Avoid Mistakes of the Past

Lemington is the latest of a number of cases to have considered officer and director fiduciary duties in the context of insolvency. See, e.g., In re The Brown Schools, 386 B.R. 37 (Bankr. D.Del. 2008); Clarkson Co. v. Shaheen, 660 F.2d 506 (2d Cir. 1981); New York Credit Men's Adjustment Bureau v. Weiss, 305 N.Y. 1 (1953). Under these cases, director and officer fiduciary duties are generally viewed as being composed of two separate duties: a duty of due care and a duty of loyalty. See, e.g., Lemington, 659 F.3d at 291 (recognizing two distinct duties); Brown Schools, 386 B.R. at 46-47 (same). Each duty carries its own burden of proof. As Judge Mary F. Walrath explained in Brown Schools, “a plaintiff asserting a duty of care violation [at least in Delaware] must prove the defendant's conduct was grossly negligent in order to overcome the deferential business judgment rule.” Brown Schools, 386 at 46 (citing Aronson v. Lewis, 473 A.2d 805, 812 (Del. 1984), overruled on other grounds by Brehm v. Eisner, 746 A.2d 244, 254 (Del. 2000)). But see Lemington, 659 F.3d at 292 n.5 (“Pennsylvania ' recognizes ' liability for negligent breach of fiduciary duty.” (emphasis in original)). “For breach of the duty of loyalty claims, on the other hand, the plaintiff need only prove that the defendant was on both sides of the transaction ' The burden then shifts to the defendant to prove that the transaction was entirely fair.” Id. at 47 (citing Weinberger v. UOP, Inc., 457 A.2d 701, 710 (Del.1983)). The obligations flowing from these duties may appear simple enough to satisfy, yet potential plaintiffs can often use the complexities of modern commerce to highlight and elevate to a cause of action any appearance of impropriety, forcing officers, directors, and others to defend themselves against breach of duty allegations.

The Fawkes and Morris article concludes with the warning that actions taken by officers and directors “will be heavily scrutinized” in the context of insolvency. We agree with their admonition and thus offer some practical tips on how officers, directors, and other involved parties can increase the chances that a scrutinizing court will determine that their conduct not only was proper, but appeared proper. For, as the late Judge Henry Friendly once stated, “[t]he conduct of bankruptcy proceedings not only should be right but must seem right.” In re Ira Haupt & Co., 361 F.2d 164, 168 (2d Cir. 1966).