Trustee Liability and the Curious Case of Maxwell v. KPMG, LLP

The dust from Maxwell I had hardly settled when the Seventh Circuit issued a subsequent, unpublished order (“Maxwell II“) on KPMG's motion for sanctions against the trustee and his attorneys under Appellate Rule 38. See Maxwell v. KPMG, LLP, Case No. 07-2819, Aug. 19, 2008 Order, at 5. In Maxwell II, the court resisted the predilection for personal sanctions that was apparent in Maxwell I, and it instead determined that the trustee was not personally liable for sanctions because he did not willfully violate his fiduciary duties in pursuing the underlying lawsuit and appeal. See Id. at 6.

Though Maxwell II reinforced the qualified immunity of bankruptcy trustees from personal sanctions, its limited dissemination as an unpublished order removed little of the sting from the contrary dicta of Maxwell I. Courts and practitioners are still taking pot shots at trustees based on Maxwell I. See, e.g., Moglia v. Pac. Employers Ins. Co., 547 F.3d 835, 839 (7th Cir. 2008). Their consequent misinterpretation of trustee liability on the basis of Maxwell I poses an undue risk of sanctions to trustees. It also adds another layer of confusion upon an area of bankruptcy law that is already confused due, in large part, to a circuit split on the appropriate standard for imposing personal liability upon bankruptcy trustees.

This article attempts to sort out some of the confusion. It examines the issue of trustee liability in the context of the two Maxwell decisions, and it reviews the applicable standards that have developed in the various circuits. Trustees and their attorneys must be ever mindful of these standards and the corresponding limitations of trustee immunity as they pursue litigation on behalf of the estates they serve.

Maxwell I: The Dicta Heard 'Round the World

Bad facts might make bad law, but an angry judge can make even worse law. Maxwell I's dicta on the personal liability of bankruptcy trustees serves as proof. It arose from a lawsuit in which a trustee had sued KPMG for malpractice in connection with its auditing services for one of the debtor's predecessors. Maxwell I, 520 F.3d at 714-715. The trustee premised his claims on the theory that if KPMG had properly disclosed overstated income and earnings reports produced shortly before the predecessor's acquisition of another company, the acquisition negotiations would have ceased and the predecessor would have continued in business unsaddled with the financial burdens imposed by the acquisition. See Id. at 715-716. The trustee's complaint sought more than $600 million in damages, a demand that was based upon the estimated value that the predecessor would have had on the petition date absent the acquisition. See Id. at 714, 717-718.

The Seventh Circuit's rejection of the trustee's theories of liability and damages was unequivocal and severe. It found nothing in the applicable law that would permit an auditor like KPMG to serve as “the insurer against the folly (as it later turned out) of a business decision (the decision to try to acquire U.S. Web) unrelated to what an auditor is hired to do.” See Id. at 717. The Seventh Circuit was also “particularly disturbed” by the trustee's damages claim, describing it as “outlandish,” “groundless,” and “intimidating.” See Id. at 717-718.

Indeed, it was “[t]he extreme weakness of the trustee's case, both on liability and on damages, [that] invite[d] consideration of the exercise of litigation judgment by a Chapter 7 trustee.” See Id. at 718. The court noted that “while the management of a going concern has many other duties besides bringing lawsuits, the trustee of a defunct business has little to do besides filing claims that if resisted he may decide to sue to enforce.” See Id. It consequently urged judges to impose sanctions against trustees that file frivolous suits, and it parenthetically noted that such sanctions should “of course ' be paid by the trustee personally, not by the bankrupt estate.” See Id. at 718-719.

Notwithstanding the certainty with which it was stated, Maxwell I's suggestion of an award of personal sanctions against the trustee was surprising and completely unsupported. It not only contradicted the decision's earlier intimation that bankruptcy judges could police a trustee's
litigation judgment through appropriate discounts on trustee compensation (see Id. at 718 (citing 11 U.S.C. ' 330(a)(4)(A)(ii)(I))), but it also contradicted well-established principles of trustee liability and qualified personal immunity. See Id. at 719.

