The Bankruptcy Trustee as Fiduciary

The following is a case update written by Adam A Lewis, Partner (Ret.), Morrison & Foerster LLP, analyzing a recent case of interest:  Community Financial Services Bank, Inc. v. Mark. R. Little as Chapter 7 Trustee (In re Morsey Constructors, LLC,  2025 WL 2881569, B.R. (Bankr. W.D. Ky. Oct. 9, 2025) (“Morsey”). 

Summary

In Morsey, the bankruptcy court granted the motion of the chapter 7 trustee (the “Trustee”) to dismiss the complaint of plaintiff Community Financial Services Bank, Inc. (the “Bank”) seeking damages for the Trustee’s alleged breach of fiduciary duty and negligence in his handling of collection of receivables comprising the Bank’s cash collateral pursuant to a contract.  In essence, the bankruptcy court reasoned that the Bank’s claim would elevate the Trustee’s fiduciary duty to the Bank above his fiduciary duty to all other creditors, as well as hold the Trustee responsible for some of the Bank’s own failures. 

To view the full decision, click here.

Facts

The debtor filed a Chapter 11 case that soon collapsed and was converted to chapter 7.  Upon conversion of the case, the Trustee was appointed.  The Bank was debtor’s largest creditor.  It held various assets of the debtor as collateral under duly-perfected liens.  The largest body of collateral was the debtor’s accounts receivable.  The Bank initially made no post-petition effort to collect them.  In the meantime, the Trustee began to fulfill his duties, including getting control of the debtor’s assets, in part by making turnover demands and filing turnover actions.  He initially made no effort to collect the Bank’s accounts since there was no equity in them for the estate.  The Bank’s inactivity continued.  After some months, the Bank and the Trustee entered into an agreement under which, for a share of the collections, the Trustee would collect the Bank’s collateral accounts.  After several months, the Trustee indicted to the Bank that he had sent out some demand letters.  In a later communication, however, the Bank said otherwise.  Finally, the Bank negotiated a stay relief stipulation with the Trustee allowing the Bank to collect the receivables that the bankruptcy court approved.  The Bank then brought an adversary proceeding against the Trustee for breach of fiduciary duty and negligence, damages for his failure to act on the collection agreement or otherwise attempt to collect the receivables.  

In response, the Trustee filed a motion to dismiss for failure to state a claim under Federal Rule of Civil Procedure 12(b)(6), as incorporated by Federal Rule of Bankruptcy Procedure 7012.  The bankruptcy court granted the motion as to both causes of action and damages. 

Reasoning

The opinion focused on three issues: (1) did the Trustee owe the Bank a fiduciary duty; (2) did the Trustee breach the duty if he had one; and (3) did the Bank suffer any damages as a result of the Trustee’s conduct if it was actionable?  The answer to the first question was “yes.”  To the second and third it was “no.” 

Fiduciary Duty.  The Trustee argued that he had no fiduciary duty to the Bank.  The bankruptcy court disagreed.  It cited to case and statutory law making it clear that a trustee has a fiduciary duty to all creditors, secured or otherwise.  See, e.g., 11 U.S.C. § 704(a).  That said, a trustee’s duty to secured creditors normally differs from a trustee’s duties to general unsecured creditors.  In the former case, a trustee’s duty is to preserve and protect collateral, but not to collect it for the creditor absent some change in circumstances.  That changed when the Trustee agreed to collect the receivables for a cut of the proceeds. 

Breach of Duty.  The Bank’s claim presupposes that a trustee must simultaneously proceed on all fronts.  But a trustee has the freedom to exercise judgment in prioritizing matters and tasks confronting him.  The indications are that the Trustee, far from being neglectful, was intensely occupied with fulfilling his section 704(a) duties.  That he chose to pursue some matters over others, including sidelining collections under the agreement for a time, did not constitute a breach of his fiduciary duty to the Bank.  It is notable that the Bank sat on the sidelines at the outset of the case before negotiating the agreement with the Trustee and then again paused its efforts before taking action by seeking the stipulation.  The bankruptcy court’s point was that the Bank saw no urgency about collections from the filing of the bankruptcy case until it sought the stipulation. 

Damages.  The bankruptcy court concluded the opinion by observing that the Bank had failed to allege facts showing it had suffered damages.  Among other things, the Bank did not discuss the value of its other collateral and whether the combination of all of its collateral was likely to fall short on collection of the debt.  Thus, even had there been a breach of fiduciary duty by the Trustee, it appeared to be a case of no harm, no foul. 

Author’s Commentary

The decision is correct given that the Trustee was busily occupied.  He had no obligation to favor the fortunes of the Bank over those of the unsecured creditors towards whose benefit he focused his early, tireless efforts.  Evidently, the Bank felt no urgency while sitting on the sidelines for many months before doing anything to foster collection of the accounts (reaching the agreement with the Trustee), and then again until yet some months later to pursue the stay relief stipulation.  Presumably, the Bank felt no harm was befalling it during that period.  There is no reason the Trustee should have been more vigilant for the Bank’s welfare than the Bank itself was. 

Perhaps the most curious thing is that the Bank did not add a claim simply for breach of the collection contract with the Trustee, although such a claim might have implicated the same issues about comparative duties to the creditors and the Bank that the breach of fiduciary duty claim did; in other words, did the contract add any weight to the Trustee’s obligations to the Bank? 

Key Takeaway

Be on your toes when dealing with a trustee who has a statutory job to do and must act for other constituents! The trustee’s fiduciary duty that you have to share with other creditors does not guarantee that you will be treated as you wish.

Why It Matters

Bankruptcy is designed to protect all creditor interests.  That goes as much for chapter 7 cases as any other.  A trustee has a finite amount of time and other resources to devote to his duties to all the creditors.  If as a creditor you have much at stake and there is some promise of a meaningful return, it is wise to be active.  The Bank was not.

These materials were written by Adam A. Lewis, Partner (Ret.), Morrison & Foerster LLP, representing debtors, creditors and other constituencies for 45 years, with editorial contributions by Zev M. Shechtman, a partner at Saul Ewing LLP’s  Los Angeles Office, and the Hon. Meredith Jury (ret.).