lehman examiner's report, vol. 6

8/14/2019 Lehman Examiner's Report, Vol. 6

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UNITEDSTATESBANKRUPTCYCOURTSOUTHERNDISTRICTOFNEWYORK

x

Inre

LEHMANBROTHERSHOLDINGSINC.,

etal.,Debtors.

:

:

:

:

:

:

:

Chapter11CaseNo.

0813555(JMP)

(JointlyAdministered)

x

REPORTOFANTONR.VALUKAS,EXAMINER

March11,2010

Jenner&BlockLLP

353N.ClarkStreet

Chicago,IL

60654

3456

3122229350

919ThirdAvenue

37thFloor

NewYork,NY 100223908

2128911600

CounseltotheExaminer

VOLUME6OF9Appendix 1


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i

EXAMINERS REPORT

TABLE OF APPENDICES

VOLUME 6

Tab 1 Legal Issues

VOLUME 7

Tab 2 Glossary, Acronyms & Abbreviations

Tab 3 Key Individuals

Tab 4 Witness Interview List

Tab 5 Document Collection & Review

Tab 6 Lehman Systems

Tab 7 Bibliography

VOLUME 8

Tab 8 Risk Management Organization and Controls

Tab 9 Risk Appetite and VaR Usage Versus Limits Chart

Tab 10 Calculation of Certain Increases in Risk Appetite Limits

Tab 11 Compensation

Tab 12 Valuation - Archstone

Tab 13 Survival Strategies Supplement

Tab 14 Valuation - CDO

Tab 15 Narrative of September 4 Through 15, 2008

Tab 16 Valuation - Residential Whole Loans


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ii

Tab 17 Repo 105

Tab 18 Summary of Lehman Collateral at JPMorgan

Tab 19Lehmans Dealings with Bank of America

Tab 20Knowledge of Senior Lehman Executives Regarding The

Inclusion of Clearing-Bank Collateral in the Liquidity Pool

Tab 21 LBHI Solvency Analysis

Tab 22 Preferences Against LBHI and Other Lehman Entities

VOLUME 9

Tab 23Analysis of APB, Journal Entry, Cash Disbursement, and

JPMorgan Collateral

Tab 24 Foreign Exchange Transactions

Tab 25Intercompany Transactions Occurring Within Thirty Days Before

Bankruptcy

Tab 26 CUSIPs with Blank Legal Entity Identifiers

Tab 27 CUSIPs Not Associated with an LBHI Affiliate

Tab 28 CUSIPs Associated Solely with an LBHI Affiliate

Tab 29 CUSIPs Associated with Both LBI and LBHI Affiliates

Tab 30 CUSIPs Associated with Subordinated Entities

Tab 31CUSIPs Associated with LBHI Affiliates Not Delivered to LBI in a

Financing Trade

Tab 32 September 19, 2008 GFS Dataset

Tab 33 Summary Balance Sheets of LBHI Affiliates

Tab 34 Tangible Asset Balance Sheet Variations


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APPENDIX1: LEGALISSUES

Appendix1provideslegalanalysissupportingmanySectionsoftheReport.

I.

COLORABLE

CLAIM

STANDARD .................................................................................. 5

A. BankruptcyStandingCases ......................................................................................... 5

B. SummaryJudgmentStandard ................................................................................... 12

C. ExaminerOrdersfromOtherBankruptcyCases .................................................... 13

1. InreWorldcom,Inc.,CaseNo.0213533(Bankr.S.D.N.Y.).............................. 13

2. InreEnronCorp.,CaseNo.0116034(Bankr.S.D.N.Y.) .................................. 14

3. InreRefco,Inc.,CaseNo.0560006(Bankr.S.D.N.Y.)...................................... 16

4. InreNewCenturyTRSHoldings,Inc.,CaseNo.0710416(Bankr.D.

Del.) ........................................................................................................................ 17

5. InreSemCrude,L.P.,CaseNo.0811525(Bankr.D.Del.) ................................ 18

D. Conclusion.................................................................................................................... 20

II. FIDUCIARYDUTIES ......................................................................................................... 20

A. DelawareCorporateFiduciaryDuties...................................................................... 21

1. BusinessJudgmentRule...................................................................................... 22

a) TheBusinessJudgmentRuleasAppliedtoDirectors............................. 22

b) TheBusinessJudgmentRuleasAppliedtoOfficers ............................... 26

c) TheIntersectionBetweentheBusinessJudgmentRuleandIllegal

Conduct theAIGCase ................................................................................ 28

2. DutyofCare .......................................................................................................... 30

3. DutyofLoyaltyandGoodFaith ........................................................................ 33

4. CaremarkDutytoMonitor ................................................................................... 35

a) OriginsoftheDutytoMonitor ................................................................... 36

b) ElementsofaCaremarkClaim ..................................................................... 37

c) ApplicationofCaremarktoRiskOversight:InreCitigroupInc. .............. 42

5. DisclosureObligations......................................................................................... 44

a) TheBoardsObligationtoProvideInformationtoShareholders .......... 45

b) ManagementsDutyofDisclosuretotheBoard....................................... 48

B. CausationandDamagesinCorporateFiduciaryCases ........................................ 54

C. LiabilityforAidingandAbettingBreachofFiduciaryDuty................................ 61

D. DutiesofDirectorsofanInsolventWhollyOwnedSubsidiary........................... 63


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2

E. DutiesofaControllingShareholder......................................................................... 67

F. StandingtoAssertFiduciaryBreachClaimsAgainstLehmanOfficers

andDirectors ................................................................................................................ 69

III. SECURITIESLAWISSUES................................................................................................ 70

A. RelevantRequiredDisclosures.................................................................................. 71

B. OverviewofPossibleDisclosureCausesofAction ................................................ 75

C. Materiality..................................................................................................................... 77

D. CausationandReliance .............................................................................................. 78

E. ClaimsBasedonLiquidityDisclosures.................................................................... 79

F. TheSarbanesOxleyAct.............................................................................................. 81

IV. BANKRUPTCYLAWISSUES........................................................................................... 84

A. AvoidanceActions ...................................................................................................... 85

1. TransferswithFraudulentIntentunderSection548(a)(1)(A) ....................... 86

2. ConstructiveFraudulentTransfersunderSection548(a)(1)(B)..................... 88

a) Insolvency ...................................................................................................... 89

b) UnreasonablySmallCapital ........................................................................ 90

c) InabilityToPayDebts .................................................................................. 96

d) EmploymentContracts................................................................................. 97

B. DefensestoAvoidanceofFraudulentTransfersPursuantto548(a)(1)of

theBankruptcyCode .................................................................................................. 99

C. AvoidanceofFraudulentConveyancesPursuanttoNewYorkDebtorCreditorLaw,art.10,27376(McKinney2010)................................................ 101

D. AvoidanceofPreferentialTransfers ....................................................................... 106

1. PreferencesunderSection547oftheBankruptcyCode............................... 106

2. PreferencesunderNewYorkandDelawareLaw ......................................... 111

E. TheSafeHarborProvisionsoftheBankruptcyCode .......................................... 112

F. ApplicabilityofthePreemptionDoctrinetoStateLawClaimsbytheSafe

HarborProvisionsoftheBankruptcyCode .......................................................... 118

G.

Avoidanceof

Transfers

under

Section

549

of

the

Bankruptcy

Code ................. 122

H. AvoidanceofTransfersoutsideoftheOrdinaryCourseofBusinessand

NotApprovedbytheCourtPursuanttoSection363oftheBankruptcy

Code............................................................................................................................. 123

I. RecoveryIssuesunderSections550and502oftheBankruptcyCode.............. 125

J. SetoffIssuesunderSection553oftheBankruptcyCode..................................... 126


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3

K. TurnoverofPropertytotheEstate.......................................................................... 129

V. NONFEDERALLAWISSUES ....................................................................................... 130

A. SeparabilityofMultipleAgreementswiththeSameParty................................. 131

B. ApparentAuthority .................................................................................................. 132

C. ExpressChoiceofLawProvisionsunderNewYorkLaw.................................. 133

D. ContractualandQuasiContractualClaims .......................................................... 135

1. EconomicDuress ................................................................................................ 135

a) NewYorkLaw............................................................................................. 135

b) EnglishLaw.................................................................................................. 136

2. FailureofConsideration.................................................................................... 138

a) NewYorkLaw............................................................................................. 138

b) EnglishLaw.................................................................................................. 139

3. BreachoftheCovenantofGoodFaithandFairDealing.............................. 140

a) NewYorkLaw............................................................................................. 140

b) EnglishLaw.................................................................................................. 143

4. ConstructionofTermsintheAbsenceofaGeneralObligationof

GoodFaith ........................................................................................................... 144

E. UnjustEnrichment..................................................................................................... 144

1. UnderNewYorkLaw........................................................................................ 144

2. UnderEnglishLaw ............................................................................................ 149

F. MisrepresentationandFraud .................................................................................. 150

1. NewYorkLaw.................................................................................................... 150

2. EnglishLaw......................................................................................................... 150

G. BreachofFiduciaryDutyandMisappropriationunderEnglishLaw............... 152

H. TortiousInterferenceunderEnglishLaw .............................................................. 153

I. DefensestoClaims: RatificationandWaiverbyEstoppel ................................. 153

1. RatificationofAgentsActingwithoutAuthorityunderNewYork

Law ....................................................................................................................... 153

2. WaiverbyEstoppelunderEnglishLaw ......................................................... 155

J. ActiontoRecoverChattel......................................................................................... 156

K. TradeSecretMisappropriation................................................................................ 160

L. UnfairCompetition ................................................................................................... 163

M. TortiousInterferencewithEmploymentRelations .............................................. 166

N. Conversion.................................................................................................................. 169


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4

O. AuditorMalpractice .................................................................................................. 174

VI. SECURITIESINTERMEDIARIES(ARTICLE8OFTHEUNIFORMCOMMERCIAL

CODE) ................................................................................................................................ 178

A. ProtectedPurchaserandtheSecuritiesIntermediaryRules ............................... 178

B. TermsUsedintheProtectedPurchaserandSecuritiesIntermediaryProvisions ................................................................................................................... 180

