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May 16, 2014

Larry Gabriel and Joe Balice Provide Expert Analysis to Law360

Another Arrow In The Chapter 11 Trustee’s Quiver

Law360, New York (May 16, 2014, 1:09 PM ET) — On May 5, 2014, the California Court of Appeal may have issued a game-changing decision in its ruling in American Master Lease LLC v. Idanta Partners Ltd., — Cal.Rptr.3d —-, Cal.App. (2 Dist., 2014, May 5, 2014), holding that a party (individual or entity) who aids and abets a breach of fiduciary duty may have to disgorge its profits from the transaction, whether or not the disgorgement relates to the actual damages suffered by the plaintiff, under the doctrine of unjust enrichment.

That is, notwithstanding whether the plaintiff suffered a loss, the defendant in this case was ordered to disgorge the profits made on the transaction that aided and abetted a breach of fiduciary duty. This may be particularly significant to bankruptcy trustees who often sue for aiding and abetting breach of fiduciary duty, but have difficulty proving actual damages. As noted by the California Court of Appeal:

Typically, the defendant’s benefit and the plaintiff’s loss are the same, and restitution requires the defendant to restore the plaintiff to his or her original position.” (County of San Bernardino, supra, at p 542.) However, “[m]any instances of ‘liability based on unjust enrichment … do not involve the restoration of anything the claimant previously possessed… includ[ing] cases involving the disgorgement of profits … wrongfully obtained ….’ [Citation.] ‘[T]he public policy of this state does not permit one to “take advantage of his own wrong”’ regardless of whether the other party suffers actual damage. [Citation.] Where ‘a benefit has been received by the defendant but the plaintiff has not suffered a corresponding loss or, in some cases, any loss, but nevertheless the enrichment of the defendant would be unjust … the defendant may be under a duty to give to the plaintiff the amount by which [the defendant] has been enriched.’ [Citation.]” (Ibid; see Feitelberg v. Credit Suisse First Boston LLC, supra, 134 Cal.App.4th at p. 1013.)[1]

The implications of the decision and the impact of the same are substantial. By way of example, in Henry v. Lehman Commercial Paper Inc. (In re First Alliance Mortgage Co.), 471 F.3d 977, 995 (9th Cir.2006), the court (and the jury) found that Lehman aided and abetted the mortgage fraud of First Alliance Mortgage, but (1) limited damages recovered by the class, and (2) refused to equitably subordinate Lehman’s $80 million secured claim to the claims of the victim borrowers. Lehman at 471 F. 3d, 1008-1009.

Had the class (or the trustee for that matter) been awarded damages under this theory of unjust enrichment as presented in American Master, Lehman would have had to repay all of its profits on a two-year $80 million loan (assume 10 percent per annum) plus all fees earned. The total recovery to the class or the trustee would therefore have been around $20 million, whereas the jury returned a verdict for around $5 million based upon damages sustained by the class of borrowers.

The American Master court explains it’s rationale:

Moreover, “‘[i]t is not essential that money be paid directly to the recipient by the party seeking restitution ….’ [Citations.] The emphasis is on the wrongdoer’s enrichment, not the victim’s loss. In particular, a person acting in conscious disregard of the rights of another should be required to disgorge all profit because disgorgement both benefits the injured parties and deters the perpetrator from committing the same unlawful actions again. [Citations.] Disgorgement may include a restitutionary element, but it ‘may compel a defendant to surrender all money obtained through an unfair business practice … regardless of whether those profits represent money taken directly from persons who were victims of the unfair practice.’ [Citation.] Without this result, there would be an insufficient deterrent to improper conduct that is more profitable than lawful conduct.” (County of San Bernardino v. Walsh, supra, 158 Cal.App.4th at pp. 542-543.)

Based thereon, the court held: “Disgorgement based on unjust enrichment is an appropriate remedy for aiding and abetting a breach of fiduciary duty.”

The case is significant for a number of reasons. First, the remedy of unjust enrichment has not been favored by the courts, and typically the claim is lost on demurrer. See, e.g. Levine v. Blue Shield of California, (2010) 189 Cal.App.4th 1117, 117 Cal. Rptr.3d 262, 278-279 (“Although some California courts have suggested the existence of a separate cause of action for unjust enrichment (Peterson v. Cellco Partnership (2008) 164 Cal.App.4th 1583, 1593, 80 Cal.Rptr.3d

316 [listing elements]), this court has recently held that ‘[t]here is no cause of action in California for unjust enrichment.’ [Citations.] Unjust enrichment is synonymous with restitution. [Citation.]” (Durell, supra, 183 Cal.App.4th at p. 1370, 108 Cal.Rptr.3d 682.) Thus, the Levines’ unjust enrichment claim does not properly state a cause of action.”)

Thus, the decision may present persuasive authority that the claim of unjust enrichment is more than a mere remedy, but in any event, is not limited to the concept of “restitution.”

Second, it paves the way for plaintiffs, and particularly Chapter 11 trustees, to seek unjust enrichment claims against aiders and abettors, such as financial institutions, recouping for creditors the untoward profits obtained by the defendant. Clearly, this may present another arrow in the trustee’s quiver of claims and rights.

However, plaintiffs and Chapter 11 trustees may want to exercise some caution in pursuing this remedy, as pursuing such a remedy may have insurance coverage implications in addition to paving the way to new damage claims. Because it is possible to trigger coverage with a claim for aiding and abetting a breach of fiduciary duty, typically under a directors and officers liability policy, a target defendant may be covered for such a claim in and of itself.

However, the applicability of the unjust enrichment doctrine may present a twist favorable to the insurance company, because the remedy of disgorgement of ill-gotten gains is generally understood to be uninsurable. Accordingly a trustee must consider collectability in electing this new remedy.

If the target defendant has assets to satisfy a judgment, disgorgement would be ideal if it represents a larger recovery. But if the trustee is relying on insurance coverage to satisfy a resulting judgment, then the trustee must prove up damages, because the defendant’s insurance carrier most likely won’t pay for the disgorgement, severely limiting actual recovery.

—By Larry W. Gabriel and Joseph G. Balice, Brutzkus Gubner LLP

Larry Gabriel is of counsel and Joseph Balice is an associate at Brutzkus Gubner.

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