Under Wisconsin law, officers and directors of corporations owe a fiduciary duty to creditors, if the corporation is both insolvent and no longer a going concern. Beloit Liquidating Trust v. Grade, 2004 WI 39, 270 Wis.2d 356, 361, 677 N.W.2d 298.
Nevertheless, the 7th Circuit held on Jan. 21 that judgments against them for breaching that state law duty can still be discharged in bankruptcy, 11 U.S.C. 523(a)(4) notwithstanding.
Follett Higher Education Group, Inc. is an Illinois corporation, managing more than 750 college bookstores nationwide.
In 2004, Follett hired Berman & Associates, Inc., to place advertisements on its behalf. The relationship soured when Berman & Associates failed to pay outstanding advertising bills, and Follett was forced to pay them, without recovering the sums it already paid to Berman & Associates for that purpose.
In 2006, Jay Berman, the president, director, and sole shareholder of Berman & Associates, filed for bankruptcy, and listed the debt to Follett on his schedule of debts.
Follett filed an adversary action, claiming that Berman breached the fiduciary duty owed to it as a creditor under Illinois law, and therefore, the debt was nondischargeable.
The bankruptcy court and district court held that Berman was not a fiduciary within the meaning of the bankruptcy code. In an opinion by Judge David F. Hamilton, the 7th circuit affirmed.
Subsection 523(a)(4) provides that a debt is not dischargeable in bankruptcy if the debtor has committed “fraud or defalcation while acting in a fiduciary capacity, embezzlement or larceny.”
Similar to Wisconsin, under Illinois law, a corporate officer or director owes a fiduciary duty to creditors, if the corporation is insolvent.
Follett argued that such a state law duty equates to a fiduciary duty for purposes of federal bankruptcy law.
The court cited extensive case law both accepting and rejecting this argument, before joining the majority in rejecting it.
Judge Hamilton wrote, “We hold that even if the evidence showed that Berman & Associates was insolvent when all or some part of the debt arose, so that Berman would have had a fiduciary duty toward creditors under Illinois law, this state law duty would not have constituted a basis for non-dischargeability of the debt owed to Follett under section 523(a)(4).”
David Ziemer can be reached at email@example.com.
What the court held
Issues: Is the fiduciary duty imposed by state law on the officers and directors of insolvent corporations sufficient to make their debts nondischargeable in bankruptcy?
Holdings: No. The state law duty does not equate to a fiduciary duty for purposes of federal bankruptcy law.