1. MeaningofGivesValueundertheUCC .................................................... 180

2. MeaningofObtainsControlundertheUCC ............................................. 181

a) ControlofaCertificatedSecurity ............................................................. 181

b) ControlofanUncertificatedSecurity....................................................... 182

c) ControlofaSecurityEntitlement ............................................................. 183

3. MeaningofNoticeofAdverseClaim.......................................................... 184

4. MeaningofCollusionundertheUCC......................................................... 186

a) TheRestatementApproach ....................................................................... 187

b) Collusion....................................................................................................... 193

VII.SFAS157............................................................................................................................. 195

A. AccountingStandardsUnderSFAS157................................................................. 195

1. TheFinancialAccountingStandardsBoardandFinancial

AccountingStandard157 .................................................................................. 197

a) DefinitionofFairValue.............................................................................. 199

b)

ValuationTechniques

and

Fair

Value

Hierarchy................................... 200

c) Disclosures ................................................................................................... 204

2. SupplementalGuidanceRegardingSFAS157 ............................................... 204

a) FSPSFAS1573: DeterminingtheFairValueofaFinancialAsset

WhentheMarketfortheAssetisNotActive ......................................... 205

b) FSPSFAS1574: DeterminingFairValueWhentheVolumeand

LevelofActivityfortheAssetorLiabilityHaveSignificantly

DecreasedandIdentifyingTransactionsThatAreNotOrderly.......... 207

B. LegalStandardsGoverningRetrospectiveReviewofValidityof

ValuationsforBankruptcyAnalysis....................................................................... 212

1. Insolvency:RelationshiptoMarktoMarketValuations ............................. 213

2. HindsightAnalysisinInsolvencyDeterminations ....................................... 213


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5

I. COLORABLECLAIMSTANDARDTheBankruptcyCourtsOrderDirectingAppointmentofanExaminerPursuant

to Section 1104(c)(2)of the Bankruptcy Code (the Examiner Order) used thephrase

colorableclaimsorcolorablecausesofactioninfourofthetopicstobeinvestigated

by the Examiner. Examiner Order, at pp. 34, Docket No. 2569, In re Lehman Bros.

Holdings,Inc.,No.0813555(Bankr.S.D.N.Y.Jan.16,2009). IntheReport,theExaminer

considers a claim tobe colorable if there is sufficient credible evidence to support

findingsof

fact

that

make

out

the

claim.1

That

standard

accords

well

with

the

extensive

factualinvestigationthattheExaminerhasconducted.

ThisSectiondiscussesthreeareasoflawthatprovidecontextfortheExaminers

considereduseofthecredibleevidencetest. SectionAdiscussestheuseofthephrase

colorable claim in connection with applicationsby creditors committees to pursue

claimsforthebenefitofadebtorsestate,astandardthatresemblestheoneappliedona

motiontodismiss;SectionBdiscussesthestandardcourtsuseindecidingmotionsfor

summaryjudgment;andSectionCreviewsthestandardsthatexaminershaveusedto

identifyclaimsinpreviouscases.

A. BankruptcyStandingCasesThe Bankruptcy Code does not define the word colorable. However, the

phrase colorable claim is used in bankruptcy cases in the context of analyzing

1SeeSectionI.A.oftheReport.


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whetheracreditorscommitteehasstandingundereither11U.S.C.1103(c)(5)2or11

U.S.C.1109(b)3tofilesuitonbehalfofadebtorinpossessionortrustee.4

UndertheBankruptcyCode,creditorscommitteesdonothaveexplicitauthority

to initiate adversary proceedings. However, courts have found that creditors

committeeshaveanimplied,butqualified,right. ..toinitiateadversaryproceedings

in the name of the debtor in possession. Unsecured CreditorsComm. ofDebtor STN

Enters.v.Noyes(InreSTNEnters.),779F.2d901,904(2dCir.1985)(Sections1103(c)(5)

and1109(b) implyaqualified right for creditors committees to initiate suit with the

approvalofthebankruptcycourt.);seealsoLa.WorldExpositionv.Fed.Ins.Co.,858F.2d

233,25253(5thCir.1988)(creditorscommitteecouldsueacorporationsofficersand

directors for gross negligence, mismanagement, andbreach of fiduciary duty). To

determine whether to allow a creditors committee or another party in interest to

pursueaclaimonbehalfofabankruptcyestate,acourtwillanalyzewhetherthedebtor

ortrusteeunjustifiablyrefusedtopursuethatclaim.

TheSecondCircuithasstatedthat,toobtainstanding,acommitteemustpresent

acolorableclaim,thatisaclaimforreliefthatonappropriateproofwouldsupporta

2Section 1103(c)(5) states: (c) A committee appointed under section 1102 of this title may . . . (5)

performsuchotherservicesasareintheinterestofthoserepresented.3Section1109(b)states:Apartyininterest,includingthedebtor,thetrustee,acreditorscommittee,an

equitysecurityholderscommittee,acreditor,anequitysecurityholder,orany indenture trustee,may

raiseandmayappearandbeheardonanyissueinacaseunderthischapter.4Thephrasecolorableclaimhasbeenusedbycourtsinawidevarietyofcasesdatingbacktoatleast

the mid19th century. Considering the context of how the phrase is used in this caseabankruptcy

courts order appointing an examinerthe research and analysis for this portion of the memorandum

waslimitedtotheuseofthephraseinbankruptcycases.


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recovery. In re STN, 779 F.2d at 905. Other courts have described the analysis as

muchthesameasthatundertakenwhenadefendantmovestodismissacomplaintfor

failure to state a claim. In reAmericasHobby Ctr., Inc., 223 B.R. 275, 282 (Bankr.

S.D.N.Y. 1998). The test is not particularly stringent: [c]aselaw construing

requirements for colorable claims has made it clear that the required showing is a

relativelyeasyone tomake. InreAdelphiaCommcnsCorp.,330B.R.364,376 (Bankr.

S.D.N.Y.2005)(Gerber,J.).

InInreSTN,acreditorscommitteerequestedleavetosuetheprobateestateof

thesole stockholder ofdebtorSTNEnterprises, Inc. aswell as thestockholderswife,

who had served as a director and corporate secretary of the debtor, alleging waste,

malfeasance, and fraudulent conveyance. In re STN, 779 F.2d at 902. The Second

Circuit concluded that the committees request triggered a twopart inquiry: (1) the

committeemustpresentacolorableclaimorclaimsforreliefthatonappropriateproof

wouldsupportarecovery;and (2) thedebtormusthaveunjustifiably failed tobring

suitinlightoftheprobabilitiesofsuccess,thepotentialfinancialrecovery,andthecost

oftheaction. Id. Becausethedistrictcourthadnotperformedthatanalysis,theSecond

Circuitreversedandremandedthecaseforfurtherproceedings. Id.at906.

The Second Circuits opinion inSTN was the first of three opinions regarding

parties standing to sue, whichbecame known as the STN Trilogy. The other two

casesare: (1)CommodoreIntlLtd.v.Gould(InreCommodoreIntlLtd.),262F.3d96(2d


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8

Cir. 2001) (extending theSTN principles to situations where the debtor in possession

consented totheprosecutionofclaimsbyacommittee);and (2)Glinkav.Murad(Inre

Housecraft Indus. USA, Inc.), 310 F.3d 64 (2d Cir. 2002) (extending the STN and

Commodore principles to permit a bankruptcy court to confer standing upon a

committeetosueasacoplaintiffwiththedebtoronbehalfoftheestate). TheSecond

CircuithascontinuedtoapplytheSTNstandard. SeeInreAdelphiaCommcnsCorp.,544

F.3d420,423424(2dCir.2008)(Sotomayor,J.)(citingtheSTNstandardforrecognizing

derivativestanding).

Severalbankruptcycases intheSecondCircuithaveutilizedtheSTNstandard.

In In reAmericasHobbyCenter, a creditors committee sued the debtors postpetition

lender. 223B.R.at278. Thebankruptcycourtpermittedthecommitteetopursuesome

butnotalloftheclaimsithadproposed. Id.at28687. Thebankruptcycourtapplied

STN to decide whether the committee presented a colorable claim and whether the

proposed actions were likely tobenefit the estate. Id. at 282. Thebankruptcy court

stated,[b]ecausethecreditorscommitteeisnotrequiredtopresentitsproof,thefirst

inquiry is much the same as that undertaken when a defendant moves to dismiss a

complaintforfailuretostateaclaim. Id.

Similarly, in Official Committee of Unsecured Creditors of the Debtors v. Austin

Financial Services (In re KDI Holdings, Inc.), the creditors committee brought an

adversary proceeding against the debtors prepetition lenders. 277 B.R. 493, 498


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9

(Bankr.S.D.N.Y.1999). ThebankruptcycourtappliedtheSTNstandardtodetermine

whether the committee had standing to pursue the adversary proceeding. The

bankruptcycourtheldthatthecommitteesclaimsweresufficientlycolorableandwere

likelytoconferabenefitontheestate,sothecourtallowedtheactiontoproceed. Id.at

520. Thecourtexplainedthat[i]ndeterminingwhetherthereisacolorableclaim,the

Court must engage in an inquiry that is much the same as that undertaken when a

defendant moves to dismiss a complaint for failure to state a claim. Id. at 50708

(quotingInreAmericasHobbyCtr.,223B.R.at281).

Finally,inInreAdelphia,thecreditorscommitteeandequityholderscommittee

movedforleavetoprosecuteclaimsagainstlendersonbehalfoftheChapter11estates.

330B.R.364,368(Bankr.S.D.N.Y.2005). Thebankruptcycourtheldthatthecommittees

wouldbeauthorizedtopursueclaimsthatincludedfraudulentconveyanceclaimsand

claimsofaidingandabettingbreachesoffiduciaryduties. Id.at386. Thebankruptcy

courtappliedtheSTNstandard,notingthat:

Caselawconstruingrequirementsforcolorableclaimshasmadeitclear

that the required showing is a relatively easy one to make. InSTN, the

Second Circuit eschewed extensive merits review, requiring instead, a

colorable claim . . . for relief that on appropriateproof would support a

recovery. In this district, on STN motions, ChiefJudge Brozman has

observed that authorization should be denied only if the claims arefacially defective, andJudge Gonzalez has noted that in determining

whether there is a colorable claim, the court must engage in an inquiry

that is much the same as that undertaken when a defendant moves to

dismissacomplaintforfailuretostateaclaim.

