Court Holds That Directors Owe Fiduciary Duties to Creditors of Insolvent Corporation

The Minnesota Court of Appeals affirmed a Ramsey County District Court ruling that a corporate director violated the Minnesota Uniform Fraudulent Transfer Act (“MUFTA”) when she transferred proceeds from the sale of real estate to herself as a judgment lien holder, instead of satisfying corporate creditor obligations. In Alerus Financial, Nat. Ass’n v. Martin Holdings, LLC, No. 62-CV-11-1664 (Minn. Ct. App. Dec. 9, 2013) (unpublished), the Minnesota Court of Appeals affirmed the district court’s holding that transfers made by corporate directors from the sale of corporate assets constitute transfers under the MUFTA. The court’s ruling provides guidance on transferring assets from an insolvent business and the fiduciary duties corporate directors of an insolvent business owe to the business’ creditors.

Background
In Alerus, Jennifer Igo (“Igo”) obtained money judgments totaling $796,805.37 against her ex-husband Richard Igo and his corporate assets during marriage-dissolution proceedings. In enforcing the judgments, Igo acquired sole controlling interest of Richard Igo’s company, Historic Renovations, Inc. (“HRI”), and a 50% stake in Martin Holdings, LLC, a company owned in part by HRI.

Prior to Igo’s acquisition of HRI, its bank, Alerus, made two loans to Martin Holdings and one loan to HRI. The Martin Holdings loans were unconditionally guaranteed by HRI. In April 2010, Alerus notified Martin Holdings that it was in default on its two loans. The unpaid principal at the time of default totaled $902,984.62.

In March 2011, Igo directed HRI to sell one of its properties for $1,850,000.00. To facilitate the sale, Igo released her judgment liens on the property. Igo transferred the sale’s net proceeds of $1,058,292.18 to her personal account to satisfy her unsecured debt of $796,805.37 against the company.

The district court concluded that Igo’s transfer of the proceeds that exceeded her judgment liens violated Minn. Stat. § 513.45(a), which prohibits a debtor from transferring assets without receiving reasonably equivalent value if the debtor is insolvent at the time or becomes insolvent as a result of the transfer. Additionally, the district court held that Igo’s transfer of the amount equal to her judgment liens violated Minn. Stat. § 513.45(b), which prohibits a debtor from making transfers to insiders for antecedent debts if the debtor is insolvent and the insider knows of the insolvency. The district court ordered Igo to return the transferred $1,058,292.18 to HRI to be divided equitably between Igo and Alerus. The court ordered that 54.4% be allocated to Alerus and 45.6% to Igo.

Igo appealed the district court’s ruling to the Minnesota Court of Appeals. On appeal, she argued that: (1) the transfer from HRI to herself of proceeds from the sale of the property did not constitute a transfer under MUFTA, because the property was not an “asset” under MUFTA to the extent it was encumbered by appellant’s valid judgment liens; (2) even if an “asset” was transferred, Alerus’ MUFTA claims fail because Alerus did not establish that HRI was insolvent and did not receive reasonably equivalent value for the funds; and (3) the district court erred by holding that Igo owed Alerus a fiduciary duty.

Court of Appeals Holds That Proceeds from the Sale Constituted a Transfer Under MUFTA
Under MUFTA, a transfer is “every mode . . . of disposing of or parting with an asset or an interest in an asset.” Minn. Stat. § 513.41(12). An asset is “property of a debtor,” excluding “property to the extent it is encumbered by a valid lien.” Minn. Stat. § 513.41(2)(i) (emphasis added).

The Minnesota Court of Appeals affirmed the trial court holding that Igo’s judgment liens were against the property, not the cash proceeds of its sale, which were not encumbered by any liens. Once Igo released her judgment liens and liquidated the property into general corporate assets to which Alerus had a valid claim, MUFTA’s lien-shielding provision no longer applied, and the unencumbered property and cash proceeds from its sale became an asset under the statute.

Court of Appeals Holds That HRI was Insolvent and Did Not Receive Reasonable Equivalent Value
Under MUFTA, a “debtor is insolvent if the sum of the debtor’s debts is greater than all of the debtor’s assets, at a fair valuation.” Minn. Stat. § 513.42(a). Because the value of HRI’s liabilities exceeded the value of its assets both before and after the transaction, the company was “insolvent at the time of the transfer and as a result of the transfer.” Additionally, Alerus established that HRI did not receive “a reasonably equivalent value in exchange for the transfer,” as required under Minn. Stat. § 513.43(a). Igo’s judgment lien against HRI totaled $796,805.37, but she transferred $1,058,292.18 to herself. Igo could not prove why she was entitled to receive the additional $261,486.81.

Court of Appeals Holds That Igo Owed Alerus a Fiduciary Duty
The directors and officers of a corporation that is insolvent or on the verge of insolvency are “fiduciaries of the corporate assets for the benefit of creditors.” Snyder Elec. Co. v. Fleming, 305 N.W.2d 863, 869 (Minn. 1981). This fiduciary duty prevents such directors or officers, even ones with legitimate antecedent debts, from using “their special position [to] treat themselves to a preference over other creditors.” Id. The Minnesota Court of Appeals held that Igo breached her fiduciary duty when she favored herself over other creditors. Igo failed to present evidence of good faith to rebut the presumption that she breached the duty.

Conclusion
The take-away from the Alerus decision is that corporate directors owe creditors a fiduciary duty when a corporation is near insolvency. Directors must take caution if transferring corporate assets to themselves in such a situation. As demonstrated by Alerus, the Minnesota Court of Appeals has shown a reluctance to give directors the benefit of the doubt when transferring corporate assets near insolvency, and has instead viewed “insider transactions” with some degree of skepticism.

If you are a corporate director or officer of an insolvent corporation, you may wish to consult legal counsel before transferring corporate assets, especially to yourself. If you have questions about your potential fiduciary duties to creditors, contact one of the business law attorneys of Trepanier MacGillis Battina P.A.
_______________________
About the Author:
Minnesota corporate attorney Jim MacGillis advises clients on corporate and business law matters such as business transactions, creditor strategies, and corporate governance. Jim may be reached at 612.455.0503 or jmacgillis@trepanierlaw.com. Trepanier MacGillis Battina P.A. is a Minnesota corporate law firm located in Minneapolis, Minnesota.