Secured Creditors Beware The Latest Tool in the Creditors Committee Toolbox Aiding and Abetting in the Breach of a Fiduciary Duty

Secured Creditors Beware The Latest Tool in the Creditors Committee Toolbox Aiding and Abetting in the Breach of a Fiduciary Duty

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Most chapter 11 debtors are more leveraged than ever before. With the increased debt leverage, secured creditors are entitled to get paid first and to receive everything. The only hope for a meaningful recovery by unsecured creditors, as well as any other stakeholders, is if the secured liens are avoided or the secured claims are disallowed or subordinated.2 Accordingly, creditors' committees and trustees are becoming more creative and aggressive with respect to actions brought in order to claim some piece of the secured creditors' pie for the benefit of the unsecured creditors. In a recent article published in the ABI Journal, I stated that deepening insolvency was another tool that had been added to the creditors' committee's toolbox and now was a standard part of the "kitchen sink" complaint filed by creditors' committees in chapter 11 cases.3 Another tool in the creditors' committee toolbox is a claim of aiding and abetting in the breach of a fiduciary duty, thereby causing harm to the unsecured creditors for which the creditors should be compensated. Of late, the aiding-and-abetting argument is a standard count in the "kitchen sink" complaint lobbed at secured creditors and is appearing in almost every significant chapter 11 case including, but not limited to, such recent cases such as Adelphia,4 Enron5 and Exide Technologies.6

The Sharp Case

Claims for aiding and abetting in the breach of fiduciary duty began to appear with gusto after the decision in Sharp International in 2003.7 In that case, the bankruptcy court dismissed the complaint against the lender for failure to state a claim, specifically finding that the complaint failed to sufficiently identify any affirmative act of participation by the lender in the principals' fraud. The district court affirmed the dismissal.


Under the laws of most states where aiding and abetting are recognized, a claim for aiding and abetting the breach of a fiduciary duty requires a showing that there (1) existed a fiduciary relationship, (2) was a breach of the fiduciary's duty, (3) was a knowing participation in the breach by a defendant who is not a fiduciary and (4) that damages are proximately caused by the breach.8 Furthermore, to the extent the underlying breaches of fiduciary duty are based on fraudulent conduct, the complaint must meet the requirement of Rule 9(b) of the Federal Rules of Civil Procedure, which mandates that all allegations of fraud must be pled with particularity. However, Rule 9(b)'s particularity requirement does not apply to "conditions of the mind"—including knowledge—that may be averred generally.9

Actual Knowledge

There is no requirement that the aider and abettor have an intent to harm. Rather, to satisfy the knowledge prong, the defendant must have actual knowledge of the primary violator's underlying breach of fiduciary duty—negligence or recklessness is generally insufficient. "Constructive knowledge" of the breach of a fiduciary duty is legally insufficient to impose aiding-and-abetting liability.10 Facts must be alleged that the defendant actually knew about the fraud. In fact, a recent court in New York stated:

Actual knowledge of a violation is necessary as New York "has not adopted a constructive knowledge standard for imposing aiding and abetting liability." It is thus insufficient to assert that the [d]efendants should have known of misdeeds by [the fiduciaries]. Thus, [the plaintiffs] must allege and prove that the [d]efendants had actual knowledge that the [fiduciaries] breached their fiduciary duties and intentionally provided them with assistance in this connection.
Lesavoy v. Lane, 304 F.Supp.2d 520, 524 (S.D.N.Y. 2004), citing Clark v. TRO Learning Inc., No. 97 C 8683, 1998 WL 292382, at *5 (N.D. Ill. May 20, 1998). The court in the Lesavoy case specifically found that the allegation that the defendants "knew or were reckless in failing to know" did not satisfy the actual knowledge standard required for an aiding-and-abetting claim.

Moreover, with respect to analyzing whether a lender had "actual knowledge" sufficient to satisfy the standards for a claim of aiding and abetting in a breach of fiduciary duty, case law suggests that assertions that an alleged aider and abettor harbored well-founded—but unconfirmed—suspicions of the primary violator's wrongdoing are not sufficient to plead actual knowledge simply because, with the benefit of hindsight, those suspicions turned out to be correct.11 Generally, given the complexity of the cases in which the aiding-and-abetting claim has been raised, where an alleged aider and abettor in fact undertakes an investigation of the primary wrongdoer's conduct, determining the precise point at which evidence giving rise to suspicions of fraud reaches a cumulative critical mass sufficient to support an inference of actual knowledge is factually intensive and not easily resolved on the face of the pleadings.12

Facts of motive and opportunity are also not sufficient to support a finding of actual knowledge. Conclusory allegations that a defendant had a motive and opportunity to formulate actual knowledge are insufficient and will not survive a motion to dismiss.13 Moreover, even if a plaintiff alleges facts of motive and opportunity that allow strong inferences to be drawn to establish actual knowledge, it is not enough to survive to satisfy the standard.14

