Delta financial liquidating trust. CDX LIQUIDATING TRUST v. VENROCK ASSOCIATES.



Delta financial liquidating trust

Delta financial liquidating trust

Seven weeks into the trial on liability the plaintiff rested and the defendants then moved for judgment as a matter of law. The district judge granted the motion with a brief oral statement of reasons, precipitating this appeal. Though based in Illinois, Cadant initially was incorporated in Maryland and later was reincorporated in Delaware. The founders received common stock in the new corporation at the outset. Others purchased common stock later.

Morgan received preferred stock in exchange for an investment in the new company that they made at the beginning of Eric Copeland, a principal of Venrock, became a member of Cadant's five-member board of directors. He is the director principally accused of disloyalty to Cadant. It was later that year that the board proposed and the shareholders approved the reincorporation of Cadant in Delaware, effective January 1, The suit involves decisions by Cadant's board made both when Cadant was incorporated in Maryland and when it was reincorporated in Delaware.

Illinois choice of law principles, which govern this case because it was filed in Illinois, makes the law applicable to a suit against a director for breach of fiduciary duty that of the state of incorporation. The earliest challenged decision by Cadant's board-the decision not to respond to ADC's acquisition offer in April —thus is easily dismissed. In the fall of , Cadant found itself in financial trouble. The defendants attribute this to the deflating—beginning in the spring of and continuing throughout the year and into the next year—of the dot-com bubble of the late s.

We'll return to the question of what caused Cadant's financial distress, but whatever the cause the company needed fresh investment. The board considered a proposal from a group of Chicago investors and a joint proposal from Venrock and J. The terms of the loan were negotiated on Cadant's behalf by Copeland.

The board of directors had grown to seven members, of whom four, including Copeland, were employees of Venrock or J. Morgan, though one of them, defendant C. Randolph Lyon, resigned from J. Morgan before the loan was made, while remaining a director of Cadant. Cadant ran through the entire loan, which had been made in January , within a few months. The loan agreement provided that in the event that Cadant was liquidated the lenders would be entitled to be paid twice the outstanding principal of the loan plus any accrued but unpaid interest on it; as a result, little if anything would be left for the shareholders.

The disinterested directors of Cadant the directors who had no affiliation with Venrock or J. Morgan who voted for the loan were engineers without financial acumen, and because they didn't think to retain their own financial advisor they were at the mercy of the financial advice they received from Copeland and the other conflicted directors. That amount was just large enough to satisfy the claims of Cadant's creditors and preferred shareholders Venrock and J.

The sale was approved by Cadant's board, but also, as required by Delaware law and the company's articles of incorporation, by a simple majority both of Cadant's common and preferred shareholders voting together as a single class and of the preferred shareholders voting separately. The stock in the Arris Group that Cadant received in exchange for Cadant's assets became the property of the bankrupt estate. It was the estate's only asset, and its value fell to a level at which Cadant was worth less than the claims of the bridge lenders and other creditors, with the result that the common shareholders were wiped out.

They brought this case initially as a freestanding suit in federal district court. But in an earlier decision in this long-running litigation, Kennedy v. Venrock Associates, F. A derivative suit is an asset of the corporation, so if as in this case the corporation is in bankruptcy the suit is an asset of the bankrupt estate.

Farmers Union Central Exchange, Inc. Our previous decision therefore directed that the suit be treated as an adversary action in the bankruptcy proceeding. Initially the district court referred the case to the bankruptcy court, but the reference was withdrawn and the case returned to the district court, pursuant to 28 U.

The district judge gave two independent grounds for granting judgment as a matter of law for the defendants. The first was that there was insufficient evidence of proximate cause to allow a reasonable jury to render a verdict for the plaintiff, and the second was that there was likewise insufficient evidence of a breach of fiduciary duty.

These grounds turn out to be intertwined. Ordinarily the issue of duty would precede that of cause, but no matter. City of New York, S. Securities Investor Protection Corp. What the courts are trying to do by intoning these words is to focus attention on whether the particular contribution that the defendant made to the injury for which the plaintiff has sued him resulted from conduct that we want to deter or punish by imposing liability, as in the famous case of Palsgraf v.

The plaintiff was injured when a heavy metal scale collapsed on the railroad platform on which she was standing. The scale had buckled from damage caused by fireworks dropped by a passenger trying, with the aid of a conductor, to board a moving train at some distance from the scale. She sued the railroad; it would have been unthinkable for her to sue the scale's manufacturer, even though if heavy metal scales did not exist she would not have been injured.

