Legal Malpractice

Trustee's Standing in Legal Malpractice

By (Andrew Lavoott Bluestone)

A bankruptcy trustee "steps into the shoes of the debtor" and obtains certain benefits from this power.  In Kirschner v. Grant Thornton we see that there are limits to that power. As Mark Hamblett writes in today's NYLJ: "Southern District Judge Gerard E. Lynch ruled Tuesday that the case brought by liquidation trustee Marc S. Kirschner, who is standing in the shoes of Refco, must be dismissed because "a trustee cannot sue to recover for a wrong undertaken by the debtor itself."

In addition to Mayer Brown, the judge in Kirschner v. Grant Thornton, 07 Civ. 11604, also granted motions to dismiss sought by Credit Suisse Securities and other investment banks, Ernst & Young U.S. and other accounting firms, and several third-party participants."

"The Wagoner rule, the circuit explained, "derives from the fundamental principle of agency that the misconduct of managers within the scope of their employment will normally be imputed to the corporation."

Because the trustee stands in the corporation's shoes, the court said, the rule "bars a trustee from suing to recover for a wrong that he himself essentially took part in."

The parties in Kirschner disagreed on whether a narrow exception to the Wagoner rule applied. The "adverse-interest" exception applies where the corporate officer has "totally abandoned" the corporation's interests and is "acting entirely for his own or another's purposes."

Here, Judge Lynch said, "The complaint is saturated by allegations that Refco received substantial benefits from the insiders' alleged wrongdoing."

"Indeed, the gravamen of the trustee's allegation is not that the insiders stole assets from Refco, but rather that the insiders fraudulent scheme was to steal for Refco - to inflate the value of Refco's interests on behalf of Refco itself by maintaining the illusion that Refco was 'fast-growing, highly profitable, and able to satisfy its substantial working capital needs without having to borrow money,'" he said.

Judge Lynch dismissed as "industrious, but without" merit, the plaintiffs' argument that the adverse-interest exception applied in any event because the insiders intended to benefit only themselves.

The trustee alleged that, in connection with the leveraged buyout and the initial public offering, the executives had wasted or "siphoned out" Refco assets.

But Judge Lynch said the insiders did not commit embezzlement. Rather, he said, they sold their interests in Refco "at fraudulently-induced prices."
 

Full post as published by New York Attorney Malpractice Blog on April 21, 2009 (boomark / email).