Following up last week’s post on fiduciary duties, we review another bankruptcy decision, also in Delaware, that provides a good refresher on the fiduciary duties of directors and officers. In dismissing claims that officers and directors had breached fiduciary duties, the bankruptcy court in Lightsway Litigation Services, LLC v. Yung (In re Tropicana Entertainment, LLC) reminds creditors when they are entitled to assert breach of fiduciary duty claims and what they must demonstrate in connection with those claims.

Background

William J. Yung, III spent decades owning and operating various hotels and casinos throughout the country.  In 2006, he ventured into the full-scale casino business by entering into agreements to acquire several properties, including Tropicana Atlantic City and Tropicana Las Vegas. Yung was the director, chief executive, and 100% owner of all equity securities of an entity called Wimar, which became the direct parent company of each casino resort entity. Yung also served as the sole director, the sole manager, or the CEO of the sole manager of many of the subsidiaries. Yung’s management of the casino resorts failed – the properties lost important gaming licenses, there were serious deficits in capital improvements, and issues with cleanliness created negative media coverage, among other things.

Ultimately, Wimar and affiliated hotel and casino subsidiaries filed for bankruptcy. As part of orders confirming plans of reorganization, a litigation trust was created to pursue certain causes of actions against insiders of the companies. The trustee of the litigation trust filed a complaint against Yung, Wimar, and others asserting (1) breach of fiduciary obligations, (2) breach of contract, (3) breach of the implied covenant of fair dealing, and (4) equitable subordination. After the defendants filed motions to dismiss, the court denied the motions but directed the trustee to file an amended complaint to rectify certain deficiencies in the complaint’s allegations.

The litigation trustee filed an amended complaint, which addressed several of these deficiencies and added a claim for aiding and abetting breach of fiduciary obligations. The defendants filed another motion to dismiss and, ultimately, the court granted in part and denied in part the defendants’ motions to dismiss the amended complaint.

Who Cares About Subsidiaries Anyway?

When addressing the trustee’s claim that Yung had breached his fiduciary duties to the casino debtors, the court found that any duties Yung owed flowed to Wimar, the parent company, and ultimately Yung himself as the sole shareholder of Wimar. Applying Delaware corporate law, the court held that so long as subsidiaries are solvent, they should be managed in the best interests of the parent and its shareholder, in a parent and wholly-owned subsidiary context. Further, the court noted that this proposition is true even if it is to the detriment of the subsidiaries.

However, the court explained that if the debtors are insolvent, the inquiry shifts. When entities are insolvent, it is the creditors who are the main constituency injured by any fiduciary duty breaches and, therefore, the creditors that have standing to bring derivative claims on behalf of the corporation (rather than shareholders). If the entity becomes insolvent after the alleged bad acts occurred, that does not change the nature of the claim—the claim remains one belonging to the corporation, but the party entitled to assert that claim derivatively expands to include creditors, not just shareholders.

Accordingly, the litigation trustee, acting on behalf of creditors, needed to demonstrate that the casino entities were insolvent or became insolvent as a result of Yung’s misconduct in order to successfully assert a breach of fiduciary duty claim derivatively on behalf of the casino debtors. Absent a showing of insolvency, the trustee’s allegations that Yung deliberately chose to prefer his other hotel properties to the financial detriment of the casino debtors, even if true, would not give the trustee derivative standing to assert the breach of fiduciary duty claims.

How Many Amended Complaints Does It Take To Plead Properly?

Throughout the opinion, the court noted that the trustee already had the opportunity to amend the complaint once. The court was not inclined to grant the litigation trustee a second opportunity and, therefore, any insufficiencies in the pleading resulted in dismissal of the cause of action. So, even though the amended complaint alleged that the casino debtors were “propelled” into insolvency, the court found that recitation of the words “insolvency” and “financial collapse” were not enough to satisfy the pleading requirements for the breach of fiduciary claim when asserted by a creditor. The court referred to those words as conclusory statements that need not be accepted when deciding a motion to dismiss.

Similarly, the breach of contract claims against the defendants were dismissed to the extent that the amended complaint failed to identify specifically the breached contracts. While the trustee in the amended complaint added eight agreements, it also generally alleged that there were other contracts that had been breached. The court held that the first element of a breach of contract claim – a contractual obligation – was not met as to the unidentified contracts. The court noted that no identifying information such as the date, parties, title of the agreement, or brief description was included in the amended complaint. The court extended this rationale to the breach of implied covenant of good faith and fair dealing cause of action as well and also dismissed that claim with respect to the unidentified contracts.

Takeaways

Directors and officers owe a duty to the corporation but if that corporation is solvent and wholly owned by a parent company, that fiduciary duty ultimately flows to the parent. Accordingly, directors’ and officers’ decisions that hurt the corporation do not necessarily breach any fiduciary duty, if the corporation remains solvent (albeit less financially sound) and the parent benefits.

Prospective plaintiffs should also take care to make sure complaints are drafted with as much detail and supporting facts available to them. The court’s dismissal of certain counts in the amended complaint demonstrates that courts will not give plaintiffs, including litigation trustees, free-reign to vaguely assert claims simply using the words of the statute or the standard, without more. If a court has already directed you to amend a complaint once, take care. You may not get a third bite at the apple.