Id.at376(citationsomitted).


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BankruptcycasesoutsideoftheSecondCircuithaveappliedsimilarstandardsin

determining whetheracreditors committee hasstanding tobringsuit. See,e.g., Inre

iPCS,Inc.,297B.R.283,291(Bankr.N.D.Ga.2003)(Ontheissueofwhetheraclaimis

colorable, the Court should consider whether the Committee has asserted claims for

relief that on appropriate proof would support a recovery. Because the creditors

committeeisnotrequiredtopresentitsproof,thefirstinquiryismuchthesameasthat

undertaken when a defendant moves to dismiss a complaint for failure to state a

claim.); In reGIHoldings, Inc., 313 B.R. 612, 652 (Bankr. D.N.J.2004) (committee did

not satisfy itsburden of presenting a colorable claim to challenge the securitization

transactionbecauseavalidaffirmativedefensetotheproposedactionexistedlackof

subjectmatterjurisdiction);InreTenn.ValleySteelCorp.,183B.R.795,800(Bankr.E.D.

Tenn.1995)(citingInreSTNforthepropositionthatthecourtmustdecidewhetherthe

committee has asserted claims for relief that on appropriate proof would support a

recovery and stating that [d]etermining whether the Committee has asserted

colorable claims in its Amended Complaint is not the equivalent of determining

whethertheDefendantsareentitledtosummaryjudgment).

A claim is colorable under STN if the allegations supporting that claim are

sufficient to withstand a motion to dismiss. Historically, federal courts reviewed

motions todismissunder the standard that acomplaintshouldnotbedismissed for

failuretostateaclaimunlessitappearsbeyonddoubtthattheplaintiffcanprovenoset


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offactsinsupportofhisclaimwhichwouldentitlehimtorelief. Conleyv.Gibson,355

U.S. 41, 4546 (1957). However, recent Supreme Court decisions have tightened the

standardappliedtomotionstodismiss. InBellAtlanticv.Twombly,550U.S.544(2007),

theSupremeCourtconstruedRule8(a)(2)torequirethatacomplaintincludeenough

factstostateaclaimtoreliefthatisplausibleonitsface. Id.at570. Twosubsequent

SupremeCourtcases,Ericksonv.Pardus,551U.S.89(2007),andAshcroftv.Iqbal,129S.

Ct.1937(2009),haveelaboratedontheplausibilityrequirement;inEricksontheCourt

emphasizedthatacourtmustassumeallfactualallegationsinacomplaintaretrue,but

inIqbal theCourtheldthattheassumptionof truthdoesnotapplytoallegations that

areconclusory.

InIqbal,theCourtexplainedtheplausibilitystandard:

Tosurviveamotiontodismiss,acomplaintmustcontainsufficientfactual

matter,accepted

as

true,

to

state

aclaim

to

relief

that

is

plausible

on

its

face. A claim has facial plausibility when the plaintiff pleads factual

content that allows the court to draw the reasonable inference that the

defendant isliableforthemisconductalleged. Theplausibilitystandard

is not akin to a probability requirement,but it asks for more than a

sheer possibility that a defendant has acted unlawfully. Where a

complaint pleads facts that are merely consistent with a defendants

liability,itstopsshortofthelinebetweenpossibilityandplausibilityof

entitlementtorelief.

Iqbal,129S.Ct.at1949.(quotingTwombly,550U.S.544at570). AlthoughTwomblyand

Iqbalhavealteredthestandard thatcourtsapply indecidingmotions todismiss, they

didnotchangethebasicprinciplethatacourtdecidingamotiontodismisslookstothe


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allegationsofthecomplaint,withoutthebenefitofthefactualrecordthatisdeveloped

indiscovery.

B. SummaryJudgmentStandardCourtsapplyadifferentproceduralmechanismsummaryjudgmenttoassess

thesufficiencyofallegationsinlightofamoredevelopedfactualrecord. FederalRule

of Civil Procedure 56(c) provides that summaryjudgment shouldbe rendered if the

pleadings,depositions,thediscoveryanddisclosurematerialsonfile,andanyaffidavits

show

that

there

is

no

genuine

issue

as

to

any

material

fact

and

that

the

movant

is

entitledtojudgmentasamatteroflaw.

In Anderson v. Liberty Lobby, the Supreme Court explained the summary

judgmentstandard: Byitsveryterms,thisstandardprovidesthatthemereexistence

ofsomeallegedfactualdisputebetweenthepartieswillnotdefeatanotherwiseproperly

supportedmotion forsummaryjudgment;therequirement isthat therebenogenuine

issueastomaterialfact. 477U.S.242,24748(1986). Todefeatamotionforsummary

judgment,thenonmovingpartymustshow(1)thatthereisagenuinedisputeastothe

factsinthecase;and(2)thatthedisputedfactsarematerialtothedeterminationofthe

case.

Indeterminingwhatfactsarematerialforsummaryjudgmentpurposes,courts

consider whether a dispute may affect the outcome of the case. Id. at 248. Only

disputesover facts thatmight affect the outcomeof the suitunder thegoverning law


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13

will properly preclude the entry ofjudgment. Factual disputes that are irrelevant or

unnecessarywillnotbecounted. Id. Indecidingasummaryjudgmentmotion,the

judges function is not himself to weigh the evidence and determine the truth of the

matterbuttodeterminewhetherthereisagenuineissuefortrial. Id.at250. Thereis

noissuefortrial,andsummaryjudgmentmaybegranted,iftheevidencefavoringthe

nonmovingpartyismerelycolorable,id.at249(citingDombrowkiv.Eastland,387U.S.

82(1967)),orisnotsignificantlyprobative.Id.at24950(citingFirstNatlBankofAriz.

v.CitiesServ.Co.,391U.S.253,28889(1968)). InLibertyLobby,theSupremeCourtnoted

that ajudge considering a typical summaryjudgment motion must ask himself not

whetherhethinkstheevidenceunmistakablyfavorsonesideortheotherbutwhethera

fairmindedjurycouldreturnaverdictfortheplaintiffontheevidencepresented. Id.

at252.

C. ExaminerOrdersfromOtherBankruptcyCasesExaminersinotherlargeandcomplexbankruptcieshaveusedvaryingstandards

to analyze potential claims. Notably, however, none of the examiner orders in those

casesusedthephrasecolorableclaim.

1. InreWorldcom,Inc.,CaseNo.0213533(Bankr.S.D.N.Y.)OnJuly 22, 2002, the Bankruptcy Court for the Southern District of New York

enteredanorderdirectingtheappointmentofanexaminerintheWorldcombankruptcy

case. OrderGrantingtheMotionoftheUnitedStatesTrusteefortheAppointmentofan


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Examiner,DocketNo.53,InreWorldcom,Inc.,CaseNo.0213533(Bankr.S.D.N.Y.July

22,2002)(theWorldcomExaminerOrder). TheWorldcomExaminerOrderdirected

theWorldcomExaminer,amongotherthings,to:

investigate any allegations of fraud, dishonesty, incompetence,

misconduct, mismanagement or irregularity in the arrangement of the

affairsofanyoftheDebtorsbycurrentorformermanagement,including

butnotlimitedtoissuesofaccountingirregularities.

WorldcomExaminerOrder,atp.2.

Inhisreport,theWorldcomExaminersetforthfindingsandidentifiedpotential

claims. TheWorldcomExaminerstated:

The Examiner does not believe that every instance of wrongdoing

identifiedinhisReportsgivesrisetoapotentialcauseofactiononbehalf

ofWorldCom.Instead,theExaminerhasidentifiedthepotentialcausesof

action that the Examiner, after reviewing the applicable facts and law,

believes would most likely survive motions to dismiss or for summary

judgmentandreachafactfinderifpresentedinalawsuit.TheExaminer

has sought to avoid discussing potential causes of action that the

Examinerbelievesbearasignificantriskofbeingdismissedasamatteroflaw.

Third and Final Report of Dick Thornburgh, Bankruptcy Court Examiner, at p.5 n.7,

DocketNo.10624,InreWorldcom,Inc.,CaseNo.0213533(Bankr.S.D.N.Y.Jan.26,2004).

2. InreEnronCorp.,CaseNo.0116034(Bankr.S.D.N.Y.)On April 8, 2002, the Bankruptcy Court for the Southern District of New York

entered an order directing the appointment of an examiner in theEnronbankruptcy

case. Order Pursuant to 11 U.S.C. 1104(c) and 1106(b) Directing Appointment of

EnronCorp.Examiner,Docket No. 2838, In reEnronCorp., CaseNo.0116034 (Bankr.


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15

S.D.N.Y. Apr. 8, 2002) (the Enron Examiner Order). The Enron Examiner Order

provided,amongotherthings,that:

theEnronExaminershallhavetheauthoritytoinvestigateandreporton

transactionsinvolvingnotonlyEnronCorp.,butalsoanyentitycontrolled

byEnronCorp.andanyotherdebtorinthesejointlyadministeredcases.

[T]heEnron Examinershall have the authority and power to investigate

alltransactions(aswellasallentitiesasdefinedintheBankruptcyCode

and prepetition professionals involved therein): (i) involving special

purposevehiclesorentitiescreatedorstructuredbytheDebtorsoratthe

behestoftheDebtors(theSPEs),thatare(ii)notreflectedontheEnron

Corp.balance sheets, or that (iii)involvehedging using the Enron Corp.

stock,or(iv)astowhichtheEnronExaminerhasthereasonablebeliefare

reflected,reportedoromittedintherelevantentitysfinancialstatements

not in accordance with generally accepted accounting principles, or that

(v)involvepotentialavoidanceactionsagainstanyprepetitioninsideror

professionaloftheDebtors;

EnronExaminerOrder,atpp.14.

In the Enron Examiners Final Report, the Enron Examiner described the

standardadopted:

The Examiner is not the ultimate decision maker on these matters. The

Examinerhas analyzed the evidence hehas gathered to date against the

legal standards applicable to the issues identified in this Report. The

Examiner has considered direct evidence and the reasonable inferences

that canbe drawn therefrom. If there are sufficient facts to support a

claim,eventhoughthere isevidencetothecontrary,thenacourtwould

submit that claim to a factfinder. Where the Examiner reaches theconclusionthatthereissufficientevidenceforafactfindertoconcludethata

claim exists, the Examiner has determined that in a legal proceeding

regarding such matter, the proposition wouldbe submitted to the fact

finder for decision. In most cases, the factfinder would be a jury,

although inequitablesubordinationactionstheBankruptcyCourtserves

as the factfinder. The decision of the factfinder wouldbe made after


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16

evaluating the documentary evidence, the testimony and credibility of

witnesses and the reasonable inferences that maybe drawn from this

evidence.

