Georgia Bankruptcy Blog

From the Delaware Bankruptcy Blog, comes the case of  Miller v. McCown De Leeuw & Co., Inc. (In re Brown Schools), No. 05-10841, Adv. No. 06-50861 (Bankr. D. Del. April 24, 2008).

Duty of care violations more closely resemble causes of action for deepening insolvency because the alleged injury in both is the result of the board of directors’ poor business decision. To defeat such an action, a defendant need only prove that the process of reaching the final decision  was not the result of gross negligence. Therefore, claims alleging a duty of care violation could be viewed as a deepening insolvency claim by another name. 

For breach of the duty of loyalty claims, on the other hand, the plaintiff need only prove that the defendant was on both sides of the transaction. Weinberger v. UOP, Inc., 457 A.2d 701, 710 (Del. 1983) (“When directors of a Delaware corporation are on both sides of a transaction, they are required to demonstrate  their utmost good faith and the most scrupulous inherent fairness of the bargain.”). The burden then shifts to the defendant to prove that the transaction was entirely fair. Id. This burden is greater than meeting the business judgment rule inherent in 5 MDC cites Paragraph 65 of the Second Amended Complaint which reads: “During the period that Defendants wrongfully perpetuated [the Debtors’] operations and existence, the insolvency of [the Debtors] increased by more than $22 million.” (Second Am. Compl. ¶ 65.) MDC also cites Paragraph 71 which reads: “As a result of the Defendants’ breach of their fiduciary duties, [the Debtors] suffered the damages previously alleged.” (Id. at ¶ 71.)  duty of care cases. Further, duty of loyalty breaches are not  indemnifiable under the Delaware law. 8 Del. C. § 102(b)(7). 

Therefore, the Court concludes that the Trustee’s claims for  breach of the fiduciary duty of loyalty in the form of self dealing are not deepening insolvency claims in disguise.  Consequently, the Trenwick and Radnor decisions are not  controlling.

The opinion also addresses deepening insolvency as a measure of damages, fraudulent transfers, aidding and abetting fraudulent transfers, and the in pari delicto defense.

From the Delaware Litigation Blog comes the case of  Nelson v. Emerson, 2008 WL 1961150 (Del. Ch., May 6, 2008) (the opinion is linked from the Delaware Litigation Blog), where the one major secured creditor alleged the directors of the corporation breached their fiduciary duty to the creditor by filing a Chapter 11 petition and paying themselves excessive compensation.

The same claims had apparently been rejected by the Bankruptcy Court in In Re Repository Tech, Inc., 363 B.R. 868 (Bankr. N.D. Ill 2007) (read this opinion here). 

The problem with Nelson's claims is that he is seeking a second chance to win the same game.Nelson made the same arguments he raises in this case to the Bankruptcy Court for the Northern District of Illinois when he sought to have Repository's bankruptcy filing dismissed as being filed in bad faith or, alternatively, due to gross mismanagement of the Company. The Bankruptcy Court, despite dismissing Repository from Bankruptcy because it could not reorganize
successfully, explicitly found that “the bankruptcy filing cannot be held to be in bad faith” and that there had not been “any mismanagement of [Repository's] assets and business.” Satisfied with the dismissal of  Repository's bankruptcy, but unhappy with the Bankruptcy Court's ruling that the bankruptcy had not been brought in bad faith, Nelson appealed to the District Court for the Northern District of Illinois and
argued that the Bankruptcy Court's findings on the bad faith issue were dicta. In essence, Nelson was attempting to preserve his ability to present his bad
faith argument to another tribunal in the hope that a new court might find the argument more substantial. The District Court rejected Nelson's argument, ruling
that the bad faith determination was an essential part of the Bankruptcy Court's holding because Nelson himself had advanced the argument that the bankruptcy filing was made in bad faith.

Francis Pileggi's more thorough review of the opinion is found here. 

By: Scott B. Riddle, Esq.

Vibratech, Inc. v. Frost, et al., 2008 WL 1704091 (Ga. App. March 27, 2008).

