FDIC v. Perry
Litigation resulting from the financial crisis of 2008 regarding director and officer liability continued in the latter part of 2011 and 2012, with several
important decisions coming out in the area. In Federal Deposit Insurance Corporation v. Perry, the Ninth Circuit Court of Appeals declined a
petition for interlocutory appeal to review a California district court decision denying defendant Matthew Perry's Motion to Dismiss plaintiff Federal
Deposit Insurance Corporation, as Receiver for Indymac Bank, F.S.B.'s Complaint on the basis that the Complaint failed to allege facts sufficient to
overcome the presumption of the business judgment rule. See FDIC v. Perry, 2012 WL 589569 (C.D. Cal. Feb. 21, 2012),
leave to appeal denied, 12-80033 (9th Cir. May 11, 2012). For a copy of the district court's decision denying the defendant's Motion to Dismiss,
please click here.
In the Complaint, the plaintiff alleged that Indymac's CEO breached his duties to Indymac and negligently permitted the
production of a pool of more than $10 billion in risky residential loans intended for sale into the secondary market, and, since the secondary market was
too volatile, Indymac was forced by the fourth quarter of 2007 to transfer the loans into its own portfolio. Allegedly, these loans generated losses of
$600 million. In July of 2008, Indymac closed, with the FDIC appointed as receiver.
Perry argued in the Motion to Dismiss that the plaintiff had not pleaded facts sufficient to overcome the business judgment rule. Perry was both an officer
and director at the time of the challenged conduct. California Corporations Code § 309, which codifies California's common law business judgment rule,
explicitly makes reference to directors and directors' duties and liabilities but does not make reference to officers. The district court found that the
plaintiff had sufficiently alleged that Perry's actions were undertaken primarily in his capacity as an officer. The district court focused on two lines of
argument. First, the court suggested that the scant case law on point tended to support the holding that the common law business judgment rule does not
apply to corporate officers. Second, the court found that the California Legislature spoke clearly on the issue when it omitted any mention of officers in
its legislation. Moreover, the legislative committee's comments revealed that it was the drafters' intent to exclude officers from the protection of the
business judgment rule.
The Perry opinion interprets only California law. However, the opinion may be persuasive authority in the interpretation of other states' common law
and corporate statutes that do not explicitly provide for the application of the business judgment rule to officers, given that so little precedent exists
in this area.
SEC v. Mudd, et al.; SEC v. Styron, et al.
In a pair of Complaints filed in December of 2011, the United States Securities and Exchange Commission alleged that certain senior executive officers of
Freddie Mac and Fannie Mae approved misleading statements which asserted that the companies had minimal holdings in high-risk mortgage loans--primarily
sub-prime loans. For a copy of the Complaints please click
here. As a result of these misleading statements, the SEC
alleged, investors materially underestimated Freddie Mac's and Fannie Mae's exposure to the risk of such loans. The SEC alleged that the officers violated
Rule 10b-5 under the Securities Exchange Act of 1934 (the "Exchange Act") and Section 17(a) of the Securities Act of 1933, in addition to Section 302 of
the Sarbanes-Oxley Act of 2002. With regard to the Freddie Mac officers, the SEC alleged that the officers were aware of Freddie Mac's increasing subprime
exposure and were responsible for Freddie Mac's disclosures to investors, and that each officer made, or aided and abetted Freddie Mac or each other in
making, false and misleading credit risk disclosures regarding sub-prime loans in a "single family" guarantee portfolio. With regard to the Fannie Mae
officers, the SEC alleged that each of the officers made or substantially assisted others in making materially false and misleading statements regarding
Fannie Mae's exposure to sub-prime and so-called "Alt-A" (reduced documentation) loans.
Louisiana Municipal Police Employee's Retirement System v. Pyott
Important developments in the law of demand futility in derivative actions also emerged in 2012. The Delaware Court of Chancery, in
Louisiana Municipal Police Employee's Retirement System v. Pyott, held that a previous dismissal with prejudice of a companion California federal
court derivative action brought by stockholder plaintiffs on behalf of the corporation based on the same allegations of the same alleged wrongs did not
collaterally estop the Delaware plaintiffs of the same corporation or finally determine the demand futility issue under Rule 23.1. 46 A.3d 313 (Del. Ch.