The Fundamentals of Trustee Liability and Qualified Immunity

The Bankruptcy Code does not explicitly confer personal immunity upon bankruptcy trustees, but that immunity is nevertheless evident from the Code's incorporation of fundamental liability principles that were applicable to common law receivers and developed under the Bankruptcy Act. See Schechter v. Illinois (In re Markos Gurnee P'ship), 182 B.R. 211, 214 (Bankr. N.D. Ill. 1995). For example, ' 323 of the Bankruptcy Code provides that bankruptcy trustees have the capacity to sue or be sued in their official capacities as representatives of their estates. See 11 U.S.C. ' 323. The provision derives from, and consequently appears to incorporate, 19th-century Supreme Court holdings that: 1) treated actions against receivers as implicitly involving only the receivers' official capacity; and 2) as a corollary, recognized the receivers' personal immunity from suit for actions arising out of the operation of their receiverships. See Markos Gurnee, 182 B.R. at 215-217, 224 (discussing and applying McNulta v. Lochridge, 141 U.S. 327, 331-32 (1891)).

The following principles, distilled and summarized from the multitude of authorities that have addressed the issue over the years, generally govern the concepts of trustee liability and qualified personal immunity and their application in practice:

• Trustees are typically immune from suit for actions arising out of the administration of their bankruptcy estates. While bankruptcy trustees are often named as defendants in their official capacities as estate representatives, their estates rather than the trustees personally are liable for corresponding claims. See Id. at 215-217.
• Trustees are not personally liable to injured parties for negligence in carrying out estate duties, but they may be personally liable for deliberate violations of applicable non-bankruptcy law. See Id. at 217-218; see also 28 U.S.C. ' 959 (requiring trustees to manage and operate property in their possession in accordance with state law).
• Trustees are personally liable to injured parties for conduct outside the scope of their duties (i.e., ultra vires acts), such as wrongfully seizing property that does not belong to their estates. See Id. at 217.
• Apart from deliberate violations of applicable non-bankruptcy law and ultra vires acts, the other general exception to the personal immunity of bankruptcy trustees is a claim for breach of fiduciary duty. See Id. at 218-219. The circuits are divided on the appropriate standard to which trustees should be held for breach of fiduciary duty claims.
• Trustees are immune from personal liability for breach of fiduciary duty claims when the bankruptcy court authorizes their actions after providing notice to affected parties and disclosing relevant facts. See Id. at 219-220.

The Circuit Split on Standards for Breach of Fiduciary Duty

As noted above, courts are divided on the appropriate standard for imposing personal liability on trustees for breaches of fiduciary duty. Some circuits have determined that personal liability should only be imposed for willful and deliberate violations of fiduciary duties, while others permit its imposition for mere negligence in carrying out fiduciary duties. The split of authority traces back to Mosser v. Darrow, 341 U.S. 267 (1951), in which the Supreme Court held that a bankruptcy trustee was personally liable for losses caused by the estate's self-dealing employees. See Id. at 269-270. Courts disagree on the appropriate application of the following passage from Mosser to a trustee's fiduciary standard of care:

We see no room for the operation of the principles of negligence in a case in which conduct has been knowingly authorized ' . The liability here is not created by a failure to detect defalcations, in which case negligence might be required to surcharge the trustee, but is a case of a willful and deliberate setting up of an interest in employees adverse to that of the trust. Id. at 272.

In Sherr v. Winkler, the Tenth Circuit Court of Appeals relied on this passage from Mosser for its holding that bankruptcy trustees are only personally liable for willful and deliberate violations of their fiduciary duties. Sherr v. Winkler, 552 F.2d 1367, 1375 (10th Cir. 1977). The Courts of Appeals for the Fourth, Sixth, and Seventh Circuits have either followed or expressed approval of Sherr. See, e.g., In re Hutchinson, 5 F.3d 750 (4th Cir. 1993); In re Chicago Pac. Corp., 773 F.2d 909, 915 (7th Cir.1985); Ford Motor Credit Co. v. Weaver, 680 F.2d 451, 462 (6th Cir. 1982); but see In re Engman, 395 B.R. 610, 624-25 & n.23 (Bankr. W.D. Mich. 2008) (suggesting that bankruptcy trustees might be held to a negligence standard notwithstanding Weaver)).

