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Delaware Judge Rejects D&O’s MTD

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July 27, 2022, US Bankruptcy Court for the District of Delaware – The US Bankruptcy Court for Delaware denied Defendants’ motion to dismiss the claim for breach of fiduciary duty alleged by Alfred T. Giuliano, the Chapter 7 trustee (“Trustee”) for bankruptcy estates of Nobilis Health Corp. et al. (the “Debtors”). The Defendants are former directors and officers of the various debtors in the Nobilis bankruptcy case.

The Trustee alleged deficiencies in the operation of the Debtors including the Defendants’ alleged failure to establish the systems and procedures necessary to collect receivables. 

The Trustee’s complaint alleged that the company allegedly adopted an “inappropriate accounting” practice under which receivables that could not be collected allegedly continued to be carried on the company’s books as “assets”. The Trustee claimed that the company’s financial statements allegedly misstated its actual financial condition and led to alleged misrepresentations to the creditors. The creditors were allegedly defrauded into extending credit.

The trustee asserted that because of the alleged breaches the company allegedly suffered tens of millions of dollars in losses from uncollectible accounts receivable and incurred debt that it would be unable to pay. The trustee further claimed that the director Defendants allegedly abdicated their roles through “intentional ignorance” and/or “willful blindness” toward the alleged operational deficiencies, system failures, and improper accounting.

While describing the Delaware law on breach of fiduciary duty, the Court observed that the directors and officers of a Delaware corporation are required to use that amount of care which an ordinarily careful and prudent person would use in similar circumstances; and consider all material information reasonably available. The Court noted that the duty of care requires directors to inform themselves, before making a business decision, of all the material information reasonably available to them.

The Court found that the Trustee’s allegations consisted of a “Caremark claim” analyzed in In re Caremark Intern, Inc. Derivative Litig. “A Caremark claim asserts that a fiduciary failed adequately to oversee or supervise corporate operations”. The Court observed that “a Caremark claim must first analyze the information system or controls that the Board implemented, and second, examine the pleading for facts suggesting that the Board consciously failed to monitor or oversee operations”.

The Court repeated its observations in In re Liquid Holdings Group, Inc., holding that fact allegations demonstrating that a director or officer observed certain “red flags” but knowingly disregarded them such that they completely disabled themselves from being informed of risks or problems are generally deemed sufficient for the purposes of a Caremark claim.

The Defendants argued that the Trustee’s complaint allegedly failed to adequately allege specific acts and omissions of breach of fiduciary duty by specific Defendants. According to their motion, the complaint also failed to allege specific “red flags” that ought to have alerted particular defendants to those failures in the corporate systems.

Although the Court found that the complaint contained some allegations of specific conduct of particular Defendants., the Court added that most of the specific allegations were not made in the complaint itself. The Court found that these specific allegations were made in a complaint filed by a creditor against some of the Defendants. The said complaint was attached as an exhibit to and quoted in the Trustee’s complaint at several places.

Rule 10(c) of the Federal Rules of Procedure allows a plaintiff to attach a “written instrument,” such as a contract or other such document that has legal effect, to a complaint without repeating the language of the instrument itself in the body of the complaint. However, the Court ruled that the term “written instrument” did not include complaints of another plaintiff.

Though the Court found that the complaint did not make specific allegations against specific Defendants, the Court considered the allegations sufficient, in light of the liberal pleading standards under Rule 8, to survive a motion to dismiss. The Court however held the trustee liable to present, at the summary judgment stage, actual evidence showing that each defendant either engaged in affirmative conduct that violated his or her fiduciary duties or failed to act in the face of a “red flag”.

Giuliano v. Fleming (In re Nobilis Health Corp.), 2022 Bankr. LEXIS 2057

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