Can the Trustee Recover? Imputation of Fraud to Bankruptcy Trustees in Suits Against Third-Party Service Providers

November 1, 2011

Corporate fraud has become a familiar headline over the last decade and has forced several companies whose managers have committed that fraud to file for bankruptcy. In these cases, a trustee will often be appointed to represent and manage the bankruptcy estate. This trustee is vested with the rights of the debtor corporation upon filing and may try to sue third-party service providers (e.g., accounting firms, law firms, investment banks) for conspiring in, or negligently failing to detect, the fraud. Federal and state courts have disagreed over whether the bankruptcy trustee should be permitted to recover damages from these third parties. Some find that the trustee is burdened by the fraud and cannot recover, while others decide that the trustee should not be burdened by it. But the line between these two camps cannot be drawn cleanly. Courts that reach the same conclusion often do so for significantly different reasons. This Note seeks to place these decisions into a clear and more understandable framework and proposes a balance between the use of federal and state law that should provide guidance to the courts when considering this matter in the future.

October 2008

No. 1