However, several other courts, including the Ninth Circuit Court of Appeals, have rejected Sherr and held that, under Mosser, bankruptcy trustees are subject to personal liability for intentional and negligent violations of duties imposed upon them by law. See Hall v. Perry (In re Cochise College Park, Inc.), 703 F.2d 1339, 1357 & n.26 (9th Cir. 1983); but see In re Continental Coin Corp., 380 B.R. 1, 15 (Bankr. C.D. Cal. 2007) (stating that Cochise may no longer be applicable for simple negligence cases). The Courts of Appeals for the First and Second Circuits have followed Cochise and adopted its negligence standard. See LeBlanc v. Salem (In re Mailman Steam Carpet Cleaning Corp.), 196 F.3d 1, 7 (1st Cir. 1999); In re Gorski, 766 F.2d 723, 727 (2d Cir. 1985).

These courts criticize Sherr and its progeny for: 1) ignoring the “unmistakable implication” of the Mosser court's observation that negligence may suffice for personal surcharges against trustees in situations where the duty of care (versus the duty of loyalty) is implicated; and 2) differentiating between surcharges and personal liability. See, e.g., Mailman, 196 F.3d at 7; Cochise, 703 F.2d at 1357, n.26. They note that the term “surcharge,” as used in Mosser, means “the imposition of personal liability on a fiduciary for willful or negligent misconduct in the administration of his fiduciary duties.” See Id. Accordingly, these courts adopt a negligence standard under which bankruptcy trustees are held to the standard of care of an ordinarily prudent person serving in the capacity of trustee. See Cochise, 703 F.2d at 1358.

A third line of authority, including the Fifth Circuit Court of Appeals, takes an “intermediate position” and holds that bankruptcy trustees are only personally liable for grossly negligent violations of their fiduciary duties. See Dodson v. Huff (In re Smyth), 207 F.3d 758, 761-62 (5th Cir. 2000). Gross negligence is defined as “[t]he intentional failure to perform a manifest duty in reckless disregard of the consequences ' It is an act or omission respecting legal duty of an aggravated character as distinguished from a mere failure to exercise ordinary care ' ” Smyth, 207 F.3d at 762.

The Courts of Appeals for the Third, Eighth and Eleventh Circuits have not taken a position on the issue. Consequently, courts in these circuits are divided on the applicable standard for fiduciary duty claims against trustees. See, e.g., In re Red Carpet Corp. of Panama City Beach, 708 F.2d 1576, 1579 (11th Cir. 1983) (“bankruptcy courts have fashioned the remedy of surcharge against a trustee or receiver for loss due to his negligence or wrongful conduct”); Barbee v. Price Waterhouse, LLP (In re Solar Fin. Servs., Inc.), 255 B.R. 801, 804 (Bankr. S.D. Fla. 2000) (gross negligence standard); In re Charlestown Home Furnishing, 150 B.R. 226, 227 (Bankr. E.D. Mo. 1993) (negligence standard); Quinn v. Fidelity & Deposit, Co. of Maryland (In re Sturm), 121 B.R. 443, 447-448 (Bankr. E.D. Pa. 1990) (negligence standard).

Maxwell II: Qualified Immunity Lives On

In Maxwell II, the Seventh Circuit revisited the personal sanctions issue that it had only parenthetically addressed in the dicta of Maxwell I. It disregarded the trustee's argument that he had personal immunity from KPMG because he pursued the lawsuit and appeal consistent with his duties as trustee. Instead, the court considered whether the trustee was liable to KPMG based on a violation of his fiduciary duties. See Maxwell II at 4-5. Considering that the trustee owed no fiduciary duty to a litigation target like KPMG, the court probably should have limited its consideration to whether the estate, which was the real party-in-interest in the underlying suit, was liable for sanctions. Any resulting claim of the estate against the trustee could have been reserved for the bankruptcy court overseeing the case. See Markos Gurnee, 182 B.R. at 220-223.

Nevertheless, the Seventh Circuit ultimately determined that the trustee was not personally liable to KPMG because he did not willfully violate his fiduciary duties. Acknowledging the circuit split on the applicable standards of trustee liability, the court relied upon dicta from its earlier decision in Chicago Pac. Corp. and applied the willful and deliberate standard. See Maxwell II at 5 (citing In re Chicago Pac. Corp., 773 F.2d 909, 915 (7th Cir.1985)). In deciding that the trustee did not willfully violate his fiduciary duties, the court found that the trustee did not have expertise in the areas of accounting or auditing malpractice and that he ultimately relied upon his counsel's judgment that the underlying lawsuit and appeal were in the best interests of creditors. See Id.