Although this Georgia Court of Appeals opinion involves a bankruptcy issue, it is more important for the discussion and holding on personal jurisdiction.  This case indicates that a defendant can be hauled into Georgia Courts based on its placing products in the "stream of commerce" that reaches Georgia, or placing products in the stream of commerce to third parties outside of Georgia, who themselves place the products in the stream of commerce that reaches Georgia.   The basic facts are as follows:

This lawsuit arises out of the crash of a Cessna twin engine aircraft in the vicinity of Apison, Tennessee on December 2, 2004, resulting in the death of the pilot and four passengers. The aircraft was owned by the Georgia Cumberland Conference of Seventh-Day Adventists (GCCSA). The GCCSA and the estates of the five decedents filed these lawsuits in Gwinnett County against multiple defendants including Vibratech. The plaintiffs allege that Vibratech negligently manufactured the plane's viscous damper, a mechanism designed to reduce engine vibration, which was installed in the aircraft's left engine.

Vibratech was a Delaware corporation with its principal place of business in Alden, New York, but is now defunct, with no officers, directors or employees. The corporation filed for bankruptcy protection on July 18, 2003, approximately 18 months before the accident. The company never maintained a certificate of authority to conduct business in the State of Georgia and did not carry out business operations in the state. Vibratech sold the damper at issue in this case to Teledyne Continental Motors, Inc. (TCM), a Delaware company with its principal place of business in Mobile, Alabama. Vibratech sold the damper “FOB Seller's Plant” in Alden New York, and TCM installed the damper in a rebuilt Cessna engine. The GCCSA purchased the engine through Air Power, Inc., a third-party Texas company, on April 9, 2001. TCM shipped the engine at Air Power's instruction to L & M Aircraft in Rome, Georgia for installation in GCCSA's airplane.

(bold emphasis added)

Vibratech did not answer the lawsuit and a default judgment was entered. However, Vibratech was an additional insured on a policy held by TCM.  At  at some point, TCM began providing a defense to Vibratech, and Vibratech moved to open the default as a matter of right and dismiss the case for, inter alia, lack of personal jurisdiction.

Vibratech argued that the trial court lacked personal jurisdiction over it because the company never transacted any business in the State of Georgia, in that it had no office, took no orders, made no sales, delivered no products and solicited no business here. In rejecting this argument, the trial court found that in Innovative Clinical & Consulting Servs. v. First Nat'l Bank, 279 Ga. 672 (620 S.E.2d 352) (2005), the Georgia Supreme Court construed subsection (1) of the Georgia long-arm statute to extend jurisdiction to the maximum limits permitted by procedural due process. OCGA § 9-10-91(1). The trial court determined that Vibratech's activities in placing its dampers into the stream of commerce by manufacturing, selling and delivering them for resale were sufficient to satisfy the requirements of due process and to confer jurisdiction over the company. Vibratech counters, however, even under the Innovative Clinical 's expanded interpretation of subsection (1), the language of the statute requires more than merely putting merchandise into the stream of commerce; it still requires the actual transaction of business by the defendant in Georgia.

 The Court's analysis, after the jump... 

Francis Pileggi, in this post, discusses the Delaware Bankruptcy Court's opinion in the case of Miller v. McDonald (In re World Health Alternatives, Inc.),  2008 WL 1002035  ( Bankr., Del. April 9, 2008) (pdf opinion here).

In this opinion on a motion to dismiss claims against an officer of a company, the Bankruptcy Court relied on decisions of the Delaware Chancery Court and the Delaware Supreme Court to deny a motion to dismiss in the course of ruling that Caremark duties would be imposed on an officer (who was not a director), that was on the management team when the President of the company committed fraud and other actions and omissions that ultimately led to the bankruptcy filing of the company. This is notable in part because there are not as many decisions that address the fiduciary duties of officers, as opposed to directors of a corporation.

