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THE TRUSTY TRUSTEE:DUTIES, RESPONSIBILITIES, AND LIABILITIES

LISA L. LAMBERTOffice of the United States trustee

110 N. College, Suite 300Tyler, TX 75702

[email protected]

16th Annual Advanced Consumer Bankruptcy CourseOctober 12-13, 2000

Dallas

CHAPTER 4

LISA L. LAMBERTOffice of the United States trustee; 110 North College, Suite 300; Tyler, TX 75702; [email protected]

EXPERIENCE

TRIAL ATTORNEY MAY 1998 - PRESENT

Office of the United States trustee

JUDICIAL LAW CLERK JUNE 1996 - MAY 1998; 1991-1992The Honorable Houston Abel, U.S. Bankruptcy Judge Tyler, Texas

ASSOCIATE ATTORNEY 1992-JUNE 1996John Flowers, Esq. Dallas, Texas

EDUCATION

DOCTOR OF JURISPRUDENCE DECEMBER 1990Texas Tech University Lubbock, TexasHonors and AwardsScholarship for contributions to The Texas Bank LawyerSelected to Board of BarristersActivitiesAssociate Editor, The Texas Bank Lawyer

BACHELOR OF ARTS IN ENGLISH MAY 1987University of North Carolina Chapel Hill, North Carolina

PROFESSIONAL

Speaker, Hit or Miss? This Year=s Bankruptcy Cases and Trends, 1999 Eastern District of TexasBankruptcy Conference

Speaker, The Grey(Tomb)stone Case: New Value and Gerrymandering of Claims, RIP,1992 Eastern District of Texas Bankruptcy Conference

Tyler Teen Court Volunteer Judge; 1998 Chairman, Tyler Law Day Essay Committee

Licensed by State Bar of Texas; admitted United States Supreme Court, United States Court ofAppeals for the Fifth and Ninth Circuits; United States District Courts for the Northern and EasternDistricts of Texas

The Trusty Trustee: Duties, Liabilities, and Remedies Chapter 4

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Table of Contents

I. INTRODUCTION......................................................................................................................................... 1

II. TRUSTEE ..................................................................................................................................................... 1A. Basic fiduciary duties ............................................................................................................................. 1B. Express Statutory and Regulatory Duties .............................................................................................. 1C. Other Duty Sources ................................................................................................................................ 1

III. TRUSTEES= LIABILITY ............................................................................................................................. 2A. Who is liable? ......................................................................................................................................... 2B. Suing Trustees in Their Official Capacity.............................................................................................. 2C. Ultra Vires Acts: Trustees= Personal Liability to Injured Parties........................................................... 3D. Breach of Duty: Personal Liability of Trustees to Bankruptcy Estate Beneficiaries............................. 3

1. Mosser v. Darrow ............................................................................................................................ 42. The Willful and Deliberate Standard............................................................................................... 43. The Mere Negligence Standard ....................................................................................................... 44. Gross Negligence: The Fifth Circuit=s Approach ............................................................................ 5

E. Recovering on the Bond ......................................................................................................................... 61. Bonding Requirements .................................................................................................................... 62. Proper Party to Seek Bond Recovery .............................................................................................. 63. Proper Party to Sue for Bond Recovery .......................................................................................... 7

F. When do the time limits run?.................................................................................................................. 7G. Where should a lawsuit be filed?............................................................................................................ 8

1. Bankruptcy Court Authorization ..................................................................................................... 82. AArising in@ or ARelated to ............................................................................................................... 93. Right to Jury Trial.......................................................................................................................... 10

IV. TRUSTEE DEFENSES .............................................................................................................................. 10A. Business Judgment ............................................................................................................................... 10B. Derived Judicial Immunity.................................................................................................................... 10C. Issue Preclusion .................................................................................................................................... 11D. Claim Preclusion................................................................................................................................... 11

V. THE UNITED STATES TRUSTEE=S ADMINISTRATIVE ROLE ........................................................ 12A. The United States Trustee=s Charge ..................................................................................................... 12B. The Complaint Procedure..................................................................................................................... 12C. Procedures for Suspension and Removal ............................................................................................. 12

1. The United States Trustee=s Action............................................................................................... 132. The Trustee=s Response ................................................................................................................. 133. Effective Dates and Stays .............................................................................................................. 134. The Director=s Review ................................................................................................................... 135. Judicial Review.............................................................................................................................. 13

VI. CONCLUSION ........................................................................................................................................... 13


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THE TRUSTY TRUSTEE: DUTIES, LIABILITIES, ANDREMEDIES1

1 The views expressed are those of the author, and they do not necessarily reflect the official

position of the Department of Justice or the Office of the United States trustee.

I. INTRODUCTIONThe bankruptcy system depends on trustees=

integrity and competence. However, honest andintelligent individuals will not serve if they fear theirdecisions are subject to costly and prolongedchallenges. This paper evaluates the case law andadministrative regulations that result from thesecompeting policy concerns.

II. TRUSTEEA. Basic fiduciary duties

Bankruptcy trustees are fiduciaries, and theygenerally have the same duties as corporatemanagement would have outside bankruptcy. Commodity Futures Trading Comm'n v. Weintraub,471 U.S. 343, 353-54 (1985). Theses duties are owedto secured creditors, unsecured creditors, shareholders,and individual debtors. Cf. Weintraub, 471 U.S. at353-54 (involving corporate debtor). Generally,fiduciaries have two duties.

First, they must exercise due care when managingthe bankruptcy estate affairs. See e.g. Meyers v.Moody, 693 F.2d 1196, 1209 (5th Cir.1982)(involving Texas corporate fiduciary standards); Thestandard of care requires that they use the care that anordinary prudent person would use under the samecircumstances. Gearhart Indus., Inc. v. Smith Int'l,Inc., 741 F.2d 707, 719-20 (5th Cir.1984)(alsoinvolving corporate fiduciaries). Failure to complywith the duty of care may establish negligence. Second, trustees owe a duty of loyalty to the estate, itscreditors, and the debtor. They must avoid acting intheir own self interest. Gearhart, 741 F.2d at 719-20;see also, Mims v. Kennedy Capital Management, Inc.(In re Performance Nutrition, Inc.), 239 B.R. 93, 111(Bankr. N.D. Tex. 1999); National ConvenienceStores, Inc. v. Shields (In re Schepps Food Stores,Inc.), 160 B.R. 792, 797-98 (Bankr. S.D. Tex. 1993)

(recognizing in both cases that trustees and debtors-in-possession must comply with duties of care andloyalty).

The Bankruptcy Code, other statutes, and thecommon law impose specific obligations on trustees,but all of these obligations can be characterized assubsets of the two general fiduciary duties. Forexample, if chapter 7 trustees operate a business andfail to pay taxes in a timely manner, they violate 28U.S.C. '960 and 11 U.S.C. '704(8), but theseviolations fall within the overall duty of care.

B. Express Statutory and Regulatory DutiesThe Bankruptcy Code contains provisions that

define the Aduties of trustee[s].@ Section 704 specifiesparticular trustee duties, and many of these duties areengrafted into the trustee provisions in other chapters.11 U.S.C. '' 704, 1106, 1202(b), 1302(b). AppendixA summarizes and compares the statutorily definedduties imposed under the different bankruptcychapters. In addition to these statutory duties, 28C.F.R. ' 58.4 defines specific fiduciary standards forstanding trustees.

C. Other Duty SourcesThe United States Court of Appeals for the Fifth

Circuit has recognized that the statutory provisionsstyled ATrustee Duties@ are not the only provisionsgoverning trustee conduct. In Southmark Corp. v.Coopers & Lybrand (In re Southmark Corp.), 163F.3d 925 (5th Cir.), cert. denied, 527 U.S. 1004(1999), the Fifth Circuit considered alleged breachesof duty by the estate=s accountants. Although trusteeobligations were not directly implicated, the FifthCircuit expressly included trustees in its fiduciary dutyanalysis. Southmark, 163 F.3d at 931. First, theCourt noted that provisions addressing trusteeobligations, including conflict of interest loyalty

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standards, were scattered throughout the BankruptcyCode. Southmark, 163 F.3d at 930 (citing 11 U.S.C.'' 321, 322, 324, 326-331). Second, the Courtexplained, A[a]lthough standards for the conduct ofcourt-appointed professionals, the breach of whichmay constitute bankruptcy malpractice, are notcomprehensively expressed in the statute, the Codeneed not duplicate relevant, also-applicable state law.@ Southmark, 163 F.3d at 931.

