BearingPoint Directors to Face Lawsuit in State Court

Former BearingPoint Inc. directors will face a $1.88 billion lawsuit over their role in the consulting company’s insolvency in state court, a repercussion of a recent Supreme Court decision that could affect many bankruptcies.

U.S. Bankruptcy Judge Robert Gerber, who in 2009 approved BearingPoint’s exit from court protection, said in an order yesterday in New York that he will lift the usual restrictions that force creditors to argue their claims against officers and directors in bankruptcy court. Gerber said he changed his mind partly because of last month’s Supreme Court ruling that Congress violated the Constitution by giving too much power to bankruptcy judges.

“Gerber’s decision gives a lot of courts much to think about in terms of what the Supreme Court intended in Stern v. Marshall,” said Jeffrey Sabin, a partner at Bingham McCutchen LLP, who said it’s probably the first decision based on the Supreme Court’s ruling.

The 5-4 high court decision, in a case involving the late Anna Nicole Smith and the estate of Texas billionaire J. Howard Marshall, clamped down on the ability of bankruptcy judges to rule on disputes governed by state law.

Chief Justice John Roberts, writing for the majority, said a 1984 law violated the Constitution by giving powers to bankruptcy judges that were reserved for Article III judges, which refers to the section of the Constitution that establishes the federal judiciary. Those judges, including district, appeals, and Supreme Court judges, have life tenure, are confirmed by the Senate and are protected from having their salaries reduced.

Procedural Complications

“Concerns emerging from my fear that, if litigated here, this action would be bogged down in procedural complications, aggravated by the Supreme Court’s recent decision in Stern v. Marshall,” led him to grant a request to send the lawsuit to Virginia state court, Gerber wrote.

The Supreme Court ruling applies when companies or individuals have a “counterclaim” or legal argument that falls under state law, and is related, but not core, to a creditor’s financial claim. In a dissenting opinion, Justice Stephen Breyer argued the ruling could have a major effect on bankruptcies, creating “jurisdictional ping-pong” and adding cost and suffering for those already in bankruptcy.

The ruling creates “logistical difficulties” for bankruptcy judges, and could force lawsuits to change locations mid-dispute, adding costs, said Weil, Gotshal & Manges LLP in a July 7 note.

Seek Vengeance

In the bankruptcies of chemical maker Chemtura Corp., General Motors Corp.’s unwanted assets, and DBSD North American Inc., Gerber said he’s stated a case for why bankruptcy courts should review claims about the fiduciary duty of directors similar to those in BearingPoint; “stakeholders all too often blame others for failures to get the recoveries they desire; seek vengeance against other parties; or simply wish to second guess the decision makers in the chapter 11 case,” Gerber wrote.

Bankruptcy judges face some limitations which other courts can overcome, he added: “It’s a cliché, but still a correct observation, that what we bankruptcy judges see in our chapter 11 cases is the tip of an iceberg.”

Bankruptcy judges often oversee lawsuits about whether company executives are liable on the grounds they’ve broken the law that holds them responsible to public shareholders. Bankruptcy Judge Arthur Gonzalez dismissed a lawsuit that argued fraud leading up to the bankruptcy of Chrysler Corp., the car company. In Charter Communication Inc.’s bankruptcy, Judge James Peck approved a reorganization plan that freed officers, directors, advisers and lawyers from lawsuits including those for violations of securities law and breach of fiduciary duty.

‘Diminished’ Recoveries

Sabin, who represented the trustee in BearingPoint, said that Gerber’s ruling may not set a precedent for other bankruptcy court disputes over fiduciary duty, as it was specific to the facts of the BearingPoint case.

In the BearingPoint lawsuit, a trustee assigned to recover money for creditors in the Chapter 11 case is accusing former Chief Executive Officer Edwin Harbach and eight former directors of breaching their fiduciary duty by ignoring opportunities to sell the company or some of its assets in 2007 and 2008.

Creditor recoveries were “diminished” as a result in BearingPoint’s bankruptcy, trustee John DeGroote Services LLC said in court papers filed in November.

BearingPoint, based in McLean, Virginia, was spun off from the accounting firm KPMG LLP in 2000. It sold most of its assets in bankruptcy, including a $350 million sale to Deloitte LLP. Its financial-services business was sold to PricewaterhouseCoopers LLP.

The case is In re BearingPoint Inc., 09-10691, U.S. Bankruptcy Court, Southern District of New York (Manhattan)

(Updates with quote from lawyer in third paragraph.)
    Before it's here, it's on the Bloomberg Terminal. LEARN MORE