Delaware Corporate and Commercial Litigation Blog : Delaware Litigation Lawyer & Attorney : Francis G. X. Pileggi : Corporate, Business, Commercial, Delaware Chancery Court

American International Group, Inc., Consolidated Derivative Litigation; AIG, Inc. v. Greenberg, et al., 2009 Del. Ch. LEXIS 15 (Feb. 10, 2009)("AIG I") 965 A.2d 763 (Del. Ch. 2009), read opinion here.

This Chancery Court decision denied a Motion to Dismiss breach of fiduciary duty claims against former AIG Chairman Maurice "Hank" Greenberg and other AIG directors in connection with the long list of claims relating to AIG's need to restate years of  financial statements, and related losses of billions of dollars in stockholder value. The opinion is 104-pages long in the original slip op.  format  and could easily be the subject of a law review article, but pressing client matters allow me only to identify the decision at this time and add a few highlights.

Notably, the  defendant officers were dismissed on jurisdictional grounds in large part because the claims originated before the Delaware statute was changed to allow jurisdiction in Delaware to be more easily imposed against officers. Also, the auditor, PricewaterhouseCoopers, was dismissed based on the application of New York law (in light of the substantial relationship test for choice of law), and New York law apparently required dismissal of the claims against them.

The best way to highlight a few aspects of a voluminous opinion like this on a blog is via bullet-points.

• The court found that the complaint stated breach of loyalty claims against directors for "knowingly tolerating inadequate internal controls and knowingly failing to monitor their subordinates' compliance with legal duties." [Caremark claim] See footnotes 123 and 124.
   
• The court emphasized that the Caremark claim was not based on one instance of fraud, but rather on such a pervasive scheme that the court actually uses the term "criminal organization" to describe the extraordinary wrongdoing alleged in the complaint.  See LEXIS format at *78.
• Acknowledging the difficulty of pleading a breach of loyalty claim under Caremark based on a duty to monitor, even under Rule 12(b)(6),  the court found that the complaint did  so.  FN 125
• Key quotes from the opinion about Caremark claims include:

• "Our Supreme Court has recognized that directors can be liable where they 'consciously failed to monitor or oversee [the company's internal controls] thus disabling themselves from being informed of risks or problems requiring their attention.'" FN 126.  And although satisfaction of this standard requires scienter, the pled facts support an inference that Matthews and Tizzio were 'conscious of the fact that they were not doing their jobs.'" FN 127

• Caremark claims against Greenberg were upheld because the complaint adequately pled that the AIG internal controls were broken and Greenberg knew they were broken (and could get around them), but failed to do anything to fix the internal controls.

• Breach of fiduciary duty claims were also upheld against directors alleged to have used insider information to profit at the expense of innocent buyers of stock (i.e., they allegedly sold their stock based on material non-public information about the pervasive fraud.) See FNs 128 to 131

• arguments were rejected that involved attempts to dismiss contribution and indemnity claims based on ripeness and related theories. See FNs 143 to 145 and Section 6302(c) of Title 10 of the Delaware Code (regarding joint tortfeasor partial settlements).

• When a "Special Litigation Committee" decides to "take no position" on a derivative suit, that is tantamount to "allowing it to proceed", and also supports demand futility.

• Equitable tolling may, in some situations, extend the three-year statute of limitations for fiduciary duty claims (FNs 181 to183) such as when a fiduciary uses his fraud to conceal his wrongdoing to prevent others from discovering the liability.

• Quote: "Many of the worst acts of fiduciary misconduct have involved frauds that personally benefited insiders as an indirect effect of directly inflating the corporation's stock price by the artificial means of cooking the books." See  LEXIS format of opinion at *122.

UPDATE: Professor Larry Ribstein comments here on this case and the recent Citigroup decision also highlighted on these pages here, which should be read together with this case. Here is another analysis by Professor Ribstein about this case and the Citigroup case on the Harvard  Law School Corporate Governance Forum. Prof. Lawrence Cunningham provides insightful commentary here.

UPDATE II:  In a June 17, 2009 decision in this case,  American International Group, Inc. v. Greenberg, No. 729-VCS (June 17, 2009),  read opinion here, the Chancery Court summarized the above decision from February thusly:

 In an earlier opinion in this action, this court addressed the motions to dismiss brought by PricewaterhouseCoopers and several former-AIG officers and employers.5

In that previous decision, this court held that the Complaint survived dismissal as against challenge by insider defendants Hank Greenberg, Edward Matthews, and Thomas Tizzio and that the Complaint stated well-pled claims of breach of fiduciary duty against those defendants.6  The Complaint also adequately alleged fraud and conspiracy claims against Tizzio. 7

By contrast, this court held that New York law governed the claims against AIG’s auditor, PricewaterhouseCoopers, and that New York law’s approach to the doctrine of in pari delicto barred AIG from recovering against PricewaterhouseCoopers. That holding was driven by the court’s choice of law analysis and did not reflect whether AIG could have maintained such a suit under Delaware law.