One must consider the Bankruptcy Code, theFederal Rules of Bankruptcy Procedure, theregulations, the court=s orders, and the case law for thetrustees= duties. As examples, a trustee has been heldliable for lost interest when funds are not invested atinterest as required by section 345. In re CharlestownHome Furnishing, 150 B.R. 226, 227 (Bankr. E.D.Mo. 1993). Federal Rule of Bankruptcy Procedure2015 requires trustees to keep records, and it has beencited by courts when evaluating fiduciary dutybreaches. E.g. Grassmueck v. Foster (In re E Z FeedCube Co., Ltd.), 115 B.R. 684, 689 (Bankr. D. Ore.1990). The Executive Office of United StatesTrustees periodically publishes handbooks fortrustees. Handbook for Chapter 13 StandingTrustees, eff. 12/01/98; Handbook for Chapter 7Trustees, eff. 10/01/98. These handbooks, which areavailable at the United States trustee=s web-site:<http://www.usdoj.gov/ust/library/trusteelib >, areAstatement[s] of operational policy and [are ] intendedas a working manual for the . . . trustee.@ Handbookfor Chapter 13 Standing Trustees, eff. 12/01/98, p. 1-1; Handbook for Chapter 7 Trustees, eff. 10/01/98,p. 1-1. Nevertheless, courts have occasionally citedthe handbooks when evaluating fiduciary dutycompliance. E.g. In re Melenyzer, 140 B.R. 155(Bankr. W.D. Tex. 1992).

Trustees= duties are defined by a variety ofsources. The duties may not be clear, and they mayhave to be weighed because of competing creditorinterests. In re Melenyzer, 140 B.R. 143, 155 (Bankr.W.D. Tex. 1992). Examples of confusing trusteeobligations abound. A split of authority exists as towhether Chapter 13 trustees are charged with pursuingavoidance actions under section 323(b) and section544. See Stangel v. United States (In re Stangel),2000 WL 977890 (5th Cir. Aug.. 1, 2000) (holdingchapter 13 debtor lacked standing to avoid tax lien);Realty Portfolio, Inc. v. Hamilton (In re Hamilton),125 F.3d 292, 295-98 (5th Cir. 1997) (compiling caselaw under both views). Chapter 7, Chapter 13, andChapter 12 trustees are expressly charged with theobligation to object to claims, if practicable, 11 U.S.C.

''704(5), 1202(b)(1)1302(b)(1), yet all parties-in-interest have standing to object to claims. 11 U.S.C.'502(a). The duty to a secured creditor oftencompetes with the duty to unsecured creditors. Courtshave recognized the complexity of the trustees=obligations when evaluating liability standards anddefenses.

III. TRUSTEES== LIABILITYAfter determining that a duty exists and that the

duty appears to have been breached, it is appropriateto evaluate the factors that one considers when filinga lawsuit: proper parties and their capacity, standardsof proof, limitations, jurisdiction, and availability of ajury trial.

A. Who is liable?Superficially, analyzing whom to sue seems the

simplest of questions. After all, this paper addressestrustee duties and liabilities. However, the case lawreveals that the type of tort involved and the injuredparty impact both the capacity in which the trusteemay be sued and the likelihood of recovery.

B. Suing Trustees in Their Official CapacityAlthough the bankruptcy estate is a legal entity, it

is not a legal person subject to suit. Schechter v.Illinois (In re Markos Gurnee Partnership), 182 B.R.211, 215 (Bankr. N.D. Ill. 1995), aff=d, 195 B.R. 380(N.D. Ill. 1996).. To hold bankruptcy estates liable,parties sue the trustee as the estate=s representative,and the estate pays.

Under the common law trustees were notseparated from the trust estate, so a judgment againstthe estate resulted in a judgment against the trusteepersonally. Markos Gurnee, 182 B.R. at 215(citations omitted). Acknowledging that bankruptcytrustees were officers of the court as well asfiduciaries, the United States Supreme Court modifiedthe common law rule for bankruptcy trustees.

In two opinions the United States Supreme Courtheld that bankruptcy trustees were not liablepersonally when a lawsuit against the estate was filed. McNulta v. Lochridge, 141 U.S. 327 (1891); Bartonv. Barbour, 104 U.S. 126 (1881). The current versionof the Bankruptcy Code seems to engraft the holdingsof Barton and McNulta. Markos Gurnee, 182 B.R. at216. It specifies that a Atrustee in a case under this titleis the representative of the estate@ and Ahas capacityto sue and be sued.@ 11 U.S.C. '323 (emphasisadded); see also Fed. R. Bankr. P. 6009 (definingtrustee=s prosecution and defense ability). As analyzed













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below, this structure does not bar suits against thetrustee individually. Rather, it establishes that onemust specifically plead and seek relief against trusteesin their personal capacity. A recovery against theestate will not, per se, establish that the trustee, as anindividual, is jointly and severally liable.

Generally, the bankruptcy estate can be chargedfor the trustee=s tortious acts or contractual breaches. In the landmark opinion Reading Co. v. Brown, 391U.S. 471 (1968), the United States Supreme Courtaddressed the estate=s liabilities for the trustee=s post-petition breach of the duty of care. The bankruptcyestate=s principal asset was an eight story buildingwhich the receiver was authorized to lease to thirdparties. Reading Co., 391 U.S. at 473. The receiverfailed to insure the property. The building burned, andadjoining properties were damaged. Reading Co., 391U.S. at 473. The adjoining landowners sued thetrustee. The trustee opposed administrative claimtreatment for these post-petition negligence claims. He contended third parties would continue to deal withbankruptcy estates even if negligence claims were notentitled to priority. On the other hand, pre-petitioncreditors would oppose bankruptcy operations if theybore the risk that negligent post-petition acts wouldminimize their claim distributions.

The United States Supreme Court disagreed withthe trustee=s arguments. The Court emphasized thatthe post-petition tort victims had not chosen to havetheir property destroyed by the debtor=s fire. AExistingcreditors are, to be sure, in a dilemma not of their ownmaking, but there is no obvious reason why theyshould be allowed to escape that dilemma at the risk ofimposing it on others equally innocent.@ Reading Co.,391 U.S. at 483. Accordingly, the Supreme Courtheld that the tort damages were Aactual and necessarycosts@ entitled to administrative priority. Reading Co.,391 U.S. at 483-84.

Reading Co. was decided under the BankruptcyAct rather than the Bankruptcy Code. However, thecurrent statutory authority echoes the statutesconstrued in Reading Co. Section 507(a)(1) gives firstpriority to administrative expenses, 11 U.S.C. '507(a)(1), and section 503 defines administrativeexpenses as Athe actual, necessary costs and expensesof preserving the estate.@ 11 U.S.C. ' 503(b)(1)(A).

In two opinions the Fifth Circuit has recognizedthat Reading Co. remains viable. In Al CopelandEnter., Inc. v. Texas (In re Al Copeland Enter., Inc.),991 F.2d 233 (5th Cir. 1993), the Fifth Circuit heldthat taxes and interest that became due post-petitionwere administrative expenses. Al Copeland, 991 F.2d

at 239 (involving debtor-in-possession rather thantrustee). In Texas v. Lowe (In re HLS Energy Co.),151 F.3d 434 (5th Cir. 1998), the Fifth Circuit heldthat the bankruptcy estate was liable for the costs thatthe state incurred when the trustee did not plug wells. HLS Energy, 151 F.3d at 436-37. Accordingly, thebankruptcy estate will be liable to third parties forpost-petition torts or contractual breaches.

