Bankruptcy Update Blog

Delaware Court Finds Texas’s Trust Fund Doctrine Lives, but Debtor's Fiduciary Claims Dead on Arrival

A Delaware bankruptcy court recently held that Texas’s “trust fund doctrine” remains applicable for companies that have not availed themselves of Texas’s formal dissolution process.  Nonetheless, fiduciary claims by a chapter 7 debtor were dismissed because the debtor failed to assert such 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 Delaware.  Its trustee then filed an adversary proceeding against ANConnect and its managers for fraudulent transfers of ANConnect’s assets and associated breaches of fiduciary duties.  The transfers at issue occurred while ANConnect was winding down operations.  In re: Our Alchemy, LLC, 16-11596 (JTD), 2022 WL 2309796, at *1 (Bankr. D. Del. June 27, 2022).

ANConnect moved to dismiss, arguing the claims were time barred and Our Alchemy lacked standing.  The court granted in part and denied in part (as factually dependent) ANConnect’s motion with respect to the statute of limitations. 

As to standing, Our Alchemy relied on Texas’s trust fund doctrine (the “Doctrine”).  Our Alchemy argued that under the Doctrine, “standing exists 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 business operations.”  The Doctrine is an equitable remedy “established principally to permit a court of equity to marshal and distribute a corporation’s assets upon its insolvency and dissolution in much the same way as would a modern bankruptcy court.” 

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

The court analyzed a Texas Supreme Court opinion from 1981, which “recognized that beginning in 1879, the Texas legislature began enacting remedial statutes that embodied the trust fund doctrine.” Id. at *7 (discussing Hunter v. Fort Worth Capital Corp., 620 S.W.2d 547 (Tex. 1981)). 

Under these remedial statutes, the legislature had given creditors of a dissolved corporation ‘the same broad measure of relief which equity would have afforded in the absence of legislation. . . . The effect of these statutes was to supplant the equitable trust fund theory by declaring a statutory equivalent.  In Texas, recognition of the trust fund theory, as applied to dissolved corporations, did not exist apart from these statutes.

Id.  Despite the Texas Supreme Court’s explanation, numerous Texas state courts and federal courts applying Texas law have continued to recognize the Doctrine.  How does one remedy the seeming incongruity? 

The court answered that, per the Texas Supreme Court, “the statutory enactments supplanted the trust fund doctrine ‘as applied to dissolved corporations,’” but the Doctrine still applies “unless a company has undertaken the [statutory] process of dissolution.”  “To hold otherwise would be fundamentally unfair to the creditors of a company that ceases business operations, distributes its assets to its shareholders or members but never seeks the protection of dissolution” (which obligates a company to deposit funds to cover all liabilities with the Texas Secretary of State). 

Because Our Alchemy did not allege that ANConnect filed for dissolution in accordance with Texas law, the Doctrine still applied.  However, Our Alchemy brought only direct, and not derivative, fiduciary duty claims.  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 those similarly situated.  [A] single creditor, acting on its own behalf, does not have standing.”  714 F.2d 1266, 1271 (5th Cir. 1983).  Thus, the “failure of [Our Alchemy’s] Trustee to bring the claims derivatively [was] fatal to the Trustee’s standing argument,” and Our Alchemy’s fiduciary claims were dismissed.

Normally, plaintiffs like Our Alchemy could amend their complaint to remedy the pleading deficiency recognized by the court.  However, Our Alchemy devoted just a single footnote to requesting leave to amend, and offered no substantive argument.  Accordingly, the court denied Our Alchemy’s request for leave as procedurally improper.