The Bottom Line
The Fifth Circuit, in In the Matter of: ATP Oil & Gas Corp. (Tow v. Bulmahn, et. al.), dismissed breach of fiduciary duty claims and fraudulent transfer claims brought by a chapter 7 trustee relating to cash bonuses and dividend payments made pre-bankruptcy to the officers and directors of a financially distressed company. In doing so, the Fifth Circuit identified several key shortcomings in the trustee’s complaint, and reaffirmed the protections of the business judgment rule when it comes to the decisions that officers and directors make while a company is in financial trouble, particularly with respect to executive compensation.
ATP Oil & Gas Corporation (“ATP”) suffered in the wake of the 2010 Deepwater Horizon explosion and oil spill, and by the summer months of 2012 was contemplating filing for bankruptcy. But before entering bankruptcy, ATP’s board of directors approved a special dividend payment for stock holders, and sizeable cash bonuses to some of its officers and directors.
After filing for chapter 11 relief, ATP’s case was converted to chapter 7, and the trustee brought suit against ATP’s officers and directors, alleging that “ATP’s cash bonuses and preferred stock dividend payout represented breaches of fiduciary duties by the [o]fficers and [d]irectors under Texas law; the cash bonuses amounted to fraudulent transfers for which ATP did not receive equivalent value in exchange; and the [o]fficers and [d]irectors conspired to breach their fiduciary duties, or aided and abetted such breaches.” In the Matter of: ATP Oil & Gas Corp. (Tow v. Bulmahn, et. al.), Case No. 17-30077 [Doc. 514213228] at 4 n.3 (5th Cir. Oct. 27, 2017).
Originally assigned to the Southern District of Texas Bankruptcy Court, the dispute was transferred to the District Court for the Eastern District of Louisiana, where the district court granted the officers’ and directors’ 12(b)(6) motions to dismiss the Trustee’s complaint. The trustee appealed, and the Fifth Circuit affirmed the district court’s dismissal.
The Fifth Circuit Opinion
In an unpublished opinion, the Fifth Circuit affirmed the district court’s dismissal of the trustee’s breach of fiduciary duty claims, civil conspiracy and aiding and abetting claims regarding the purported breaches of fiduciary duties, and fraudulent transfer claims.
With respect to the breach of fiduciary duty claims, in dismissing the claims the Fifth Circuit focused on the fact that the trustee failed to allege with specificity which officers and which directors authorized the disputed payments, along with the fact that the trustee failed to distinguish between the different roles of the officers and directors (but instead alleged improprieties by the officers and directors generally). The court also found the trustee’s complaint lacking with respect to the trustee’s allegations that the cash bonuses paid to the officers and directors were improper and excessive, citing to the lack of any indication in the complaint that the bonuses were not comparable with bonuses made to executives at other similarly situated companies. Likewise, the court pointed out that, with respect to the trustee’s allegation that the company was insolvent during the relevant time period, the trustee failed to present any information showing that ATP was insolvent or had insufficient capital when the bonus payments were made. Importantly, the court also emphasized the protections afforded to the officers and directors on account of the “business judgment rule,” which “generally protects corporate officers and directors, who owe fiduciary duties to the corporation, from liability for acts that are within the honest exercise of their business judgment and discretion.” Id. at 6 (quoting Sneed v. Webre, 465 S.W.3d 169, 173 (Tex. 2015)). Recognizing that the award of cash bonuses and other compensation to officers and directors during a time of financial hardship may ultimately benefit a distressed company, the Fifth Circuit explained:
Executives may judge that continuing to compensate corporate management during times of financial hardship may be necessary to retain those employees. And during a time of potential insolvency, retaining corporate leadership may be the best way to revitalize the corporation.
Id. at 9. The Fifth Circuit reiterated that the courts will generally not interfere with a company’s affairs “unless officers or directors commit acts that are ultra vires, fraudulent, or oppressive to minority shareholder rights.” Id. at 9 (citation omitted).
Why This Case is Interesting
There are two ramifications of the decision – one specific and one more general. By identifying several shortcomings in the trustee’s complaint against the defendant officers and directors, this case clearly signals the Fifth Circuit’s views regarding the specificity needed for a complaint of this nature. This includes clearly identified defendants and their respective roles, non-conclusory allegations as to the impropriety of a bonus award, and more than bare-bones assertions as to a company’s insolvency.
However, the decision also more generally recognizes that there are numerous decisions that a distressed company’s board must make in navigating the choppy waters of distress which events may ultimately lead to a potential filing. By embracing the flexibility afforded by the business judgment rule, including to stabilize operations, the court recognizes that executive compensation may be a bona fide consideration for a financially distressed business to retain key personnel and, therefore, bonuses are not per se improper. Nonetheless, boards should proceed with caution as to the timing and size of any such bonuses and comparable support before awarding them. One thing remains clear – pre-bankruptcy bonuses will always attract scrutiny (whether or not ultimately found to be within the business judgment rule).