When the estate is held liable for post-petitionnegligence but the trustee is not held personally liable,the trustees fees presumably are still subject toreduction under sections 326 and 330 of theBankruptcy Code. A trustee=s negligent conduct couldbe addressed under either of two statutory standards: Anecessary to the administration of, or beneficial atthe time at which the service was rendered@ orAperformed within a reasonable amount of timecommensurate with the complexity, importance, andnature of the problem . . .@ 11 U.S.C. '330(a)(3)(C),(D); cf. Walsh v. Northwestern Nat=lIns. Co. (In re Ferrante), 51 F.3d 1473 (9th Cir. 1995)(bond surety was liable for return of trustee=s interimfee award when trustee forfeited fee by breachingfiduciary duty); but see discussion of Agrossnegligence@ standard for personal liability below.

C. Ultra Vires Acts: Trustees== Personal Liabilityto Injured Parties

When trustees commit ultra vires acts, or actbeyond the scope of their duties, then they becomepersonally liable to the injured party, but no liability isimposed on the estate. For example, when trusteeshave seized assets that do not belong to thebankruptcy estate, they have been held individuallyliable, but the estate has not been charged. E.g.Leonard v. Vrooman, 383 F.2d 556 (9th Cir. 1967). It is not within the scope of the trustee=s duties torecover non-estate property.

D. Breach of Duty: Personal Liability of Trusteesto Bankruptcy Estate Beneficiaries

Often creditors or debtors seek to recover directlyfrom a trustee. If the estate as a whole was harmed,then the trustee may be surcharged and the bankruptcyestate recompensed. Mosser v. Darrow, 341 U.S.267, 272 (1951). If a creditor or debtor is harmeddirectly, then the surcharge recompenses the harmedparty. Lopez-Stubbe v. Rodriguez-Estrada (In re SanJuan Hotel Corp.), 847 F.2d 931, 938 (1st Cir. 1988);In re Gorski, 766 F.2d 723, 727-28 (2d Cir. 1985). But a surcharge assumes that personal liability exists. The Bankruptcy Code fails to define the standard ofcare to impose personal liability on a trustee. Dodson

















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v. Huff (In re Smyth), 207 F.3d 758, 761 (5th Cir.2000)(citing Yadkin Valley Bank & Trust Co. v.McGee (In re Hutchinson), 5 F.3d 750, 752 (4th Cir.1993)). Thus, the courts have defined the standards. They have not reached a consensus.

As a practical point, focusing on the implicatedduty illuminates the case law. Daniel B. Bogart,Finding the Still Small Voice: the Liability ofBankruptcy Trustees and the Work of the NationalBankruptcy Review Commission, 102 Dick. L. Rev.703, 711-26 (1998); Ralph C. McCullough, TrusteeLiability: Is There Enough Protection for TheseAArms of the Court?@ 103 Com. L.J. 123 (1998).Courts generally punish trustees and impose personalliability when the duty of loyalty is violated. Thecourts have more difficulty imposing liability for dutyof care violations.

1. Mosser v. DarrowThe confusing case law begins with the United

States Supreme Court=s decision in Mosser v. Darrow,341 U.S. 267 (1951). Mosser involved a trustee whoallowed the estate employees to purchase and tradesecurities in competition with the bankruptcy estate. Mosser, 341 U.S. at 269-70. Although the trustee didnot benefit, he knew the employees were self-dealing. He did not disclose the situation to the creditors or thecourt.

The Supreme Court was troubled that the trusteecondoned the employees= self-dealing. AEquitytolerates in bankruptcy trustees no interest adverse tothe trust. This is not because such interests are alwayscorrupt but because they are always corrupting.@ Mosser, 341 U.S. at 271. The Supreme Courtemphasized, A[w]e see no room for the operation of theprinciples of negligence in a case in which conduct hasbeen knowingly authorized . . . . The liability here isnot created by a failure to detect defalcations, in whichcase negligence might be required . . . but is a case ofa willful and deliberate setting up of an interest inemployees adverse to the trust.@ Mosser, 341 U.S. at272. The employees= conflict of interest established abreach of the duty of loyalty rather than a breach ofthe duty of care. The trustee breached his duty ofloyalty because he condoned the self dealing ratherthan punishing it or disclosing it. His conduct wasAwillful and deliberate.@

2. The Willful and Deliberate StandardIn Scherr v. Winkler, 552 F.2d 1367 (10th Cir.

1977), the trustee obtained an ex parte turnover orderin which the bankruptcy court required the delivery ofoil production funds to the trustee. The production

owners contended that the trustee failed to review thepublic records to ascertain ownership of theproduction interests and therefore wrongfully obtainedthe order. Scherr, 552 F.2d at 1369. The case thusapproached an ultra vires issue. (See above sectiondiscussing ultra vires.) The trustee responded that itwas his first case appointment, that he was not anattorney, that the estate owned numerous properties allover the country, and that he relied on his counsel toreview the records and advise him of the legalconsequences. Scherr, 552 F.2d at 1371. Reviewingthe language in Mosser, the Tenth Circuit held thattrustees would only be personally liable if their actionswere Awillful and deliberate.@ Scherr, 552 F.2d at1375. The Court did not draw a distinction betweenbreaching the duty of loyalty and breaching the duty ofcare.

The Supreme Court has recognized that Awillful@has a variety of legal meanings. E.g. McLaughlin v.Richland Shoe Co., 486 U.S. 128(1988). However,the addition of Adeliberate@ in the expressionimplicates intent. See In re Compos, 787 F.2d 1155,1157-58 (10th Cir. 1985) (involving definition ofAwillful@ in dischargeability context). At least twoother circuits followed Scherr and adopted the Awillfuland deliberate@ standard. In re Chicago PacificCorp., 773 F.2d 909, 915 (7th Cir. 1985); Ford MotorCredit Co. v. Weaver, 680 F.2d 451, 461-62 (6th Cir.1982) (involving debtor-in-possession rather thantrustee).

3. The Mere Negligence StandardIn Hall v. Perry (In re Cochise College Park,

Inc.), 703 F.2d 1339 (9th Cir. 1983), the Ninth Circuitdisagreed with the Scherr court=s interpretation ofMosser. Cochise College involved a real estate scam. The debtor sold plots to individuals withrepresentations that roads, utilities, and otheramenities would be added. After the bankruptcyfiling, the trustee continued to demand payment fromthe land purchasers. Ultimately, the land owners fileda class action against the trustee, alleging bothfraudulent and negligent misrepresentation plusnegligent failure to reject the executory contracts in atimely fashion. The Ninth Circuit held that thecontracts were executory and that an ordinary, prudentperson acting as a trustee would stop collectingpayments after deciding to reject the contracts. Cochise Park, 703 F.2d at 1358.

In concluding that all negligent conduct subjectedthe trustee to liability, the Ninth Circuit construedMosser as addressing the trustee=s personal liability













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for employee conduct but not as limiting personalliability when the alleged negligence arises from thetrustee=s own act. Cochise Park, 703 F.2d at 1357 n.26. The Second and Eleventh Circuits subsequentlyagreed with the Ninth Circuit=s approach. In reGorski, 766 F.2d 723, 727 (2d Cir. 1985); RedCarpet Corp. v. Miller, 708 F.2d 1576, 1579 (11th

Cir. 1983).

4. Gross Negligence: The Fifth Circuit=s ApproachThe Fifth Circuit rejected both the Awillful and

intentional@ standard and the Amere negligence@standard for imposing personal liability on trustees. InDodson v. Huff (In re Smyth), 207 F.3d 758 (5th Cir.2000), the Fifth Circuit adopted a standard betweenthe two extremes. Trustees are personally liable forAgross negligence.@

In Smyth a creditor sought to hold the trusteepersonally liable for damages arising from purportederrors in the bankruptcy estate=s tax returns. Smyth,207 F.3d at 758. The trustee was a certified publicaccountant, and he had employed himself as theestate=s accountant. Smyth, 207 F.2d at 758. TheFifth Circuit affirmed the district court and bankruptcycourt, which both had held that the trustee=s conductwas not grossly negligent. When it adopted the gross negligence standard, theFifth Circuit relied heavily on the National BankruptcyReview Commission=s recommendation and analysis.The Commission recommended the following:

3.3.2 Personal Liability of TrusteesTrustees appointed in cases under Chapter 7, 11,12 or 13 of the Bankruptcy Code should not besubject to suit in their individual capacity for actstaken within the scope of their duties as delineatedin the Bankruptcy Code or by order of the court,as long as the applicable order was issued onnotice to interested parties and there was fulldisclosure to the court.

