Delaware Court Finds Texas Trust Fund Doctrine Alive, But Debtor’s Trust Claims Dead on Arrival | Patterson Belknap Webb & Tyler LLP

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A Delaware bankruptcy court recently ruled that Texas’ “trust fund doctrine” remains applicable to companies that have not availed themselves of Texas’ formal dissolution process. Nevertheless, a Chapter 7 debtor’s fiduciary claims were dismissed because the debtor failed to assert those claims derivatively.

After a 2015 transaction between Our Alchemy, LLC (“Our Alchemy”) and ANConnect, LLC (“ANConnect”) ended in litigation, Our Alchemy filed for Chapter 7 bankruptcy in the Delaware. Its trustee then filed adversarial proceedings against ANConnect and its officers for fraudulent transfers of ANConnect’s assets and associated breaches of fiduciary duties. The transfers at issue took place when ANConnect was winding down its operations. In re: Our Alchemy, LLC16-11596 (JTD), 2022 WL 2309796, at *1 (Bankr. D. Del. June 27, 2022).

ANConnect filed for dismissal, arguing that the claims were statute-barred and that Our Alchemy lacked standing. The court granted in part and denied in part (as factually dependent) ANConnect’s motion regarding the statute of limitations.

With respect to standing, Our Alchemy relied on the Texas Trust Fund Doctrine (the “Doctrine”). Our Alchemy argued that under the doctrine, “there is a right for creditors of a Texas corporation (and by extension an LLC) to sue officers and directors for breach of fiduciary duty when an entity is insolvent and ceases its commercial activities”. The doctrine is an equitable remedy “established primarily to enable a court of equity to collect and distribute the assets of a corporation in the event of insolvency and dissolution in the same manner as a modern bankruptcy court would.”

ANConnect responded that the doctrine “has been superseded by Texas statutory law.” The court disagreed.

The court analyzed a 1981 Texas Supreme Court opinion, which “recognizes that beginning in 1879, the Texas Legislature began to enact remedial statutes that embodied the trust fund doctrine.” Identifier. at 7 O’clock (discussing Hunter v. Fort Worth Capital Corp.620 SW2d 547 (Texas 1981)).

Under these remedial statutes, the legislature had granted the creditors of a dissolved company “the same broad measure of relief as equity would have afforded in the absence of legislation.” . . . The effect of these laws was to supersede the equitable trust fund theory by declaring a legal equivalent. In Texas, recognition of the trust fund theory, as applied to dissolved corporations, did not exist outside of these statutes.

Identifier. Despite the Texas Supreme Court’s explanation, many Texas state courts and federal courts applying Texas law have continued to recognize the Doctrine. How to remedy the apparent incongruity?

The court responded that, according to the Texas Supreme Court, “statutory enactments have superseded the trust fund doctrine” as applied to dissolved companies”, but the Doctrine still applies “unless a company has undertaken the [statutory] dissolution process. “To decide otherwise would be fundamentally unfair to the creditors of a company which ceases its business activities, distributes its assets to its shareholders or members but never seeks the protection of dissolution” (which requires a company to deposit funds to cover all debts with the Texas Secretary of State).

Since Our Alchemy did not allege that ANConnect filed for dissolution under Texas law, the Doctrine still applied. However, Our Alchemy only made direct, not derivative, claims of fiduciary duty. And as the Fifth Circuit recognized in In re Mortgage America Corp.if an action is to be brought under the Doctrine, “it must be brought on behalf of all who are in the same position. [A] sole creditor, acting on his own account, does not have standing to act”. 714 F.2d 1266, 1271 (5th Cir. 1983). Thus, “the failure of [Our Alchemy’s] Trustee to carry claims in a derivative manner [was] fatal to the permanent fiduciary argument,” and Our Alchemy’s fiduciary claims were dismissed.

Ordinarily, plaintiffs like Our Alchemy could amend their complaint to remedy the pleading deficiency recognized by the court. However, Our Alchemy only devoted a single footnote to the request for edit permission and made no substantive argument. Accordingly, the court dismissed Our Alchemy’s request for leave as procedurally flawed.

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