The Bankruptcy Code’s priority scheme provides that the shareholders generally cannot receive anything on account of their investment until all secured, priority and unsecured creditors are paid in full. This principle applies even when the company—and by extension, its shareholders—is a victim of fraud. When such an unfortunate situation arises, as it has in the case of Syntax-Brillian, one cannot help but sympathize with the affected shareholders who have seen their investment wiped out with slim hope for any recovery. It is often in these despairing contexts that we see parties seek atypical forms of relief in an effort to recapture the value of their investment. That was the case in Syntax-Brillian, where the court considered whether it was appropriate to disqualify and terminate the Debtors’ liquidating trustee.
Syntax-Brillian was a NASDAQ-listed designer, developer and distributor of high-definition televisions based out of Tempe, Arizona that filed for chapter 11 protection in 2008. Influential in precipitating the Company’s chapter 11 filing in 2008 was the confluence of an SEC inquiry, four class action securities lawsuits, and a derivative shareholder complaint, each brought against the company with respect to allegedly false statements and omissions in its public disclosure filings. In 2009, the bankruptcy court confirmed a chapter 11 plan (the “Plan”) that provided for the liquidation of Syntax-Brillian’s assets, and authorized the establishment of a liquidating trust and appointment of the Trustee.
Equity holders were to receive no distributions under the Plan. However, the Plan provided that if there were residual assets in the estates following the satisfaction of prepetition and administrative claims, the estates’ liquidating trustee (the “Trustee”) could seek authority to make distributions to equity holders. Equity holders made various attempts during the Debtors’ chapter 11 proceedings to obtain value by raising allegations of fraudulent acts by certain of the Debtors’ management and suppliers. During the cases, the bankruptcy court recognized that Company was the victim of a fraud, apparently perpetrated by certain members of its management team as well as its suppliers. Although the Trustee pursued various causes of action, including against the former officers and directors of the Debtors, holders of unsecured claims have only received distributions representing 21% of their allowed claims, and it is not expected that equity holders will receive a distribution.
Seemingly unsatisfied with the efforts of the Trustee to fully prosecute the fraud allegations, a group of former equity holders (the “Movants”) brought a motion to remove the Trustee on the grounds that the Trustee has (1) concealed forgeries perpetrated by the Debtors, and denied access to or destroyed forged documents, and (2) failed to treat all shareholders equally by entering into litigation settlements with certain other creditors.
The bankruptcy court reviewed a Liquidation Trustee Agreement among the Trustee and certain of the Debtors’ creditors, which provided that the Trustee could be removed “for cause” by an order of the Court. Furthermore, section 324 of the Bankruptcy Code provides that the Court may remove a trustee for cause after notice and a hearing. The bankruptcy court questioned whether section 324 applies to a post-confirmation liquidating trustee appointed pursuant to a plan or trust agreement, but conducted the removal analysis in any event.
Determining “cause” for the removal of a trustee is not defined by the Bankruptcy Code, but is determined on a case-by-case basis. However, “a party seeking removal of a trustee must prove actual injury or fraud.” The Court acknowledged that the Movants had suffered harm on account of the collapse of the Debtor companies, but found that the Movants did not prove (1) that they were harmed by the actions of the Trustee, (2) that the Trustee failed to perform his duties under the Plan, or (3) that there was evidence of gross negligence, breach of breach of fiduciary duty, breach of trust, or reckless or willful mishandling of the liquidation trust assets. Accordingly, the Court denied the motion to remove the Trustee.
Despite alleging that the Trustee was appointed by a plan that “concealed a massive forgery that was used to implement [a] Ponzi scam”, the Court found that the Movants did not provide any evidence of such concealment. The Court found instead that the motion to remove the Trustee was merely reiterative of arguments made in other shareholder pleadings that have sought to invalidate most of the events that have taken place in the chapter 11 cases since 2008. Contrary to the Movants’ assertions, the Court held that the Trustee has pursued various causes of action, including against the former officers and directors of the Debtors, and had not improperly denied access to or destroyed the Debtors’ books and records.
With regards to the Movants’ second argument, the Court held that the trustee had authority to enter into settlements without disclosure to other shareholders, and accepted the Trustee’s argument that the settlement was entered into to stop the burn of legal fees associated with those litigants.
Despite being acutely aware of the suffering endured by the Debtors’ shareholders on account of the collapse of the company, the Court found that such suffering was not a result of the Trustee’s conduct, and thus, consistent with the appropriate legal principles, dismissed the Movants’ motion.
Syntax-Brillian reminds us that the bankruptcy court will steadfastly apply the Bankruptcy Code and its associated legal principles, and will not grant an adversely affected parties’ requested relief merely based a parties’ suffering. Although the Bankruptcy Code can provide many avenues for relief for parties in interest, the bankruptcy court in Syntax-Brillian had previously held that the plight of the equity holders was neither “neither remarkable nor fixable” and that their continued litigation was merely “throwing good money after bad in pursuit of an investment that went bust eight years ago”. Lamentably for the Movants, bankruptcy courts are courts of equity, not courts of sympathy, and there comes a time in every case where the parties have to cut their losses and go home. According to the bankruptcy court in Syntax-Brillian, that time has long since passed.