Chapter 7, 12 and 13 trustees only should besubject to suit in the trustee's representativecapacity and subject to suit in the trustee'spersonal capacity only to the extent that thetrustee acted with gross negligence in theperformance of the trustee's fiduciary duties.Gross negligence should be defined as recklessindifference or deliberate disregard of the trustee'sfiduciary duty.

A Chapter 11 trustee of a corporate debtoronly should be subject to suit in the trustee'srepresentative capacity and subject to suit in thetrustee's personal capacity only to the extent thatthe trustee has violated the standard of careapplicable to officers and directors of acorporation in the state in which the Chapter 11case is pending . . . .

National Bankr. Review Comm=n Final Report ' 3.3.2at 859, reprinted athttp://www.nbrc.gov/report/19admini.pdf.The Commission=s report analyzed the conflictingappellate precedent and focused on the policyconcerns. If it is easy to impose personal liability,then competent individuals will not become trustees. Id. at 860-61. This concern has special merit inbankruptcy because bankruptcy trustees must be freefrom conflicts of interest, meaning they do not have ahistory with the debtor=s business and often areunfamiliar with the debtor=s industry. Smyth, 207 F.3dat 762 (citing In re J.F.D. Enterpr., Inc., 223 B.R.610, 628 (Bankr. D. Mass. 1998)). They also oftenmust act quickly, and creditors may oppose theiractions. Smyth, 207 F.2d at 762. However, a highthreshold for liability hinders responsible bankruptcyestate management and liquidation. Naional Bankr.Review Comm=n Final Report at 860-61.

After weighing the competing concerns andagreeing with the Commission that gross negligencewas the proper standard, the Fifth Circuit definedgross negligence. The Fifth Circuit adopted Black=sLaw Dictionary=s definition, which is:







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The intentional failure to perform a manifest dutyin reckless disregard of the consequences . . . . Itis an act or omission respecting legal duty of anaggravated character as distinguished from a merefailure to exercise ordinary care. It amounts toindifference to present legal duty and to utterforgetfulness of legal obligations so far as otherpersons may be affected.

Smyth, 207 F.3d at 762 (quoting Black=s LawDictionary at 1033 (6th ed. 1990)).

The Fifth Circuit then reviewed each of the allegedtax problems and affirmed the trial court=s conclusionthat gross negligence was not established. Only oneaspect of the application of the gross negligencestandard to the facts merits further scrutiny.

The estate filed two years of tax returns tardily,and it incurred $4,906.57 in penalties. Thosepenalties would be treated as Aactual, necessary costsof administration@ and therefore would receiveadministrative priority. 11 U.S.C. '' 503(b)(1)(A),507(a)(1). At the trial level the trustee agreed towaive his trustee fee and his professional accountingfee, which cumulatively totaled $4,400. Although thetrustee recognized that his fee waiver differed from hispersonal liability, the Fifth Circuit stated, Athe sanctionimposed against the Trustee, if subjected to closescrutiny, would in all likelihood be founded in simplenegligence. However, since the Trustee agreed to thesanction, we see no reason to disturb the status quo.@ Smyth, 207 F.3d at 763. This dicta conflates personaland estate liability. The bankruptcy trustee=s waiverimplicitly acknowledged that fees reduce thebankruptcy estate. The fees do not become thetrustee=s personal property until the bankruptcy courtissues a final fee order. 11 U.S.C. ' 330. Whentrustees file late tax returns, they often have notAperformed within a reasonable amount of timecommensurate with the complexity, importance, andnature of the problem . . . . .@ 11 U.S.C. '330(a)(3)(D). It would be appropriate to reduce thetrustee=s fee. Like the tax penalties, trustee andprofessional fees are subject Aactual, necessary costsof administration@ that receive administrative priority.11 U.S.C. '' 503(b)(2); 507(a)(1). When allocatingthe cost of the trustee=s negligent conduct, it isequitable to reduce the fees to the trustee and hisprofessionals if they increased other administrativecosts. This language could unnecessarily raise issuesabout the standards under which courts conduct fee

reviews when trustees act negligently, but it should beconstrued as dicta.

E. Recovering on the BondAll trustees must file Aa bond in favor of the

United States conditioned on the faithful performanceof . . . official duties.@ 11 U.S.C. ' 322(a). TheUnited States trustee defines the amount of the bondand evaluates Athe sufficiency of the surety.@ 11 U.S.C.' 322(b)(2). The United States trustee Amay authorizea blanket bond . . . to cover (1) a person who qualifiesas a trustee in a number of cases, and (2) a number oftrustees each of whom qualifies in a different case.@ Fed. R. Bankr. P. 2010(b).

1. Bonding RequirementsBlanket bond documentation is filed with the

United States Bankruptcy Court, and it typicallydefines a per case limit. Blanket bonds do not coverthe trustee=s operations, so the trustee must acquire aseparate bond when the court authorizes the trustee toconduct business. Handbook for Chapter 7 trustees,eff. 10/01/98, p. 8-14. In addition, A[t]he trustee hasan obligation to continually review the adequacy ofbond coverage and to inform the United States Trusteeof any situation, such as an upcoming asset sale, whichmay necessitate an increase in bond coverage.@ Handbook for Chapter 7 trustees, p. 5-2.

Section 322(b)(2) and Federal Rule of BankruptcyProcedure 2010 also apply to standing chapter 13trustees. Their minimum blanket surety bond amountis A150% of the average monthly bank balances for theprior three months for all bank accounts, certificates ofdeposit or other permissible investments . . . .@ Handbook for Chapter 13 Standing Trustees, eff.12/01/98, p. 2-2. Like the chapter 7 trustees= blanketbond information, the standing chapter 13 trustees=bond documentation is filed with the United StatesBankruptcy Court.

2. Proper Party to Seek Bond RecoveryUnder Federal Rule of Bankruptcy Procedure

2010(b), any party in interest may seek to recover thebond. The action is brought Ain the name of theUnited States for the use of the entity injured by thebreach.@ Fed. R. Bankr. P. 2010(b). The United Statesis a nominal party that does not actually file the action.United States v. Hartford Casualty Ins. Co. (In reArmstrong), 245 B.R. 123, 126 (Bankr. D. Neb.1999). Thus, parties in interest will not be able tocreate a fictional, uninvolved government party. Theywill be charged with their knowledge of thebankruptcy proceedings, and their bankruptcy case



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involvement may result in dismissal based onpreclusion. In re Armstrong, 245 B.R. at 126; seealso issue and claim preclusion sections below.

3. Proper Party to Sue for Bond RecoveryIf a party seeks to recover the bond, the bond

surety is a necessary party under Federal Rule of CivilProcedure 19, made applicable in bankruptcy throughFederal Rule of Bankruptcy Procedure 7019. UnitedStates v. Nigro (In re Louis Rosenburg Auto Parts,Inc.), 209 B.R. 668, 672 & n. 7 (Bankr. W.D. Pa.1997). In Louis Rosenburg, the bond surety was nota named party, but the Court did not dismiss the caseon that basis. The defect could be cured by amendingunder Federal Rule of Civil Procedure 21, madeapplicable in bankruptcy through Federal Rule ofBankruptcy Procedure 7021. Louis Rosenburg Auto,209 B.R. at 673.

F. When do the time limits run?2

Just as the Bankruptcy Code is silent on thestandard for evaluating breaches of fiduciary duty, soalso it is silent regarding the statute of limitations forsuch actions. United States v. Nigro (In re LouisRosenburg Auto Parts, Inc.), 209 B.R. 668, 676(Bankr. W.D. Pa. 1997). Under one view the statuteof limitations does not expire until the trustee files thefinal report and the case is closed. Lopez-Strubbe v.Rodriguez-Estrada (In re San Juan Hotel Corp.),847 F.2d 931, 938 (1st Cir. 1988) (alternativeholding). Other courts have adopted the statute oflimitations that applies when trustees are sued understate law. Louis Rosenburg Auto, 209 B.R. at 676(citing United States v. H.R. Morgan, Inc., 542 F.2d262, 268 (5th Cir. 1976). In Texas, the statute oflimitations for negligence is two years. Tex. Rev. Civ.Prac. & Rem. Code '16.003. These limitations oftenare extended by a Adiscovery@ rule. E.g. Lopez-Strubbe v. Rodriguez-Estrada (In re San Juan HotelCorp.), 847 F.2d 931, 938 (1st Cir. 1988) (applyingPuerto Rico statute of limitations).