I have written about the waning popularity of deepening insolvency  (and here) as a cause of action.  Bob Eisenbach refers to a new article by his colleagues in the Bankruptcy & Restructuring group at Cooley Godward Kronish LLP, Michael Klein and Ronald Sussman.

The article is entitled "Tide Has Turned On Deepening Insolvency - Courts Now Rejecting Theory As Cause Of Action," published in the February 2008 issue of the Journal of Corporate Renewal.

In the corporate litigation field, the Delaware Supreme Court has held that directors of Delaware corporations, who are not shareholders of the corporation, cannot assert derivative claims against fellow directors.  While this issue may not arise often, it is important as many corporations are governed by Delaware law, and other states follow Delaware law.

The case is Schoon v. Smith, (Del. Supr., Feb. 12, 2008), and you can read about the case on the Delaware Corporate and Litigation Blog, the Harvard Corporate Governance Law Blog (with link to pdf of opinion) and Business Associations Blog.

Francis Pileggi has written a summary of the key Delaware Chancery Court and Supreme Court cases of 2007.  Obviously, these cases are important to corporate litigation lawyers in other states, including Georgia.  You can access the summary from the Delaware Corporate and Commercial Litigation Blog.

By: Scott B. Riddle, Esq.

This is not a bankruptcy case, but it will be applicable in many large bankruptcy cases involving allegations of fraud by shareholders or investors.

On January 15, 2008, the United States Supreme Court entered an important decision in Stoneridge Investment Partners v. Scientific-Atlanta (06-43) (click here to download the opinion).

There is no need to re-invent the wheel here, or wait on law review articles to analyze the case.  Lawyers and scholars have already provided a thorough analysis of the important two-day old opinion.  Here are just a few of the articles:

From the Supreme Court Blog --

The Supreme Court, in one of the most important securities law rulings in years, decided Tuesday that fraud claims are not allowed against third parties that did not directly mislead investors but were business partners with those who did. ...

Investors, the Court said, may only sue those who issued statements or otherwise took direct action that the investors had relied upon in buying or selling stock — whether that involved public statements, omissions of key facts, manipulative trading, or conduct that was itself deceptive. One impact of the decision is likely to be the scuttling of a massive $40 billion lawsuit against financial institutions growing out of the Enron scandal. The Court has a case on its docket involving that very dispute, and Tuesday’s ruling will be followed up soon, perhaps by next week, with action on that case — California Regents v. Merrill Lynch, et al. (06-1341).

...
Justice Anthony M. Kennedy, who wrote the Stoneridge ruling, said the private right to sue for securities fraud “does not reach the customer/companies because the investors did not rely upon their statements or misrepresentations.” The ruling upheld a decision by the Eighth Circuit Court rejecting claims against Scientific Atlanta, Inc., and Motorola, Inc. The investors contended that those two companies helped a giant cable TV firm, Charter Communications, inflate artificially its financial statements in order to bolster its stock’s price. The investors contended that the two companies should be treated as “primary violators,” even though they had not themselves issued any public statements to advance the alleged manipulation plot.

Prof. Larry Ribstein's Ideoblog -

I’m very sympathetic with the result. The amicus brief I signed onto argued against a 10b-5 private right of action “against a non-trading, non-speaking entity that merely ‘enables’ the commission of an alleged fraud by a public company on its shareholders.”

My problem is that, instead of focusing on the type of conduct that should get a defendant into trouble under the securities laws, the Court focused on reliance. This is a weak theory once you accept, as the Court does, that 10b-5 liability can be based on conduct rather than misstatements. Given the fraud-on-the-market presumption of reliance, it's far from clear why reliance was missing here, as the dissent pointed out. ...

Professor Stephen Bainbridge has a primer on the case on his Business Associations Blog, and summarizes the opinion in this post.  

 A few other random articles:

• Conde Nast Portfolio -  Champagne Popping Over Stoneridge Ruling
• Wall Street Journal Law Blog
• Washington Post: Corporate Fraud lawsuits Restricted: Enron and Other Shareholders Limited By Court.

