You'd think that a corporation would have to have some gall if it sued its officers and directors for prolonging its life.
Even if they defrauded lenders out of the money that kept the firm chugging far past the point of genuine insolvency.
Does the situation change if the company ends up in chapter 11 and the bankruptcy court appoints a litigation trustee to pursue the entity's claims against the insiders?
No, the Second Circuit held today. The trustee lacks standing because New York law imputes all the bad acts to him because he stands in the shoes of the company, the court held. Kirschner v. KPMG LLP, No. 09-2020-cv (2d Cir. Nov. 18, 2010).
The issue came down to whether the trustee could invoke the "adverse interest" exception to New York's imputation rule, which originated in Shearson Lehman Hutton, Inc. v. Wagoner, 944 F.2d 114, 118 (2d CIr. 1991). Under the exception, a bad-acting insider must have totally abandoned the corporation's interests and acted solely for his own or another's purposes.
With the help of answers to questions it certified to the New York Court of Appeals, the Second Circuit panel concluded that the trustee couldn't show enough of an adverse interest. That the insiders intended to benefit themselves didn't suffice. Nor could the trustee deploy the exception unless he could prove that the insiders' fraud hurt the company. Their wrongdoing in fact helped the company by enabling it to borrow $1.4 billion. And "'[i]t is a basic principle of corporate finance that extending credit to a distressed entity in itself does the entity no harm.'" Kirschner, slip op. at 9 (quoting district court opinion).