In jurisdictions applying the shorter state statuteof limitations, sureties have argued that they are notliable when the state statute of limitations has expiredbut the Bankruptcy Code=s limitation period forpursuing the bond has not run Under 11 U.S.C.

2 Although limitations is an affirmative defense,

it is addressed in this section because most parties maketiming allegations in their original complaint. Fed. R. Civ.P. 8(c), made applicable in bankruptcy through Fed. R.Bankr. P. 7008.

'322(d), Aa proceeding on a trustee=s bond may not becommenced after two years after the date on whichsuch trustee was discharged.@ 11 U.S.C. '322(d). Few cases have addressed this issue.

One of the first cases to address this dichotomyarose in Texas. In Oles Grain Co. v. SAFECO Ins.Co., 206 B.R. 126 (Bankr. N.D. Tex. 1997), vacated,221 B.R. 371 (N.D. Tex. 1998), the trustee wasappointed in 1985, and the lawsuit was filed in 1994. The lawsuit alleged that the trustee failed to pursuevalid and recoverable claims owed to the estate. At thetime the lawsuit was filed, the bankruptcy case wasopen, and the trustee was still in office. However, theUnited States Bankruptcy Court held that the Texastwo year statute of limitations for negligence actionsapplied and that under any construction of the factsthat two year period had expired. Oles Grain, 206B.R. at 130 & n. 14 (citing Tex. Civ. Prac. & Rem.Code Ann. ' 16.003 (Vernon 1986 & Supp. 1996)). The Court then considered whether section 322(d)extended the negligence statute of limitations withrespect to the bond. The bankruptcy court held that itdid not. Section 322(d) Asupplements but does notsupplant the underlying state statutes of limitations .. . . [I]t does not reawaken a suit on a trustee=s bond.@ Oles Grain, 206 B.R. at 132. To reach thisconclusion, the bankruptcy court reviewed Texas casesand concluded that under Texas law the surety=sliability derives from the trustee=s liability. OlesGrain, 206 B.R. at 132-33 & nn. 25-27 (citations toTexas cases omitted).

On appeal, the federal district court disagreed. Inre Oles Grain, Co. v. SAFECO Ins. Co., 221 B.R. 371(N.D. Tex. 1998). The district court mused thatsection 322(d) was a federal statute and therefore thefederal common law might govern. Oles Grain, 221B.R. at 376 & n. 8. However, because the partiesassumed Texas law applied, the court turned to Texascases. Concluding that the Texas Supreme Court hadnot decided the issue, the Court conducted an AErie-guess.@ The Texas Supreme Court had drawn adistinction between actions Aevidenced and foundedupon@ the bond and actions founded on Amerelycollateral securities.@ Oles Grain, 221 B.R. at 378(interpreting Hatcher v. State, 125 Tex. 84, 81 S.W.2d499 (1935)). The district court felt the Texas SupremeCourt would consider cases from other states= highestcourts, and the district court concluded that otherstates had not excused the surety merely becauselimitations had run against the principal. Oles Grain,221 B.R. at 378. Accordingly, the district court




















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concluded that the action remained viable against thesurety.

A subsequent bankruptcy court opinionmisconstrues the district court=s opinion in Oles Grainas holding that limitations is a matter of federal law. It then holds that section 322(d) is the only applicablestatute. United States v. Hartford Casualty Ins. Co.(In re Armstrong), 245 B.R. 123, 129 (Bankr. D. Neb.1999).

Intriguingly, the Oles Grain district court and theArmstrong bankruptucy court did not address thepractical consequences of their holdings. Traditionally,statutes of limitations exist because witnesses,documents, and memories disappear with time. Fromthe outset, sureties are not directly involved in theunderlying facts, so they learn about the facts throughothers. Their burden in recovering applicableinformation is even more onerous than for the trusteewhose statute of limitations has run. Using the caseclosing as the applicable date on which to commencelimitations for both the trustee and the bondingcompany has the salutary effect of harmonizing therecord keeping requirements. On the other hand, asthe ten year gap in Oles Grain illustrates, not all casescan be closed quickly. It is onerous to impose liabilityon trustees for a decade or more.

G. Where should a lawsuit be filed?Three procedural points merit consideration when

action against a trustee is contemplated. First, courtsdetermine whether the bankruptcy court=sauthorization is necessary for an action against thetrustee. Second, courts decide whether the issue is acore or non-core matter. Third, courts have evaluatedwhether a right to a jury trial exists.

1. Bankruptcy Court AuthorizationWhen filing a lawsuit against a trustee, parties

should evaluate whether the lawsuit involves thetrustee=s actions while administering the estate orwhile operating a business. In Barton v. Barbour,104 U.S. 125 (1881), the United States SupremeCourt addressed the ability to sue the trustee foractions arising from the estate=s administration. A[I]tis immaterial whether the suit is brought against [thetrustee] to recover specific property or to obtainjudgment for a money demand. In either case leaveshould first be obtained.@ Barton, 104 U.S. at 129.

Congress subsequently created an exception tothis general rule. If the action involves businessoperations, then court permission is not required.

Trustees . . . may be sued, without leave of thecourt appointing them, with respect to any of theiracts or transactions in carrying on businessconnected with such property. Such actions shallbe subject to the general equity power of suchcourt so far as the same may be necessary to theends of justice, but this shall not deprive a litigantof his right to trial by jury.

28 U.S.C. ' 959(a). By defining suits that may bebrought without leave of court as suits arising from thetrustee=s actions while operating a business, section959(a) still impliedly excludes lawsuits involving thetrustee=s conduct while administering an estate. In reLasiter, 136 F.3d 544, 545 (7th Cir. 1998). In LasiterJudge Posner, joined by Judges Easterbrook andEvans, concluded that leave must be sought even if thelawsuit is filed after the case is closed. Lasiter, 136F.3d at 545. The court cited three policy reasons.First, trustees would be unwilling to serve if they weresubject to suit in a variety of forums. Second,bankruptcy administration costs would increase asmalpractice and bonding costs increased. Third,requiring the bankruptcy court=s approval promotedthe bankruptcy court=s ability to evaluate trustees=work and to decide whether to appoint them insubsequent cases. Lasiter, 136 F.3d at 545.

The First Circuit has narrowed this general rule. It has held that leave of the bankruptcy court is notrequired if the lawsuit is filed in the bankruptcy court. LeBlanc v. Salem (In re Mailman Steam CarpetingCorp.), 196 F.3d 1 (1st Cir. 1999). The First Circuitdoes not elaborate on its holding, and it cites only abankruptcy court opinion. But the policy concernsraised in Lasiter are minimized when the suit is filedin the bankruptcy court. Bankruptcy trustees acceptcase appointments voluntarily, so they have acceptedthe bankruptcy forum. The costs and inconvenience ofdefending in a foreign location are not implicated. Theappointing bankruptcy court has familiarity with thecase. If the trustee=s conduct reflects incompetence,mismanagement, or another problem, the bankruptcycourt will be able to consider the conduct=s impact onthe existing case and on future appointments.

Recently, the Eleventh Circuit decided an issuethat fell between the facts in Linton and MailmanSteam. In Carter v. Rodgers, No. 99-13703, 2000WL 1059527 (11th Cir. Aug. 2, 2000), the EleventhCircuit affirmed the federal district court=s dismissal ofthe debtor=s negligence and breach of duty lawsuit.

The trustee=s wife and the estate employedauctioneer had purchased auctioned assets from the







9

debtor=s bankruptcy estate. Initially, the debtor soughtremoval of the bankruptcy trustee, contending thepurchases destroyed the trustee=s disinterested status. Carter, 2000 WL at *1. The trustee resigned. Thedebtor then filed suit in the federal district court, andthe district court dismissed the case under Barton.