Final Report of Neal Batson, CourtAppointed Examiner, at pp. 1314, Docket

No.14455,InreEnronCorp.,CaseNo.0116034(Bankr.S.D.N.Y.Nov.24,2003)(footnote

omitted).

3. InreRefco,Inc.,CaseNo.0560006(Bankr.S.D.N.Y.)OnMarch16,2006,theBankruptcyCourtfortheSouthernDistrictofNewYork

entered

an

order

directing

the

appointment

of

an

examiner

in

the

Refco

bankruptcy

case.

Order Granting the Motion of the United States Trustee for the Appointment of an

Examiner,DocketNo.1487,InreRefco,Inc.,CaseNo.0560006(Bankr.S.D.N.Y.Mar.16,

2006)(theRefcoExaminerOrder). TheRefcoExaminerOrderauthorizedtheRefco

Examinerto:

investigateandtoreportonanytopicthatmightreasonablyresultintheassertion of a claim or right by any of the Debtors estates with the

exceptionofanyclaimorrightofRefcoCapitalMarkets,Ltd.

RefcoExaminerOrder,atpp.12.

TheRefcoExaminersFinalReportexplainedthestandardapplied:

The Examiner concludes that the Debtors estates could state claims for

relief, sufficient to withstand a motion to dismiss, against certain of

Refcosprepetitionprofessionalswhocontributedto,orfailedtoprevent,the harm sufferedby Refco, including: . . . [listing potential claims for

professional negligence, breaches of fiduciary duties, violations of

Delaware General Corporation Law, aiding and abetting fraud and

breaches of fiduciary duty, avoidance and recovery of fraudulent

conveyancesandpreferentialtransfers].


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17

Several significant factual and legal defenses are potentially available to

all parties against whom claims may be asserted. Among the most

significant potential defenses are the Wagoner rule and, in some cases,

thestatuteoflimitations.

FinalReportofExaminer,pp.78(footnoteomitted),DocketNo.5530,InreRefco,Inc.,

CaseNo.0560006(Bankr.S.D.N.Y.July11,2007).

4. InreNewCenturyTRSHoldings,Inc.,CaseNo.0710416(Bankr.D.Del.)

OnJune 1, 2007, the Bankruptcy Court for the District of Delaware entered an

order directing the appointment of an examiner in theNewCenturybankruptcy case.

OrderDenyinginPartandGrantinginPartMotionoftheUnitedStatesTrusteeforan

Order Directing the Appointment of a Chapter 11 Trustee, or in the Alternative, an

Examiner, Docket No. 1023, In reNewCenturyTRSHoldings, Inc., Case No. 0710416

(Bankr.D.

Del.

June

1,

2007)

(the

New

Century

Examiner

Order).

The

New

Century

ExaminerOrderdirectedtheNewCenturyExaminerto:

(a) investigate any and all accounting and financial statement

irregularities, errors or misstatements, includingbut not limited to such

irregularities,errorsormisstatements that(i)gaverisetotheannounced

needtorestatetheDebtorsfinancialstatementsforthefirstthreequarters

of2006and/or(ii)ledtheDebtorsmanagementandAuditCommitteeto

concludethatitwasmorelikelythannotthatpretaxearningsinthe2005

financialstatementsweremateriallyoverstated,andidentifyandevaluate

anyclaimsorrightsofactionthattheestatesmighthavearisingfromor

relatingtosuchirregularities,errorsormisstatements,(b)investigateany

possible postpetition unauthorized use of cash collateralby the Debtor,

and (c) otherwise perform the duties of an examiner set forth in section


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18

1106(a)(3) (as limitedby this Order) and 1106(a)(4) of the Bankruptcy

Code.

NewCenturyExaminerOrder,at.pp.23.

In the New Century Examiners Final Report, the New Century Examiner

identified potential causes of action and defenses that the bankruptcy estates may

assert. Final Report of Michael J. Missal Bankruptcy Court Examiner, pp. 51751,

DocketNo.5518,InreNewCenturyTRSHoldings,Inc.,CaseNo.0710416(Bankr.D.Del.

Mar.26,2008)(theNewCenturyExaminersFinalReport). Withrespecttopotential

causes of action regardingbreaches of fiduciary duties, the New Century Examiner

discussedtheofficersanddirectorsconductbutdidnotincludeadetaileddiscussion

of potential claims because [b]reach of fiduciary duty claims against officers and

directorshavestrongdefensestoovercome,particularlythebusinessjudgmentruleand

statutoryorotherlimitations. NewCenturyExaminersFinalReport,atp.2.

5. InreSemCrude,L.P.,CaseNo.0811525(Bankr.D.Del.)On September 10, 2008, the Bankruptcy Court for the District of Delaware

enteredanorderdirectingtheappointmentofanexaminerintheSemCrudebankruptcy

case. OrderDirectingUnitedStatesTrusteetoAppointanExaminer,DocketNo.1295,

Inre

SemCrude,

L.P.,

Case

No.

08

11525

(Bankr.

D.

Del.

Sept.

10,

2008)

(the

SemCrude

Examiner Order). The SemCrude Examiner Order directed the SemCrude Examiner

to:


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19

(a) investigate the circumstances surrounding (i) the Debtors Trading

Strategy and the transfer of their NYMEX account, (ii) the Insider

TransactionsandtheformationofEnergyPartners,and(iii)thepotential

improperuseofborrowed fundsand fundsgeneratedfromtheDebtors

operationsandtheliquidationoftheirassetstosatisfymargincallsrelated

to the Trading Strategy for the Debtors and certain entities owned or

controlled by the Debtors officers and directors; and (b) otherwise

perform thedutiesofanexaminerset forth in11U.S.C.1106(a)(3)and

1106(a)(4)oftheBankruptcyCode;[and]

reportonwhether(a)anydirectors,officers,oremployeesoftheDebtors

participated in fraud, dishonesty, incompetence, misconduct,

mismanagement, or irregularity in the management of the affairs of the

Debtors and (b) the Debtors estates have claims or causes of action

againstcurrentor formerofficers,directors,oremployeesoftheDebtors

arisingfromanysuchparticipation.

SemCrudeExaminerOrder,atpp.23.

In the SemCrude Examiners Final Report, the SemCrude Examiner identified

potentialclaimsorcausesofactionthatthedebtorsestateshad. FinalReportofLouisJ.

Freeh, pp. 1821, Docket No. 3701, In reSemCrude,L.P., Case No. 0811525 (Bankr. D.

Del.Apr.15,2009) (theSemCrudeExaminersFinalReport). Regarding theories of

potentialliability,theSemCrudeExaminerstated:

The Examiner has summarized the basic elements which support the

Examiners conclusions with respect to certain potential causes of action

that the Debtors estates may have under Delaware and Oklahoma law

againstKivisto,

Wallace,

Foxx,

Cooper,

and

others,

and

leaves

the

task

of

preparingdetailed legalanalysesandargumentstothefiduciariesofthe

Debtorsestatestotheextentsuchclaimsarepursued.

SemCrudeExaminersFinalReport,atp.249.


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D. ConclusionInlightofSTNandsubsequentcases,thereislegalsupportforastandard,akin

tothatappliedtoamotiontodismiss,underwhichanyclaimsupportedbyplausible

allegations is colorable. However,because the Examiner has conducted an extensive

factual investigation, the Examiner has concluded that a higher threshold is

appropriate,just as a motion for summaryjudgment is decided on a more exacting

standardthanamotiontodismissattheoutsetofacase. Accordingly, intheReport,

theExaminer

considers

aclaim

to

be

colorable

if

there

is

sufficient

credible

evidence

to

supportfindingsoffactthatmakeouttheelementsofthatclaim.

II. FIDUCIARYDUTIESThis Section discusses principles of fiduciary duty law that are applied in the

ExaminersReport. BecauseLBHIwas incorporated inDelaware,thoseprinciplesare

governedbyDelawarelaw. SeeTeleglobeUSAInc.v.BCEInc.(InreTeleglobeCommcns

Corp.),493F.3d345,38586(3dCir.2007);InreToppsCo.SholdersLitig.,924A.2d951,

95860(Del.Ch.2007). PartAbelowconsidersthefiduciarydutiesthatdirectorsand

officersoweunderDelawarelaw. PartBaddressescausationanddamagesinfiduciary

dutycases. PartCdiscussesaclaimforaidingandabettingabreachoffiduciaryduty

PartDconsidersthedutiesofdirectorsofinsolventwhollyownedsubsidiaries. PartE

addresses the duties that a controlling shareholder owes to the minority shareholder.


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1. BusinessJudgmentRulea) TheBusinessJudgmentRuleasAppliedtoDirectors

Delawarecourtswillnot substitute theirownjudgments for those ofcorporate

directors. Consequently, most decisions madeby directors will notbe adjudicated

based on their substantive meritsbut rather on whether the directors employed the

appropriate procedures to come to the decision. That is a result of the business

judgmentrule,whichpresumesthatofficersactionsweresubstantivelyproper.

The

business

judgment

rule

creates

a

presumption

that

in

making

a

business

decisionthedirectorsofacorporationactedonaninformedbasis,ingoodfaithandin

thehonestbeliefthattheactiontakenwasinthebestinterestsofthecompany. Unocal

Corp.v.MesaPetroleumCo.,493A.2d946,954(Del.1985)(quotingAronsonv.Lewis,473

A.2d805,812(Del.1984)). Somecourtshaveemployedthebusinessjudgmentruleonly

in cases involving the duty of care, while other courts have applied the rule in cases

implicating thedutiesof loyaltyandgoodfaithaswell. CompareKahnv.Roberts,No.

C.A. 12324, 1995 WL 745056, at *4 (Del. Ch. Dec. 6, 1995) (applying the business

judgmentruletojustthedutyofcare),withRyanv.Gifford,918A.2d341,357(Del.Ch.

