The phrase “bad boys” is one that conjures up a multitude of contradictory connotations. In sports, the Detroit Pistons wore the moniker proudly as they pummeled their way to consecutive NBA championships. Those bad boys, however, are long gone and now the same team is just plain bad. 

In art, Jerry Bruckheimer produced “Bad Boys” in…

Often, the only unencumbered assets left after a company goes bankrupt are potential causes of action against deep-pocketed professionals that witnessed or contributed to the debtor’s demise.  Of course, it’s one thing to allege misconduct; proving it (as noted here) is a horse of a different color.  A trilogy of recent decisions from the 7th Circuit Court of Appeals, however, demonstrates the increasing impatience of courts with plaintiffs who, as the 7th Circuit’s Chief Judge Frank Easterbrook recently put it in one of these cases, sue the debtor’s professionals in an “attempt to find a deep pocket to reimburse investors for the costs of managers’ blunders.”  HA2003 Liquidating Trust v. Credit Suisse Secs. (USA) LLC, 517 F.3d 454 (7th Cir. 2008) (pdf)

The latest failed effort is found in a decision authored by Judge Diane P. Wood, as compassionate and fair–and inspirational!–a judge as you’ll find (and possibly the next Supreme Court justice), in Joyce v. Morgan Stanley & Co., Inc., 2008 WL 3844111 (7th Cir. 8/19/08) (pdf).  In this case, Morgan Stanley, once the advisor to RCN, was engaged by 21st Century Telecom Group in late 1999, just before the telecom industry busted, to serve as 21st Century’s financial advisor in an ill-fated stock-for-stock merger with RCN.  As part of its engagement, Morgan Stanley delivered a “fairness opinion” to 21st Century’s board.  Between the 12/12/1999 date of the merger agreement and the 4/28/2000 effective date of the merger, RCN’s stock price plummeted and 21st Century’s stockholders ended up left holding the bag.

Nobody, however, leaves Ed Joyce–a famed Chicago commercial litigator–holding the bag and gets away with it, at least not without a good fight.  The problem for Ed, however, was finding a deep pocket to compensate him and his fellow stockholders for their losses, not an easy task particularly since they first filed suit more than six years after the merger’s effective date.  In their one-count complaint, which alleged “constructive fraud” on the part of Morgan Stanley, Ed and his fellow plaintiffs argued that Morgan Stanley had a duty to advise 21st Century’s shareholders about how to minimize their exposure to a potential drop in RCN’s stock price following execution of the merger agreement.  Morgan Stanley didn’t, they alleged, because that would likely have caused RCN’s stock price to decline.  Further, they alleged, Morgan Stanley didn’t want that to happen because of its conflict-of-interest stemming from the fact that it had served as RCN’s financial advisor before the merger.

Judge Wood, together with Judges William J. Bauer and Terence T. Evans, agreed that Ed and the other shareholders had standing to sue because their claims were direct, not derivative.  That’s all they agreed with, however.   While everyone recognized that in order to tag Morgan Stanley with liability, Morgan Stanley had to owe the 21st Century shareholders a fiduciary duty, here’s where the wheels fell off the bus because the 7th Circuit would not agree that Morgan Stanley owed the 21st Century shareholders a duty of full and fair disclosure.  To the 7th Circuit, the duties of Morgan Stanley were rooted in its engagement agreement, and no extra-contractual fiduciary duty existed to require Morgan Stanley to advise the 21st Century shareholders about hedging strategies that might minimize their exposure to fluctuations in the value of RCN stock.  Judge Wood wrote:Continue Reading 7th Circuit Nixes Attempts to Hold Investment Bankers Responsible for Matters Beyond Their Engagement Agreements

Thanks to Francis Pileggi, Delaware’s premier blogger, for kindly alerting me to Nelson v. Emerson, 2008 WL 1961150 (Del. Ch., 5/6/08), in which Vice Chancellor Strine issued a well-crafted discourse on the interplay between Delaware’s law governing corporate fiduciaries and federal bankruptcy law governing their conduct.  Francis wrote a long post quoting extensively from Vice Chancellor Strine’s opinion, which I strongly recommend you first read, and will not repeat here.

Briefly, in this case, the company’s former officer, director, and shareholder, wearing his tough guy hat as the company’s major secured creditor, unsuccessfully challenged the company’s bankruptcy filing in Chicago, with Bankruptcy Judge Jack B. Schmetterer issuing a lengthy opinion finding that (i) the former insider’s claims should be only partially recharacterized as equity, but not equitably subordinated, and (ii) most importantly for purposes of this post, the debtor’s chapter 11 filing was not in bad faith because there was a business to reorganize and the filing was a "rational reaction" to the creditor’s threat to foreclose on debtor’s business assets.  Repository Technologies, Inc. v. Nelson (In re Repository Technologies, Inc.), 363 B.R 868 (Bankr. N.D. Ill. 2007) (pdf). 

