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GT Alert

More Fiduciary Claims Against Directors and Officers Will Survive Dismissal: Third Circuit Panel Rejects Application of Stricter Delaware Pleading Standard

August 2005

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A recent decision by a federal Court of Appeals reduces the burden on bankruptcy trustees, and by extension creditors’ committees and stock-holders, to sue corporate directors in federal court for breach of fiduciary duty and survive a motion to have such claims dismissed. A three-judge panel of the Third Circuit Court of Appeals – which has federal jurisdiction over Delaware, New Jersey and Pennsylvania – recently reversed a federal trial court’s dismissal of several fiduciary duty claims asserted against the directors and officers of Tower Air, Inc. (“Tower”), allowing those claims to proceed to discovery.1

"Corporate directors are increasingly subject to claims that by allegedly “rubber-stamping” management’s recommendations or allegedly failing to exercise diligent oversight over management, the directors may be held personally liable for acting in 'bad faith.'"

Tower was a Delaware corporation involved in domestic and international air service. Beginning in the mid-1990s, Tower began experiencing financial difficulty, and in 2000 it filed for bankruptcy. The plaintiff in the case, Stanziale, was appointed as a trustee, and in June 2001, Stanziale filed suit on behalf of the company and its bankruptcy estate against the directors and officers for alleged breaches of fiduciary duty and waste of corporate assets.

The gravamen of the claims is that the directors and officers had engaged in ongoing mismanagement and lack of oversight throughout the period of the company’s financial decay. The trial court had dismissed plaintiff’s claims for failure to plead “specific facts” sufficient to overcome the presumption of the business judgment rule under Delaware law; i.e., the corporate law presumption that Tower’s directors and officers had acted with due care, loyalty, and good faith.

The Third Circuit Court of Appeals reversed the dismissal of four of these claims. The appeals court seemed particularly troubled by allegations that corporate officers, including the company’s Chairman and CEO, were not responsive to reports of aircraft safety concerns, and allegations that the Chairman and CEO had established and maintained unprofitable air service to a particular destination purely to please his family.

In reversing the dismissal of several counts of the complaint, the Third Circuit’s decision highlights several issues of note:

  • Corporate directors are increasingly subject to claims that by allegedly “rubber-stamping” management’s recommendations or allegedly failing to exercise diligent oversight over management, the directors may be held personally liable for acting in “bad faith.” This trend places a premium on preparation of quality Board agendas, Board packets, meeting minutes and thoughtful corporate disclosure as a means of warding off, or summarily defeating, unfounded claims of Board laxity or inattention.
  • The “bad faith” fiduciary duty claim is a particularly potent allegation, because it may not only deprive a director of the protection of the Delaware business judgment rule, but may also place at risk corporate indemnification and insurance, exposing directors to an enhanced risk of personal liability.
  • The federal standard for asserting such a claim – as articulated by the Court of Appeals – allows actions against corporate directors to proceed into discovery, when such claims may have been dismissed at the outset had the case been filed in Delaware state court. In particular, under the Court of Appeals’ decision, a plaintiff seeking to assert such a claim in federal court need only provide notice of the grounds for its claim. This standard appears to contrast markedly with that employed by the Delaware courts, which requires a complaint to state “specific allegations of fact” sufficient to overcome the presumption of the business judgment rule.
  • One justification for the Delaware standard is the recognition that bankruptcy trustees and shareholders have power, under the Bankruptcy Code and Delaware corporate law, respectively, to obtain access to company books and records, and in the case of a trustee, may even obtain testimony from corporate officers and directors, before drafting their complaints. The Court of Appeals’ opinion does not reflect whether the Court was aware of these powers in framing its decision, or whether that Court, or other federal courts, would take a different view of the matter in light of such powers.
  • Finally, the Court of Appeals’ decision casts doubt on the viability of a Delaware Section 102(b)(7) defense at the outset of a fiduciary duty case in federal court. Section 102(b)(7) was enacted by the Delaware General Assembly after the land-mark case of Smith v. Van Gorkum2 to insulate loyal directors from monetary liability arising from breaches of the fiduciary duty of care. The Court of Appeals did not explicitly rule on the applicability to the trustee’s claims of Tower’s Section 102(b)(7) charter provision. However, the Court’s articulation of the “notice pleading” standard for stating claims of director “bad faith” suggests that the directors may not have been able to avail themselves of Tower’s exculpatory charter provision at the pleading stage of the case in any event.

Whether other federal courts, or indeed the Third Circuit as a whole, will follow the lead of the Tower Air panel remains to be seen. At all events, the Tower Air decision underscores that directors and officers should seek to insure that the processes by which they make decisions are as informed and well-advised as reasonably possible, and that their decision-making processes are well-documented.

 


Footnotes

1 Stanziale v. Nachtomi, et al. (In Re: Tower Air, Inc.), No. 04-3633 (3d Cir. Aug. 3, 2005).

2 488 A.2d 858 (Del. 1985).

 

This Alert was written by Roger A. Lane in the Boston office, Paul D. Brown and Joseph B. Cicero in the Delaware office. Please contact Mr. Lane at 617.310.6006, Mr. Brown at 302.661.7380, and Mr. Cicero at 302.661.7391 or your Greenberg Traurig liaison, if you have any questions regarding the subject matter of this Alert.

© 2005 Greenberg Traurig


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This GT ALERT is issued for informational purposes only and is not intended to be construed or used as general legal advice. Greenberg Traurig attorneys provide practical, result-oriented strategies and solutions tailored to meet our clients’ individual legal needs.