Conclusion

Regardless of whether the lasting legacy of the Maxwell decisions will be the fury of Maxwell I as opposed to the more circumspect analysis of Maxwell II, the decisions collectively serve to remind trustees of the standards of fiduciary conduct and personal liability that will apply to their exercise of litigation judgment on behalf of the estates they represent. The willful and deliberate standard, which the Seventh Circuit ultimately applied in Maxwell II and which controls in the Fourth, Sixth and Tenth Circuits, creates a relatively high bar for imposing personal liability upon bankruptcy trustees for actions initiated in the course of an estate's administration. By contrast, the negligence standard adopted by the First, Second and Ninth Circuits and the gross negligence standard adopted in the Fifth Circuit expose trustees to a greater risk of personal liability.

The Maxwell decisions also underscore the necessity of experienced counsel and experts to advise trustees on the merits of the litigation that they intend to pursue on behalf of their estates. In Maxwell II, the Seventh Circuit specifically referred to the trustee's reliance upon experienced litigation counsel as evidence that militated against a finding of willful fiduciary misconduct and personal sanctions in his pursuit of the underlying lawsuit and appeal. See Maxwell II at 5. Even under a negligence or gross negligence standard of trustee liability, that reliance would presumably have had the same militating effect and would have insulated the trustee from personal liability.

Peter J. Roberts and Gordon E. Gouveia are attorneys in the commercial bankruptcy and restructuring group of the law firm of Shaw Gussis Fishman Glantz Wolfson & Towbin LLC in Chicago. They may be reached at [email protected] and [email protected].

Last year, Judge Richard A. Posner of the Seventh Circuit Court of Appeals wrote an opinion that sent shockwaves throughout the bankruptcy community, particularly in trustee circles. The shocking part of Maxwell v. KPMG, LLP , 520 F.3d 713 (7th Cir. 2008) (“ Maxwell I “) was not its holding, but its dicta. In affirming the dismissal of a bankruptcy trustee's $600 million accounting malpractice case, the Seventh Circuit admonished bankruptcy judges to “be vigilant in policing the litigation judgment exercised by trustees in bankruptcy,” and it also suggested the imposition of personal sanctions against trustees who file frivolous lawsuits. See Maxwell I, 520 F.3d at 718-719.

Some commentators have applauded Maxwell I as just deserts for a bankruptcy trustee who brought suit based on overly aggressive theories of liability and damages. Others have been troubled by the Seventh Circuit's criticism of bankruptcy trustees and its unsupported suggestion of personal sanctions against plaintiff trustees. However, almost all commentators have correctly regarded Maxwell I as a cautionary tale for any trustee embarking upon an aggressive litigation strategy.

'Maxwell II'

The dust from Maxwell I had hardly settled when the Seventh Circuit issued a subsequent, unpublished order (“Maxwell II“) on KPMG's motion for sanctions against the trustee and his attorneys under Appellate Rule 38. See Maxwell v. KPMG, LLP, Case No. 07-2819, Aug. 19, 2008 Order, at 5. In Maxwell II, the court resisted the predilection for personal sanctions that was apparent in Maxwell I, and it instead determined that the trustee was not personally liable for sanctions because he did not willfully violate his fiduciary duties in pursuing the underlying lawsuit and appeal. See Id. at 6.

Though Maxwell II reinforced the qualified immunity of bankruptcy trustees from personal sanctions, its limited dissemination as an unpublished order removed little of the sting from the contrary dicta of Maxwell I. Courts and practitioners are still taking pot shots at trustees based on Maxwell I. See, e.g., Moglia v. Pac. Employers Ins. Co. , 547 F.3d 835, 839 (7th Cir. 2008). Their consequent misinterpretation of trustee liability on the basis of Maxwell I poses an undue risk of sanctions to trustees. It also adds another layer of confusion upon an area of bankruptcy law that is already confused due, in large part, to a circuit split on the appropriate standard for imposing personal liability upon bankruptcy trustees.

This article attempts to sort out some of the confusion. It examines the issue of trustee liability in the context of the two Maxwell decisions, and it reviews the applicable standards that have developed in the various circuits. Trustees and their attorneys must be ever mindful of these standards and the corresponding limitations of trustee immunity as they pursue litigation on behalf of the estates they serve.

