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In re Tropicana Entertainment: Court Dismisses Breach of Fiduciary Duty Claims Against Sole Owner of Solvent, but Injured, Debtor Subsidiaries
Practical Law Legal Update 5-593-9967 (Approx. 5 pages)
In re Tropicana Entertainment: Court Dismisses Breach of Fiduciary Duty Claims Against Sole Owner of Solvent, but Injured, Debtor Subsidiaries
by Practical Law Bankruptcy and Practical Law Finance
| Published on 21 Jan 2015 • USA (National/Federal) |
In Lightsway Litigation Services, LLC v. Yung (In re Tropicana Entertainment, LLC), the US Bankruptcy Court for the District of Delaware dismissed breach of fiduciary duty claims against the sole owner of a parent company who was also a director or CEO of its subsidiaries because under Delaware law, the directors of a solvent debtor subsidiary are only obligated to manage the subsidiary's affairs in the best interest of the parent, even if their actions harm the subsidiary.
On November 25, 2014, the US Bankruptcy Court for the District of Delaware in Lightsway Litigation Services, LLC v. Yung (In re Tropicana Entertainment, LLC) dismissed a litigation trustee's breach of fiduciary duty claims against the sole owner of a parent company who was also a director or CEO of its subsidiaries because, under Delaware law, the directors of a solvent debtor subsidiary are only obligated to manage the subsidiary's affairs in the best interest of the parent, even if their actions harm the subsidiary (520 B.R. 455 (Bankr. D. Del. 2014)). The Court further held that, because the trustee failed to properly plead the debtors' insolvency, it did not have standing to pursue this claim.
Background
William J. Yung (Yung) founded Columbia Sussex Corporation (Columbia) in 1972, which held a portfolio of more than 70 hotels. In 1990, Yung created Wimar Tahoe Corporation (Wimar) to purchase, develop and operate several casino properties. In 2007, Wimar acquired Aztar, Inc., which owned five casino properties, including Tropicana Atlantic City (Tropicana), for $2.1 billion in cash. Yung publicly acknowledged "limited experience operating a full-scale casino resort" and admitted that the operation of the newly acquired casinos might strain management resources and divert attention from other important business concerns.
After acquiring the casinos, Yung attempted cost-cutting measures which were intended to maximize his profits, but were unsuitable for the casino industry and led to the denial of Tropicana's gaming license by the New Jersey Casino Control Commission (CCC). The CCC demanded that Yung resign as the sole member of Tropicana's board of directors. However, Yung refused to cede control which resulted in further losses and damages. This ultimately led to the filing of a Chapter 11 bankruptcy in 2008 by Wimar and several affiliated hotels and casinos, which were all wholly owned by Yung through various subsidiary companies (Debtors).
In 2009, the Court confirmed plans of reorganization (Plans) which created a litigation trust to pursue certain "insider causes of action" for the benefit of certain classes of unsecured creditors. Lightsway Litigation Services, LLC (Trustee) was appointed as the trustee of the Litigation Trust. The Trustee filed a complaint against Yung, Wimar and Columbia (Defendants), alleging that Yung had driven the company into insolvency by his mismanagement of the casinos, and asserted, among other things, that:
- Columbia and Wimar aided and abetted Yung in breaching his fiduciary duties.
The Defendants moved to dismiss the complaint, arguing that the Trustee's claim for breach of fiduciary duty must be dismissed because:
- The doctrine of in pari delicto, which provides a defense to a claim against a defendant if the plaintiff bears fault for the alleged injury, prevented the Trustee from pursuing breach of fiduciary duty claims.
- Yung did not owe any fiduciary duty to the Debtors and even if a fiduciary duty existed, the Trustee lacked standing to pursue a breach of fiduciary duty claim on behalf of creditors.
Outcome
The Court:
- Held that Yung cannot prevail on the equitable defense of in pari delicto because the doctrine does not preclude claims against corporate insiders.
- Dismissed the Trustee's breach of fiduciary duty claims.
Breach of Fiduciary Duty
To prevail on a claim for a breach of fiduciary duty:
- The fiduciary duty must exist.
- The fiduciary must breach that duty.
For a fiduciary duty to exist, there must first be a fiduciary relationship. The Supreme Court of Delaware has determined that directors owe fiduciary duties to the corporation, and held in North American Catholic Educational Programming Foundation, Inc. v. Gheewalla that:
"When a corporation is solvent, those duties may be enforced by its shareholders, who have standing to bring derivative actions on behalf of the corporation because they are the ultimate beneficiaries of the corporation's growth and increased value. When a corporation is insolvent, however, its creditors take the place of the shareholders as the residual beneficiaries of any increase in value"
(930 A.2d 92, 99 (Del. 2007)). As a result, the creditors of an insolvent corporation have standing to maintain derivative claims against the directors on behalf of the corporation for breaches of fiduciary duties.
The Court explained that if the Debtors were solvent, any fiduciary duties that Yung owed to the Debtors flowed to Wimar, the sole shareholder and parent of the Debtors. Citing to the Delaware Court of Chancery's decision in Trenwick America Litigation Trust v. Ernst & Young, LLP, the Court noted that "in a parent and wholly-owned subsidiary context, directors of the subsidiary are obligated only to manage the affairs of the subsidiary in the best interests of the parent and its shareholder" and further, that under Trenwick, this is required even if the directors' actions make the subsidiary less valuable (906 A.2d 168, 200 (Del. Ch. 2006)). Therefore, even assuming that "Yung deliberately chose to prefer the financial health of his hotels to the financial harm of his casinos," the Court held that this argument does not support a claim for breach of fiduciary duty because Yung was only obligated to manage the solvent Debtor subsidiaries in the best interest of Wimar and, ultimately, himself as the sole shareholder of Wimar.
The Court then explained that if the Debtors were insolvent, the analysis would change because under Gheewalla, the creditors of an insolvent corporation have standing to maintain derivative claims on behalf of the corporation for breaches of fiduciary duties. In that case, Yung would owe fiduciary duties to the Debtors' creditors, rather than to Wimar. The Court noted that under Trenwick, a plaintiff must allege either that a corporation was insolvent or became insolvent as a result of the misconduct. To meet the burden of pleading insolvency, a plaintiff must plead facts showing that the company either:
- Had debts exceeding its assets, with no reasonable prospect of continuing the business.
- Could not pay its obligations as they became due.
The Court held that the Trustee's claims regarding Yung's alleged mismanagement were either overly broad or conclusory allegations and the Court could not infer whether any or all of the Debtors were insolvent or when insolvency occurred. Therefore, the Court dismissed the Trustee's claim against Yung for breach of fiduciary duty. Without a claim for breach of fiduciary duty, the Court also dismissed the Trustee's claim against Wimar and Columbia for aiding and abetting Yung's breach of fiduciary duty.
Practical Implications
This case draws the Delaware law on fiduciary duties to its logical conclusions by demonstrating that when a subsidiary company is solvent, directors' fiduciary duties ultimately flow back to the shareholders of the parent company, who are required to manage the subsidiary in the best interests of the parent, even if doing so harms the subsidiary. Therefore, there is no breach of fiduciary duty if the subsidiary remains solvent and the parent benefits, because creditors are not harmed, even if the value of the subsidiary is reduced.
In addition, this case illustrates that plaintiffs alleging insolvency in a breach of fiduciary duty action must support their allegations with sufficient facts to survive a motion to dismiss.
For more information on fiduciary duties, see Practice Notes, Fiduciary Duties of Directors of Financially Troubled Corporations and Fiduciary Duties of the Board of Directors.