Citing five appellate courts and a bankruptcyappellate panel, the Eleventh Circuit held that theBarton doctrine remained viable under the BankruptcyCode. Carter, 2000 WL at *1 (citations omitted). The court was unpersuaded by the debtor=s contentionthat the lawsuit involved business operations ratherthan the trustee=s administrative duties. Carter, 2000WL at *4.

Finally, the debtor contended that a distinctionexisted between federal and state courts and that theproceeding was proper in district court because it wasArelated to@ the bankruptcy case. The Eleventh Circuitconcluded the distinction between federal district courtand state court was irrelevant. Carter v. Rodgers, No.99-13703, 2000 WL 1059527 at *3(11th Cir. Aug. 2,2000).

The Eleventh Circuit did not attribute anysignificance to filing the lawsuit in the same federaldistrict where the bankruptcy was pending. If thelawsuit had been filed in a different federal district,then applying Barton would have been correct, and theanalysis would have been exactly the same as for astate court. However, under the facts of Carter, thefederal district court had original jurisdiction over theentire bankruptcy case, and the bankruptcy courtderived its jurisdiction from the district court=s referralof the reference. 28 U.S.C. '1334; 28 U.S.C.'157(a). The district court could have withdrawn thereference to hear the lawsuit against the trustee or tohear the entire bankruptcy case. 28 U.S.C. '157(d). Assuming the First Circuit correctly held thatbankruptcy court permission is not needed to file suitin the bankruptcy court, filing in the federal districtcourt where the bankruptcy case was pending couldhave been construed as being the same.

Although it would have been instructive for theEleventh Circuit to address this jurisdictional detail,the Eleventh Circuit=s result still has merit. Whenevaluating withdrawal of the reference, courts oftenare instructed to consider encouraging uniformbankruptcy administration, minimizing forumshopping, economizing the creditors= and debtors=resources, and expediting the bankruptcy=s resolution. Holland Am. Ins. Co. v. Roy, 777 F.2d 992, 999 (5th

Cir. 1985). Many of these concerns overlap theconcerns expressed in Barton and its progeny.

In the Eleventh Circuit=s case, the bankruptcycourt had appointed the bankruptcy trustee and knewthe bankruptcy case facts. When the motion to removethe trustee was filed, the bankruptcy court becamefamiliar with the specific facts involved in the auction,and the bankruptcy court would have to consider thesefacts again when deciding any fee requests. Inessence, the bankruptcy court already had exercisedjurisdiction over the issues involved in the fiduciaryduty lawsuit. Allowing the issues to proceed in twoforums would have promoted inconsistent results,encouraged forum shopping, and increased costs. Therefore, when the Eleventh Circuit required thedebtor to obtain bankruptcy court permission, itreaffirmed the policy considerations announced inBarton and in withdrawal of the reference cases.

Barton and its progeny historically have beenlimited to trustees. Fifth Circuit Bankruptcy Codeprecedent involves non-trustee professionals or trusteeactions that arose in bankruptcy cases, so it seems thatthe Fifth Circuit has not yet addressed the applicabilityof Barton under the Bankruptcy Code. However,considering the great weight of appellate authorityapplying Barton, litigants who want to file suit in aforum other than the bankruptcy court should obtainbankruptcy court permission unless it is clear that thelawsuit involves the trustee=s business operations.

The merit of this extra step is evidenced by theremedies for its violation. Courts have crafted severalpunishments for Barton violations. In Carter, thedistrict court dismissed the lawsuit for lack of subjectmatter jurisdiction. Carter , 2000 WL 1059527 at *1. Other courts suggest that the non-bankruptcy courtshould stay or abate the case until the bankruptcycourt approves the suit. In re Linton, 136 F.3d 544,546 (7th Cir. 1998). When the automatic stay does notapply, some bankruptcy courts enjoin actions in othercourts. In dicta the Linton court suggested that such injunctions Aprotect or effectuate [the bankruptcycourt=s] judgments@ and therefore do not violate theAnti-Injunction Act. Linton,136 F.3d at 546. Onebankruptcy court recommended contempt or sanctionswhen permission was required but not obtained. Inre Baptist Med. Ctr., 80 B.R. 637, 647 (Bankr.E.D.N.Y. 1987).

2. AArising in@ or ARelated toBreach of duty, negligence, and malpractice

actions all arise under state law. When challenging theconduct of bankruptcy trustees or bankruptcyprofessionals, litigants have contended that thebankruptcy court lacks the power to resolve these





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issues because they are Arelated to@ the bankruptcycase rather than core matters Aarising in@ thebankruptcy case or Aarising under@ the BankruptcyCode. 28 U.S.C. '1334(c). In Southmark Corp. v.Coopers & Lybrand (In re Southmark Corp.), 163F.3d 925 (5th Cir.), cert. denied, 527 U.S. 1004(1999), the Fifth Circuit stated, A[i]t is somewhatdisingenuous . . . to attempt to pry these claims out oftheir bankruptcy setting.@ Southmark, 163 F.3d at931. First, Athe state law origin of [the] claims is notdispositive.@ Southmark, 163 F.3d at 931. Second,A[a] sine qua non in restructuring the debtor-creditorrelationship is the court=s ability to police thefiduciaries, whether trustees or debtors-in-possession.@ Third, the claims against the accountants were knownat the time of the fee hearing and therefore were in thenature of counterclaims. Southmark, 163 F.3d at 931. The Fifth Circuit therefore elected to join Third,Ninth, and Sixth Circuits in holding that actionsagainst estate professionals are core issues for thebankruptcy court to decide. Southmark, 163 F.3d at932 (string citation omitted). The Eleventh Circuitrecently agreed with these decisions. Carter v.Rodgers, No. 99-13703, 2000 WL 1059527 at *3(11th

Cir. Aug. 2, 2000). ANo appeals court decision hasheld otherwise.@ Southmark, 163 F.3d at 932.

3. Right to Jury TrialA full analysis of the bankruptcy court=s ability to

conduct jury trials and the right to jury trials is beyondthe scope of this paper. See e.g. In re Clay, 35 F.3d190 (5th Cir. 1994) (holding that bankruptcy courtlacked authority to conduct jury trials absent parties=consent); S. Elizabeth Gibson, Jury Trials and CoreProceedings, 65 Am. Bankr. L.J. 143 (1991). Courtshave held that the power to hold a bankruptcy trusteeliable for breaches of duty arises in equity rather thanin common law negligence. Yadkin Valley Bank &Trust v. McGee (In re Hutchinson), 5 F.3d 750, 757-58; (4th Cir. 1993); Compton v. Walker (In re CoralPetroleum, Inc.), 249 B.R. 721, 2000 WL 815298(Bankr. S.D. Tex. June 16, 2000) (involving chapter11 plan trustee).

Other courts have expanded on the United StatesSupreme Court=s holding that filing a proof of claim inthe bankruptcy court waives the right to a jury trial. Katchen v. Landy, 382 U.S. 323 (1996). These courtshave held that trustees and professionals waive theright to a jury trial by being appointed, byparticipating in the bankruptcy, and by requestingfees. Billing v. Ravin, Greenberg, & Zackin, P.A. (Inre Billing), 22 F.3d 1242, 1252-53 (3d Cir. 1994);

Simmons v. Johnson, Curney & Fields, P.C., 205B.R. 834, 849-50 (Bankr. W.D. Tex. 1997); see alsoCompton v. Walker (In re Coral Petroleum, Inc.),249 B.R. 721, 2000 WL 815298 (Bankr. S.D. Tex.June 16, 2000) (alternative holding).

IV. TRUSTEE DEFENSESThe case law reveals that trustees often prevail

when they file motions to dismiss or motions forsummary judgment invoking the following fourdefenses. Occasionally, it is unclear in opinions howthe defense is raised and who bears the burden. Therefore, specific authority has been cited for eacharea. Although issue and claim preclusion cases arisein the context of bankruptcy professional malpracticeclaims, the opinions turn on the orders approving fees. Trustees are subject to the same fee approvalrequirements, so the case law should apply to them,too. 11 U.S.C. ''326,330.

