In-house counsel exposure.
A recent decision of the United States Bankruptcy Court for the District of Delaware highlights some dangers for in-house counsel regarding a potentially wide range of pre‑bankruptcy conduct and transactions, even as to matters in which counsel was not involved and from which he or she derived no discernible benefit.
On April 9, 2008, the bankruptcy court denied a motion to dismiss claims against the alleged "de facto" in-house counsel of a failed health services staffing company for breach of fiduciary duty, professional negligence, negligent misrepresentation, and aiding and abetting the former senior executive (and other officers and a director) in allegedly committing fraud, breach of fiduciary duty and corporate waste. The case is Miller v. McDonald (In re World Health Alternatives, Inc.), __ B.R. __, 2008 WL 1002035 (Bankr. D. Del. Apr. 9, 2008) (Case No. 06‑10166, Adv. No. 07-51350).
According to the company's Chapter 7 trustee, the company's vice president of operations and de facto in-house counsel knew or should have known about a variety of wrongdoing. Some alleged wrongdoing may have been obvious ("double borrowing" on receivables, for example), but the alleged corporate waste also included monthly lease payments on luxury automobiles and other expenses and bonuses that, even though made at a time when the company had a negative net income, might not have been so obviously wrongful.
Breach of fiduciary duty.
The court refused to dismiss the trustee's claim that the in‑house counsel could be liable for breach of fiduciary duty for "failing to implement any internal monitoring system and/or failing to utilize such system . . . ." (Slip Opinion at 26.) The court also relied on Section 307 of the Sarbanes-Oxley Act (15 U.S.C. § 7245 (2005)) and rules thereunder (17 C.F.R. Part 205 (Jan. 29, 2007)) in imposing an affirmative duty on in-house counsel to inspect the truthfulness of SEC filings and requiring attorneys to report evidence of a material violation of securities law or breach of fiduciary duty or similar violation. (Slip Opinion at 26.)
Waste of Corporate Assets.
Although there was "no allegation that [the in-house counsel] personally benefited from the alleged expenditures" and he was not personally involved in the expenditures, the court declined to dismiss the claim for corporate waste because the complaint could be read to assert that the in-house counsel was "aware of the alleged corporate waste and took no action, as [a] fiduciar[y], to prevent such conduct . . . [I]t is conceivable that no person acting in good faith in pursuit of [the company's] interest would approve [the expenditures]." (Slip Opinion at 32-33, emphasis added.) The expenditures at issue included (i) leasing 25 hours of private flight time from an executive jet service for $112,939.70 and monthly lease payments of $2,207.38 for a luxury automobile at a time when the company had a negative net income of $33,094.00 and only $117,699 of cash available, and (ii) the following year, more private flight costs and paying the chief operating officer a $500,000 bonus together with 1,000,000 shares of stock when the company had a net loss of $13,427,523 for the fiscal year. (Id. at 31-32.)
Professional negligence.
The Chapter 7 trustee alleged that the company's in-house counsel breached the applicable standards of care by "not providing oversight and failing to provide advice that would have prevented the Company from submitting SEC filings that included material misrepresentation" and "became or aware or should have been aware of the malfeasance and misdealing and discrepancies in the Company's revenue; however, no actions were taken consistent with [his] fiduciary duties to remedy or ameliorate the discrepancies until after [the President's] resignation." (Slip Opinion at 43, emphasis added.) The court declined to dismiss the trustee's claim for professional negligence.
Some caveats, and conclusion.
(1) It is not entirely clear how much of the in-house counsel's exposure was due to his alleged role as de facto in-house counsel and how much to his role as a corporate officer. (2) The court acknowledges that on the corporate waste claim, "the call" is "a close one." (Slip Opinion at 32.) (3) The bar is high on a motion to dismiss, so the fact that the court declined to dismiss the claims is far from a determination of liability. The court had to "accept as true all allegations in the complaint," "draw reasonable inferences in the light most favorable to the plaintiff" and not grant the in-house counsel's motion to dismiss unless it "appears to a certainty that no relief could be granted under any set of facts which could be proved." (Id. at 22, citations omitted.) All of that said, in the post-Enron era, the law appears to be continuing to evolve to impose greater duties on in-house counsel, including fiduciary duties to implement and utilize monitoring systems, provide oversight and advice regarding possible wrongdoing, and take action to prevent, remedy or ameliorate others' wrongdoing. Bankruptcy trustees, in their quest for recoveries for the benefit of a bankruptcy estate and its creditors, have become increasingly aggressive in recent years in asserting claims against a debtor company's former officers, directors and professionals for alleged negligence and malfeasances during the pre-bankruptcy period. Because it is impossible to know at any given point in time whether a company may wind up with financial troubles and voluntarily or involuntarily become a debtor in a federal bankruptcy case, it behooves all in-house counsel to be mindful of cases like Miller v. McDonald and to conduct themselves in a way that will be defensible with the benefit of 20-20 hindsight.