Does Fiduciary Duty Enter a Zone of Insolvency?

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.