The insolvency of prominent contractor Bostic Construction, Inc. has been a fertile source of Business Court litigation over the last couple of years in three cases against the company’s officers and directors. A recent Bankruptcy Court decision from the Middle District permits the Business Court cases to proceed, holding that they are not barred by a settlement between the bankruptcy trustee and those officers and directors.
The procedural history is complicated (as you would expect with three cases in Business Court and one in Bankruptcy Court) but the underlying facts are not. Bostic Construction was formed by one of the "Hogs," former Redskins guard Jeff Bostic, and his brother, former St. Louis Cardinals guard Joe Bostic, both Greensboro natives. In its heyday, Bostic was the nation’s second-largest apartment builder, with over $200 million in revenue. Bostic Construction’s operating model focused on construction management, delegating most or all of the labor, materials, and equipment to subcontractors.
During the 1990s, Bostic Construction performed most of its work for unrelated third parties, but at the turn of the millenium, the company transitioned to projects for LLCs owned or controlled by company insiders. Those insiders also formed other LLCs to provide labor and materials to Bostic Construction at a profit for the LLCs. Bostic Construction’s financial condition deteriorated in 2003 and 2004, and the company’s creditors allege that the insiders began acting to ensure the profitability of the LLCs rather than Bostic Construction itself.
Bostic Construction’s creditors filed an involuntary Chapter 7 petition in January 2005. The trustee settled the company’s claims against the insiders in 2007. Three cases then were filed in Superior Court against the insiders: the Phillips & Jordan case in January 2008, and the American Mechanical and Yates Construction cases in October 2009.
The insiders moved for Judge Diaz to dismiss the American and Yates cases and moved the Bankruptcy Court for an interpretation that its order approving the 2007 settlement barred the creditors’ claims against the insiders. (By that time, Judge Diaz had already ruled that the plaintiffs in the Phillips & Jordan case had direct claims against the insiders which were not impacted by the trustee’s settlement). Judge Diaz stayed the American and Yates cases pending the Bankruptcy Court’s ruling.
The Bankruptcy Court held that the settlement did not bar the Business Court claims. The key question was whether the creditors’ claims were personal, direct claims against the insiders or whether they were derivative claims that could be asserted only by the trustee. That question is determined by state law.
Judge Waldrep cited North Carolina cases for a familiar series of propositions:
Although the general rule is that directors of North Carolina corporations do not owe a fiduciary duty to the creditors of the corporation, an exception exists when there are circumstances amounting to a winding up or dissolution of the corporation. . . . If the directors and officers continue to operate an insolvent corporation only to recover the amounts owed to them, to the detriment of the corporation’s other creditors, North Carolina courts equate that to a winding up or dissolution and find that the directors and officers owe a fiduciary duty to creditors. . . . However, no duty is owed to creditors, even if the corporation is balance sheet insolvent, when the directors and officers are acting in good faith in running the business.
The claims of constructive fraud, aiding and abetting constructive fraud, and violations of the NC RICO statutes were personal to the creditors, not derivative. The circumstances of Bostic Construction amounted to a winding up or dissolution of the business, creating a fiduciary duty from the directors to each creditor to support the constructive fraud and aiding and abetting claims. (The Court noted the ongoing doubt over whether any aiding and abetting claims exist under North Carolina law anymore, but ruled that if they existed at all, they were direct claims). Similarly, the Court examined the text of Chapter 75D, which includes the element that RICO defendants personally benefit from the illegal conduct. Based on that element, the Court concluded that the RICO claims were direct, not derivative, and were not barred by the settlement.