District Court Judge Amy St. Eve, who’s had one of the more interesting years as federal judge while overseeing the Tony Rezko and Lord Conrad Black of Crossharbour trials, heard the appeal in her spare time, and affirmed Judge Schmetterer’s decision in its entirety.  Nelson v. Repository Technologies, Inc., 381 B.R. 852 (N.D. Ill. 2008) (pdf).  This opinion itself is worth reading for its reminder that "[b]ankruptcy is not a ‘free-for-all’ equity balancing act" and that dicta is defined by the Seventh Circuit (see my previous post entitled, Judge Posner’s "Dictum" on "Dicta") as what a court "says" not what it "holds."  Id. at 867, 873.  As regards the latter point, Judge St. Eve concluded, "Nelson’s argument that the Bankruptcy Court’s language is dictum is defeated by his own motion requesting a finding of bad faith in support of dismissing [Repository]’s bankruptcy case."  Id., 381 B.R. at 873. 

After Judge St. Eve had ruled, Nelson backtracked and recrafted his theory of the case as a breach of fiduciary duty case instead of a bad faith bankruptcy case and filed a complaint in Delaware Chancery Court asserting that management breached its fiduciary duties to the corporation by filing bankruptcy in bad faith.  Adopting the standards for claim preclusion from the 7th Circuit, not Delaware (which were noted to be essentially the same as the 7th Circuit’s), Vice Chancellor Strine held that Nelson was collaterally estopped from asserting a breach of duty claim based on management’s alleged bad faith in filing the bankruptcy petition because, in the first instance, Judge St. Eve had already ruled in the district court case that Judge Schmetterer’s finding on the bad faith issue was not "dicta."  As an aside, one has to wonder whether Nelson miscalculated by first having the District Court, not the Chancery Court, decide whether Judge Schmetterer’s ruling was dicta.  Indeed, Judge St. Eve’s own ruling looks a bit like dicta itself, since that ruling on dicta really wasn’t essential to affirming Judge Schmetterer’s decision.  But once she was asked to decide whether it was in fact dicta, and she did so decide, then Nelson was most definitely bound by that result.

Still, Vice Chancellor Strine covered his bases by not relying exclusively upon Judge St. Eve’s holding that Judge Schmetterer ruling wasn’t dicta, and instead undertook his own independent analysis of Judge Schmetterer’s decision, drawing the following important two conclusions:Continue Reading Be Careful What You Wish For: Delaware Chancery Court Provides a Cautionary Tale Against Perfunctory Requests “For Other And Further Relief As The Court Deems Just And Equitable”

Davey and Zack are now 6 1/2 months, and finally consistently sleeping through the night!  The temperature in Chicago has also finally hit 60 degrees in Chicago, for only the seventh time this year. Put ’em together, add another great post from my good friend Francis X. Pileggi, the Lou Gehrig of legal blogging, and–without making any vows–it’s time to dust off the blog and awaken from my blogging hibernation.  Thanks to those who’ve reached out to me in the interim with their kind words, comments, suggestions, and encouragement.

Here’s a link to Francis’s recent post on his Delaware Corporate and Commercial Litigation Blog about a decision handed down by one of the country’s preeminent bankruptcy judges, Judge Peter J. Walsh, in Miller v. McDonald (In re World Health Alternatives, Inc.), 2008 WL 1002035 (Bankr. D. Del. 4/9/08) (pdf). In this decision, Judge Walsh refused to dismiss this complaint filed by Francis and his colleagues against Brian Licastro, the former vice-president of operations and in-house general counsel of World Health Alternatives.  The opinion is a must read because–

• it explicitly extends the so-called Caremark duties to officers of a corporation, and in particular here, to the VP-operations and in-house general counsel, who was alleged "responsible for failing to implement any internal monitoring system and/or failing to utilize such system as is required by Caremark and Araneta"; (Op. at 26.)  

• it sustains, by a narrow margin, a corporate waste count against the VP/GC, despite his not having personally benefited from the alleged waste, based on the allegation that he was "aware of the alleged corporate waste and took no action, as fiduciaries, to prevent such conduct";  (Op. at 33.)

• it upholds a negligent misrepresentation count against the VP/GC alleging that "if [he] properly performed his duty as in-house counsel, these misrepresentation[s] [in public filings] would not have been made and the resulting harm [resulting in a $2.7 million payout in a shareholder class action] would have been avoided.  (Op. at 36-37.)

