The recent decision by the California Court of Appeal, Berg & Berg Enterprises v. John Boyle et al., a reaffirmation of California earlier Trust Fund doctrine and rejecting the so-called “zone of insolvency” approach of other jurisdictions when defining the scope of when and to what extent to fasten duties owed by boards of directors of near insolvent corporations to its creditors.
The October 29, 2009, decision rendered by the California Court of Appeal, Sixth Appellate District, in the case Berg & Berg Enterprises, LLC versus John Boyle et. al. concluded that Berg failed to plead a cognizable claim for breach of fiduciary duty against the individual directors (John Boyle et. al.) of Pluris Inc. being sued.
The Berg case was born out of a dispute between Berg & Berg, a real estate developer, and Pluris, a Silicon Valley-based start-up company engaged in the business of developing advanced network routers. Pluris dissolved in 2002, a victim of a depressed sector economy as its financing efforts and product development efforts “tanked.” Berg alleged that it became Pluris’s largest creditor when its predecessor-in-interest, MWP, agreed to build and then lease two office buildings in San Jose, California, to Pluris and Pluris allegedly repudiated the lease agreement and subsequently made an assignment of its entire assets for the benefit of its creditors. Berg retaliated initially by attempting to file an involuntary bankruptcy proceeding against Pluris to try to exploit approximately $50 million in net operating losses. When the involuntary bankruptcy proceeding was dismissed, Berg litigated, claiming in state court that Pluris’s directors had breached fiduciary duty, alleging that the directors had failed to conduct a reasonable probe into the proposal to pursue the Berg bankruptcy plan for the intent of preserving the net operating losses. After several additional challenges, the actions were dismissed due to Berg’s “failure to state a cause of action for breach of fiduciary duty” and Berg appealed.
On appeal, Berg raised the theory that directors of a corporation owe a fiduciary duty to the corporate creditors even before the corporation is actually insolvent and merely in the “zone of insolvency” so as to vitiate the normally singular duty owed to shareholders. The rule was originally posted in a Delaware Chancery court in the case of Credit Lyonnais Bank Nederland N.V. v. Pathe Communications Corp., 1991 Del. Ch. Lexis 215 (Del. Ch. Dec. 30, 1991). In rejecting the invitations to expand directors duties before actual insolvency, the court instead reaffirmed California’s “Trust Fund” approach which rejects a fiduciary duty to creditors and merely fasten liability where the assets which otherwise could have been used to satisfy creditors is in some way diverted, dissipated or put at undue risk.
Roni Balint writes for the Law Office of Alan M. Insul. The content contained within this feature is not intended as legal advice and does not constitute an attorney-client relationship. To learn more, contact Los Angeles business attorney and California corporate lawyer, Alan M. Insul by visiting Insullaw.com.