North Carolina Business Litigation Report

Directors Of Corporation Facing "Deepening Insolvency" Owed Fiduciary Duties To Creditor

Directors of corporations verging on insolvency can owe fiduciary duties to creditors under certain circumstances.  Whether those duties were owed -- and whether the claim for their breach had been released as a part of the corporation's bankruptcy proceeding -- were the main issues yesterday in Phillips and Jordan, Inc. v. Bostic, 2009 NCBC 13 (N.C. Super. Ct. June 2, 2009).

The Plaintiff claimed that the Defendant directors had diverted money through "a web of sham entities" for their own personal benefit during a time when the corporation faced "deepening insolvency" and that they were liable to it under a theory of constructive fraud.

Here's how Judge Diaz described North Carolina law on the duties of directors of a corporation in financial difficulty:

In certain circumstances. . . corporate directors may owe a fiduciary duty to creditors of the corporation. The circumstances under which a director’s fiduciary obligations extend to creditors have been limited to those situations 'amounting to a "winding up" or dissolution of the corporation.'

'Once the fiduciary duty arises, a director must treat all creditors of the same class equally by making any payments to such creditors on a pro rata basis.'

Where a creditor can show constructive fraud by a director at a time when the corporation 'is in declining circumstances and verging on insolvency,' or 'where such facts establish circumstances that amount "practically to a dissolution,"' the claim is one that 'belongs to the creditor and not the corporation.'

Op. ¶¶42-45.

The Court denied the Defendants' motion to dismiss the Plaintiff's claim for constructive fraud.  It also rejected arguments that the claim had been settled as a part of the corporation's bankruptcy proceeding, ruling that "where . . . the claim arises from a purported breach of a fiduciary duty owed by a corporate director to a creditor, and where the claim, therefore, properly belongs to the creditor and not the corporation, 'it is not a part of the bankruptcy estate, and the trustee in bankruptcy does not have authority to bring [or settle the] claim.'"  

In another part of the Opinion, the Court granted a motion to dismiss a fraud claim because it failed to comply with Rule 9(b).  The Complaint, which asserted the fraud claim against a group of individuals, did not identify the specific person who made the alleged misrepresentations.  The Court allowed leave to amend.

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Mack Sperling
Brooks Pierce, LLP
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