Tag Archives: Fiduciary

Delaware Supreme Court Holds That Insider Trading Claims Alleging Misuse of Confidential Corporate Information Need Not Show Injury To the Corporation

In Kahn et al v. Kolberg Kravis Roberts & Co., L.P., No. 1808, 2011 WL 2447690 (Del. June 20, 2011), the Delaware Supreme Court reversed the dismissal of breach of fiduciary duty claims brought by minority shareholders against corporate officers and a controlling shareholder. The Supreme Court held that plaintiffs could state a claim seeking disgorgement by fiduciaries who allegedly profit from using confidential corporate information, even if the corporation did not suffer actual harm. In so holding, the Court rejected earlier, lower court precedent, and declined to limit the disgorgement remedy to a usurpation of corporate opportunity or cases where the insider used confidential corporate information to compete directly with the corporation.

Shareholders of Primedia, Inc. brought a derivative action against officers and directors of Primedia and against Kohlberg, Kravis, Roberts & Co. (“KKR”), which indirectly controlled a majority of Primedia’s common stock. Plaintiffs alleged that the defendants breached their duty of loyalty by causing Primedia to call hundreds of millions of dollars of preferred stock that it was not yet obligated to redeem, enriching KKR at Primedia’s expense. The complaint was amended several times — most recently to add a “Brophy claim” that the KKR defendants breached their fiduciary duties to Primedia by purchasing the preferred stock at a time when they possessed material, non-public information. A “Brophy claim” (see Brophy v. Cities Serv. Co., 70 A.2d 5(Del. Ch. 1949)), is one in which a corporate fiduciary possesses material nonpublic company information and the corporate fiduciary uses that information improperly by making trades because he or she was motivated, in whole or in part, by the substance of that information. See, e.g., In re Oracle Corp. Deriv. Litig., 867 A.2d 904, 934 (Del. Ch. 2004), aff’d, 872 A.2d 960 (Del. 2005).

The Delaware Court of Chancery granted the Primedia Special Litigation Committee’s motion to dismiss the derivative claims. The court held that under the law as explained in Pfeiffer v. Toll, 989 A.2d 683 (Del. Ch. 2010), disgorgement was not an available remedy for the plaintiffs’ Brophy claims because Primedia was not actually harmed. Plaintiffs appealed.

The Delaware Supreme Court reversed. The Court explained that in Brophy, a corporate employee acquired inside information that the plaintiff issuer was about to enter the market and purchase its own shares. Using this confidential information, the employee, who was not an officer, bought a large block of shares and, after the corporation’s purchases had caused the price to rise, resold them at a profit. The court stated that because the employee occupied a position of trust and confidence within the corporation, his relationship was analogous to that of a fiduciary. The employee argued that the corporation failed to state a claim against him because the corporation suffered no loss through the purchase of its stock. The Delaware Supreme Court, however, disagreed, holding that “actual harm to the corporation is not required for a plaintiff to state a claim under Brophy.”

The Supreme Court recognized that the Brophy court relied on the principles of restitution and equity for the proposition that a fiduciary cannot use confidential corporate information for his own benefit. The Court explained that public policy will not permit an employee occupying a position of trust and confidence toward his employer to abuse that relation to his own profit, regardless of whether his employer suffers a loss. Hence, the Court held that “[e]ven if the corporation did not suffer actual harm, equity requires disgorgement of that profit.” The Court remanded and directed the trial court to analyze the Brophy claim “without any assumption that an element of harm to the corporation must exist before a disgorgement equitable remedy is available.”

In its decision, the Delaware Supreme Court clarified that Brophy focused on preventing a fiduciary wrongdoer from being unjustly enriched based on the misuse of confidential corporate information. In so holding, the Court declined to adopt Pfeiffer’s “thoughtful, but unduly narrow” interpretation of Brophy and its progeny. The Court also disagreed with Pfeiffer’s conclusion that the purpose of Brophy is to “remedy harm to the corporation.” This decision expands the availability of Brophy claims for insider trading, as potential plaintiffs need not prove a harm to the corporation before a disgorgement equitable remedy is available.