2007) (discussing thebusinessjudgment rule in the contextof the duty of loyaltybut

findingthatithadbeenovercomethroughthefiduciarysdisloyalty). Thedistinctionis

largely an academic one,because a party acting disloyally or inbad faith would not

satisfytherulesprerequisitesinanyevent.


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Under thebusinessjudgment rule, directors decisions willbe respectedby

courtsunlessthedirectorsareinterestedorlackindependencerelativetothedecision,

donotactingoodfaith,actinamannerthatcannotbeattributedtoarationalbusiness

purposeorreachtheirdecisionbyagrosslynegligentprocessthatincludesthefailure

toconsiderallmaterialfactsreasonablyavailable. Brehmv.Eisner,746A.2d244,264

n.66(Del.2000). SeealsoUnocal,493A.2dat954(quotingAronson,473A.2dat812).

Courts are reluctant to invoke the exception to thebusinessjudgment rule for

failuretoconsiderallreasonablyavailablematerialfacts. See,e.g.,Moranv.Household

Intl,Inc.,500A.2d1346,1356(Del.1985)(defendantdirectorswereproperlyinformed

whentheyhadbeenprovidedwithathreepagenotebooksummarizingtheissuesand

theboardhaddiscussedtheissueswithcounselandinvestmentbankers);Omnicare,Inc.

v.NCSHealthcare, Inc., 818 A.2d 914, 929 (Del. 2003) (it was not aper sebreach of

fiduciary duty that aboard of directors did not read a merger agreementbut relied

insteadonasummaryoftheterms); Brehm,746A.2dat261(aboardofdirectorswas

entitled to rely on an expertin making abusinessjudgment and, in relying on that

opinion without necessarily evaluating the underlying factsindependently, was fully

protectedbythebusinessjudgmentrule);Citronv.FairchildCameraandInstrumentCorp.,

Civ.A. No. 6085, 1988 WL 53322, at *17 (Del. Ch. May 19, 1998) (directors rushed

decisionwasnotoutside theboundsof thebusinessjudgmentrulebecause,although

theboarddidnotthoroughlyconsiderallalternatives,thedecisionwascomplicatedby


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ashortdeadline);seealsoDEL.CODEANN.tit.8,141(e)(2010)(Amemberoftheboard

ofdirectors,oramemberofanycommitteedesignatedbytheboardofdirectors,shall

...befullyprotected inrelying ingoodfaithupontherecordsofthecorporationand

uponsuchinformation,opinions,reportsorstatementspresentedtothecorporationby

any of the corporations officers or employees, or committees of the board of

directors.). But see Smith v. Van Gorkom, 488 A.2d 858, 87475 (Del. 1985) (At a

minimumforareporttoenjoythestatusconferredby141(e),itmustbepertinentto

thesubjectmatteruponwhichaboardiscalledtoact,andotherwisebeentitledtogood

faith,notblind,reliance.),overruledonothergroundsbyGantler,965A.2dat713.6

Adecisionbyadirectorfallsoutsidethebusinessjudgmentrule inthoserare

cases where the decision under attack is so far beyond the bounds of reasonable

judgment that it seems essentially inexplicableon anyground other thanbad faith[,]

[or][t]hedecisionmustbeegregious,...constituteagrossabuseofdiscretion,orbe

sothoroughlydefectivethatitcarriesabadgeoffraud. Alidinav.Internet.comCorp.,

No.Civ.A.17235NC,2002WL31584292,at*4(Del.Ch.Nov.6,2002)(internalcitations

omitted). Acourtwillnotsubstitute[its]judgmentforthatoftheboardifthelatters

decisioncanbeattributedtoanyrationalbusinesspurpose. Unocal,493A.2dat949

6In Gantler, the Delaware Supreme Court overruled its previous holding in Smith v. Van Gorkom

regardingwhetheraratifyingshareholdervoteextinguishesaclaimforviolationof thedutyofcareor

simplysubjectsthedecisiontobusinessjudgmentreview. OtherportionsofthecourtsdecisioninSmith

v.VanGorkomwereaffectedbytheDelawarelegislaturesenactmentofDEL.CODEANN.tit.8,102(b)(7),

which established a corporations ability to exculpate its directors from personal liability for potential

violationsofthedutyofcare. Thebalanceof thecourtsholding inSmithv.VanGorkomremainsgood

lawandcontinuestobecitedbyDelawarecourts.


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25

(quotingSinclairOilCorp.v.Levien,280A.2d717,720(Del.1971));seealsoInreCaremark

IntlInc.,DerivativeLitig.,698A.2d959,967(Del.Ch.1996).

Thebusinessjudgment rule does not protect decisions that involve fraud or

illegality.SeeSmithv.VanGorkom,488A.2dat873;Littv.Wycoff,C.A.No.19083NC,

2003 WL 1794724, at *67 (Del. Ch. Mar. 28, 2003); In reW.NatlCorp.SholdersLitig.,

ConsolidatedC.A.No.15927,2000WL710192,at*2627(Del.Ch.May22,2000).Under

Delaware law,intentionallycausingacorporationtoviolatethe law isabreachofthe

dutiesofloyaltyandgoodfaith.Gifford,918A.2dat357358. Afailuretoactingood

faithmaybeshown,forinstance,wherethefiduciaryintentionallyactswithapurpose

other thanthatofadvancing thebest interestsofthecorporation,where the fiduciary

acts with the intent to violate applicable positive law, or where the fiduciary

intentionallyfailstoactinthefaceofaknowndutytoact,demonstratingaconscious

disregard for his duties. In reWaltDisneyCo.DerivativeLitig., 906 A.2d 27, 67 (Del.

2006); see alsoDesimone v.Barrows, 924 A.2d 908, 934 (Del. Ch. 2007) ([I]t is utterly

inconsistent with ones duty of fidelity to the corporation to consciously cause the

corporation to act unlawfully.);Metro Commcn Corp. BVI v.AdvancedMobileComm

Techs.,Inc.,854A.2d121,131(Del.Ch.2004)(UnderDelawarelaw,afiduciarymaynot

choosetomanageanentityinanillegalfashion,evenifthefiduciarybelievesthatthe

illegalactivitywillresultinprofitsfortheentity.);Guttmanv.Huang,823A.2d492,506

n.34 (Del. Ch. 2003) ([O]ne cannot act loyally as a corporate directorby causing the


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26

corporation to violate the positive laws it is obliged to obey.). Directors have no

authority knowingly to cause the corporation to become a rogue, exposing the

corporationtopenaltiesfromcriminalandcivilregulators. Desimone,924A.2dat934.

Thebusinessjudgmentruledoesnotprotectadirectorfrompersonalliabilityfor

inaction unless the failure to act resulted froma conscious decision to take no action.

OfficialComm.ofUnsecuredCreditorsv.Hendricks(InreDwightsPianoCo.),No.1:04CV

066, 2009 WL 2913942, at *18(S.D. Ohio Sept.9, 2009) (applying Delaware law) (The

businessjudgmentruledoesnotapplytodirectorinaction.Theappropriatestandard

fordeterminingliabilityfordirectorinactionisgenerallygrossnegligence.).

b) TheBusinessJudgmentRuleasAppliedtoOfficersActionsallegingbreachesoffiduciarydutiesagainstofficersarerarely litigated

in Delaware, and as a result only a few reported cases analyze the application of the

businessjudgment rule to officers.7 However, based upon the Delaware Supreme

Courts recent holding in Gantler, 965 A.2d at 70809, that the fiduciary duties of

directors and officers are identical, it is likely that officers are protected by the

businessjudgment rule when they act under an express delegation of authority from

theboard. It also is likely that officers are protectedby thebusinessjudgment rule

7UntilrecentlyDelawareprovidedthatnonresidentdirectors,butnotofficers,ofDelawarecorporations

weredeemedtohaveconsentedtopersonaljurisdictioninDelawarecourts. SeeDEL.CODEANN.tit.10

3114 (2010). The former rule may have limited the number of cases in which Delaware courts were

calledupontoapplythebusinessjudgmentruletoofficers.


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27

when they act within the scope of their discretion (even if not pursuant to express

delegationbytheboard).

Itisunlikely,however,thatthebusinessjudgmentrulewouldprotectcorporate

officersfrompersonalliabilityunderseveralothercircumstances.

First,becauseanofficermustactonaninformedbasistoqualifyforprotection

underthebusinessjudgmentrule,thatruleshouldnotcoveranofficerwhofailedtobe

fully informed of the facts relevant to the decision in question. See, e.g.,McMullinv.

Beran,

765 A.2d 910, 922 (Del. 2000) (Thebusinessjudgment rule is rebutted if the

plaintiff shows that the directors failed to exercise due care in informing themselves

beforemakingtheirdecision.);seealsoSmithv.VanGorkom,488A.2dat872;Aronson,

473A.2dat812.

Second,thebusinessjudgmentrulemaynotprotectanofficerwhoactedwithout

disclosing material facts concerning the matter in question to theboard or a superior

officer,becausethatfailuretodisclosedeprivestheofficerofthepresumptiveauthority

totaketheactioninquestion. Cf.MillsAcquisitionCo.v.Macmillan,Inc.,559A.2d1261,

1279(Del.1988)([J]udicialreluctancetoassessthemeritsofabusinessdecisionendsin

the face of illicit manipulation of a boards deliberative process by selfinterested

corporate fiduciaries.). Similarly, where a plaintiff challenges an action that was

beyondthescopeofanofficersauthority,thebusinessjudgmentrulemaynotprotect

the officer. Gifford, 918 A.2d at 354 (Aboards knowing and intentional decision to


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exceedtheshareholdersgrantofexpress(butlimited)authorityraisesdoubtregarding

whethersuchdecision isavalidexerciseofbusinessjudgment.);Massarov.Vernitron

Corp,559F.Supp.1068,1080(D.Mass.1983)(businessjudgmentrulecanbeovercome

upon a showing of fraud, bad faith, gross overreaching or abuse of discretion

(quotingPainterv.MarshallField&Co.,646F.2d271,293(7thCir.1981)));Omnibankv.

United Southern Bank, 607 So. 2d 76, 8485 (Miss. 1992) (refusing to applybusiness

judgmentrulewhenofficerexceededhis authority). Anactionoutside ofan officers

authorityorcontrarytocorporatepolicymaybeconsideredtohavebeentakeninbad

faith and thus fall outside the protection of thebusinessjudgment rule. Stanziale v.

