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Chancery Court Dismisses Direct and Derivative Claims Against Company in Bankruptcy

By Francis G. X. Pileggi, Esq.

Thornton, et al. v. Bernard Technologies, Inc., (Del. Ch., C.A. No. 962-VCN, February 20, 2009), read opinion here.

Kevin Brady, a highly respected Delaware litigator,  prepared the following review of this case.

In this Chancery Court decision, Vice Chancellor Noble granted defendants' motion to dismiss a direct and derivative action brought in December 2004 by three plaintiffs, who were preferred stockholders and former directors of Bernard Technologies, Inc. ('Bernard') against the company and five former directors. The pro se plaintiffs filed this action eight days after Bernard filed for Chapter 7 liquidation proceedings in the United States Bankruptcy Court for the District of Delaware.

Plaintiffs brought this action seeking, in general, accountability from those responsible for the loss of their investment. In particular, plaintiffs objected to a series of management decisions, which included: (a) the failure to hold and attend board meetings as needed and when appropriate; and (b) failure to require the Company's management to provide the board of directors with financial statements for the period of January 1, 2004 through October 31, 2004. Plaintiffs next challenged actions authorized by the defendant directors that resulted in 'unnecessary, and self-interested, expenditures by the company." Finally, the plaintiffs alleged that there were false and misleading disclosure statements made by the defendant directors which included the issuance of a Proxy Statement which 'falsely stated the number and price of stock options granted to' the defendant directors.

With respect to the corporation, the Court dismissed the action because under Section 362 of the Bankruptcy Act, actions against the Company were automatically stayed as of the date of the filing. The Court next addressed whether the Plaintiffs' claims against the director defendants were direct or derivative. The Court found that the actions that the plaintiffs complained about were 'quintessential director mismanagement' and as a result any recovery would be for the benefit of the corporation itself and thus were derivative in nature. The Court also found that when a director engages in self-dealing or commits waste, he takes from the corporate treasury and any recovery would flow directly back into the corporate treasury and as a result, these claims were derivative as well. With respect to the disclosure claims, however, the Court found that there were direct in nature because '[t]hey claim that the failure to disclose accurate balance sheets and information related to stock option issuance prevented [the shareholders] from making an informed decision when electing the [d]efendants to their positions on the Bernard Board of Directors.'

The derivative claims, upon the commencement of the bankruptcy proceeding, became the property of the bankruptcy estate and subject to the control of the Bankruptcy Court. In short, plaintiffs lacked standing to proceed with their derivative claims, unless the Plaintiffs were able to show: (1) that the bankruptcy trustee has affirmatively assigned or abandoned the claims to the plaintiffs; and (2) the Bankruptcy Court approved of plaintiffs' prosecution of the claims in the Chancery Court. The plaintiffs failed to provide such proof and as a result, their derivative claims were dismissed.

The direct disclosure claims sought both injunctive relief and money damages. For the injunctive relief, the plaintiffs sought an order requiring the company to issue corrected financial statements for certain years and to hold an election for a new board of directors. The Court found that:

 '[b]ecause Bernard is presently in Chapter 7 liquidation, requiring new disclosures and holding new elections will not remedy any harm that may have resulted from allegedly invalid elections allegedly attributable to inaccurate disclosures; Bernard will remain in liquidation. There can be no right to injunctive relief when all opportunities to avert (or repair) harm to Bernard have long since passed.'

For money damages, the Court found that '[d]amages are limited only to those ‘that arise logically and directly from the lack of disclosure.' Because the plaintiffs failed to plead 'some reasonable relationship between the alleged disclosure claims and harm suffered individually by the shareholders,' their claims were dismissed.
 

Full post as published by Delaware Corporate and Commercial Litigation Blog on February 28, 2009 (boomark / email).