Insights
Publications

California Court Erects A Strong Barrier To Creditor Claims Against Corporate Directors And Officers

11/4/2009 Articles

The Sixth District Court of Appeal, resolving a previously unanswered question in California, has drawn a bright line shielding company directors and officers from personal liability arising from creditor claims of breach of fiduciary duty.  Berg & Berg Enterprises, LLC v. Boyle, --- Cal. App. 4th ---, 2009 WL 3470631, 09 Cal. Daily Op. Serv. 13, 305 (Oct. 29, 2009).  California has now joined Delaware in holding that directors do not owe creditors a fiduciary duty, even when the corporation is operating in the so-called "zone of insolvency."

Berg & Berg Enterprises, LLC, was the largest creditor of Pluris, Inc. when Pluris did an assignment for the benefit of creditors under California law and closed its doors.  Berg subsequently brought an action against several of Pluris's directors, challenging decisions the directors made as breaches of the fiduciary duties the directors owed to all creditors when the company was operating in the "zone of insolvency."  The legal theory was not novel, but no California court had ever resolved the question of whether directors and officers owe creditors - as opposed to the company and its shareholders - a duty of care when insolvent or near insolvency.

The theory originated from a footnote in a Delaware case, Credit Lyonnais Bank Nederland N.V. v. Pathe Communications Corp., 1991 Del. Ch. LEXIS 215 (Del. Ch. Dec. 30, 1991), which, although finding no breach of fiduciary duty, posited that "where a corporation is operating in the vicinity of insolvency, a board of directors is not merely the agent of the [shareholders], but owes its duty to the corporate enterprise" as a whole, including its creditors.  Id. at *108, n.55.  Cases and legal commentary following Credit Lyonnais have suggested that when a corporation is actually or nearly insolvent, the directors may owe a duty of care that is paramount to the common law and statutory fiduciary duties owed to shareholders.

Berg & Berg soundly rejected that theory.  The court held that no duty of directors to creditors is created "solely due to a state of corporate insolvency."  Rather, the court held that, even where a corporation is actually insolvent, the duty of care directors owe to the corporation's creditors is limited to avoiding actions that would harm the corporation itself, such as acts that involve self-dealing or the preferential treatment of creditors.  Although never previously decided by a California court, this holding of Berg & Berg is consistent with federal cases applying California law, which have held that upon actual insolvency, a corporation's assets become subject to a constructive trust for the benefit of corporate creditors - the so-called "trust fund doctrine."  The Berg & Berg court found that the "trust fund doctrine" is applicable in California to corporations that are legally insolvent, but that it is limited to cases where directors or officers have diverted corporate assets to insiders or preferential creditors, or have otherwise "dissipated or unduly risked the insolvent corporation's assets." 

The Berg & Berg court had even more antipathy toward finding that directors owed a heightened duty to creditors in the impossible-to-define "zone of insolvency."  Recognizing that as long as the corporation remains solvent, the corporation is able to satisfy its contractual obligations to creditors and the directors' primary duties are to exercise their business judgment in an effort to maximize the corporation's overall financial health for the benefit of its shareholder owners.  The court, therefore, concluded that "because the existence of a zone or vicinity of insolvency is even less objectively determinable than actual insolvency, we hold that there is no fiduciary duty prescribed under California law that is owed to creditors by directors of a corporation solely by virtue of its operating in the ‘zone' or ‘vicinity' of insolvency."

Berg & Berg essentially adopted the holding in the seminal Delaware case on the issue, North American Catholic Educ. Programming Found., Inc. v. Gheewalla, 930 A.2d 92 (Del. 2007).  Gheewalla held that creditors have no direct cause of action against individual directors or officers for breach of their fiduciary duties either when actually insolvent or when operating in the "zone of insolvency," and may only bring a derivative action against the directors for such a breach if the corporation is actually insolvent. 

With California joining Delaware in concluding that directors' primary obligations are to offer effective, good faith leadership to their corporations for the benefit of the company and its shareholders, creditors' attempts to hold directors and officers personally liable for their business decisions will be severely hampered.

Firm Highlights

News

Farella Adds Technology Industry Group Depth

Read More
News

Farella Braun + Martel Attorneys Recognized in The Best Lawyers in America© 2020

Read More
Publication

3 Trends in Criminal Trade Secret Prosecution

Criminal trade secret prosecutions are on the rise nationwide and in the Northern District of California, especially cases relating to alleged theft by Chinese nationals and entities. According to a 2017 report by the...

Read More
News

Ninth Circuit Upholds Data Miner's Injunction Against LinkedIn

The U.S. Court of Appeals for the Ninth Circuit sided with data analytics company hiQ Labs, Inc. and upheld an injunction barring LinkedIn from blocking it from accessing information made publicly available by the professional networking site’s users...

Read More
News

Carly Alameda and Eugene Mar Named to Benchmark Litigation’s 40 & Under Hotlist 2019

Farella Braun + Martel partners  Carly O. Alameda and Eugene Y. Mar have been named to Benchmark Litigation ’s “ 40 & Under Hotlist” for 2019. The list honors partners 40 or younger who...

Read More
News

A Major Victory for hiQ Labs, Ninth Circuit Upholds Its Right to Access Publicly Available LinkedIn Data

In a blockbuster ruling, the Ninth Circuit Court of Appeals affirmed startup hiQ Labs, Inc.’s preliminary injunction (PI) against LinkedIn granted by Judge Edward Chen of the United States District Court for the Northern...

Read More
News

40 Farella Braun + Martel Attorneys Named to 2019 Northern California Super Lawyers and Rising Stars

SAN FRANCISCO, July 8, 2019: Forty Farella Braun + Martel attorneys across practice areas were named to the Super Lawyers and Rising Stars lists of top attorneys in Northern California for 2019. Farella attorneys...

Read More