A. Business JudgmentTrustees make decisions prospectively, but their

results are reviewed retroactively. In re Melenyzer,140 B.R. 143 (Bankr. W.D. Tex. 1992). In Mosser v.Darrow, 341 U.S. 267 (1951), the United StatesSupreme Court stated, ACourts are quite likely toprotect trustees against heavy liabilities fordisinterested mistakes in business judgment.@ Mosser,341 U.S. at 274. Following this language, courts havenot imposed liability for business judgment decisions. Hall v. Perry (In re Cochise), 703 F.2d 1339, 1357(9th Cir. 1983); cf. Dodson v. Huff (In re Smyth), 207F.3d 758, 762 (5th Cir. 2000) (noting thatAdisinterested@ trustee must make complex decisionsquickly). The business judgment rule is a defense.Gearhart Indus .v. Smith Intn=l, Inc., 741 F.2d 707,721 (discussing business judgment rule under Texaslaw and noting Ait is a defense to accusations of breachof the duty of care.@) . It is available when parties seekto impose liability on the estate or on the trusteeindividually.

B. Derived Judicial ImmunityJudges are absolutely immune from liability for

damages arising from their judicial determinations. Pierson v. Ray, 386 U.S. 547, 553 (1967). In Mosserv. Darrow, 341 U.S. 267 (1951), the United StatesSupreme Court suggested that the trustees would beinsulated from liability if (1) they candidly disclosedfacts, (2) in a motion served on all parties in interest,(3) and obtained a court order authorizing theiractions. Mosser, 341 U.S. at 274. When the court
























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approves the trustee=s actions, the trustee receivesderived judicial immunity, also known as quasi-judicial immunity. Boullion v. McClanahan, 639F.2d 213, 214 (5th Cir. 1981) (per curiam); Clementsv. Barnes, 834 S.W.2d 45 (1992) (per curiam). Derived judicial immunity is an affirmative defensewhich must be plead or waived. Fed. R..Civ. P. 8(c);made applicable in bankruptcy through Fed. R.Bankr. P. 7008; cf. Boyd v. Carroll, 624 F.2d 730,732-33 (5th Cir. 1980) (holding judge waivedaffirmative defense of absolute immunity). It isengrafted into paragraph one of the NationalBankruptcy Review Commission=s Report. See aboveGross Negligence: The Fifth Circuit=s Approach.

C. Issue PreclusionIssue preclusion, formerly known as collateral

estoppel, is an affirmative defense that must be plead. Fed. R. Civ. P. 8(c), made applicable in bankruptcythrough Fed. R. Bankr. P. 7008(c). Three elementsexist. First, the issue at stake must be identical. Second, the issue must have been actually litigated inthe first proceeding. Third, the issue=s resolution musthave been integral to the court=s judgment in the firstlitigation. Southmark Corp. v. Coopers & Lybrand(In re Southmark Corp.), 163 F.3d 925, 932 (5tth

Cir.), cert. denied, 527 U.S. 1004 (1999). In Southmark, the accounting firm served as

examiner and made litigation recommendations. Thefirm failed to disclose that it represented one of thepotential defendants. While the firm did notrecommend litigation against this client, it urgedlitigation against others who were similarly situated. After the conflict of interest was discovered, thebankruptcy court ordered the accounting firm todisgorge $550,000 in fees. Thereafter, the debtor fileda malpractice suit in state court, contending that theaccounting firm had failed to investigate the claim. The action was removed to the bankruptcy court, andthe bankruptcy court granted the accounting firm=smotion for summary judgment, which alleged that thelawsuit was barred by the disgorgement order. Southmark, 163 F.3d at 927-28.

The Fifth Circuit affirmed based on issuepreclusion. Southmark, 163 F.3d at 932-33. TheFifth Circuit held that the conflict of interest causedthe damages in both the disgorgement matter and theremoved lawsuit. Causation was litigated, and thefinding was necessary to the bankruptcy court=sdisgorgement order. Southmark, 163 F.3d at 933. The Fifth Circuit noted that it was reserving the claimpreclusion question because the disgorgement hearing

involved a contested matter rather than an adversaryproceeding. It was not to skirt claim preclusion forlong.

D. Claim PreclusionClaim preclusion, formerly referred to as res

judicata, is an affirmative defense. Fed. R. Civ. P.8(c), made applicable in bankruptcy through Fed. R.Bankr. P. 7008. Four elements must be established. First, the parties must be identical or in privity. Second, the first action=s judgment must have beendecided by a court with jurisdiction. Third, the firstaction must have been resolved by final judgment. Fourth, the same claim or cause of action must beinvolved in both proceedings. E.g. Swate v. Hartwell,99 F.3d 1282, 1286 (5th Cir. 1996).

Approximately one year after the Fifth Circuitdecided Southmark Corp. v. Coopers & Lybrand (Inre Southmark Corp.), 163 F.3d 925, 932 (5th Cir.),cert. denied, 527 U.S. 1004 (1999), it consideredanother case involving similar facts, and it decided theclaim preclusion issue that it had reserved inSouthmark.

Osherow v. Ernst & Young, LLP (In re IntelogicTrace, Inc.), 200 F.3d 382 (5th Cir. 2000), againinvolved accountants. The accountants providedaudited numbers that were used for plan projections. Two months after confirmation the debtorexperienced a cash flow crisis. The debtor=s boardrecognized that the accountants= figures must havebeen incorrect, but they were reluctant to object to theaccountants= $218,000 fee request. They did not wantthe bankruptcy court to learn that the confirmed planmight fail. Instead of objecting, they negotiated a$37,000 agreed fee reduction. Osherow v. Ernst &Young, LLP (In re Intelogic Trace, Inc.), 200 F.3d382, 385 (5th Cir. 2000).

Ultimately, a second bankruptcy case was filed,and it converted to chapter 7. In response to thechapter 7 trustee=s lawsuit, which raised severaltheories, including breach of duty and negligence, theaccountants= plead that the final fee order entitled themto claim preclusion. The bankruptcy court grantedsummary judgment for the accountants. Intelogic,200 F.3d at 385.

The Fifth Circuit agreed, but it underscored thatits determination was fact specific. Intelogic, 200F.3d at 391. The only claim preclusion element atissue was the fourth: whether the same claim or causeof action was involved in both proceedings. First, thepanel applied the transactional test, which requiresthat the court evaluate whether the two lawsuits arise














12

from a Acommon nucleus of operative facts.@ Intelogic, 200 F.3d at 386 (citing Restatement(Second) of Judgments '24 (1982) and quoting In reHowe, 913 F.2d 1138, 1144 (5th Cir. 1990)). TheFifth Circuit concluded that the fee hearing and thetrustee=s malpractice met the transactional test. Intelogic, 200 F.3d at 387-88.

The Court then evaluated three additional factors:the first matter=s procedural structure as a contestedmatter or an adversary proceeding, the connectionbetween the first judgment and the new litigation, andthe time that had elapsed. ANone of these factors is alitmus test.@ Intelogic, 200 F.3d at 388. The FifthCircuit acknowledged that fee application hearings arecontested matters. Fed. R. Bankr. P. 9014. Claimpreclusion does not arise in all contested matters, butclaim preclusion may result. Compare In re Howe,913 F.2d 1138, 1146-47 (5th Cir. 1990) (holding thatconfirmation hearing barred subsequent lawsuit) withD-1 Enter. v. Commercial State Bank, 864 F.2d 36,38 (5th Cir. 1989) (holding that automatic staydetermination did not bar tort claims against lender). In Intelogic, the crux was that before the fee hearingthe debtor=s board had actual or imputed knowledgethat the accountants had blundered. Intelogic, 200F.3d at 388. Accordingly, the board should haveobjected and asked the bankruptcy court to apply allthe adversary rules.

The Fifth Circuit=s focus on actual or imputedknowledge is evidenced in R & C Petroleum, Inc. v.Henry & Peters, P.C. (In re R & C Petroleum, Inc.),236 B.R. 355 (Bankr. E.D. Tex. 1999), where thebankruptcy court again considered allegations thataccountants. However, the trustee alleged that theaccountants= fee order was entered in October but themalpractice could not have been discovered untilDecember. Although the summary judgment evidenceincluded documents that contradicted this allegation,the court concluded it would have to weigh evidence. Accordingly, the court held that claim preclusion wasnot established as a matter of law and denied themotion for summary judgment. R & C Petroleum, 236B.R. at 359-60.