On January 14, 2007, I linked to various 27 bankruptcy-related cases discussed on Francis’s blog.  Time for an update linking to the next 27 bankruptcy-related posts by Francis since then:Continue Reading Delaware’s Premier Blogger Wins Important Motion Before Delaware’s Judge Walsh Imposing the Caremark Fiduciary Duty on Corporate General Counsel

As every blogger will agree, "thank goodness for guest bloggers!" (especially with my wife now 37 weeks and counting–laboriously so–with twins).

Today’s guest blog is from my colleague at The Coleman Law Firm, Elizabeth E. Richert, who has been at my side–for better or for worse–since her graduation from Duke Law School in 2001.

If you’re wondering how I had the time to blog, it’s in large measure because Elizabeth does a lot of the spade work for me.  If you’re also wondering why I’m not blogging as regularly, well, Elizabeth’s starting to do that for me too.   Unfortunately, I don’t think she does diapers (but see training video here).

So thanks Elizabeth for stepping up to the plate, and congratulations on your first of what I hope will be many more excellent posts!

***Continue Reading Judge Peck Rules in Iridium’s Bankruptcy That Stock Market Valuations Are No “Fool’s Game”

Back from a blogging R&R to take time to smell the roses, catch up on the ever-burgeoning e-precedent file, reflect on a year gone by since my mom’s passing, and–most significantly–get the house ready for Malthusian growth with a pair of twins due sometime next month (adding to the two young Jakubowski’s already here)!  So please excuse my patchy blogging as of late, but as Livy first wrote, "better late than never…" (though, for the sake of completeness, I suppose I should add that Livy concluded, "but better never late").

Anyway, back to blogging, and thanks for reading.

As Bob Eisenbach, Francis Pileggi, and Scott Riddle were quick to observe, the Delaware Supreme Court just put the official kibosh on "deepening insolvency" as an independent cause of action.  That is not the end of the story for bankruptcy litigators, however, since Vice-Chancellor Strine’s opinion in Trenwick America Litigation Trust v. Billet, 906 A.2d 168 (Del. Ch. 2006) (pdf), upon which the Delaware Supreme Court relied, doesn’t address whether deepening insolvency remains valid as a theory of damages. 

As to the latter point, as I recapped here and here, last year the Third Circuit in Seitz v. Detweiler, Hershey & Assocs., P.C. (In re CitX, Inc.), 448 F.3d 672 (3d Cir. 2006) (pdf), held that–at least under Pennsylvania law–deepening insolvency "is not an independent form of corporate damage" and that its earlier decision in Official Comm. of Unsecured Creditors v. R.F. Lafferty & Co., 267 F.3d 340 (3d Cir. 2001) (pdf), "should not be interpreted to create a novel theory of damages for an independent cause of action like malpractice … [or] for any other cause of action, such as fraud."  In support of this proposition, the Third Circuit pointed to bankruptcy lawyer/novelist Sabin Willett’s oft-cited article, The Shallows of Deepening Insolvency, 60 Bus. Law. 549, 575 (2005), for the proposition that "[w]here an independent cause of action gives a firm a remedy for the increase in its liabilities, the decrease in fair asset value, or its lost profits, then the firm may recover, without reference to the incidental impact upon the solvency calculation."

Two recent opinions authored by the Seventh Circuit’s Judge Posner and the Southern District of New York’s Judge Lewis A. Kaplan, however, don’t adopt this per se rule (or at least, as regards Judge Kaplan, not in its entirety).  In Fehribach v. Ernst & Young LLP, 2007 WL 2033734 (7th Cir. 7/17/07) (pdf), Judge Posner provides the following short discourse on the "controversial theory" of deepening insolvency as a theory of damages (including answering how shareholders might be "ineluctably" harmed by a company’s deepening insolvency):Continue Reading Damages for Deepening Insolvency: Judges Posner and Kaplan Consider the Elements of Proof

The Truman Show is Jim Carrey’s greatest acting moment and one of Peter Weir’s greatest directorial moments.  In this first reality TV show from which all current variants have been spawned, Jim Carrey plays Truman Burbank, an unwanted baby who’s been adopted by T.V. Corp. to play the lead role in a world that everyone…

Bankruptcy and restructuring attracts one who yearns to be a "Renaissance Man" because business failure is everywhere and does not discriminate among industries…including, for example, the rap industry.  Indeed, only bankruptcy can prompt one to ask:  "Why were the prices for rap/hip-hop slashed [in Tower Records’ bankruptcy sale] vastly more than those…