The Harvard Law Corporate Governance Blog Blog summarizes a Delaware Chancery case that might apply to lawsuits nationwide involving businesses incorporated in Delaware.  Note that the decision is based upon the Corporate Code, applicable to Delaware corporations, and not jurisdictional discovery rules -

Chancery Orders Production of Records for Periods Prior to Stock Ownership, by Francis G.X. Pileggi, Fox Rothschild LLP.

The Delaware Court of Chancery issued a decision last week of both practical and theoretical importance for corporate lawyers. The opinion is Melzer v. CNET Networks, Inc.....

 the court held that Section 220 of the Delaware General Corporation Law, which is the statutory basis on which stockholders can demand books and records of a company, enables plaintiffs under certain circumstances to receive documents for a period prior to their stock ownership...

Francis has a more thorough analysis of the case on his Delaware Litigation Blog.

By: Scott B. Riddle, Esq.

In the last week, since the Delaware Supreme Court's opinion in North American Catholic Educational Programming Foundation, Inc. v. Gheewalla, several lawyers and scholars have posted discussion about the case and holding:

• Bob Eisenbach, Esq. at the Business Bankruptcy Blog.
• Francis Pileggi, Esq. at the Delaware Litigation Blog.
• Professor Stephen Bainbridge. 
• Professor Larry Ribstein at Ideoblog.
• Professor Fred Tung at Conglomerate.

No need to wait six months for a law review article.

By: Scott B. Riddle, Esq.

 I have previously posted (follow the link to the Delaware Litigation Blog) on the subject of whether creditors have a direct action against directors of a corporaton that has entered the zone of insolvency.  Chief Justice Steele's comments were prophetic.  Yesterday, in an opinion that will likely have a far reaching affect (even if we only consider Delaware corporations), the Delaware Supreme Court ruled that creditors of an insolvent corporation do not have a direct action against directors (and presumably officers?) for breach of fiduciary.  Note that while Chief Justice Steele participated in the case, he did not write the opinion. Thanks to Ideoblog for the tip.

In North American Catholic Educational Programming Foundation, Inc. v. Gheewalla, et al, No. 521,2006, 2007 Del. LEXIS 227 (Del. May 18, 2007), the issue before the court - one of first impression for the Delaware Supreme Court - was whether creditors of an insolvent corporation may bring a direct action (as opposed to a derivative action) against directors for breach of fiduciary duty. The Court said no.

 This Court has never directly addressed the zone of insolvency issue involving directors' purported fiduciary duties to creditors that is presented by NACEPF in this appeal. That subject has been discussed, however, in several judicial opinions and many scholarly articles.   ...

Direct Claims For Breach of Fiduciary Duty May Not Be Asserted by Creditors

It is well settled that directors owe fiduciary duties to the corporation. When a corporation is solvent, those duties may be enforced by its shareholders, who have standing to bring derivative actions on behalf of the corporation because they are the ultimate beneficiaries of the corporation's growth and increased value. When a corporation is insolvent, however, its creditors take the place of the shareholders as the residual beneficiaries of any increase in value.

Consequently, the creditors of an insolvent corporation have standing to maintain derivative claims against directors on behalf of the corporation for breaches of fiduciary duties. The corporation's insolvency "makes the creditors the principal constituency injured by any fiduciary breaches that diminish the firm's value." Therefore, equitable considerations give creditors standing to pursue derivative claims against the directors of an insolvent corporation. Individual creditors of an insolvent corporation have the same incentive to pursue valid derivative claims on its behalf that shareholders have when the corporation is solvent. 
 

By: Scott B. Riddle, Esq.