V. THE UNITED STATES TRUSTEE==SADMINISTRATIVE ROLE

The courts can reduce fees and impose liability. Ultimately, they can disapprove case appointmentsand remove trustees. However, as discussed above,the courts have had difficulty balancing the competinggoals of protecting trustees from being second guessedwhile at the same time ensuring that the trustees

conduct comports with the duties of care and loyalty.

The United States trustee has a role in thisbalancing process. Sometimes the amount of moneyinvolved does not justify a fee objection or a lawsuit,but a systemic problem is identified. The United Statestrustee=s office has the flexibility to evaluate remediesranging from education to removal. These remediescan be considered contemporaneously with litigationor in the absence of litigation.

A. The United States Trustee==s ChargeThe United States trustee oversees panel and

standing trustees. With respect to chapter 7 paneltrustees, the United States trustee must Aestablish,maintain, and supervise@ a panel of chapter 7 trustees. 28 U.S.C. '586(a)(1). Minimum qualifications are setforth in 28 C.F.R. 58.3. When panel trustees are addedto the panel, they become eligible as interim trustees. 11 U.S.C. '701. They receive performance reviewsevery other year.

The United States trustee has discretion to appointstanding chapter 13 or 12 trustees if the case loadmerits a permanent position. 28 U.S.C. '586(a)(2). The United States trustee then supervises thesestanding trustees Ain the performance of their duties.@ 28 U.S.C. '586(b). Standing trustees must meet theminimum qualifications set forth in 28 C.F.R. 58.4. They receive annual reviews.B. The Complaint Procedure

Consonant with the obligation to supervise paneltrustees, the United States trustee responds to publiccomplaints. Whether complaints are oral or written,the United States trustee considers them. However,written complaints, including pleadings asking forremedial relief against a trustee, are subject to formalprocedure and are tracked internally. After receivinga formal, written complaint, the United States trusteewill inform the trustee and define a time period for thetrustee to respond. After the trustee=s response isreceived, the United States trustee investigates thecomplaint independently. Afterwards, the UnitedStates trustee informs the complaining party and thetrustee in writing of the conclusions and any remedialactions. Public complaints are considered when theUnited States trustee completes the performancereview.

C. Procedures for Suspension and RemovalTrustees do not have constitutionally or statutorily

protected interests in their position. Joelson v. UnitedStates, 86 F.3d 1413 (6th Cir. 1996). Accordingly, the









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United States trustee has the right to suspend orremove trustees. Before 28 C.F.R. ' 58.6 waspromulgated, it was unclear whether courts couldreview the United States trustee=s actions. Id. Thisregulation now defines the procedure for suspendingor removing a trustee. The timing sequence echoes anappellate briefing schedule.

The regulation lists fourteen reasons a trustee maybe suspended but notes that the list is not intended tobe exhaustive. In addition to being available in theCode of Federal Regulations, 28 C.F.R. ' 58,6 isavailable on the United States trustee=s website. <http://www.usdoj.gov/ust/rule_reg.html>

1. The United States Trustee=s ActionThe United States trustee must inform the panel or

standing trustee in writing of the decision to suspendor terminate. The United States trustee also maydecide not to renew a slot. Under any of thesecircumstances, the United States trustee must providesupporting documentation for the decision. Thisdocumentation may consist of statistical data,pleadings, prior correspondence, or similarinformation. A copy of this package is sent to theExecutive Office of United States trustees.

2. The Trustee=s ResponseTrustees who receive such letters must be advised

of their Aright to review.@ 28 C.F.R. ' 58.6(b). Theyhave twenty days from the date of the United Statestrustee=s letter to request review. 28 C.F.R. ' 58.6(b). A response must include all relevant facts anddocumentation. The United States trustee then hasfifteen days to respond..28 C.F.R. ' 58.6(g).

3. Effective Dates and StaysIf a trustee declines to respond, then the

termination or suspension becomes effective when thereview time expires. If the trustee responds, then thetermination or suspension becomes effective if theDirector issues a final review agreeing with the UnitedStates trustee. However, either with the suspension orthereafter, the United States trustee may issue aninterim directive which immediately discontinues caseassignments. 28 C.F.R. ' 58.6(d).

To discontinue case assignments, the UnitedStates trustee must find one of three problems: (1) thatcontinuing assignments to the trustee endangers estateassets; (2) that the trustee is ineligible underapplicable law, rule, or regulation; or (3) that thetrustee is engaged in gross misconduct which Aisunbefitting his or her position as trustee or violates the

trustee=s duties.@ 28 C.F.R. ' 58.6(d). When theUnited States trustee issues an interim directive, thetrustee has the right to seek a stay if a request forreview has been timely filed. 28 C.F.R. ' 58.6(e).

4. The Director=s ReviewAfter receiving the trustee=s response and any sur-

reply from the United States trustee, the Director,currently Kevyn Orr, has the power to request moreinformation from other sources. 28 C.F.R. ' 58.6(h). The Director may be assisted by a reviewing officialfrom the United States trustee Program. Thereviewing official must be from a different UnitedStates trustee region and cannot have participated inthe United States trustee=s original decision. 28 C.F.R.' 58.(j). Unless the parties agree to a longer period oftime, the Director must issue his decision within thirtydays of receiving the United States trustee=s sur-reply. 28 C.F.R. ' 58.6(i).

The Director evaluates whether the United Statestrustee=s decision was an appropriate exercise ofdiscretion and whether the record supported thedecision. 28 C.F.R. ' 58.6(i). Approximately twentydecisions have been issued by the directors since theregulation was enacted in 1997. The Director=sdecisions are available at the following website:<http://www.usdoj.gov/ust/foia/admin-decisions/ad_re_pt.htm>

5. Judicial ReviewA decision by the Director is subject to judicial

review under the Administrative Procedures Act. 5U.S.C. ' 551 et. seq. The review occurs in the federaldistrict court.

VI. CONCLUSIONTrustees= conduct must be scrutinized by others,

but both trustees and bankruptcy estate parties-in-interest benefit from knowing what standards andprocedure apply. The Fifth Circuit and the ExecutiveOffice of United States trustees have clarified thestandards and procedures. However, other questionssuch as the statute of limitations and the availability ofjury trials remain unclear. In the absence oflegislation, these questions remain subject to litigation.


15

APPENDIX ATable Summarizing Trustee Duties

The following chart summarizes the trustees= duties as set forth in 11 U.S.C. '' 704, 1106(a), 1202, and 1302.

Trustee Duty 7 11 12 13

Collect estate assets and reduce to money x

Close estate expeditiously x

Account for property received x x x x

Ensure that debtors comply with statement of intentions x x x

Investigate debtors= financial affairs x x

Review claims and file any objections x x x x

Pursue appropriate discharge objections x x x

Share requested information about the estate and its administrationwith parties-in-interest

x x x x

File periodic financial reports when operating a business x x ?

File a final report and account x x x x

File any omitted lists of creditors, schedules, and statements offinancial affairs

x ?

Investigate the acts, conduct, assets, liabilities, and financialcondition of debtor (unless court orders otherwise)

x ? $

File and serve a statement of investigation x ? $

File plan, statement why plan is not to be filed, or motion todismiss or convert

x ?

Furnish, without personal liability, information to governmentalagencies when debtor failed to file tax returns

x ?

File post-confirmation reports x ?

Attend and be heard at confirmation, modification, and valuation(plus sale hearings in chapter 12)

x x

Ensure that the debtor commences timely plan payments x x

Advise debtors on non-legal matters and assist with planperformance

x

Dispose of funds in accordance with Administrative Office ofUnited States Courts regulations

x

? Reflects that the Court has discretion to order that duty exists when the debtor is removed as debtor-in-possession. 11U.S.C. '1202(b)(3),(5).

$ Reflects that the Chapter 13 trustee completes these tasks when the debtor is engaged in business.

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