Finally, in that decision, this court held that it did not have personal jurisdiction over certain AIG officers and employees who had allegedly engaged in improper behavior before 10 Del. C. § 3114 was broadened to cover certain corporate officers.
Because none of the acts relevant to the illegal conduct pled in the Complaint occurred in Delaware and none of those defendants was a Delaware resident, this court could not exercise jurisdiction over them.

I now address the motions to dismiss brought by the third parties who allegedly conspired with AIG to commit illegal acts. The relevant allegations in the Complaint center on two separate courses of illegal conduct: the Fake Reinsurance Conspiracy and the Bid-Rigging Conspiracy.

5 See generally AIG I, 965 A.2d 763.
6 Id. at 799.
7 Id. at 807
 

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In Gantler v. Stephens, (Del. Supr., Jan. 27, 2009), read opinion here, the Delaware Supreme Court, yesterday,  issued a major decision on important matters of Delaware corporate law. Delaware's High Court  for the first time confirmed and clarified that officers of Delaware corporations have the same fiduciary duties as directors of Delaware corporations.

In addition, the Delaware Supreme Court clarified and enunciated Delaware common law on the issue of  "shareholder ratification".

In a rare reversal of the Chancery Court,  the Supreme Court determined that the breach of fiduciary duty claims in this case should be allowed to proceed, and explained why the board should not enjoy the presumption of the business judgment rule at this stage of the proceedings,  based on the pled facts (contrary to the Chancery Court's dismissal of the case, based on an earlier opinion summarized here.)

 The Supreme Court's own succinct  introductory summary to its opinion follows:

The plaintiffs in this breach of fiduciary duty action, who are certain shareholders of First Niles Financial, Inc. (“First Niles” or the “Company”), appeal from the dismissal of their complaint by the Court of Chancery The complaint alleges that the defendants, who are officers and directors of First Niles, violated their fiduciary duties by rejecting a valuable opportunity to sell the Company, deciding instead to reclassify the Company’s shares in order to benefit themselves, and by disseminating a materially misleading proxy statement to induce shareholder approval. We conclude that the complaint pleads sufficient facts to overcome the business judgment presumption, and to state substantive fiduciary duty and disclosure claims. We therefore reverse the Court of Chancery’s judgment of dismissal and remand the case for further proceedings consistent with this Opinion.

 The distilled essence of the factual genesis of this case is the decision of the Board of First Niles Financial  to sell itself, but thereafter not taking seriously three offers that it received, and instead appearing to favor a privatization or a reclassification plan. The three basic claims in the complaint were that the board members breached their fiduciary duties to the First Niles shareholders by rejecting an offer from a potential buyer and abandoning the sale of the company.  Secondly, the claim was that the defendant directors breached their fiduciary duty of disclosure by disseminating a materially false and misleading proxy regarding the reclassification. Third, the amended complaint alleges that it was a breach of fiduciary duty to implement the reclassification plan.

The Chancery Court dismissed the amended complaint, ruling that it failed to allege facts that were sufficient to overcome the presumption of the business judgment rule and for failing to establish that the proxy was materially false and misleading, as well as based on the argument that the shareholders “ratified “ the decision of the board to reclassify the shares.

The Supreme Court reviewed the trial court’s grant of the motion to dismiss on a “de novo basis”  to determine whether “the trial judge erred as a matter of law in formulating or applying legal precepts.”

Although Count I of the complaint alleged that the directors breached their duties of loyalty and care by abandoning the sale of the bank in order to retain the benefits of incumbency, the trial court concluded that the Unocal  standard did not apply because the complaint did not allege any “defensive” action by the board. The trial court also determined that the entire fairness review was not applicable because the board did not interpose itself between the shareholders and a potential acquirer by means of defensive measures, and thus  the trial court applied the business judgment standard and concluded that the allegations in the complaint failed to rebut the presumption of business judgment.

The Supreme Court upheld the Chancery Court’s refusal to apply the Unocal standard because the essence of the transaction at issue was not defensive and the initial count in the complaint was based on disloyalty as opposed to defensive conduct. Nor does Count I allege any hostile takeover attempt or similar threatened external action from which it could be inferred that the defendants acted defensively, despite the allegation that they improperly delayed or sabotaged the due diligence process.

The Business Judgment Rule

Next, the Supreme Court addressed whether the trial court appropriately found that the plaintiff did not satisfy the burden of pleading facts sufficient to rebut the presumption of the business judgment rule that  “in making a business decision the directors of a corporation acted on an informed basis, in good faith and in the honest belief that the action taken was in the best interest of the company.” (citing Aronson v. Lewis, 473 A.2d 805, 812 (Del. 1984)).

Delaware’s High Court recognized that a board is generally entitled to the presumption of the business judgment rule in declining a merger opportunity because implicit in the statutory authority of the board to propose a merger, is also the power to decline a merger.

In order to determine whether the board merits the business judgment presumption, the court makes a two-part analysis. First, did the board reach its decision in the good faith pursuit a legitimate corporate interest. Second, did the board do so advisedly (see footnotes 29 to 31).

