LEON SILVER, co-managing partner of the Phoenix office of Gordon &
Rees LLP, is a trial lawyer with more than 25 years of experience
handling complex commercial and real estate disputes. He is the leader
of the Firm’s Retail & Hospitality Practice Group and a member of the
firm’s Commercial Litigation, and Privacy & Data Security Practice
Group. ANDY JACOB is a member of Gordon & Rees’s Commercial
Litigation and Appellate Practice Groups.
Kohlberg also required Southwest to
pay to Kohlberg nearly $6 million to cover
its anticipated tax liabilities from Southwest
profits. Because much of those profits never
materialized, Southwest paid $2.9 million
more than what was needed to cover taxes.
Southwest was soon in financial distress.
Yet, “despite Southwest’s financial distress,
Kohlberg did not voluntarily repay the $2.9
million tax overpayment, nor require
Southwest to demand it, but rather sought
to keep ‘quiet’ about it.” 2
In 2001, Southwest filed for Chapter 7
bankruptcy. In 2003, the bankruptcy
trustee sought to recover much of the
funds that Southwest paid to Kohlberg.
The trustee made claims under theories
of fraudulent transfer and fiduciary breach.
Although the limitations had expired for
an ordinary fiduciary-breach claim, the
bankruptcy court held that the claims for
fiduciary breach were not subject to limitations because the fiduciaries at issue
(Southwest directors and officers appointed
by Kohlberg) engaged in “self-dealing for
a profit.” 3 (“Equitable tolling is appropriate
when a fiduciary of two corporations causes
one corporation to pay money to the other
for largely nonexistent services.”).
Kohlberg denied that Southwest’s directors and officers owed fiduciary duties to
Southwest. Rather, they only owed duties
to Kohlberg, the sole owner of Southwest.
The bankruptcy court agreed. 4 The court
explained that the trustee cannot “establish
that Kohlberg or Debtor’s officers and
Buying groceries is fairly straightforward business. Buying grocery stores, however,
can be another matter entirely. In this article, we take a look at where fiduciary duty
lies when a company buys a grocery-store chain, and the officers and directors of the
wholly owned subsidiary grocery-store chain make decisions that serve the interest
of the parent company to the detriment of the subsidiary. When such a subsidiary
ends up in bankruptcy, will its creditors have claims against those directors and
officers for breach of fiduciary duties owed to the subsidiary? Or will such claims fail
because the directors and officers owed their loyalty to the parent entity? Let’s take a
stroll down the aisle and find out what the courts have to say.
The story begins back in July 1995,
when Kohlberg & Co. purchased South-
west Supermarkets. As part of the acquisi-
tion, Kohlberg required fees that, in part,
contributed to the financial demise of
Kohlberg required Southwest to pay
to Kohlberg a $1 million acquisition
fee that provided no apparent benefit
to Southwest, but only to Kohlberg.
Kohlberg [also] required Southwest to
pay it management fees based on an
earnings formula that disregarded
the massive debt obligations that
Southwest incurred to generate such
earnings, and that ultimately drove
Southwest into bankruptcy. 1
BY LEON SILVER & ANDREW JACOB