8/14/2019 Lehman Examiner's Report, Vol. 6
1/225
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
8/14/2019 Lehman Examiner's Report, Vol. 6
2/225
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
8/14/2019 Lehman Examiner's Report, Vol. 6
3/225
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
8/14/2019 Lehman Examiner's Report, Vol. 6
4/225
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
8/14/2019 Lehman Examiner's Report, Vol. 6
5/225
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
8/14/2019 Lehman Examiner's Report, Vol. 6
6/225
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
8/14/2019 Lehman Examiner's Report, Vol. 6
7/225
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
8/14/2019 Lehman Examiner's Report, Vol. 6
8/225
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.
8/14/2019 Lehman Examiner's Report, Vol. 6
9/225
6
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.
8/14/2019 Lehman Examiner's Report, Vol. 6
10/225
7
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
8/14/2019 Lehman Examiner's Report, Vol. 6
11/225
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
8/14/2019 Lehman Examiner's Report, Vol. 6
12/225
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).
8/14/2019 Lehman Examiner's Report, Vol. 6
13/225
10
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
8/14/2019 Lehman Examiner's Report, Vol. 6
14/225
11
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
8/14/2019 Lehman Examiner's Report, Vol. 6
15/225
12
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
8/14/2019 Lehman Examiner's Report, Vol. 6
16/225
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
8/14/2019 Lehman Examiner's Report, Vol. 6
17/225
14
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.
8/14/2019 Lehman Examiner's Report, Vol. 6
18/225
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
8/14/2019 Lehman Examiner's Report, Vol. 6
19/225
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].
8/14/2019 Lehman Examiner's Report, Vol. 6
20/225
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
8/14/2019 Lehman Examiner's Report, Vol. 6
21/225
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:
8/14/2019 Lehman Examiner's Report, Vol. 6
22/225
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.
8/14/2019 Lehman Examiner's Report, Vol. 6
23/225
20
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.
8/14/2019 Lehman Examiner's Report, Vol. 6
24/225
8/14/2019 Lehman Examiner's Report, Vol. 6
25/225
22
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.
8/14/2019 Lehman Examiner's Report, Vol. 6
26/225
23
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
8/14/2019 Lehman Examiner's Report, Vol. 6
27/225
24
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.
8/14/2019 Lehman Examiner's Report, Vol. 6
28/225
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
8/14/2019 Lehman Examiner's Report, Vol. 6
29/225
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.
8/14/2019 Lehman Examiner's Report, Vol. 6
30/225
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
8/14/2019 Lehman Examiner's Report, Vol. 6
31/225
28
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
8/14/2019 Lehman Examiner's Report, Vol. 6
32/225
29
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
8/14/2019 Lehman Examiner's Report, Vol. 6
33/225
30
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
8/14/2019 Lehman Examiner's Report, Vol. 6
34/225
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)
8/14/2019 Lehman Examiner's Report, Vol. 6
35/225
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
8/14/2019 Lehman Examiner's Report, Vol. 6
36/225
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
8/14/2019 Lehman Examiner's Report, Vol. 6
37/225
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:
8/14/2019 Lehman Examiner's Report, Vol. 6
38/225
35
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
8/14/2019 Lehman Examiner's Report, Vol. 6
39/225
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.
8/14/2019 Lehman Examiner's Report, Vol. 6
40/225
37
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
8/14/2019 Lehman Examiner's Report, Vol. 6
41/225
38
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
8/14/2019 Lehman Examiner's Report, Vol. 6
42/225
39
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
8/14/2019 Lehman Examiner's Report, Vol. 6
43/225
40
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.
8/14/2019 Lehman Examiner's Report, Vol. 6
44/225
41
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
8/14/2019 Lehman Examiner's Report, Vol. 6
45/225
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,
8/14/2019 Lehman Examiner's Report, Vol. 6
46/225
43
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
8/14/2019 Lehman Examiner's Report, Vol. 6
47/225
44
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,
8/14/2019 Lehman Examiner's Report, Vol. 6
48/225
45
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
8/14/2019 Lehman Examiner's Report, Vol. 6
49/225
46
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.
8/14/2019 Lehman Examiner's Report, Vol. 6
50/225
47
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