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Third Circuit Opens the Door to Breach of Fiduciary Duty Claims

By Thomas J. Fleming and Adam H. Friedman
January 03, 2006

Recently, the Third Circuit Court of Appeals, in In re Tower Air, Inc., 416 F.3d 229 (3rd Cir. 2005), queried: 'How far will the federal courthouse door swing open for a direct suit against corporate directors and officers for Breaches of Fiduciary Duties?' In firmly answering this question, the Third Circuit has widened the door for bankruptcy trustees and creditors' committees, by making it easier, at the pleading stage, to assert a claim for breach of fiduciary duty in federal court. This decision comes at a time when plaintiffs are held to high pleading standards in federal securities cases (as a result of the Private Securities Litigation Reform Act, 15 U.S.C. ' 78u-4 (1997)) and breach of fiduciary duty cases in state court, each of which have presented significant hurdles for plaintiffs. In Tower Air, the Third Circuit Court of Appeals reversed the District Court and held that it erred in assuming that Delaware state law pleading standards were 'interchangeable' with federal notice pleading standards, Thus, Tower Air evidences a particularly unique opportunity for litigants in bankruptcy cases, as the Third Circuit has made it significantly easier for plaintiffs to succeed in defeating motions to dismiss, allowing them to proceed to discovery to build and support a claim.

The Facts

In Tower Air, the Chapter 7 Trustee commenced an action against certain officers and directors (the Defendants) for breach of fiduciary duty and corporate waste. The Trustee alleged that the Defendants of the debtor drove the company into bankruptcy through 'indifference and egregious decision making'. In Tower, defendant Morris Nachtomi was at relevant times the Chairman and CEO, President and a director of Tower. Nachtomi and his family also owned a substantial majority of the common stock of the debtors and he controlled the company. In 1996, the company lost $23 million, at a time when the company was expanding its international flight routes. The company allegedly added routes to Santo Domingo because Nachtomi's daughter expressed a 'personal interest' in having the airline do so. The court noted that the Santo Domingo route never turned a profit. The Trustee further alleged that Nachtomi ran the debtors' Tel Aviv office with no oversight from the companies other officers and directors in the U.S. Eventually, the Tel Aviv office accumulated debt and its creditors forced it into a liquidation proceeding.

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