2012). Instead, the California federal court's dismissal was merely persuasive on the issue, not preclusive. Pyott is significant because it upsets
decades of established precedent across the country on collateral estoppel. For a copy of the Pyott opinion please click
arises from Allergan Inc.'s settlement with the United States Department of Justice pursuant to which Allergan pleaded guilty to criminal misdemeanor
misbranding and paid $600 million relating to its off-label promotion of Botox. Very soon after the settlement, several law firms filed derivative actions
in California federal court and the Delaware Court of Chancery. The California court ultimately dismissed a consolidated complaint pursuant to Rule 23.1
with prejudice for failure to demonstrate demand futility, reasoning that because a stockholder plaintiff in a derivative action sues in the name of the
corporation, all other stockholder plaintiffs whose suits arise under the same facts are in privity with the plaintiff.
The defendants then moved to dismiss the complaint in the Court of Chancery on grounds, among others, of collateral estoppel. Denying the motion, the Court
of Chancery held that the issue of privity is governed by the internal affairs doctrine and, accordingly, would be governed by Delaware law. The Court of
Chancery stated that Delaware Supreme Court precedent requires that until a Rule 23.1 motion has been denied, a derivative plaintiff does not have
authority to sue in the name of the corporation; thus, privity does not exist at the early stages of such lawsuits. The Court of Chancery proceeded to
analyze the defendant's motion to dismiss on grounds of Rule 23.1 and Rule 12(b)(6). The Court of Chancery disagreed with the California federal court on
the Rule 23.1 issue and denied the motion.
If Pyott survives as the law of Delaware, successive derivative actions could become the norm. Corporate defendants had relied on the grant of a
motion to dismiss a derivative case for failure to sufficiently plead demand futility to collaterally estop other similar suits. However, such early-won
victories could have significantly less impact in the future.
Monday v. Meyer
The U.S. District Court for the Northern District of Ohio in Monday v. Meyer issued an opinion granting a motion to dismiss, which, while not
ground-breaking, provides a thorough defense-friendly analysis of demand futility in a derivative case--an area in which there is an increasing amount of
director liability litigation. The complaint in the case alleged that the directors of KeyCorp violated Section 10(b) of the Exchange Act and Rule 10b-5,
breached their fiduciary duties, committed corporate waste, and were unjustly enriched by way of their approval of certain tax strategies. Defendants moved
to dismiss the complaint on grounds, among others, that plaintiffs had failed to make any pre-suit demand. The court reasoned that "[d]emand is excused
only when Plaintiffs adequately plead actionable claims against a majority of the board at the time the suit was filed, thus showing that a majority of the
board faces a substantial likelihood of liability." The court's analysis of the complaint's allegations against specific directors and officers at the time
the complaint was filed is instructive: "It is insufficient to allege that, because Defendants were members of certain committees, and because of the
defined roles of those committees, Defendants automatically knew or should have known about the falsity of financial statements. . . . In order to allege
futility based on a director's committee membership, the complaint would have to show some specific report or piece of information that the committee was
given which would have tipped them off to misconduct. Click
here to read more.
Hermelin v. K-V Pharmaceutical Co.
The Delaware Court of Chancery, in Hermelin v. K-V Pharmaceutical Co., issued a noteworthy decision in summary judgment involving Delaware law and
contract indemnity provisions. 54 A.3d 1093 (Del. Ch. 2012). For a copy of the opinion, please click
here. The opinion provides a rare
analysis of indemnity provisions under Delaware case law. Marc Hermelin, former CEO and member of the board of directors of the defendant K-V
Pharmaceutical Company (K-V), filed suit against his former employer seeking indemnification or advancement for several criminal, civil, and regulatory
matters that arose due to K-V's manufacturing and distributing oversized morphine tablets. Hermelin pleaded guilty to criminal misdemeanor charges under
the "Responsible Corporate Officer" doctrine. Separately, the U.S. Food and Drug Administration and K-V entered into a consent decree to refrain from
manufacturing, holding or distributing any drug until the defendants undertook certain quality control measures, and the U.S. Department of Health and
Human Services barred Hermelin from all federal healthcare programs for twenty years. Hermelin and K-V were parties to an indemnification agreement which,
crucially, made mandatory the otherwise permissive provisions for indemnification under the General Corporation Law of the State of Delaware ("DGCL")
(K-V's bylaws also made those provisions mandatory).