Maxwell I: The Dicta Heard 'Round the World

Bad facts might make bad law, but an angry judge can make even worse law. Maxwell I's dicta on the personal liability of bankruptcy trustees serves as proof. It arose from a lawsuit in which a trustee had sued KPMG for malpractice in connection with its auditing services for one of the debtor's predecessors. Maxwell I, 520 F.3d at 714-715. The trustee premised his claims on the theory that if KPMG had properly disclosed overstated income and earnings reports produced shortly before the predecessor's acquisition of another company, the acquisition negotiations would have ceased and the predecessor would have continued in business unsaddled with the financial burdens imposed by the acquisition. See Id. at 715-716. The trustee's complaint sought more than $600 million in damages, a demand that was based upon the estimated value that the predecessor would have had on the petition date absent the acquisition. See Id. at 714, 717-718.

The Seventh Circuit's rejection of the trustee's theories of liability and damages was unequivocal and severe. It found nothing in the applicable law that would permit an auditor like KPMG to serve as “the insurer against the folly (as it later turned out) of a business decision (the decision to try to acquire U.S. Web) unrelated to what an auditor is hired to do.” See Id. at 717. The Seventh Circuit was also “particularly disturbed” by the trustee's damages claim, describing it as “outlandish,” “groundless,” and “intimidating.” See Id. at 717-718.

Indeed, it was “[t]he extreme weakness of the trustee's case, both on liability and on damages, [that] invite[d] consideration of the exercise of litigation judgment by a Chapter 7 trustee.” See Id. at 718. The court noted that “while the management of a going concern has many other duties besides bringing lawsuits, the trustee of a defunct business has little to do besides filing claims that if resisted he may decide to sue to enforce.” See Id. It consequently urged judges to impose sanctions against trustees that file frivolous suits, and it parenthetically noted that such sanctions should “of course ' be paid by the trustee personally, not by the bankrupt estate.” See Id. at 718-719.

Notwithstanding the certainty with which it was stated, Maxwell I's suggestion of an award of personal sanctions against the trustee was surprising and completely unsupported. It not only contradicted the decision's earlier intimation that bankruptcy judges could police a trustee's
litigation judgment through appropriate discounts on trustee compensation (see Id. at 718 (citing 11 U.S.C. ' 330(a)(4)(A)(ii)(I))), but it also contradicted well-established principles of trustee liability and qualified personal immunity. See Id. at 719.

The Fundamentals of Trustee Liability and Qualified Immunity

The Bankruptcy Code does not explicitly confer personal immunity upon bankruptcy trustees, but that immunity is nevertheless evident from the Code's incorporation of fundamental liability principles that were applicable to common law receivers and developed under the Bankruptcy Act. See Schechter v. Illinois (In re Markos Gurnee P'ship), 182 B.R. 211, 214 (Bankr. N.D. Ill. 1995). For example, ' 323 of the Bankruptcy Code provides that bankruptcy trustees have the capacity to sue or be sued in their official capacities as representatives of their estates. See 11 U.S.C. ' 323. The provision derives from, and consequently appears to incorporate, 19th-century Supreme Court holdings that: 1) treated actions against receivers as implicitly involving only the receivers' official capacity; and 2) as a corollary, recognized the receivers' personal immunity from suit for actions arising out of the operation of their receiverships. See Markos Gurnee , 182 B.R. at 215-217, 224 (discussing and applying McNulta v. Lochridge , 141 U.S. 327, 331-32 (1891)).

The following principles, distilled and summarized from the multitude of authorities that have addressed the issue over the years, generally govern the concepts of trustee liability and qualified personal immunity and their application in practice:

• Trustees are typically immune from suit for actions arising out of the administration of their bankruptcy estates. While bankruptcy trustees are often named as defendants in their official capacities as estate representatives, their estates rather than the trustees personally are liable for corresponding claims. See Id. at 215-217.
• Trustees are not personally liable to injured parties for negligence in carrying out estate duties, but they may be personally liable for deliberate violations of applicable non-bankruptcy law. See Id. at 217-218; see also 28 U.S.C. ' 959 (requiring trustees to manage and operate property in their possession in accordance with state law).
• Trustees are personally liable to injured parties for conduct outside the scope of their duties (i.e., ultra vires acts), such as wrongfully seizing property that does not belong to their estates. See Id. at 217.
• Apart from deliberate violations of applicable non-bankruptcy law and ultra vires acts, the other general exception to the personal immunity of bankruptcy trustees is a claim for breach of fiduciary duty. See Id. at 218-219. The circuits are divided on the appropriate standard to which trustees should be held for breach of fiduciary duty claims.
• Trustees are immune from personal liability for breach of fiduciary duty claims when the bankruptcy court authorizes their actions after providing notice to affected parties and disclosing relevant facts. See Id. at 219-220.