Breach of Fiduciary Duty in the Context of Insolvency: Can Individual Creditors Seek Recovery?

In the context of today’s distressed financial markets, we have witnessed desperate people doing desperate things. Financial fraud (i.e., fraud committed against financial institutions) has risen dramatically. Owners and officers of companies are getting more than just a little creative with accounting functions, inventory controls and receivable reporting, to name just a few hot spots. As a result, they are more and more frequently becoming the target of suits by lenders and other creditors. These suits seek to hold the officers of the insolvent company responsible for fraud, and in some cases breach of fiduciary duties to creditors (primarily, in an effort to reach D&O policies).

Are these actions against officers and directors a source of potential recovery by an individual creditor? Though the Supreme Court of Illinois has yet to rule on this issue, a recent bankruptcy case holds that individual creditors lack standing to bring this type of action.

The Question of Insolvency

In the day-to-day operations of a going concern, officers and directors owe a fiduciary duty to their shareholders. But what happens when the company enters the “zone of insolvency”? The officers and directors then also owe a fiduciary duty to the company’s creditors. Companies often ask, “How do we know when are we in the zone of insolvency?” The answer is simple: if you are asking the question, you are likely in the zone. Of course, there are established legal assessments—such as the “balance sheet test,” the “cash flow test” and the “unreasonably small capital test.” But, in practice, if the board of directors is pondering the question of its own insolvency, then it’s a safe bet that the company is already there.

If an officer or director breaches his fiduciary duties in any number of ways, who may bring the action against that individual? May a creditor, on its own, successfully sue an officer or director for breaching his fiduciary duties? Judge Carol A. Doyle, former Chief Judge of the Northern District of Illinois Bankruptcy Court, predicted how the Illinois Supreme Court would handle this question in the context of insolvency.

In this recently published case (In Re John H. Netzel, et al., January 20, 2011), the court discussed the important distinction raised by the 7th Circuit Court of Appeals between claims based on liability owed to the general creditor body (which only a trustee in bankruptcy can assert) and claims that are more specific to an individual creditor (which only the creditor can assert). As a general rule, fiduciary duty is owed to shareholders, not creditors. That means a creditor may not sue an officer or director for a breach of fiduciary duty. The advent of insolvency, however, creates the exception to the general rule. Upon finding that the exception exists, the fiduciary owes a duty not only to the shareholders, but also to the general creditor body.

The state of the law in Illinois is that the winding up of an insolvent company’s affairs requires the officers and directors to marshal the assets and hold them in trust for the entire creditor body, pro rata. In this context, Judge Doyle made a small step of well-reasoned logic by holding that the Illinois Supreme Court would likely not permit an individual creditor to sue on its own behalf in order to obtain more than its pro ratashare of the insolvent company’s remaining assets. Therefore, according to this recent case, individual creditors lack standing to bring an individual action for breach of fiduciary duty by an officer or director of an insolvent company.

It appears that the exception to this standard would be a harm that was personal to the creditor—not injurious to the creditor body as a whole. However, it is difficult to imagine a scenario where a breach of fiduciary duty or a fraud committed by an officer or director would not also be injurious on some level to the entire creditor body.

Seventh Circuit Reverses Summary Judgment In Kraft ERISA “Excessive Fees” Case

On April 11, 2011, a divided Seventh Circuit panel reversed summary judgment in favor of Kraft Foods Global, Inc. in a class action ERISA breach of fiduciary duty case involving “excessive fees” claims in connection with Kraft’s 401(k) plan. The main take away from the decision is that fiduciaries must continue to be diligent and thoroughly consider plan administration issues and document why decisions were made or not made or practices followed, even on decisions and practices once thought to be routine or common industry standards. By following such a prudent practice, fiduciaries will substantially increase their ability to defend challenges concerning fiduciary conduct.

In Kraft, plaintiffs alleged three primary claims considered on appeal: that the use of a unitized company stock fund as an investment option was improper; that the plan’s recordkeeping fees were too high and imprudently monitored; and that the fiduciaries imprudently allowed the plan trustee to retain interest income from “float.”