No one would think the scale's manufacturer should be liable, because no one would think that tort law should try to encourage manufacturers of scales to take steps to prevent the kind of accident that befell Mrs. The railroad was a more plausible defendant; its conductor had tugged the passenger aboard while the train was already moving. But how could he have foreseen that his act would have triggered an explosion, as distinct from a possible injury to the boarder?

If an accident is so freakish as to be unforeseeable, liability is unlikely to have a deterrent effect. Coming closer to our case, the defendants cite our decision in Movitz v.

First National Bank of Chicago, F. The plaintiff had bought a building in Houston in reliance on what he claimed was the defendant's misrepresentation of its value. Had it not been for the misrepresentation he would not have bought it. Shortly after the purchase the Houston real estate market collapsed and his investment was wiped out.

The misrepresentation had not caused that collapse but it had been a cause of the plaintiff's buying the building and thus had contributed to his loss.

That would be as futile as making the manufacturer of the scale an insurer of Mrs. The present case is superficially similar to Movitz because it is possible that what did in Cadant and hence its common shareholders some at least of the preferred shareholders—such as Venrock and J. Morgan—seem to have come out all right was not the defendants' alleged misconduct but the collapse of the dot-com bubble.

But we disagree with his ruling in two respects. Second, there was enough evidence that the bursting of the dot-com bubble did not account for the entire loss to Cadant to make causation an issue requiring factfinding and therefore for the jury to resolve. The dot-com bubble was primarily in the stocks of firms that marketed their goods or services over the Internet.

Cadant did not, and anyway it was in the hardware business, the fortunes of which depend on the volume of Internet traffic, which continued to increase even after the bubble burst. There may have been a crossover effect; the collapse of stock values, and the recession mild though it was that accompanied it, reduced the amount of venture capital available for technology companies generally, and so may have made it difficult for Cadant to obtain needed investment on reasonable terms.

Our point is only that the effect of the bubble's bursting on Cadant was a jury issue, not an issue that the judge could resolve because the effect was incontestable. The first point—that the burden of proof on the issue of causation was on the defendants—is counterintuitive. Ordinarily the burden of proving causation is on the plaintiff, since without an injury caused by the defendant there is no tort no matter how wrongful the defendant's behavior was.

McNeil Consumer Healthcare, F. Delaware law, however, creates an exception for suits against directors of a corporation—an exception not to the requirement that there be proof of causation but to the requirement that the plaintiff prove causation rather than the defendant's having to prove absence of causation. When a director is sued for breach of his duty of loyalty or care to the shareholders, his first line of defense is the business-judgment rule, which creates a presumption that a business decision, including a recommendation or vote by a corporate director, was made in good faith and with due care.

But the presumption can be overcome by proof that the director breached his fiduciary duty to the corporation—his duty of loyalty and his duty to exercise due care in its performance. Delaware law permits the shareholders to adopt and Cadant's shareholders did adopt a charter provision exculpating directors from liability in damages for failure to exercise due care, but does not enforce a provision exculpating them from liability for disloyalty, Emerald Partners v.

But does Delaware law govern the issue? Cadant's articles of incorporation in both Maryland and Delaware said that its directors would be exempted from liability for breaches of fiduciary duty to the fullest extent permitted by state law—and the two states' laws are, or at least may be, different. An unpublished decision by the Fourth Circuit interprets the term in the Maryland statute as including fraud, Hayes v.

Crown Central Petroleum Corp. App'x , 4th Cir. The negotiations leading up to the first bridge loan took place in the fall of and the loan was approved by Cadant's board on January 10, —nine days after Cadant's reincorporation in Delaware took effect. Some of the plaintiff's strongest evidence of the disloyalty of the conflicted directors concerns Copeland's actions during the negotiation of the first loan, and the plaintiff argues that that loan initiated the events which led to the desperation sale of the company to Arris.

We cannot apply both states' law to the first bridge loan, and so we fall back as did the court in the only factually similar case we've found, Demoulas v. Demoulas Super Markets, Inc. The answer to both questions is Delaware. The board would have assumed that, certainly from that day forward, the duties of the directors relating to both that loan and the second bridge loan would be governed by Delaware law.

Apart from the board's refusal to sell the company to ADC Telecommunications, moreover—an act squarely governed by Maryland law and exempted from liability by that law because it was concluded before reincorporation was resolved upon, let alone accomplished—most of the disloyal acts of which the plaintiff complains occurred while Cadant was a Delaware corporation, and most that occurred earlier occurred after the board had decided that Delaware law made a better fit with Cadant than Maryland law did.

