Delaware Bankruptcy Court Allows Oversight Liability Claim Against General Counsel
 
May 5, 2008
 

In a recent case arising from the liquidation of World Health Alternatives, Inc., the United States Bankruptcy Court for the District of Delaware ruled that general counsel and other corporate officers have a fiduciary duty to implement or use internal monitoring controls that may prevent fraud from occurring within their company.

Following the liquidation of World Health Alternatives in October 2007, the trustee filed suit against the company’s general counsel and other officers and directors alleging that they had engaged in corporate waste and breached their fiduciary duties to implement or use controls that would have prevented misleading tax and SEC filings, misrepresentations in financial statements and certain other fraudulent activities. The general counsel moved to have the claim dismissed on the grounds that the complaint failed to establish that he had committed fraud and that the fiduciary duties at issue did not apply to corporate officers.

The Court denied the motion on both grounds. In accordance with Caremark, the Court ruled that the failure to implement or use controls is sufficient to give rise to liability for breach of fiduciary duty and that the misrepresentations in the company’s SEC filings were examples of such failure. The Court went on to state that since under Disney officers generally have the same fiduciary duties as directors, corporate officers are subject to the Caremark duties to implement or use controls to the same extent as directors.

The Court also inferred a duty to inspect the company’s SEC filings from the up-the-ladder reporting requirements applicable to in-house lawyers under Section 307 of the Sarbanes-Oxley Act and concluded that the general counsel should have known about the fraud occurring in the company. This was a more difficult argument for the plaintiff to make because, under applicable SEC rules (17 C.F.R. Part 205), the duty at issue is limited to reporting a material violation of the law that the lawyer becomes aware of and the SEC has exclusive jurisdiction to prosecute these violations. Although of limited precedent value, this represents an interesting new step in the plaintiff’s efforts to use the provisions of the Sarbanes-Oxley Act in support of private actions.

Miller v. McDonald (In re World Health Alternatives, Inc.), B.R., 2008 WL 1002035 (Bkrtcy D.Del. April 2008)