In Claybrook v. Morris, 2006 Bankr. LEXIS 1123 (Bankr. D. Del. June 23, 2006), the trustee filed suit against the officers and directors of the debtor, a wholly owned subsidiary of another corporation.  The trustee’s claims included breach of fiduciary duty, aiding and abetting breach of fiduciary duty and breach of employment contracts. 

The defendants filed a motion to dismiss the breach of duty claims on the grounds that their duties were owed to not to the debtor but to the parent corporation.  The court disagreed —

The defendants argue that the directors do not owe any duties to the subsidiary itself. In support of this, the defendants rely principally on Southwest Holdings, L.L.C. v. Kohlberg & Co. (In re Southwest Supermarkets, L.L.C.), 315 B.R. 565 (Bankr. D. Ariz. 2004), in which the court interpreted Delaware corporate law to the effect that "Delaware law appears to hold that when a subsidiary is wholly owned, its officers and directors owe their fiduciary duties solely to the single shareholder, and not to the subsidiary corporation itself" and that "there is nothing to suggest this law changes when the corporation becomes insolvent." Id. at 575-76. I respectfully do not agree with that interpretation, however. In my view, Delaware law would recognize that the directors and officers of an insolvent wholly-owned subsidiary owe fiduciary duties to the subsidiary and its creditors. This view is supported by a number of courts that have addressed the issue.

The Southwest court relied on the Delaware Supreme Court’s decision in Anadarko Petroleum Corp. v. Panhandle Eastern Corp., 545 A.2d 1171 (Del. 1998) for the proposition that the directors of a wholly-owned insolvent subsidiary owe fiduciary duties to the parent but not the subsidiary corporation. I do not believe that Anadarko advances this position.

Rather, the issue in Anadarko involved "whether a corporate parent and directors of a wholly-owned subsidiary owe fiduciary duties to the prospective stockholders of the subsidiary after the parent declares its intention to spin-off the subsidiary." Anadarko, 545 A.2d at 1172. The Delaware Supreme Court concluded "that prior to the date of distribution the interests held by Anadarko’s prospective stockholders were insufficient to impose fiduciary obligations on the parent and the subsidiary’s directors." Id. Thus, Anadarko did not address the situation addressed here.

The court further found that it would be inconsistent to hold that directors owed a duty to creditors when the company was in the "zone of insolvency" but not to the corporation itself prior to entering that zone —

According to Southwest, the directors of a wholly-owned insolvent subsidiary do not owe any fiduciary duties to the subsidiary corporation but nevertheless owe fiduciary duties to the subsidiary’s creditors. Southwest, 315 B.R. at 575-76. This result is awkward. Under Delaware law, creditors of an insolvent corporation are owed. fiduciary duties. Geyer v. Ingersoll Publications Co., 621 A.2d 784, 787 (Del. Ch. 1992). These duties, however, are typically derivative of the duties owed to the subsidiary corporation itself. See Production Resources Group, L.L.C. v. NCT Group, Inc., 863 A.2d 772, 791-92 (Del. Ch. 2004); see also DONALD J. WOLFE, JR. & MICHAEL A. PITTENGER, CORPORATE AND COMMERCIAL PRACTICE IN THE DELAWARE COURT OF CHANCERY § 9-2 [a] (2005) ("[C]laims brought by creditors of an insolvent corporation for breach of duty on the part of directors for harming the economic value of the firm have . . . been characterized as derivative. . . ."). Thus, if the subsidiary’s creditors are said to be owed a fiduciary duty upon insolvency, the subsidiary itself must also be owed such a duty. Prod. Res., 863 A.2d at 791-92.

While the holding of this case is limited to Delaware corporations, it obviously may affect cases in other jurisdictions that look to Delaware law as persuasive, including Georgia.  It is important to note, however, that the Delaware state courts will have the last word on the issue. 

It obviously may provide a deterrent for the officers and directors of a parent company to dump a subsidiary into bankruptcy with the assumption that the subsidiary’s officers and directors (often the same individuals) will enjoy immunity for their actions.