Nachtomi(InreTowerAir,Inc.),416F.3d229,238(3dCir.2005)(plaintiffscoulddefeat

thebusinessjudgmentruledefenseiftheycoulddemonstratethatnobusinessperson

could possibly authorize the action in good faith.); see alsoMassaro, 559 F. Supp. at

1080.

c) TheIntersectionBetweentheBusinessJudgmentRuleandIllegalConduct theAIGCase

The Delaware Chancery Courts recent decision in In reAmerican International

Group, Inc. (In reAIG), 965 A.2d 763 (Del. Ch. 2009), illustrates the limits of the

businessjudgmentrule. Inthatcase,thecourtheldthatshareholdersstatedaclaimfor

breach of the duty of loyalty and the duty to monitor against AIGs top managers,

includingitsChairman/CEOandhisinnercircle,formateriallymisleadingfinancial

statementsthatoverstatedthevalueofthecorporationbybillionsofdollarsandmade


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AIGappearmorefinanciallysecurethanitreallywas. Id.at77475. Thesinglelargest

deception involvedanelaborate$500millionshamtransactionstagedtomakeAIGs

balancesheetlookbetter. Id.at775. Althoughtheplaintiffsdidnotallegetheprecise

involvementofeachofthedefendantsineachoftheputativeschemesanddeceptions,

thecomplaintdetailedtheshamtransactionandotherschemeswithenoughspecificity

that the court was unwilling to infer that AIG engaged in risky and innovative

transactions of such magnitude without the involvement or knowledge of the

Chairman/CEOandhisinnercircle. Seeid.at79599. Thecourtrejectedthecontention

that the disputed products came to market through the spontaneous, unsupervised

actionsoflowerlevelAIGactors. Id.at797. The court noted that fiduciaries

involvedinanimproperschemepossessamotivetohideinformationrelatingtotheir

wrongdoing. Cf. id. at 795 ([T]hose who engage in sophisticated forms of financial

fraud do theirbest not to leave an obvious paper trail. Rather, consistent with their

improperobjectives,thoseatthetopofsuchschemestrytoconcealtheirrolesandnot

leavemarkedpathsleadingtotheirdoorsteps.).

One defendant, who knew that the sole purpose of the $500 million sham

transactionwastomanipulatethecompanysbalancesheet,triedtoescapeliabilityfor

fraudbyimputinghisknowledgetothecorporation. Thecourtrejectedthatargument,

stating:

[U]nder Delaware law, where officers and directors have disabling

conflicts that give them an interest in hiding information from a


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corporations independent directors and stockholders, the conflicted

fiduciariesknowledge isnot imputedtothecorporationforpurposesof

holding those fiduciaries liable for the harm they caused to the

corporation. In colloquial terms, a fraud on the board has long been a

fiduciary violation under our law and typically involves the failure ofinsiders to come clean to the independent directors about their own

wrongdoing, the wrongdoing of other insiders, or information that the

insiders fear willbe usedby the independent directors to take actions

contrarytotheinsiderswishes. Delawarelawprovidesnosafeharbortohigh

levelfiduciarieswhogroup together to defraud the board. The Stockholder

Plaintiffs have alleged that Tizzio and the other AIG insiders who

participated in the Gen Re Transaction [the sham transaction] violated

theirfiduciarydutiesbycausingAIGtoengageinillegalconduct. Iftrue,that

wasbad faith conduct that gave Tizzio and the other guilty insiders an

interestinhidingwhattheyhaddone.

Id. at 80607 (emphasis added). AIG illustrates how fiduciaries who cause their

companytoengageinillegalconductbreachtheirdutiesofloyaltyandgoodfaith.

2. DutyofCareAcorporatedirectorsdutyofcareisadutyofinformeddecisionmaking. Smith

v.VanGorkom,488A.2dat873. Thedutypolicestheprocessbywhichdirectorsmake

business decisions, not the content of those decisions. Caremark, 698 A.2d at 967. In

assessingwhetherafiduciarysatisfiedthedutyofcare,courtsdonotmeasure,weigh

orquantifydirectorsjudgments[and]donotevendecideiftheyarereasonableinthis

context. Duecareinthedecisionmakingcontextisprocessduecareonly. Brehm,746

A.2dat264.

The duty of care has two aspects. First, prior to making abusiness decision,

directors are responsible for informing themselves of all material information


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31

reasonablyavailabletothem.Aronson,473A.2dat812. Second,havingconsideredthe

necessaryinformation,directorsmustactwithrequisitecareinthedischargeoftheir

duties. Id.

Gross negligence is required for a court to find abreach of the duty of care.

Smithv.VanGorkom,488A.2dat873.[A]claimthatacorporatemanageractedwith

grossnegligence isthesameasaclaim thatshebreachedher fiduciarydutyofcare.

Albertv.Alex.BrownMgmt.Servs.Inc.,C.A.Nos.04C05250PLA,04C05251PLA,2004

WL 2050527, at *6 (Del. Super. Ct. Sept. 15, 2004). [G]ross negligence is a high

standard requiring proof of reckless indifference or gross abuse of discretion.

Tomczakv.MortonThiokol,Inc.,Civ.A.No.7861,1990WL42607,at*12(Del.Ch.Apr.5,

1990) (internal citations omitted). In addition, Delaware protects directors from

personal liability to the extent their decisions arebased on information provided to

thembymanagement. SeeDEL.CODEANN.tit.8,141(e)(2010);seealsoBrehm,746A.2d

at261;InreCitigroupInc.SholderDerivativeLitig.,964A.2d106,132n.86(Del.Ch.2009).

LikemanyDelawarecorporations,Lehmanimmunizeditsdirectorsfromclaims

ofbreachesofthedutyofcare. Lehmanscertificateofincorporationprovides:

A director shall not be personally liable to the Corporation or its

stockholders for monetary damages for breach of fiduciary duty as adirector; provided that this sentence shall not eliminate or limit the

liability of a director (i) for any breach of his duty of loyalty to the

Corporationoritsstockholders,(ii)foractsoromissionsnotingoodfaith

or which involve intentional misconduct or a knowing violation of law,

(iii)underSection174ofthe[DelawareGeneralCorporationLaw],or(iv)


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32

foranytransactionfromwhichthedirectorderivesanimproperpersonal

benefit.

Lehman,RestatedCertificateofIncorporationofLehmanBrothersHoldings,Inc.(Oct.

10,2006),10.1,LimitationofLiabilityofDirectors,attachedtoLehman,QuarterlyReport

(Form10Q)(filedonOct.10,2006).

ThewordingofLehmansexculpatoryclauseisnearlyidenticalto102(b)(7)of

theDelawareGeneralCorporationLaw,whichauthorizesacorporationtoexculpateits

directors frompersonal liability forbreachesof fiduciaryduties. SeeDEL. CODE ANN.

tit.8,102(b)(7)(2010). Courtsupholdexculpatoryclausesinordertoprotectdirectors

fromliability,providedthattheconductinquestiondoesnotviolatethedirectorsduty

of loyalty. SeeStone,911A.2dat367 (Suchaprovisioncanexculpatedirectors from

monetaryliabilityforabreachofthedutyofcare,butnotforconductthatisnotingood

faithorabreachofthedutyofloyalty.). Asdiscussedbelow,however,anexculpatory

clausedoesnotextendtodirectorsCaremarkdutytomonitormanagement. Moreover,

Lehmanscertificateofincorporationdoesnotimmunizeofficersfrompersonalliability

forbreaching the duty of care. See Lehman, Restated Certificate of Incorporation, at

10.1,LimitationofLiabilityofDirectors.

Therearerelatively fewDelawaredecisionsaddressingbreachesof thedutyof

care. Inonecase,theDelawareChanceryCourtheldthatissuingsharesinviolationof

aclearandunambiguouslimitationwasaviolationofadirectorsdutyofcare. Sanders

v.Wang,CaseNo.16640,1999WL1044880,*5 (Del.Ch.Nov.8,1999). TheDelaware


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33

Supreme Court also has held that directors may breach their duty of care if they

approveamergerwithoutreceivingawrittensummaryofthetermsofthemergerand

without informationtosupporttheadequacyofthepriceofthemerger. Smithv.Van

Gorkom,488A.2dat874. Inothercases,courtsapplyingDelawarelawhaveheldthat

failingtoconsideraproposedtransactionwithsufficientinformation,consideration,or

deliberationcouldconstituteabreachof thedutyofcare. OfficialComm.ofUnsecured

CreditorsofIntegratedHealthServs.,Inc.v.Elkins,No.Civ.A20228NC,2004WL1949290,

at *12 (Del. Ch. Aug. 24, 2004) (boards approval of compensation arrangements);

McMullin,765A.2dat92122(boardsallegedlyrushedapprovalofsaleofcorporation).

3. DutyofLoyaltyandGoodFaithAdirectorsdutyofloyaltyessentially...mandatesthatthebestinterestofthe

corporation and its shareholders takes precedence over any interest possessedby a

director, officer or controlling shareholder and not shared by the stockholders

generally. Cede&Co.v.Technicolor,634A.2d345,361(Del.1993). Casesinvolvingthe

duty of loyalty often involve situations in which directors utilize their corporate

authoritytoconferspecialbenefitsontothemselvesormajoritystockholders. Aronson,

473A.2dat812. Thosecircumstancesarereferred toasselfdealingorinterested

situations. Seeid. Adirectorisconsideredinterestedwhenhewillreceiveapersonal

financialbenefitfromatransactionthatisnotequallysharedbythestockholdersona

proratabasis. GlobisPartners,L.P.v.PlumtreeSoftware,Inc.,Civ.A.No.1577VCP,2007


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34

WL 4292024, at *5 (Del. Ch. Nov. 30, 2007). Directors also are considered interested

wheretheirmotivationsinexecutingabusinessdecisionappeartobesubservienttothe

interests ofamajoritystockholder. Seee.g.,EmeraldPartnersv.Berlin, 787A.2d 85,94

(Del.2001);Tooleyv.AXAFin.,Inc.,No.18414,2005WL1252378,at*5(Del.Ch.May13,

2005).