The Circuit Split on Standards for Breach of Fiduciary Duty

As noted above, courts are divided on the appropriate standard for imposing personal liability on trustees for breaches of fiduciary duty. Some circuits have determined that personal liability should only be imposed for willful and deliberate violations of fiduciary duties, while others permit its imposition for mere negligence in carrying out fiduciary duties. The split of authority traces back to Mosser v. Darrow , 341 U.S. 267 (1951), in which the Supreme Court held that a bankruptcy trustee was personally liable for losses caused by the estate's self-dealing employees. See Id. at 269-270. Courts disagree on the appropriate application of the following passage from Mosser to a trustee's fiduciary standard of care:

We see no room for the operation of the principles of negligence in a case in which conduct has been knowingly authorized ' . The liability here is not created by a failure to detect defalcations, in which case negligence might be required to surcharge the trustee, but is a case of a willful and deliberate setting up of an interest in employees adverse to that of the trust. Id. at 272.

In Sherr v. Winkler, the Tenth Circuit Court of Appeals relied on this passage from Mosser for its holding that bankruptcy trustees are only personally liable for willful and deliberate violations of their fiduciary duties. Sherr v. Winkler , 552 F.2d 1367, 1375 (10th Cir. 1977). The Courts of Appeals for the Fourth, Sixth, and Seventh Circuits have either followed or expressed approval of Sherr. See, e.g., In re Hutchinson, 5 F.3d 750 (4th Cir. 1993); In re Chicago Pac. Corp., 773 F.2d 909, 915 (7th Cir.1985); Ford Motor Credit Co. v. Weaver , 680 F.2d 451, 462 (6th Cir. 1982); but see In re Engman , 395 B.R. 610, 624-25 & n.23 (Bankr. W.D. Mich. 2008) (suggesting that bankruptcy trustees might be held to a negligence standard notwithstanding Weaver)).

However, several other courts, including the Ninth Circuit Court of Appeals, have rejected Sherr and held that, under Mosser, bankruptcy trustees are subject to personal liability for intentional and negligent violations of duties imposed upon them by law. See Hall v. Perry (In re Cochise College Park, Inc.), 703 F.2d 1339, 1357 & n.26 (9th Cir. 1983); but see In re Continental Coin Corp., 380 B.R. 1, 15 (Bankr. C.D. Cal. 2007) (stating that Cochise may no longer be applicable for simple negligence cases). The Courts of Appeals for the First and Second Circuits have followed Cochise and adopted its negligence standard. See LeBlanc v. Salem (In re Mailman Steam Carpet Cleaning Corp.), 196 F.3d 1, 7 (1st Cir. 1999); In re Gorski, 766 F.2d 723, 727 (2d Cir. 1985).

These courts criticize Sherr and its progeny for: 1) ignoring the “unmistakable implication” of the Mosser court's observation that negligence may suffice for personal surcharges against trustees in situations where the duty of care (versus the duty of loyalty) is implicated; and 2) differentiating between surcharges and personal liability. See, e.g., Mailman, 196 F.3d at 7; Cochise, 703 F.2d at 1357, n.26. They note that the term “surcharge,” as used in Mosser, means “the imposition of personal liability on a fiduciary for willful or negligent misconduct in the administration of his fiduciary duties.” See Id. Accordingly, these courts adopt a negligence standard under which bankruptcy trustees are held to the standard of care of an ordinarily prudent person serving in the capacity of trustee. See Cochise, 703 F.2d at 1358.

A third line of authority, including the Fifth Circuit Court of Appeals, takes an “intermediate position” and holds that bankruptcy trustees are only personally liable for grossly negligent violations of their fiduciary duties. See Dodson v. Huff (In re Smyth), 207 F.3d 758, 761-62 (5th Cir. 2000). Gross negligence is defined as “[t]he intentional failure to perform a manifest duty in reckless disregard of the consequences ' It is an act or omission respecting legal duty of an aggravated character as distinguished from a mere failure to exercise ordinary care ' ” Smyth, 207 F.3d at 762.

