What Constitutes Misconduct by a Bankruptcy Trustee?

What Constitutes Misconduct by a Bankruptcy Trustee?

Trustees in a bankruptcy situation are expected to conduct themselves in a fair and professional manner, especially to the creditors and bankruptcy inspectors involved in the process. To do otherwise can be costly.

A trustee may argue that he or she can be duty bound to take a position detrimental to a major creditor. However, this can’t be simply for tactical purposes. A trustee is not considered in the same light as a typical litigant in a strictly adversarial proceeding. The trustee must conduct him or herself in a fair, impartial and even-handed manner at all times, following principles set out in Engels v. Richard Killen & Associates Ltd. [2002] O.J. No. 2877 (Ont. S.C.) (Affirmed by Ont. C.A.). If a court finds misconduct in this regard, it can disallow legal fees and costs engendered by the trustee.

As an example, Re Sally Creek Environs Corporation [2008] O.J. No. 2491 (Ont. S.C.J. Reg in Bktcy) is a good case study of what a trustee should not do when administering a bankruptcy estate, and provides a helpful look at previous case law on trustee misconduct and the factors a court will consider when reducing a trustee’s fees because of such.

In Sally Creek, the animosity between the trustee and the major creditor regarding the estate’s administration resulted in the disallowance of $293,000 out of $333,000 in trustee legal costs as a disbursement to the estate, and the reduction of trustee legal fees from more than $240,000 to $1.

In rendering this judgment, Registrar Nettie said, “Trustees cannot obfuscate, prevaricate, mislead, hide behind counsel, expand estate funds without proper authorizations, and generally comport themselves as if an estate were their personal fiefdom, and then expect to be rewarded by the Creditors or this Court for so doing.”

This ruling clearly laid down the principle that the manner in which an estate is administered is as important as the outcome. Among other things, the ruling addressed the case of trustee malfeasance with inspectors, who in the bankruptcy system are representatives of the creditors. Their job is to ensure that creditors will not incur unnecessary costs from an overzealous trustee. The trustee has a duty to keep inspectors informed of all issues and to give them an opportunity to comment on complicated decisions. In this case, the trustee was cited for basically ignoring the inspectors and failing to get their approval, or even court direction, for taking certain legal steps.

Again, it is incumbent upon the trustee to treat all entities in a bankruptcy proceeding in a reasonable, fair and respectful manner. If a creditor can establish misconduct in this regard, it is also reasonable for the creditor to be entitled to substantial indemnity costs against the trustee.