy (or in the corollary litigation or both) that would be adverse to another of his or her claimant/clients, there is real potential for conflict. Each potential conflict (and its waivability) should be analyzed in light of the specific facts of the case and of the applicable conflict-of-interest law. (As to the latter, note that the federal bankruptcy courts may fashion their conflicts law from some combination of the forum state's law, the bankruptcy court local rules, the district court local rules, special bankruptcy statutes regarding conflicts of interest, and general sources like the ABA's Model Rules of Professional Conduct.)

(5.) See Schimmelpenninck v. Byrne (In re Schimmelpenninck), 183 F.3d 347, 359 (5th Cir. 1999).

(6.) See Caplin v. Marine Midland Grace Trust Co., 406 U.S. 416, 434 (1972).

(7.) This is known as the "deepening insolvency" doctrine. See, e.g., Official Comm. of Unsecured Creditors v. R.F. Lafferty & Co., 267 F.3d 340, 350 (3d Cir. 2001); Schacht v. Brown, 711 F.2d 1343, 1350 (7th Cir. 1983); Official Comm. of Unsecured Creditors v. Credit Suisse First Boston (In re Exide Tech., Inc.), 299 B.R. 732, 751-52 (Bankr. D. Del. 2003).

(8.) 11 U.S.C. [section] 108(a) (2000 & Supp. 2005).

(9.) 11 U.S.C. [section] 362(d) (2000 & Supp. 2005).

(10.) See Schnelling v. Thomas (In re Agribiotech, Inc.), 319 B.R. 207, 214-15 (D. Nev. 2004); Turoff v. Jackson Walker, LLP (In re Precept Bus. Servs., Inc.), No. 01-31351-SAF-7, 04-3216, 2004 WL 2074169, at *5 (Bankr. N.D. Tex. Aug. 23, 2004).

(11.) See Logan v. JKV Real Estate Serv. (In re Bogdan), 414 F.3d 507, 514 (4th Cir. 2005).

(12.) The range of actions possible under federal and state securities law is beyond the scope of this article, but a typical action will allege practices in violation of Securities and Exchange Commission Rule 10b-5 and similar antifraud statutes and rules. Both class action and securities law have undergone numerous changes recently that have tended to make both federal and state securities class actions more difficult to bring and maintain.

(13.) Third-party defendants typically have three types of resources to satisfy a judgment: their personal assets (for example, the assets of an individual accountant); corporate assets (the assets of the accounting firm employing the accountant); and the proceeds of liability insurance policies covering both. Attenuated officer/director professional liability litigation drains all these resources. When the defendants are fighting on multiple fronts (as in the scenarios envisioned here), those resources are drained at an even faster rate. That is especially true of liability insurance coverage, which is typically reduced by defense costs incurred on each day of the litigation.

(14.) In a public company bankruptcy filing that comes as a surprise (that is, where the true financial condition of the company has not been publicly disclosed), that surprise will often come in the form of a precipitous drop in its stock price. In almost all cases, that will trigger the filing of one or more shareholder class actions. Thereafter, the statutory calendar for the "lead plaintiff/lead counsel" selection process pushes the class action plaintiff and lawyers to move rapidly. By contrast, the corollary actions by the debtors, by the bankruptcy trustee, or by the creditors committee can often be postponed by a delay in the filing or organizing of the bankruptcy and by the more pressing nonlitigation needs that arise at the start of a bankruptcy.