Hampshire Group, Limited v. Kuttner, C.A. No. 3607-VCS (Del. Ch. July 12, 2010), read opinion here.
This 132-page decision by the Delaware Court of Chancery addresses the fiduciary duties of officers of a corporation. The most efficient manner in which to present a blog post about an opinion the size of a small book is to highlight the important issues addressed and recite the statements of law pronounced by the Court, and encourage those readers who are interested in the topics addressed to download the entire opinion at the foregoing link.
This case began with an investigation by the board of the founder and CEO of a publicly held company based on accusations of lavish spending and self-dealing. Claims were brought against the CEO and key officers. Although the CEO settled for a substantial sum, this opinion addresses the claims that proceeded against the modestly paid CFO and Accounting Officer who were left “holding the bag” for the transgressions at issue.
Their breach of fiduciary duties was the result, for example, of approving for reimbursement personal expenses of others that were not business related and not properly reimbursable. One of the items for which the CFO was found liable involved the payment of tuition for the assistant of the CEO but describing it, and disguising it, in the records of the company as a charitable donation to the school. In addition to the officers not enjoying the protection of DGCL § 102(b)(7) that directors enjoy, the Court observed the sad reality that the investigation and litigation costs incurred by the parties far exceeded any potential financial harm to the company from any of the underlying conduct at issue in the litigation. For example, both Navigant Consulting and the law firm of Paul Weiss each billed more than $2 million dollars for their investigative services, and together with the legal fees incurred, those amounts far exceeded any liability of the remaining officers who are the subject of this opinion.
Indeed, the first sentence in the opinion begins as follows: “This is an unfortunate case in which it is clear that the parties have spent far more money investigating and litigating over certain matters, than those matters involved.” (That is, the litigation did not make economic sense).
This is one of the few decisions in Delaware that thoroughly examines the fiduciary duties of officers (as compared to directors only) in the context of specific actions taken at the request of a CEO/director, and perhaps is the first that fully examines that duty after the Delaware Supreme Court decision of Gantler v. Stephens.
As key employees of the Hampshire Group, the Court emphasized the truism that the officers, Clayton and Clark, “owed certain fiduciary duties to the company and its stockholders.” The Court observed that, like directors, Clayton and Clark “were expected to pursue the best interests of the company in good faith (i.e., to fulfill their duty of loyalty) and to use the amount of care that a reasonably prudent person would use in similar circumstances (i.e., to fulfill their duty of care).” See footnote 76. The foregoing is perhaps one of the more pithy descriptions of the fiduciary duty of an officer or director that has been stated in recent Delaware decisions.
The Court also recognized that the due care claim requires proof that Clayton and Clark acted with gross negligence. See footnote 78 (citing Smith v. Van Gorkom, 48 A.2d 858, 873 (Del. 1985)).
The Court made the important point that where, as in this case, the defendant officers were not accused of self-dealing, but rather facilitating wrongful action by another (in this case the CEO), the Court was required to examine the state of mind of the officers “to determine whether they acted in bad faith for a purpose other than advancing the best interests of the corporation.” See footnote 81.
In this situation when the Court is examining whether the officers breached their duty by performing disloyal acts at the behest of their CEO, the Court is required: “To make a difficult, but necessary, judgment of whether the subordinates acted loyally by trying to do their job for proper corporate purposes and in good faith, or acted disloyally in bad faith by putting the self-interest of their superiors ahead of the corporation’s best interest.” To act in good faith in this context is to act with a loyal state of mind. See footnote 83. The Court also acknowledged that the officers and key employees in these situations face exposure to liability that is greater than that of directors because they cannot be shielded from personal liability by § 102(b)(7) which protects directors from gross negligence that causes injury to the corporation.
Remedies for Breach of Duty
The second important aspect of Delaware law treated by the Court begins on page 120 of the opinion and involves the remedies that the Court may provide for breach of the fiduciary duty of officers who wrongly approved expenses of others in the corporation. See footnotes 417-419. The Court describes in excruciating and extensive factual detail the expenses over a ten year period that were incurred by the CEO but were not justified as business expenses. The Court was very critical of the report prepared by Navigant Consulting which, for example, charged $500 per hour to review a $40 expense that was disputed, and whose report questioned some expenses that were clearly business related.
The third statement of Delaware law that would be of great interest to readers begins on page 126 and involved the claim by the officers for indemnification for the attorneys’ fees they incurred and for any damages awarded against them. The Court declined to rule on this issue which it considered to be unripe, and thus would not be addressed until after the merits of the entire case were decided and all appeals had been resolved. See footnotes 442 and 443.
Next, a very useful discussion at page 129 and in the corresponding footnotes addresses the concept of “equitable contribution” which is independent from the statutory basis of analyzing the sharing among joint tortfeasors of liability, and credit that is required or allowable by one for payments made by another. See footnotes 447-450 (citing section 3604 and section 6063 of Title 10 of the Delaware Code regarding crossclaims and statutes relating to contributions among joint tortfeasers).
One theme that appears throughout the opinion is that the CEO often submitted questionable or improper requests for reimbursement–and the board was aware (or should have been aware) of this practice, so it seemed somewhat disingenuous to place all the blame on the CFO–but they did anyway. The Court also observed that Navigant and Paul Weiss had many people spending many hours reviewing expense reports in hindsight, but that was only one small part of the CFO’s job, and his ability to challenge the requests (which he did on a regular basis) was not the same as independent consultants who were being paid handsomely to find problems–as opposed to a CFO whose salary, presumably, was dependent on not alienating the CEO.
Approximately 30 pages of the opinion dealt with counterclaims by the officers that were governed by South Carolina law and which will not be covered in this short blurb.
UPDATE: Professor Bainbridge provides his scholarly insights on this case here. He suggests to the Delaware courts (who often cite his writings in their opinions), that they should be cautious if they expect subordinates to monitor their superiors.