Francis Pileggi at the Delaware Litigation Blog has posted a summary of comments made by Delaware Supreme Court Chief Justice Myron Steele at the Spring meeting of the American Bar Association, concerning developments in Delaware corporate law and recent Delaware Supreme Court cases. Francis credits Mark Saltzburg with the summary of the speech.  I have included only a short excerpt here:

First, Chief Justice Steele noted that the Delaware Supreme Court had just heard argument in the Trenwick America Litigation Trust litigation that may result in a decision on whether creditors may bring a cause of action for violation of fiduciary duty where a company deepens its insolvency in a way that further damages creditors after any residual interest of shareholders is out of the picture. Typically, fiduciary duties are only owed by directors to shareholders and not to creditors. Steele noted, however, that in an earlier decision by former Delaware Court of Chancery Chancellor William Allen in the Credit Lyonnais case, the court commented that directors may owe creditors a fiduciary duty where a company is in the vicinity of insolvency.

Professor Bainbridge has followed up with his commentary on the issue.  

 I have previously discussed another opinion in the Trenwick America Litigation Trust case: Deepening Insolvency Is Not A Valid Cause Of Action, Or A "Coherent Concept," Under Delaware Law. 

Posted By: Scott B. Riddle, Esq.

In Kaye v. Dupree, et al. (In re Avado Brands, Inc.), Adv. No. 05-3823, 2006 Bankr. LEXIS 3631 (Bankr. N.D. Tex. December 28, 2006), the Trustee of the Debtor's Litigation Trust filed a post-confirmation suit against the Debtor's former officers and directors.  The causes of action included preferential transfers, breach of fiduciary duty, fraud and deepening insolvency.  The defendants filed motions to dismiss and motions for summary judgment. The court addressed several matters raised by the motions, not all of which are addressed in this post. 

The court first determined that it did have post-confirmation jurisdiction over the proceeding as the claims arose pre-petition, were provided for under the plan, and transferred to the trust for prosecution by the Trustee.

The Court next addressed whether O.C.G.A. §14-2-202, the exculpation provision, protected the directors of Debtor (a Georgia corporation) from liability for breach of fiduciary duty. The statute states the following -

(b) The articles of incorporation may set forth:
* * *
(4) A provision eliminating or limiting the liability of a director to the corporation or its shareholders for monetary damages for any action taken, or any failure to take any action, as a director, except liability:
* * *
(B) For acts or omissions which involve intentional misconduct or a knowing violation of law; or
(D) For any transaction from which the director received an improper personal benefit, provided that no such provision shall eliminate or limit the liability of a director for any act or omission occurring prior to the date when such provision becomes effective. 

This provision (for which there are no reported cases in Georgia) was adopted by Debtor, but the Trustee argued that the Directors are still liable for intentional, wrongful, and grossly negligent conduct, as alleged in the Complaint. The Court agreed with the Trustee -

Georgia's statute is similar but not identical to Delaware's. One provision found in Delaware's exculpation statute specifically limits the ability of a corporation to absolve directors from breaches of the duty of loyalty; however, they both contain limitations on conduct that is intentional or knowing. In Delaware, this has been extended by case law to intentionally reckless acts and acts taken in bad faith. ...

A recent decision by the Delaware Chancery Court in In re Walt Disney Co. Derivative Litigation, 825 A.2d 275, 289 (Del. Ch. 2003), stated that where the facts of the complaint, taken as true, "suggest that the defendant directors consciously and intentionally disregarded their responsibilities, adopting a 'we don't care about the risks' attitude," they sufficiently allege claims of intentional misconduct that fall outside of the exculpatory statutes. Id. (emphasis original). "Knowing or deliberate indifference by a director to his or her duty to act faithfully and with appropriate care is conduct . . . that may not have been taken honestly and in good faith to advance the best interests of the company" and, thus, constitutes intentional misconduct. Id. "Put differently, all of the alleged facts, if true, imply that the defendant directors knew that they were making material decisions without adequate information [or] deliberation, and that they simply did not care." Id.

The Court finds this rationale instructive in interpreting the similar provisions in Georgia's exculpatory statute. The Complaint alleges that the Outside Directors breached their fiduciary duties of care, good faith and loyalty to Avado through their intentional, wrongful and/or reckless conduct. At this early stage of the litigation, reviewing the Outside Director's Motion to Dismiss against the Trustee's Complaint and accepting the facts pled in the Complaint as true, the Court finds that the Exculpation provisions in Avado's articles of incorporation do not protect the Outside Directors from liability

The Defendant Directors also sought dismissal of the Trustee's claims for the tort of deepening insolvency.   The court granted the motion, finding --

By: Scott B. Riddle, Esq.