Thedutytoactingoodfaith isasubsidiaryelementofthedutyof loyaltyand

does not establish an independent fiduciary duty thatstandson the same footing as

thedutiesofcareandloyalty. Stone,911A.2dat370. Althoughthedutyofgoodfaith

hasbeendescribedasoneofatriadofdutiesonparwiththedutiesofcareandloyalty,

thedutyofgoodfaithisbestseenasasubsetofthedutyofloyalty. Id. Thegoodfaith

requiredofacorporatefiduciaryincludes...allactionsrequiredbyatruefaithfulness

anddevotiontotheinterestsofthecorporationanditsshareholders. InreWaltDisney,

906A.2dat67.

Actstakeninbadfaithviolatethedutyofloyalty. Gifford,918A.2dat357. Bad

faith fiduciary conduct is not limited to conduct motivatedby an actual or subjective

intent to do harm. In reWaltDisney, 906 A.2d at 6467. Bad faith also encompasses

misconduct that does not involve selfinterest in a decisionbut is qualitatively more

culpablethangrossnegligence. Id.at66. Apartfromselfinteresteddealing,thisduty

imposespersonalliabilityonlyondirectorswhohavehandledtheirresponsibilityina

recklessorirrationalmanner:


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Directorsdecisionsmustbereasonable,notperfect.Inthetransactional

context,[an]extremesetoffacts[is]requiredtosustainadisloyaltyclaim

premised on the notion that disinterested directors were intentionally

disregarding their duties. . . . Only if they knowingly and completely

failedtoundertaketheirresponsibilitieswouldtheybreachtheirdutyof

loyalty.

LyondellChem.Co. v.Ryan, 970 A.2d 235, 24344 (Del. 2009) (quoting In reLearCorp.

SholderLitig.,967A.2d640,65455(Del.Ch.2008)).

4. CaremarkDutytoMonitorThe

Delaware

Chancery

Courts

decision

in

Caremark

established

that

directors

may be liable for failing to fulfill the fiduciary duty to monitor managements

compliance with corporate reporting and control systems. Citigroup, 964 A.2d at 122.

The fiduciary duty to monitor management isbreached if (a) the directors utterly

failed to implement any reporting or information system or controls; or (b) having

implemented such a system or controls, consciously failed to monitor or oversee its

operations thus disabling themselves from being informed of risks or problems

requiring their attention. Id. at 123. The Delaware Supreme Court has adopted the

Caremark standard for assessing director oversight liability. Stone, 911 A.2d at 365.

The Supreme Court stressed, however, that a director maybe held liable only for a

consciousfailuretofulfilltheoversightfunction:

[I]mposition of liability requires a showing that the directors knew that

theywerenotdischargingtheirfiduciaryobligations. Wheredirectorsfail

to act in the face of a known duty to act, thereby demonstrating a


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36

conscious disregard for their responsibilities, theybreach their duty of

loyaltybyfailingtodischargethatfiduciaryobligationingoodfaith.

Id.at370.

a) OriginsoftheDutytoMonitorCaremark created an exception to the general rule set forth inGraham v.Allis

ChalmersMfg.Co., 188 A.2d 125 (Del. 1963), that directors are entitled to rely on the

honesty and integrity of their subordinates until something occurs to put them on

suspicion

that

something

is

wrong

and

that

absent

cause

for

suspicion

there

is

no

dutyuponthedirectorstoinstallandoperateacorporatesystemofespionagetoferret

outwrongdoingwhichtheyhavenoreasontosuspectexists. SeeCaremark,698A.2d

at969(quotingGraham,188A.2dat130).

Caremark qualified the holding inGrahamby distinguishingbetween a board

decisionthatresultsinloss[tothecorporation]becausethatdecisionwasilladvisedor

negligent (which decision is subject to the business judgment rule) and an

unconsideredfailure of the board to act in circumstances in which due attention would,

arguably,havepreventedtheloss(whichfailurecangiverisetoliabilityifitreflectsa

sustainedorsystemicfailure). SeeCaremark,698A.2dat96771(emphasisinoriginal).

The latter category includes an unconsidered failure to ensure there is a corporate

informationandreportingsystem,whichtheboardconcludesisadequate.Id.at970.


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A plaintiff asserting a Caremark claim must establish that the directors are

responsible for a failure to properly monitor or oversee employee misconduct or

violations of law. Citigroup, 964 A.2d at 123 (citing David B. Shaev Profit Sharing

Accountv.Armstrong,C.A.No.1449N,2006WL391931,at*2(Del.Ch.Feb.13,2006)).

Tomeetthatstandard,plaintiffsmaypointtosocalledredflagsthatshouldhaveput

defendantsonnoticeoftheproblemsatissue. Citigroup,964A.2dat124. Theburden

of proof for such a claim is high: director liabilitybased on the duty of oversight is

possiblythemostdifficulttheoryincorporationlawuponwhichaplaintiffmighthope

towinajudgment. Caremark,698A.2dat967.

b) ElementsofaCaremarkClaimBareallegationsthatdirectorsfailedtodiscoverafraudoracrimecommittedby

thecorporationor itsemployeesdonotstateaCaremarkclaim. Desimone,924A.2dat

940 (Delaware courts routinely reject the conclusory allegation thatbecause illegal

behavior occurred, internal controls must havebeen deficient.);DavidB.ShaevProfit

SharingAccount,2006WL391931,at*5(Aclaimthatanauditcommitteeorboardhad

notice of serious misconduct and simply failed to investigate . . . would survive a

motion to dismiss, even if the committee or board was well constituted and was

otherwisefunctioning. ButtheonethingthatisemphaticallynotaCaremarkclaimisthe

bald allegation that directors bear liability where a concededly wellconstituted

oversight mechanism, having received no specific indications of misconduct, failed to


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discover fraud.); see also Stone, 911 A.2d at 373 ([D]irectors good faith exercise of

oversightresponsibilitymaynotinvariablypreventemployeesfromviolatingcriminal

laws,orfromcausingthecorporationtoincursignificantfinancialliability....).

[D]irectors willbe potentially liable forbreach of their oversight duty only if

they ignore red flags that actually come to their attention, warning of [internal]

complianceproblems. Forsythev.ESCFundMgmt.Co.(U.S.),Inc.,CA.No.1091VCL,

2007WL2982247,at*7(Del.Ch.Oct.9,2007). Directorsliabilityforfailuretomonitor

is strictly limitedbecause with an effective compliance system in place, corporate

directors are entitled tobelieve that, unless red flags surface, corporate officers and

employeesareexercisingtheirdelegatedpowersinthebestinterestofthecorporation.

Id.

To date nearly allCaremark claims havebeenbrought against directors rather

thanofficers. Unlikeofficers,directorsarenotinvolvedinthedaytodayaffairsofthe

corporation. Courts consider directors limited role in applying theCaremark duty to

monitor. Mostof the decisions that a corporation,acting through its human agents,

makesare,ofcourse,notthesubjectofdirectorattention. Caremark,698A.2dat968;

seealsoStone,911A.2dat372. [E]vendirectorswhomakeagoodfaitheffort...might

missakeyproblemareaorbedeceivedbymanagement,socourtsproceedwithgreat

caution, recognizing that directors can only be expected to fulfill certain core


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oversightresponsibilities.LeoE.Strine,Jr.,DerivativeImpact?SomeEarlyReflectionson

theCorporationLawImplicationsoftheEnronDebacle,57BUS.LAW.1371,1393(2002).

Accordingly, to state a claim that directors failed to monitor and correct a

corporate impropriety, a plaintiff must allege (1) the directors knew or should have

knownthataviolationofthelawwasoccurringand,(2)thedirectorstooknostepsinagoodfaithefforttopreventorremedythesituation. Beamexrel.MarthaStewartLiving

Omnimedia,Inc.v.Stewart,833A.2d961,976(Del.Ch.2003)(quotingCaremark,698A.2d

at971).

In thepast, DelawarecourtsevaluatedCaremarkclaims under the dutyofcare.

However, inStone, the Delaware Supreme Court recategorizedCaremark claims from

thedutyofcaretothedutyofloyaltyandclarifiedoneofthemostdifficultquestions

in corporate law when directors with no motivation to injure the firm canbe held

responsible ifthecorporation incursseriousharmasaresultof itsfailuretoobeythe

law. Desimone, 924 A.2d at 935; see also Stone, 911 A.2d at 370. The Stone court

explainedthatthefiduciarydutyofloyaltyisnotlimitedtocasesinvolvingafinancial

or other cognizable fiduciary conflict of interest. Stone, 911 A.2d at 370. It also

encompasses cases where the fiduciary fails to act in good faith. Id. A fiduciary

cannotactloyallytowardsthecorporationunlesssheactsinthegoodfaithbeliefthat

heractionsareinthecorporationsbestinterest. Id.(quotingGuttman,823A.2dat506

n.34). StoneexplainedthatCaremarkarticulatesthenecessaryconditionspredicatefor


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directoroversightliabilityand[w]heredirectorsfailtoactinthefaceofaknownduty

to act, thereby demonstrating a conscious disregard for their responsibilities, they

breach their duty of loyaltyby failing to discharge that fiduciary obligation in good

faith. Stone,911A.2dat370. Accordingly,inordertoholdadirectorliableforfailure

tomonitor,thedirectorsindolence[mustbe]sopersistentthatit[can]notbeascribed

to anything other than a knowing decision not to even try to make sure the

corporations officers had developed and were implementing a prudent approach to

ensuringlawcompliance. Desimone,924A.2dat935(discussingStone).

ThereclassificationofCaremarkclaimsasbreachesofthedutyofloyaltyrather

thanthedutyofcaremeansthattheexculpatoryprovisionofacorporationsarticlesof

incorporationnolongerapplies. Caremarkbasedclaimsdonotfallundertheprotection

ofSection102(b)(7)oftheDelawareGeneralCorporationLaw(authorizingexculpation

ofdirectorsfrommonetaryliabilityforabreachofthedutyofcarebutnotforconduct

thatisinbadfaith)orSection145oftheDelawareGeneralCorporationLaw(permitting

indemnification of a director, officer, employee, or agent where that person acted in

goodfaithandinamannerthepersonreasonablybelievedtobeinornotopposedto

thebest interests of the corporation). DEL. CODE ANN. tit. 8, 102(b)(7)(2010); DEL.

CODEANN.tit.8,145(a)(2010);seeStone,911A.2dat367;InreWaltDisney,906A.2dat

6566.