Knowing Participation

The "knowing participation" element of the aiding-and-abetting claim requires more than the defendant's knowledge of the primary violation.15 To state a claim, a plaintiff must allege some sort of participation by the alleged aider and abettor in the primary wrongdoing. Broadly speaking, the case law identifies two forms of actionable "participation." Aiding-and-abetting liability can attach where a defendant provides substantial assistance to the wrongdoer.16

Substantial Assistance

The determination of whether the lender provided substantial assistance requires an analysis of the nature of the act, how much assistance was actually provided and the person's state of mind.17 Substantial assistance is provided when there is affirmative assistance to help conceal, or by virtue of failing to act when doing so enables a breach of a fiduciary duty to proceed.18 Generally, inaction, such as a failure to investigate or to alert third parties about another's misconduct, does not constitute substantial assistance in the absence of an independent duty to act.19 Further, the existence of the primary violator's duty is not sufficient to hold a non-fiduciary secondary actor liable for inaction based on an aiding-and-abetting theory:20

[I]t is unlikely that there will be much case law generated specifically on aiding and abetting the breach of fiduciary duty.

It is well settled that without an independent duty to disclose, mere inaction does not amount to substantial assistance for purposes of determining aider and abettor liability.21

For example, in the Sharp case, the debtor's action against its lender for aiding and abetting the debtor's principals in the breach of fiduciary duty was based on the debtor's assertion that the principals caused the debtor to obtain a loan from the lender/defendant by inflating revenues to obtain the loan. The debtor further alleged that the lender knew of the inflation as evidenced by an independent investigation conducted by the lender, which revealed that many of the receivables reported by the principals were fictitious.22 The principals subsequently caused the debtor to raise additional capital through a note offering, the proceeds of which were used, in part, to pay down the obligation to the lender, with the remaining funds inappropriately taken by the principals. Although the court determined that actual knowledge had been adequately pled in reciting the investigation and the information it provided, the court ultimately granted the lender's motion to dismiss because the debtor could not plead substantial assistance based on the lender's inaction.

Inducing or Encouraging a Breach of Fiduciary Duty

Second, "participation" can be found even without directly assisting the commission of the underlying wrong. A defendant may still be liable as an aider and abettor for "inducing" or "encouraging" a fiduciary to breach his duties to another.23 The Restatement (Second) of Torts explains that "[a]dvice or encouragement to act, in instances where 'the act' encouraged is known to be tortious...has the same effect upon the liability of the advisor as participation or physical assistance."24 A lender is not a fiduciary of a borrower and has no duty to act simply because it suspects or even knows of a fraud perpetuated by the borrower's management. The legal relationship between a borrower and a lender is a contractual one of debtor and creditor and does not create a fiduciary relationship between the lender and the borrower.25 There is very little authority setting forth exactly what conduct qualifies as inducement.26 However, it is difficult for a court to hold a lender accountable for inducing a fraudulent scheme that was underway before the lender is alleged to have any knowledge of it. Clearly, the actors would require no encouragement or inducement to defraud creditors when funds had already been diverted by the time the lenders are supposed to have discovered the fraud.27


It is clear that claims for aiding and abetting the breach of a fiduciary duty are being seen in high-stakes cases with regularity. As with many of the new creative theories being prosecuted by creditors' committees, it is unlikely that there will be much case law generated specifically on aiding and abetting the breach of fiduciary duty. Most cases are likely to result in a global settlement, of which the aiding and abetting claim is only a small part. In fact, in the Exide case, a count for aiding and abetting was included in the complaint against the group of lender defendants, and the court did not specifically address the count at all when it analyzed the probability of the success on the merits of the various counts in order to determine whether to approve the settlement.28 The court included a more general statement, which will apply to many of the cases where a "kitchen sink" complaint is filed against the secured lenders: "There is no doubt that this litigation involves complex issues on a variety of topics that will require costly and time-consuming discovery in addition to a potentially lengthy trial, possibly delaying the debtor's exit from chapter 11."29 Accordingly, given the motivation and incentive for creditors' committees to proceed aggressively, it is likely that the aiding-and-abetting claim is here to stay unless a strong decision is issued by some court that would provide precedent that the claim cannot be brought without violating the standards of Rule 11.