The Courts of Appeals for the Third, Eighth and Eleventh Circuits have not taken a position on the issue. Consequently, courts in these circuits are divided on the applicable standard for fiduciary duty claims against trustees. See, e.g., In re Red Carpet Corp. of Panama City Beach, 708 F.2d 1576, 1579 (11th Cir. 1983) (“bankruptcy courts have fashioned the remedy of surcharge against a trustee or receiver for loss due to his negligence or wrongful conduct”); Barbee v. Price Waterhouse, LLP (In re Solar Fin. Servs., Inc.), 255 B.R. 801, 804 (Bankr. S.D. Fla. 2000) (gross negligence standard); In re Charlestown Home Furnishing, 150 B.R. 226, 227 (Bankr. E.D. Mo. 1993) (negligence standard); Quinn v. Fidelity & Deposit, Co. of Maryland (In re Sturm), 121 B.R. 443, 447-448 (Bankr. E.D. Pa. 1990) (negligence standard).

Maxwell II: Qualified Immunity Lives On

In Maxwell II, the Seventh Circuit revisited the personal sanctions issue that it had only parenthetically addressed in the dicta of Maxwell I. It disregarded the trustee's argument that he had personal immunity from KPMG because he pursued the lawsuit and appeal consistent with his duties as trustee. Instead, the court considered whether the trustee was liable to KPMG based on a violation of his fiduciary duties. See Maxwell II at 4-5. Considering that the trustee owed no fiduciary duty to a litigation target like KPMG, the court probably should have limited its consideration to whether the estate, which was the real party-in-interest in the underlying suit, was liable for sanctions. Any resulting claim of the estate against the trustee could have been reserved for the bankruptcy court overseeing the case. See Markos Gurnee, 182 B.R. at 220-223.

Nevertheless, the Seventh Circuit ultimately determined that the trustee was not personally liable to KPMG because he did not willfully violate his fiduciary duties. Acknowledging the circuit split on the applicable standards of trustee liability, the court relied upon dicta from its earlier decision in Chicago Pac. Corp. and applied the willful and deliberate standard. See Maxwell II at 5 (citing In re Chicago Pac. Corp., 773 F.2d 909, 915 (7th Cir.1985)). In deciding that the trustee did not willfully violate his fiduciary duties, the court found that the trustee did not have expertise in the areas of accounting or auditing malpractice and that he ultimately relied upon his counsel's judgment that the underlying lawsuit and appeal were in the best interests of creditors. See Id.

Conclusion

Regardless of whether the lasting legacy of the Maxwell decisions will be the fury of Maxwell I as opposed to the more circumspect analysis of Maxwell II, the decisions collectively serve to remind trustees of the standards of fiduciary conduct and personal liability that will apply to their exercise of litigation judgment on behalf of the estates they represent. The willful and deliberate standard, which the Seventh Circuit ultimately applied in Maxwell II and which controls in the Fourth, Sixth and Tenth Circuits, creates a relatively high bar for imposing personal liability upon bankruptcy trustees for actions initiated in the course of an estate's administration. By contrast, the negligence standard adopted by the First, Second and Ninth Circuits and the gross negligence standard adopted in the Fifth Circuit expose trustees to a greater risk of personal liability.

The Maxwell decisions also underscore the necessity of experienced counsel and experts to advise trustees on the merits of the litigation that they intend to pursue on behalf of their estates. In Maxwell II, the Seventh Circuit specifically referred to the trustee's reliance upon experienced litigation counsel as evidence that militated against a finding of willful fiduciary misconduct and personal sanctions in his pursuit of the underlying lawsuit and appeal. See Maxwell II at 5. Even under a negligence or gross negligence standard of trustee liability, that reliance would presumably have had the same militating effect and would have insulated the trustee from personal liability.

Peter J. Roberts and Gordon E. Gouveia are attorneys in the commercial bankruptcy and restructuring group of the law firm of Shaw Gussis Fishman Glantz Wolfson & Towbin LLC in Chicago. They may be reached at [email protected] and [email protected].