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Although the issue rarely has been litigated, a Caremark fiduciary duty of

oversight or duty to monitor likely applies to officers, provided that those officers

occupiedapositionofseniorityandhadsupervisoryresponsibilities. SeeWorldHealth

Alternatives, Inc. v.McDonald (In reWorldHealthAlternatives, Inc.), 385 B.R. 576, 591

(Bankr. D. Del. 2008) (construing Florida law but looking to Delaware law for

guidance). But seeBridgeportHoldings Inc.,LiquidatingTrust v.Boyer (In reBridgeport

Holdings, Inc.), 388 B.R. 548, 574 (Bankr. D. Del. 2008) (stating that, with respect to a

charge of sustained and systemic failure of oversight . . . under Delaware law, this

theoryofliabilitytypicallyappliestodirectorsandnottoofficers). Applyingtheduty

tomonitortoofficersappearstofollowdirectlyfromestablishedprinciplesofDelaware

law: Caremark establishes that directors have a duty to monitor, and the Delaware

Supreme Court has held that the fiduciary duties of directors and officers are

identical.SeeGantler,965A.2dat70809.

AlthoughtheDelawareSupremeCourtandChanceryCourthavenotexpressly

appliedtheCaremarkdutytoofficers,aDelawarebankruptcycourthaspermittedsuch

aclaimtoproceed. InInreWorldHealthAlternatives,thebankruptcycourtheldthatthe

Chapter7trusteestatedaCaremarkclaimforbreachoffiduciarydutyagainstaformer

officer(vicepresidentofoperationsandgeneralcounsel) forfailing to implementan

adequate monitoring system and/or the failure to utilize such system to safeguard

against corporate wrongdoing the result of which included material


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42

misrepresentationscontained inWorldHealthsSECfilings. 385B.R.at59091. The

courtnotedthatunderSECrulesageneralcounselhasanaffirmativedutytoinspect

the truthfulness of the SEC filings. Id. (citing SarbanesOxley Act 307, 15 U.S.C.

7245(2006)and17C.F.R.205.01etseq.(2010)). Anattorneymustreportevidence

ofamaterialviolationofsecuritieslaworbreachoffiduciarydutyorsimilarviolation

bythe issueruptheladderwithinthecompany. Id.at591(quotingSarbanesOxley

Act307,15U.S.C.7245(2006)). Thecourtheldthatastheinhousegeneralcounsel

andonlylawyerintopmanagementofWorldHealthduringtherelevantperiod,[the

defendant]hadadutytoknoworshouldhaveknownofthesecorporatewrongdoings

and reported suchbreaches of fiduciary dutiesby the management. Id. The court

furtherreasonedthatcourtsapplyingDelawarelawhaverecognizedthatofficersowe

the same fiduciary duties to the corporation as directors, and that the Caremark

decisionitselfsuggeststhatthesametest[fordutytomonitor]wouldbeapplicableto

officers. Id.at592.

c) ApplicationofCaremarktoRiskOversight:InreCitigroupInc.In Citigroup, the Delaware Chancery Court rejected a claim that Citigroups

currentandformerdirectorsandofficershadbreachedtheirfiduciarydutiesbyfailing

to properly monitor and manage the risks the Company faced from problems in the

subprime lending market and for failing to properly disclose Citigroups exposure to

subprimeassets. 964A.2dat111. Thecomplaintallegedmultipletheoriesofliability,


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including abreach of theCaremark duty to monitor. Plaintiffsbased their claims on

severalredflagsthatallegedlyshouldhavegivendefendantsnoticeoftheproblems

thatwerebrewingintherealestateandcreditmarkets. Id.

Thecourtrejectedtheclaim. Notingthatthesupposedredflagsamount[ed]to

littlemorethanportionsofpublicdocumentsthatreflectedtheworseningconditionsin

the subprime mortgage market and the economy generally, the court found the

allegations legally insufficient to show that the directors were or should havebeen

aware of any wrongdoing at the Company or were consciously disregarding a duty

somehowtopreventCitigroupfromsuffering losses. Id.at128. Thecourtheldthat

thecomplaintfailedtostateaclaimfordirectorliabilityundertheCaremarkstandard.

Id.at13940.

The court also held that aCaremark claim involving risk management mustbe

consistentwiththebusinessjudgmentrule:

Itisalmostimpossibleforacourt,inhindsight,todeterminewhetherthe

directorsofacompanyproperlyevaluatedriskandthusmadetheright

businessdecision.

To impose liability on directors for making a wrongbusiness decision

would

cripple

their

ability

to

earn

returns

for

investors

by

taking

business

risks.

Id.at126.

TheplaintiffsadmittedthatCitigrouphadproceduresandcontrolsinplacethat

weredesignedtomonitorrisk. Id.at127. Theyassertedthatthedirectorshadfailedto


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satisfytheiroversightdutybecausethecorporatemechanismswereinadequateorthe

directors failed to comply with established procedures. Id. The court held that the

plaintiffshadfailedtoallegehowtheputativelyinadequatecorporateriskmanagement

systemformedthebasisforaCaremarkclaim:

[P]laintiffs allegations do not even specify how theboards oversight

mechanisms were inadequate or how the director defendants knew of

theseinadequaciesandconsciouslyignoredthem. Rather,plaintiffsseem

to hope the Court will accept the conclusion that since the Company

suffered large losses, and since a properly functioning risk management

systemwouldhaveavoidedsuchlosses,thedirectorsmusthavebreached

theirfiduciarydutiesinallowingsuchlosses.

Id.

ThecourtemphasizedthatredflagssufficienttostateaCaremarkclaimmust

gobeyondsignsinthemarketthatreflectedworseningconditionsandsuggestedthat

conditions may deteriorate even further . . . . Id. at 130. The court stressed that

misreading

market

signals

does

not

render

directors

personally

liable

for

their

corporationslosses:

Oversight duties under Delaware law are not designed to subject

directors,evenexpertdirectors,topersonalliabilityforfailuretopredictthe

futureandtoproperlyevaluatebusinessrisk.

Id.at131.

5. DisclosureObligationsIn some situations, a failure to properly inform shareholders or directors of

materialinformationhasbeenevaluatedasapotentialbreachofthedutyofcare. Inre

TranskaryoticTherapies, 954 A.2d 346, 35658 (Del. Ch. 2008). At other times, though,


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courts have reviewed nondisclosures under the standards for abreach of the duty of

loyalty. Id. In still other circumstances, failures to disclose are considered to be

breaches of an independent fiduciary duty. Id. The following subparts discuss a

boardsdutyofdisclosuretoshareholdersandmanagementsdutyofdisclosuretothe

board.

a) TheBoardsObligationtoProvideInformationtoShareholders(1) TheStandardforDirectorsPersonalLiability

(a)Information

Material

to

a

Shareholder

Vote

The duty of disclosure applies in situations where the corporation has made

statements to shareholders in connection with a request for shareholder action. See

Skeenv.JoAnnStores,Inc.,750A.2d1170,1172(Del.2000);Orloffv.Shulman,No.Civ.A.

852N,2005WL3272355,at*14(Del.Ch.Nov.23,2005);Steinmanv.Levine,No.Civ.A.

19107,2002

WL

31761252,

*13

(Del

Ch.

Nov.

27,

2002),

affd

822

A.2d

397

(Del.

2003).

Where the nondisclosure of material information occursbefore a shareholder

vote, Delaware courts are more likely to grant injunctive relief delaying the vote in

order to permit the information tobe provided rather than to award afterthefact

damages, that maybe difficult if not impossible to determine. See In reTranskaryotic

Therapies,954A.2dat36063. Acourtmayawarddamagesfornondisclosurewithout

evidence that the nondisclosure amounted to abreachby directors of their duties of


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loyalty or good faith. Id.at 362. An award of damages, though, requiresproof of at

leastgrossnegligence.Metro,854A.2dat157.

(b) InformationProvidedGenerallytoShareholdersIf aboard disseminates false information to shareholders outside a situation

involving a request for shareholder action, the issue is not whether the directors

breached their duty of disclosure,but whether theybreached their more general

fiduciary duty of loyalty and good faith by knowingly disseminating to the

stockholdersfalse

information

about

the

financial

condition

of

the

company.

Malone

v.

Brincat, 722 A.2d 5, 10 (Del. 1998). Stockholders are entitled to rely upon the

truthfulness of all information disseminated to them, including public statements

directorsorofficersmake to themarket. Id.at1011;seealsoMalpiedev.Townson,780

A.2d 1075, 1086 n.2 (Del. 2001) ([D]irectors who knowingly disseminate false

information that results in corporate injury or damage to an individual stockholder

violate their fiduciaryduty,andmaybe heldaccountable ina mannerappropriate to

the circumstances.) (quotingMalone, 722 A.2d at 9). The Delaware Chancery Court

recentlyexplained:

WhenaDelawarecorporationcommunicateswith itsshareholders,even

in the absence of a request for shareholder action, shareholders areentitled to honest communication from directors, given with complete

candor and in good faith. Communications that depart from this

expectation,particularlywhenitcanbeshownthatthedirectorsinvolvedissued

their communicationwith the knowledge that it was deceptive or incomplete,

violatethefiduciarydutiesthatprotectshareholders. Suchviolationsare

sufficienttosubjectdirectorstoliabilityinaderivativeclaim.


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InreinfoUSA,Inc.SholdersLitig.,953A.2d963,990(Del.Ch.2007)(emphasisadded).

Insituationsnotinvolvingrequestsforshareholderaction,directorscanbeheld

liable for failing to provide material information when communicating with

shareholders, only on proof that they knowingly disseminated false information, a

standardofproofthatishigherthanevencommonlawfraud. Metro,854A.2dat157

58.

(2) MaterialityastoShareholdersAbreach of the duty of disclosure requires proof that the defendant failed to

disclose information that was material and within the defendants control. Wayne

CountyEmployeesRet.Sys.v.Corti,Civ.A.No.3534CC,2009WL2219260,at*8(Del.

Ch.July 24, 2009); see alsoMalone, 722 A.2d at 12. The standard for materiality is

whetherareasonableperson,standingintheshoesofthepartytowhomthedisclosure

shouldhave

been

made,

would

have

considered

the

information

lehman examiner's report, vol. 6

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