I previously posted about the Delaware case of Stone v. Ritter, (Del. Supr., Nov. 6, 2006), in which the Delaware Supreme Court "clarified its position on whether "good faith" is a separate stand-alone duty, in the same way as loyalty and due care are."  There the court stated -

First, although good faith may be described colloquially as part of a "triad" of fiduciary duties that includes the duties of care and loyalty, the obligation to act in good faith does not establish an independent fiduciary duty that stands on the same footing as the duties of care and loyalty. Only the latter two duties, where violated, may directly result in liability, whereas a failure to act in good faith may do so, but indirectly. The second doctrinal consequence is that the fiduciary duty of loyalty is not limited to cases involving a financial or other cognizable fiduciary conflict of interest. It also encompasses cases where the fiduciary fails to act in good faith. As the Court of Chancery aptly put it in Guttman, "[a] director cannot act loyally towards the corporation unless she acts in the good faith belief that her actions are in the corporation's best interest."

Gordon Smith, at the Conglomerate Blog, has a post entitled "Good Faith, Care and Loyalty in Delaware," in which this important case is discussed. Professor Stephen Bainbridge has followed up that post with a post of his own, entitled Good Faith in Delaware After Stone v. Ritter. Professor Bainbridge also has a post on his Blog entitled "Stone v Ritter: Directors Caremark Oversight Duties."   His post focuses on issues raised by the decision, other than the duty of good faith (which he previously wrote about here).

By: Scott B. Riddle, Esq.

While the focus of the Blog is on Bankruptcy law and cases, there is also a significant overlap with corporate and fiduciary litigation cases and commentary.  It is common for causes of action such as breach of fiduciary duty, corporate waste, deepening insolvency (where it exists), and similar claims to be brought in the context of a corporate bankruptcy or insolvency.  I also have done a significant amount of work in these areas outside of bankruptcy.  For these reasons, I have created a new category for the Blog: Corporate and Fiduciary Litigation.  Most of the posts in this category will also be posted in the existing categories, but this will allow readers to bypass some of the bankruptcy-specific posts.  Over time, I'll go back and cross-post previous entries in the new category.

Thanks for reading!

By: Scott B. Riddle, Esq.  

In a prior post, I noted that the Georgia Court of Appeals had recognized a cause of action for aiding and abetting breach of fiduciary duty.  You can review that post for lengthy excerpts from the opinion in Insight Technology, Inc. v. Freightcheck, Inc., No. A06-0710, Ga. App. LEXIS 738, 2006 WL 1679391 (Ga. App. June 20, 2006), including the reasoning of the court in recognizing the claim.  The Georgia Supreme Court has subsequently denied cert in the case.

In this post, I focus specifically on the actual elements of the claim identified by the Court of Appeals.  These elements are --

In summary, regardless of whether denominated "aiding and abetting a breach of fiduciary duty," "procuring a breach of fiduciary duty," or "tortious interference with a fiduciary relationship," Georgia law authorizes a plaintiff to recover upon proof of the following elements: (1) through improper action or wrongful conduct and without privilege, the defendant acted to procure n12 a breach of the primary wrongdoer's fiduciary duty to the plaintiff; (2) with knowledge that the primary wrongdoer owed the plaintiff a fiduciary duty, the defendant acted purposely and with malice and the intent to injure; n13 (3) the defendant's wrongful conduct procured a breach of the primary wrongdoer's fiduciary duty; and (4) the defendant's tortious conduct proximately caused damage to the plaintiff.

Clearly, the Court equated aiding and abetting breach of fiduciary duty with tortious interference with fiduciary duty and in doing so included the requirement (or affirmative defense) that the offending party act without privilege.  Does the inclusion of this element, brought over from tortious interference claims, make sense and is it workable?