The court looked to four different proceedings for which Hermelin sought a declaration that he was entitled to indemnification - the criminal matter, the
HHS exclusion matter, the FDA consent decree matter and the Audit Committee matters. The court held that Hermelin was not entitled to mandatory
indemnification under Section 145(c) of the DGCL for the criminal matter and the HHS exclusion matter, since his guilty plea meant he was not "successful
on the merits or otherwise." However, the court held that he was entitled to mandatory indemnification for the FDA consent decree matter. The court then
performed an analysis of the matters for which indemnification is permitted under Section 145(a) of the DGCL, which generally applies to indemnification of
directors, officers, employees and agents in third-party proceedings and criminal actions. That provision was made mandatory by the indemnification
agreement and the bylaws. The court held that with regard to the criminal matter, the HHS exclusion matter and the Audit Committee matter, Hermelin might
be entitled to the otherwise permissive indemnification due to the expansive scope of his indemnification agreement, as long as he met the standard of
conduct in Section 145(a) (i.e., he "acted in good faith and in a manner [he] reasonably believed to be in or not opposed to [KV's] best interest."
Whether he met this standard of conduct would depend on the results of a further evidentiary hearing. In short, the court held that there could be room
between an indemnitee's failure to be "successful on the merits or otherwise" and Section 145(a)'s standard of conduct. In raising the question of good
faith, this opinion highlights an area for which there is little case law and provides practitioners with additional guidance when drafting
indemnifications and advancement provisions.
America's Mining Corporation v. Theriault
In 2012, in America's Mining Corporation v. Theriault (a decision affirming the Court of Chancery's decision in the Southern Peru Copper
litigation), the Delaware Supreme Court affirmed what is believed to be the largest award--$2 billion for breach of fiduciary duty in addition to
approximately $304 million in attorney fees--in a shareholder derivative case in Delaware history. 51 A.3d 1213 (Del. 2012). For a copy of the opinion,
please click here.
The Court of Chancery had held that the defendant-appellants breached their fiduciary duty of loyalty to a subsidiary and
its minority stockholders by causing the subsidiary to acquire the controller's 99.15% interest in a Mexican mining company.
The Delaware Supreme Court, in a 110-page opinion, held that the Court of Chancery was correct in concluding after a full trial that, in analyzing
fiduciary duty, the "inquiry must focus on how the special committee actually negotiated the deal--was it 'well-functioning'" rather than merely focusing
on the mandate of the committee and how it was composed. The Delaware Supreme Court determined that, applying this standard, "evidence of unfairness was .
. . overwhelming."
The attorney fee award represented approximately 15% of the judgment for breach of fiduciary duty, plus post-judgment interest until the attorney fee and
expense award is satisfied. Plaintiff had sought 22.5% of the recovery, plus interest. The Court of Chancery had explored whether the fee award "fairly
implements" numerous factors, including "1) the results achieved; 2) the time and effort of counsel; 3) the relative complexities of the litigation; 4) any
contingency factor; and 5) the standing and ability of counsel involved." In addition, the court looked to whether the fee award "creates a healthy
incentive" for plaintiff's lawyers to seek substantial achievement for plaintiffs in derivative actions and the classes that they represent in class
actions, among other factors. In this analysis, the Court of Chancery, in determining whether the fee award was appropriate, looked beyond a mere
examination of counsel's time and effort. The Delaware Supreme Court, after a careful analysis, held that the fee award was a proper exercise of the Court
of Chancery's broad discretion in applying the multi-factored test.