The first prong of the analysis requires that the duty of loyalty be examined. In this case, the plaintiff alleges that the directors had a disqualifying self-interest because they were financially motivated to maintain the status quo and to keep their current positions. The Supreme Court was wary of such an argument which it recognized to be tautological, to some extent, because a board decision to reject a merger proposal could always enable plaintiff to assert that a majority of the directors had an entrenchment motive. For that reason, the court explained that in addition to that argument, other facts that support a disloyal motive must be stated.

The Supreme Court determined that a sufficient showing to establish disloyalty at least at this early procedural stage was demonstrated. The court reasoned that the pled facts were sufficient to establish the disloyalty of at least three of the directors, which suffices to rebut the business judgment presumption because in this case three of the directors constituted a majority. Also, for purposes of Rule 12(b)(6) there was a sufficient “director-specific analysis” to demonstrate that a majority of the board was conflicted based on specific alleged conduct from which a duty of loyalty violation can reasonably be inferred. The court recites in detail in its opinion specific facts about each individual director and why such allegations support a conflict.

Officers Share Same Fiduciary Duties as Directors

Importantly, in this decision, the Delaware Supreme Court for the first time explicitly holds, what has been implicitly stated previously and has been also acknowledged by the Delaware Chancery Court, and that is: “officers of Delaware corporations, like directors, owe fiduciary duties of care and loyalty, and the fiduciary duties of officers are the same of directors.” (See footnote 36, but also note footnote 37 which acknowledges that DGCL Section 102(b)(7) does not exculpate officers from liability for breaches of their duty of care in the current statutory provision.)

On the issue of whether a delay in the due diligence process was a breach of the fiduciary duty of the directors, the Supreme Court disagreed with the trial court. The Supreme Court explained that  on a motion to dismiss, the trial court is “not free to disregard that reasonable inference, or to discount it by weighing it against other, perhaps contrary inferences that might also be drawn,” making reference to the decision of the trial court that a delay of a couple of weeks could not be the basis for a breach of fiduciary duties.

Disclosure Violations Held Material

In addition, the Supreme Court determined that the proxy disclosures concerning the deliberations of the board about the offer that was rejected, were materially misleading. The court reviewed the materiality standard and reached a different conclusion than the trial court, thus allowing that claim to proceed.

Duty of Loyalty Claim Allowed to Proceed

Lastly, the Supreme Court also reversed the trial court’s decision on Count III of the complaint which alleged that the directors breached their duty of loyalty by recommending the reclassification proposal to shareholders for purely self-interested reasons (that is, to enlarge their ability to engage in stock buy-backs and to trigger appraisal rights). The Supreme Court reasoned that the trial court’s ruling on “shareholder ratification grounds” was in error for two reasons. First, because a shareholder vote was required to amend the certificate of incorporation, without the approving vote it could not operate to “ratify” the challenged conduct of the interested directors. Second, the claim that the reclassification proxy contained a material misrepresentation, eliminates the essential prerequisite for applying the ratification doctrine, namely, that the shareholder vote was fully informed.

Common Law Shareholder Ratification Doctrine Clarified and Enunciated

The Supreme Court recognized that the current scope and effect of the common law doctrine of “shareholder ratification”  in Delaware is unclear. Thus, in order to

“restore coherence and clarity to this area of our law, we hold that the scope of the shareholder ratification doctrine must be limited to its so-called ‘classic’ form; that is, to circumstances where a fully informed shareholder vote approves director action that does not legally require shareholder approval in order to become legally effective. Moreover the only director action or conduct that can be ratified is that which the shareholders are specifically asked to approve. With one exception, the “cleansing” effect of such a ratifying shareholder vote is to subject the challenged director action to business judgment review, as opposed to “extinguishing” the claim altogether (i.e., obviating all judicial review of the challenged action.) " 

(emphasis in italics and underlining are mine)(See footnotes 52 through 54 for supporting citations).

Moreover, yet another major judicial statement in this opinion is contained in footnote 54. Referring to the last sentence in the foregoing block quote, footnote 54 states that “to the extent that Smith v. Van Gorkom holds otherwise, it is overruled.” (488 A.2d 858, 889-90 (Del. 1985)). Of special note in footnote 54 also is the clarification that the references in this opinion only refer to the common law  doctrine of shareholder ratification and are not intended to alter the jurisprudence governing the approving vote of disinterested shareholders pursuant to Section 144 of the Delaware General Corporation Law.

Much more can be written, and much more will be written, about this very momentous decision that announces very substantial clarifying statements of Delaware corporate law. This summary is already longer than most blog posts but I look forward to linking to additional scholarly commentary by others.
UPDATE: Prof. Usha Rodrigues on The Conglomerate blog comments on the case here and  she links to her own article on the topic as well as to seminal writings on the issue by Prof. Lyman Johnson here.   The Unincorporated Business Law Prof Blog comments on the case here. Also,  Prof. Lawrence Cunningham on the Concurring Opinions blog comments, with some aggregation of other remarks about the case, here.

UPDATE II: Here is a post about the opinion on DealLawyers Blog which agrees it is an important decision.

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