For many litigants, the decision whether to prosecute or defend a lawsuit vigorously boils down to a rather basic calculus: What are my chances of success? What is the potential recovery or loss? Is this a “bet the company” litigation? And, how much will I have to pay the lawyers? In many respects, it is not all that different from a poker player eyeing his chip stack and deciding whether the pot odds and implied odds warrant the call of a big bet.
In a traditional litigation, parties usually do not know the other party’s entire hand until discovery is conducted. Parties usually can estimate their chance of success at trial and calculate whether it makes financial sense to continue to invest in their hand. And the judge usually does not care who wins, as he or she should be interested only in seeing that the game is played fairly, in accordance with the rules.
These are some basic assumptions that often guide the way litigation plays out. However, many of them—and sometimes all—get thrown out the window when defending a director or officer in an adversarial proceeding in a bankruptcy court. As explained in detail below, the unique interplay between the bankruptcy court, a trustee for a bankruptcy estate, the bankruptcy estate itself, and a defendant who served as a director or officer of a now-bankrupt company requires a different approach to risk assessment.
A trustee is likely to already have the vast majority of a defendant’s responsive discovery—i.e., data owned by the estate.
Rarely do plaintiffs have many of the documents, access to former employees, outlines of likely testimony, and other evidence they need to prove their case prior to the start of litigation. They may have enough on “information and belief” to assert the necessary allegations and elements in a complaint to survive a motion to dismiss, but until discovery runs its course, they rarely have the smoking gun or the chain of documents necessary from the defendant’s files to pull their case together. Instead, those documents sit in the possession of the defendant, in its files, data centers, and the memories of its employees— repositories to which plaintiffs rarely have access prior to the commencement of formal discovery.
But, in the bankruptcy context, the plaintiff-trustee often does not need to wait for discovery because the trustee likely comes loaded for bear with documents, interviews with former employees, and a map of the case with key supporting evidence before the complaint is even drafted. If the defendant is a former officer or director, that defendant’s relevant acts and statements are likely already captured in files and documents owned and retained by the bankrupt company itself—e.g., board meeting minutes, emails housed on company servers, or company purchase or sale orders. There may still be some documents and data that the plaintiff-trustee lacks—maybe emails between board members sent from their personal email accounts—but a lot of data that will be needed to substantiate a claim will already be in the plaintiff-trustee’s possession.
A trustee will have had the opportunity to fully analyze his position.
As discussed above, the plaintiff-trustee will likely have a wealth of relevant data in his possession before he and his outside counsel even consider filing an adversary action. This often means that the plaintiff-trustee had the opportunity to review that data, interview employees and other individuals, and consult with his lawyers before bringing an adversary action. Given that the adversary proceeding will likely be filed with the same judge overseeing the bankruptcy itself, the plaintiff-trustee will already have a good feel for how the bankruptcy judge may resolve an adversary proceeding. And the plaintiff-trustee probably knows the personality of the company well enough to decide whether to go after an entire board of directors or instead take a divide and conquer strategy and target specific individual directors and officers; taking whichever approach is most likely to score a payout from the D&O insurance policy at risk in either scenario. After all, the plaintiff-trustee views the D&O insurance policy as an asset of the estate and is just evaluating how best to unlock the policy limits.
The takeaway here is that, unlike many plaintiffs, a trustee often has an opportunity to review a significant amount of responsive material, consult his experts, and weigh his likelihood of success. He may have even reached settlements and entered cooperation agreements with other officers, directors, employees and/or third parties earlier in the proceedings in a manner that helps his pursuit of certain officers and/or directors. This means a trustee—and his counsel working on contingency—is unlikely to be firing blind or bluffing when filing an adversary action; to the contrary, there is a greater possibility that he has reason to hold a certain level of confidence in his case.
A trustee has personal incentives.
Trustees bring suits against former directors and officers in order to augment the assets in the bankruptcy estate.1 However, trustees also have some distinct personal incentives that influence their decision whether to pursue an adversary proceeding. Chapter 7 trustees receive a commission based on a sliding scale relative to the amount of money disbursed by the estate to professionals and creditors. Specifically, 11 U.S.C. § 326 allows a trustee to receive 25% of the first $5,000; 10% of amounts between $5,000 and $50,000; 5% of amounts between $50,000 and $1 million; and 3% of amounts over $1 million. Therefore, if a trustee can bring a profitable adversary proceeding against a former director or officer, the trustee himself profits. But, simultaneously, if funds are spent on what results in being an unsuccessful litigation, the trustee will have less to pay creditors and, therefore, less to pay himself.
Bankruptcy judges usually have deep connections to the local bankruptcy bar.
Unlike federal district court judges, bankruptcy judges are appointed and serve terms of fourteen years.2 These appointments are made by the courts of appeals for the circuit in which the bankruptcy court is found, meaning that bankruptcy judges are not subject to the same Congressional review and approval as other federal judges.3 Whether it is this hiring process or the fundamental nature of the position that causes it, bankruptcy judges often have a different background than other federal judges. For example, in four of the busiest bankruptcy courts across the country, over 80% of the bankruptcy judges were in private practice immediately before taking the bench, many of them as active members of the local bankruptcy bar. Compare this to the U.S. District Court for the District of Columbia, where only about half of the judges took their seats on the federal bench immediately after leaving private practice.
But this goes deeper than simply the number of judges who may have been in private practice before taking the bench. It is important to note that the bankruptcy bar is a smaller, more focused and closer-knit bar.4 Indeed, in many bankruptcy courts, it is not unheard of that an attorney may be serving as a trustee in one matter and as counsel for the trustee in another; where counsel for the trustee in the first is the trustee in the second. This creates a heightened level of familiarity between members of this bar—and with the bankruptcy judges who preside over it. Further, when a bankruptcy case also requires counsel for various individual creditors, for the unsecured creditors committee, and all the other various constituents and interests in a bankruptcy case, it potentially involves all local bankruptcy counsel in a larger matter. There is no analogue in the courts of general jurisdiction. Resultantly, when individuals are elevated from this small pool to positions as bankruptcy judges, they are inherently bringing with them an intimacy and collegiality with this local bar.