What authority do directors of a corporation have to put the company into bankruptcy after those directors have been removed by a receiver? Does a corporation have the right to file bankruptcy under the federal Bankruptcy Code despite a state court order appointing a receiver with powers to replace the board of directors? This article will discuss the contrasting views in recent decisions from Nevada, California, Arizona, and Pennsylvania to compare how the issue has been handled by different courts.

1. New Nevada Authority
   
   The United States District Court for the District of Nevada recently decided that directors ousted by a state-court-appointed receiver have no legal authority to initiate a bankruptcy over the corporation. See Sino Clean Energy, Inc. v. Seiden, 565 B.R. 677 (D. Nev. 2017).

   The Sino decision was the result of litigation between corporate shareholders and the board of directors. The shareholders eventually asked a Nevada state court to appoint a Receiver, and it did so, after determining that Sino’s directors had, over time, committed an abundance of illegal managerial maneuvers.

   The state court appointed a receiver because the directors had been guilty of grossly mismanaging the corporation and engaging in internecine litigation warfare. The Receiver sought the directors’ cooperation, but to no avail. Thus, more than a year after the Receiver took over, he replaced the directors with a new board of directors.

   However, the dissension continued. Not deterred by the Receiver’s action in replacing the board of directors with new directors, the former directors commenced a voluntary corporate bankruptcy case. The Receiver moved to dismiss the bankruptcy case, contending that the former directors were without authority to seek bankruptcy relief on behalf of Sino, having lost their legal status as such after being legally removed as directors. After extensive briefing and argument, the Bankruptcy Court ruled that the former directors had no authority to act for the corporation and denied their motion. In rendering its ruling, the Bankruptcy Court placed considerable reliance on Oil & Gas Co. v. Duryee, 9 F.3d 771 (9th Cir. 1993). The Duryee court affirmed the Bankruptcy and District Court’s respective dismissals of the bankruptcy case and imposed sanctions against the former officer of the appellant and his attorney, jointly and severally.

   The Receiver achieved victory over the putative, unsuccessful initiators of Sino’s corporate bankruptcy case, not only in the Bankruptcy Court, but also on appeal to the United States District Court for the District of Nevada. The appellate court properly analyzed the applicable legal precedents as to the legal duties carried out by the directors of a corporation.
    

2. Similar California Authority.

   The United District Court for the Central District of California, sitting in Santa Ana, had, a few years earlier, reached a similar decision on appeal from a Bankruptcy Court ruling. In re Torero, 2013 WL 6834609 (C.D. Cal 2013).

   Siblings sued each other and third parties over breach of a partnership agreement. Several years later, the Superior Court in Orange County appointed a receiver. The order appointing receiver (“Receiver Order”), among other provisions, gave to the Receiver the sole authority to initiate a bankruptcy; further, the Receiver Order specifically provided that certain siblings of the Plaintiff could not initiate a corporate bankruptcy on behalf of the entity (“El Toro Santa Ana”).

   On January 22, 2013, those siblings nevertheless initiated a voluntary Chapter 11 case. On the Receiver’s motion, the Bankruptcy Court ordered the Chapter 11 case dismissed. On appeal, the court affirmed the Bankruptcy Court order dismissing the bankruptcy case.

   Among the Bankruptcy Court’s findings was a determination that the siblings lacked standing, determining that the siblings were precluded by the exclusivity language in the Receiver Order from proceeding with any bankruptcy.

   The court rejected the contention of the siblings that it could not deprive them of a U. S. Constitutional right. It said instead that “. . . ‘nowhere is there any indication that Congress bestowed on the bankruptcy court jurisdiction to determine that those who in fact do not have the authority to speak for the corporation as a matter of local law are entitled to be given such authority and therefore should be empowered to file a petition on behalf of the corporation.’” 2013 WL 6834609 at * 6, citing Price v. Gurney, 324 U.S. 100, 107 (1945).
    

3. Differing Authority from a Bankruptcy Court in Arizona.

   In re Corporate and Leisure Event Productions, Inc. (“CALEP”), 351 B.R. 724 (D. Ariz. 2006), involves a more simplistic view that bankruptcy trumps an existing receivership irrespective of rationale to the contrary. The Bankruptcy Court’s opinion starts with a clear statement of the issue: “The issue here is who, if anyone, may file a Chapter 11 petition for a Debtor after a state court has appointed a Receiver for the debtor, enjoined the Debtor from filing a bankruptcy petition, and removed the Debtor’s corporate officers and directors.” The CALEP court, in reliance of the Bankruptcy Code’s definition of “eligible debtor pursuant to section 109, then stated: “The Court concludes that federal bankruptcy law preempts state law and remains available to an “eligible debtor” and its constituents notwithstanding creditors’ use of state law remedies in an attempt to bar the bankruptcy courthouse door.”

   Bankruptcy Code Section 109 allows any “person” to be a debtor under Chapter 7, excluding railroads, banks, savings and loan associations, credit unions and many varieties of insurance companies, domestic and foreign. However, the court’s simplistic view of Section 109 does ignores the state law entity governance issues that cannot be ignored. A corporation is a legal entity, and it is governed by a board of directors. Therefore, the dismissal of a board of directors leaves those individuals bereft of legal power to act. (See California Corporations Code, §§ 300, et seq.).
    

4. Pennsylvania Bankruptcy Court Opinion Reconciles Sino and Leisure:

   The court in Monroe Heights Development Corporation, 2017 WL 3701857 at *5 (W.D Penn, Aug. 22, 2017), recently significantly reconciled the apparent conflict between Sino and Leisure in considering whether to dismiss a bankruptcy filing by a board that had been replaced by a receiver. A member of the board argued, among other things, that “the Receiver Order did not merely change the identity of the party authorized to file bankruptcy on behalf of the Debtor from the board of directors to [the receiver]”, but that the Supremacy Clause of the Constitution “effectively blocked the Debtor from access to the bankruptcy court by appointing a receiver and enjoining the parties who had previously enjoyed the power to authorize a bankruptcy filing.” Id. at 14. The court reconciled the Sino and Leisure opinions by acknowledging that “there may well be instances when it would be appropriate to allow those formerly in control of a corporation to file a bankruptcy even though a receiver has been appointed, for instance if the receiver is biased in favor of the interest of the creditor that got it appointed, or if the receiver is being derelict in its duties.”
    

5. Conclusion.

   The Sino and Torero decisions decided the issue of who has authority to file a bankruptcy petition following the appointment of a receiver and removal of the board of directors based on state laws regarding corporate governance. The Leisure decision reached the opposite conclusion, but it may be distinguished from Sino and Torero, under principles set forth in Monroe Heights Development.