In a 2-1 decision, the panel ruled that the plaintiffs could proceed to trial on their theory that the unitized company stock fund was imprudently designed because of “investment drag” and “transaction drag” that is inherent with the widely popular unitized funds. Like most company stock funds, Kraft plan participants held units of the fund rather than directly holding shares of company stock. The plaintiffs alleged that the fiduciaries should have considered the “drag” that unitized funds cause on gains (and losses). The Seventh Circuit ruled that there was no evidence that the fiduciaries ever consciously decided in favor of a unitized plan finding that the benefits of a unitized fund outweighed the downsides, or whether they just ignored the issue. According to the majority, that was sufficient to proceed to trial. In a strongly worded dissent, Judge Cudahy called the plaintiffs’ theories on this, and others in the case, an “implausible class action based on nitpicking with respect to perfectly legitimate practices of fiduciaries.”

The majority further reversed summary judgment for the defendants on whether the recordkeeping fees were too high. The plaintiffs argued that the fiduciaries should have solicited competitive bids from other recordkeepers about every three years. Kraft had used the same recordkeeper since 1995, without a competitive bid, although Kraft received advice from several third-party independent consultants that the fees were reasonable. The plaintiffs submitted an opinion from an expert finding that the fees were excessive. In a decision with potentially wide-sweeping ramifications, the Seventh Circuit held that while the defendants’ reliance on the contemporaneous opinions of outside independent consultants that the fees were reasonable may be enough to prevail at trial, it was not enough to overcome the plaintiffs’ contrary admissible expert opinion at summary judgment which created a genuine issue of fact. The use of a consultant cannot “whitewash” otherwise unreasonable fees and a trier of fact could conclude that the defendants did not satisfy their duty solely through the use of independent consultants to ensure that the recordkeeping fees were reasonable. The dissent argued that the fiduciaries’ use of an outside consultant to confirm the reasonableness of the fees showed a prudent process and asked “what the majority’s holding means for ERISA fiduciaries” and “what is adequate to support a fee without the fear of litigation?” As noted by the dissent, this decision “will only serve to steer [fiduciaries] attention toward avoiding litigation instead of managing employee wealth.”

The Seventh Circuit upheld summary judgment for the defendants on whether the float income the trustee received was a reasonable part of the trustee’s overall compensation, because the fiduciaries proved that they received reports showing the float income and the plaintiffs failed to offer admissible evidence that such information was not considered.

Fifth Circuit Update: Trade Secrets, Fiduciaries in Bankruptcy and Mass Tort Class Actions

Here is the Murphy’s Law of the blogosphere: courts will let fly with all kinds of new opinions when the blogger lacks time to keep up with them.

Lest I fall too far behind, here are three from the mighty Fifth Circuit’s output in the last week that may be of interest to the civil practitioner.

The opinions run the gamut from:

Texas Trade Secrets Composed Of Publicly Available Components

Tewari De-Ox Systems v. Mountain States involved claims of misappropriation of trade secrets under Texas law. The interesting part of the case arose because aspects of the “secrets” weren’t secret at all because they had been part of a patent application which became public 18 months later under the terms of the Intellectual Property and Communications Omnibus Reform Act of 1999, 35 U.S.C. § 122(b)(1)(A). But the Fifth Circuit revived the trade secret claims because

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a trade secret can exist in a combination of characteristics and components each of which, by itself, is in the public domain, but the unified process, design and operation of which in unique combination, affords a competitive advantage and is a protectible secret.

Judge Prado wrote the court’s opinion.

Bankruptcy: Officer Of General Partner Also Acting As Fiduciary To Limited Partnership 

FNFS v. Harwood principally involved the question of whether the debtor had committed fraud or defalcation while acting in a fiduciary capacity such that his debts to a limited partnership were not discharged in bankruptcy under11 U.S.C. § 523(a)(4). The debtor was an officer and director of a company that acted as general partner of a limited partnership to which the money was owed. He argued that while he was a fiduciary to the general partner company, he was not a fiduciary of the limited partnership. Looking to the substance of the business relationship,  the control he exercised and the confidence reposed in him, the court ruled that he was “acting in a fiduciary capacity” to the limited partner.  Some of the key language:

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We conclude that an officer of a corporate general partner who is entrusted with the management of the limited partnership and who exercises control over the limited partnership . . . owes a fiduciary duty to the partnership that satisfies Section 523(a)(4). We emphasize that it is not only the control that the officer actually exerts over the partnership, but also the confidence and trust placed in the hands of the controlling officer, that leads us to find that a fiduciary relationship exists sufficient for the purposes of Section 523(a)(4).