1 Ms. Brighton is special counsel with Kennedy Covington Lobdell & Hickman, Charlotte, N.C., in the Debt Finance Group, where she practices primarily in the areas of bankruptcy, workouts and secured lending. She is Board Certified in Business Bankruptcy Law by the American Board of Certification. Return to article

2 See Grillo, "From First Dibs to the Last in Line," 25 N.Y.L.J. (Col. 11) 8/18/03. Return to article

3 See Brighton, Jo Ann J.,"Deepening Insolvency—Secured Lenders and Professionals Beware, It is not Just for Officers and Directors Anymore,"ABI Journal Vol. XXXIII, No. 3 (April 2004). Return to article

4 In re Adelphia Comm. Corp., Case No. 02-41729 (Bankr. S.D.N.Y.). Return to article

5 In re Enron Corp., Case No. 01-16034 (Bankr. S.D.N.Y); see, also, Fox and Friedman 21 No. 2 Bankr. Strategist, "Enron Versus Wall Street" (Dec. 2003). Return to article

6 In re Exide Technologies Inc., 299 B.R. 732 (Bankr. D. Del. 2003) (court determined creditors stated claim against lenders for aiding and abetting debtor's breach fiduciary duty and ultimately settled). Return to article

7 In re Sharp Int'l. Corp., 302 B.R. 760 (E.D.N.Y. 2003). Return to article

8 See Exide, 299 B.R. at 749; Sharp, 302 B.R. at 770; see, also, 1 Lender Liability: Law, Prac. & Prevention §5.10 (2004). Return to article

9 Fed. R. Civ. Proc. 9(b); Sharp, 302 B.R. at 770. Return to article

10 Sharp, 302 B.R. at 770 (other citations omitted); see, also, 1 Lender Liability: Law Prac & Prevention §5.10; Exide, 299 B.R. at 749-50; Fox and Friedman 21 No. 2 Bankr. Strategist, "Enron Versus Wall Street" (Dec. 2003). Return to article

11 Sharp, 302 B.R. at 771-72, citing Ryan v. Hunton & Williams, 2000 WL 1375265 (E.D.N.Y. Sept. 20, 2000); see, also, Remer v. Chase Manhattan Bank, 2000 WL 781081 at *12 (S.D.N.Y. June 16, 2000) (granting §12(b)(6) motion to dismiss claim against a bank for aiding and abetting customer's prime bank guarantee scam, despite bank official's suspicions of fraud—which led them to reject one of the customer's proposed transactions, because the complaint alleged no "factual basis for the assertion that the bank officials actually knew the fraud (which they suspected) was in fact, occurring"); Kolbeck v. LIT America Inc., 939 F. Supp. 240 (S.D.N.Y. 1996) (finding that brokerage firm could not be charged with knowledge despite defendants' awareness of plaintiff's accusations, "knowledge of accusations without more did not give rise to duty to investigate, and did not support on inference of actual knowledge)." Return to article

12 Sharp, 302 B.R. at 772. Return to article

13 See In re Compuware Sec. Litig., 301 F.Supp. 2d 672 (E.D. Mich. 2004). Return to article

14 In re Stone & Webster Inc., Sec. Litig., 253 F.Supp.2d 102, 112 (D. Mass. 2003), quoting Greebel v. FTP Software Inc., 194 F.3d 185, 197 (1st Cir. 1999). Return to article

15 Sharp, 302 B.R. at 774; 1 Lender Liability: Law, Prac. & Prevention §5.10. Return to article

16 Sharp, 302 B.R. 774. Return to article

17 Sharp, 281 B.R. at 771-72; 1 Lender Liability: Law, Prac & Prevention §5.10; Restatement (Second) Torts §876 clause (b). Return to article

18 Id. Return to article

19 Sharp, 302 B.R. at 774; see, also, McDaniel v. Bear Stearns Co., 196 F.Supp.2d 343, 352 (S.D.N.Y. 2002); 1 Lender Liability: Law, Prac & Prevention §5.10; Calcutti v. SBU Inc., 273 F.Supp.2d 488, 494 (S.D.N.Y. 2003); Nat'l. Westminster Bank USA v. Weksel, 124 A.D. 2d 144, 511 N.Y. S.2d 626 (1st Dep't. 1987). Return to article

20 Sharp, 302 B.R. at 774. Return to article

21 Calcutti v. SBU Inc., 273 F. Supp. 2d 488, 494 (S.D.N.Y. 2003). Return to article

22 Sharp, 302 B.R. at 772. Return to article

23 Sharp, 302 B.R. at 775, citing Kaufman, 760 N.Y.S.2d at 169; see, also, McDaniel, 196 F.Supp. at 352. Return to article

24 Restatement (Second) of Torts §876, comment "d"; see, also, Sharp, 302 B.R. at 775, citing Lindsay v. Lockwood, 163 Misc.2d 228, 233, 625 N.Y.S.2d 393, 397 (Sup. Ct. Monroe Co. 1994) (the archetypical aiding-and-abetting defendant is one who encourages another to commit a tortuous act). Return to article

25 Sharp, 302 B.R. at 776-77 (other citations omitted). Return to article

26 Sharp, 302 B.R. at 777. Return to article

27 See Sharp, 302 B.R. at 777. Return to article

28 Exide, 303 B.R. at 68. Return to article

29 Id. Return to article

Journal Date: 
Friday, October 1, 2004