Here, the test was satisfied because, as a factual matter, there was evidence that the debtor had exercised near-complete control over both tiers of the entity until a few months prior to his termination, and the general partner’s board entrusted the debtor with the sole and plenary authority over the day-to-day management of the partnership enterprise. Judge King wrote the court’s opinion.

Mass Tort: No Class Certification Without A Trial Plan To Deal With Individual Issues

Finally, Madison v. Chalmette Refining represents another attempt to certify a class of plaintiffs claiming injury from a mass accident, here the emission of petroleum coke dust from a refiner. According to the Fifth Circuit, the trial court had not done the “rigorous analysis” and “close look” that is necessary before determining that common issues predominate and the case would not degenerate into mini-trials.

The court reversed the district court’s class certification order and cast some doubt on its pre-Amchem mass-tort precedents in language indicating (as in Texas state court) importance of a trial plan for dealing with individualized issues:

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Whether Watson has survived later developments in class action law–embodied in Amchem and its progeny–is an open question, but even in Watson, the district court had “issued orders detailing a four-phase plan for trial.”. . . . In Turner v. Murphy Oil USA, Inc., . . .  [c]ritical to the court’s predominance inquiry was the fact that “Plaintiffs submitted a proposed trial plan to the Court. The plan provides for a three-phase trial.”  * * *

We must reverse because, “[i]n its certification order, the [district] court did not indicate that it [had] seriously considered the administration of the trial. Instead, it appears to have adopted a figure-it-out-as-we-go-along approach . . . By failing to adequately analyze and balance the common issues against the individualized issues, the district court abused its discretion in determining that common issues predominated and in certifying the class. We do not suggest that class treatment is necessarily inappropriate. As Chalmette Refining acknowledged at oral argument, class treatment on the common issue of liability may indeed be appropriate. But our precedent demands a far more rigorous analysis than the district court conducted.

Judge Clement wrote the court’s opinion.

Can a 401(k) Plan Member Recover Damages to His Individual Account Caused By a Plan Administrator’s Breach of Fiduciary Duty?

An ERISA Plaintiff cannot seek individual monetary damages for a Plan Administrator’s breach of fiduciary duty to the plan. Importantly, however, seeking damages on behalf of the 401(k) Plan as a result of a Plaintiff’s losses in his individual account is explicitly permitted under LaRue v. DeWolff, Boberg & Associates, Inc., 552 U.S. 248 (2008), which held that ERISA Section 502(a)(2) authorizes recovery by a plan participant for fiduciary breaches “that impair the value of plan assets in a participant’s individual account.” 522 U.S. at 256. The Supreme Court in LaRue made clear its reasoning for this holding:

Whether a fiduciary breach diminishes plan assets payable to all participants and beneficiaries, or only to persons tied to particular individual accounts, it creates the kind of harms that concerned the draftsmen of § 409.  Id. at 256.

For instance, a Plaintiff may rely upon ERISA Section 502(a)(1)(B) for a Defendant’s failure to provide the Plaintiff with the full 401(k) benefits owed to him under the 401(k) Plan at issue. And the Plaintiff may also rely upon ERISA Section 502(a)(2) for a Defendant’s breaches of fiduciary duties. A plain reading of Sections 502(a)(1)(B) and 502(a)(2) establishes that the two sections provide for different relief. Indeed, as the 9th Circuit explicitly noted in Harris v. Amgen, Inc.:

Section 502(a)(1)(B) allows a plan participant “to recover benefits due to him under the terms of his plan.” By contrast, Section 502(a)(2) encompasses claims based on breach of fiduciary duty and allows for the more expansive recovery of “appropriate relief,” including disgorgement of profits and equitable remedies.  573 F.3d 728, 734, n. 4 (9th Cir. 2009) (citations omitted).

Regardless, some defendants incorrectly assert that “the Eighth Circuit and other courts alike have repeatedly held that participants cannot state claims for breach of fiduciary duty under ERISA Section 502(a) when they are also seeking to recover the same benefits under ERISA Section 502(a)(1)(B).” The falsity of this assertion is clear upon a review of the federal caselaw. Indeed, the cases usually cited are inapplicable in that each is either irrelevant or is limited in scope to claims brought under ERISA Sections 502(a)(1)(B) and 502(a)(3), not Sections 502(a)(1)(B) and 502(a)(2). See Geissal ex rel. Estate of Geissal v. Moore Medical Corp., 338 F.3d 926, 933 (8th Cir. 2003) (narrowly holding that a beneficiary cannot bring a claim for benefits under Section 502(a)(1)(B) and Section 502(a)(3)(B)); Conley v. Pitney Bowes, 176 F.3d 1044, 1047 (8th Cir. 1999) (citing Wald v. Southwestern Bell Corporation Customcare Medical Plan, 83 F.3d 1002, 1006 (8th Cir. 1996) in holding that “where a plaintiff is ‘provided adequate relief by [the] right to bring a claim for benefits under [Section 502(a)(1)(B)],’ the plaintiff does not have a cause of action to seek the same remedy under [Section 502(a)(3)(B)]”). Some defendants also cite Coyne & Delaney Co. v. BCBS of Va., Inc., 102 F.3d 712 (4th Cir. 1996). However, Coyne is not relevant in that it analyses whether a plan fiduciary can bring a claim for benefits under ERISA Section 502(a)(3). 102 F.3d at 713.

Some plan defendants also rely upon the U.S. Supreme Court’s holding in LaRue v. DeWolff, Boberg & Assoc., Inc., 552 U.S. 248 (2008) for the proposition that duplicative claims under ERISA Section 502(a)(1)(B) and 502(a)(2) are inappropriate. Specifically, defendants may rely upon commentary by Chief Justice Roberts in that case, without revealing that Justice Roberts wrote the concurring opinion rather than the opinion of the Court. Accordingly, his analysis is not binding. Id. at 249. In fact, at the conclusion of his concurring opinion, Justice Roberts acknowledged that his analysis is not binding on the issue: “In any event, other courts in other cases remain free to consider what we have not—what effect the availability of relief under § 502(a)(1)(B) may have on a plan participant’s ability to proceed under § 502(a)(2).” Id. at 260.

Indeed, in Crider v. Life Ins. Co. of N. Am., 2008 WL 2782871 (W.D. Ky. 2008), the Western District of Kentucky acknowledged that Justice Roberts’ analysis in LaRue is not binding, and therefore noted that in deciding whether to allow a claim under both ERISA Section 502(a)(1)(B) and Section 502(a)(2), the question for the court is whether the facts the plaintiff alleges “state a claim for breach of fiduciary duty under Section 502(a)(2) which is separate from her claim for benefits under Section 502(a)(1)(B).” Id. at *2. The court further noted that in deciding this question, the Sixth Circuit has on at least three occasions “allowed plaintiffs to pursue both a claim for benefits under Section 502(a)(1) and also to attempt to hold a plan responsible for breaches of fiduciary duty under a separate Section 502(a) action.” Id. Finally, In Hill v. Blue Cross & Blue Shield of Mich., the Sixth Circuit observed that plan-wide claims are distinct from claims seeking to correct the denial of individual benefits. 409 F.3d 710, 718 (6th Cir. 2005).

Finally, it is well-established that “[i]n ruling on a motion to dismiss, a court must view the allegations of the complaint in the light most favorable to the plaintiff.” Guarantee Co. of North America, USA v. Middleton Bros., Inc., 2010 WL 2553693, at *2 (E.D. Mo. June 23, 2010). To survive a motion to dismiss, a claim need only be facially plausible, “meaning that the factual content…allows the court to draw the reasonable inference that the defendant is liable for the misconduct alleged.” Id. (quoting Cole v. Homier Dist. Co., Inc., 599 F.3d 856, 861 (8th Cir. 2010)).