So Delaware had a greater regulatory interest than Maryland in the governance of Cadant's internal affairs in the critical period in which the events giving rise to this lawsuit occurred. In a case like this, everything. That's another way of saying that the disloyal acts had no effect on the shareholders—no causal relation to their loss. An alternative mode of rebuttal would be to prove that despite evidence of disloyalty, the directors had been loyal; and then the business-judgment rule would spring back in and insulate the directors from liability.

The disloyalty of the defendant directors must be assumed because the judge aborted the trial, and so the defendants have to prove that their misconduct had no causal efficacy because Cadant made as good a deal as it would have done had the defendants been loyal. The defendants think it heresy to excuse a plaintiff from having to prove causation and to make them prove its absence. But not only is this unambiguously the Delaware rule in a case like this; shifting to the defendant the burden of proof on causation is common in other areas of law, such as employment discrimination.

Mary's Honor Center v. The shift makes sense in cases governed by the business-judgment rule, which creates such a commodious safe harbor for directors that overcoming it requires the plaintiff to make a very strong showing of misconduct. Misconduct however great can be rendered harmless by a supervening event such as the bursting of a commodity bubble, as in Movitz. But as that is exceptional, it makes sense to place the burden of proving supervening cause on the defendant; indeed that is where the burden of proving supervening cause a cause that wipes out the defendant's responsibility for the plaintiff's injury usually rests.

Heartwood 88, LLC, No. March 24, ; Roberts v. Actually there's enough proof that the alleged misconduct caused loss to Cadant's shareholders to make the issue of causation one for the jury no matter which side has the burden of proof.

Cadant couldn't hold out for a comparable deal because of the terms of the bridge loans.

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Delta financial liquidating trust

Seven weeks into the trial on liability the plaintiff rested and the defendants then moved for judgment as a matter of law. The district judge granted the motion with a brief oral statement of reasons, precipitating this appeal. Though based in Illinois, Cadant initially was incorporated in Maryland and later was reincorporated in Delaware. The founders received common stock in the new corporation at the outset.

Others purchased common stock later. Morgan received preferred stock in exchange for an investment in the new company that they made at the beginning of Eric Copeland, a principal of Venrock, became a member of Cadant's five-member board of directors. He is the director principally accused of disloyalty to Cadant.

It was later that year that the board proposed and the shareholders approved the reincorporation of Cadant in Delaware, effective January 1, The suit involves decisions by Cadant's board made both when Cadant was incorporated in Maryland and when it was reincorporated in Delaware. Illinois choice of law principles, which govern this case because it was filed in Illinois, makes the law applicable to a suit against a director for breach of fiduciary duty that of the state of incorporation.

The earliest challenged decision by Cadant's board-the decision not to respond to ADC's acquisition offer in April —thus is easily dismissed. In the fall of , Cadant found itself in financial trouble. The defendants attribute this to the deflating—beginning in the spring of and continuing throughout the year and into the next year—of the dot-com bubble of the late s. We'll return to the question of what caused Cadant's financial distress, but whatever the cause the company needed fresh investment.

The board considered a proposal from a group of Chicago investors and a joint proposal from Venrock and J. The terms of the loan were negotiated on Cadant's behalf by Copeland. The board of directors had grown to seven members, of whom four, including Copeland, were employees of Venrock or J. Morgan, though one of them, defendant C.

Randolph Lyon, resigned from J. Morgan before the loan was made, while remaining a director of Cadant. Cadant ran through the entire loan, which had been made in January , within a few months. The loan agreement provided that in the event that Cadant was liquidated the lenders would be entitled to be paid twice the outstanding principal of the loan plus any accrued but unpaid interest on it; as a result, little if anything would be left for the shareholders.

The disinterested directors of Cadant the directors who had no affiliation with Venrock or J. Morgan who voted for the loan were engineers without financial acumen, and because they didn't think to retain their own financial advisor they were at the mercy of the financial advice they received from Copeland and the other conflicted directors. That amount was just large enough to satisfy the claims of Cadant's creditors and preferred shareholders Venrock and J.

The sale was approved by Cadant's board, but also, as required by Delaware law and the company's articles of incorporation, by a simple majority both of Cadant's common and preferred shareholders voting together as a single class and of the preferred shareholders voting separately.

The stock in the Arris Group that Cadant received in exchange for Cadant's assets became the property of the bankrupt estate. It was the estate's only asset, and its value fell to a level at which Cadant was worth less than the claims of the bridge lenders and other creditors, with the result that the common shareholders were wiped out. They brought this case initially as a freestanding suit in federal district court.

But in an earlier decision in this long-running litigation, Kennedy v. Venrock Associates, F. A derivative suit is an asset of the corporation, so if as in this case the corporation is in bankruptcy the suit is an asset of the bankrupt estate.

Farmers Union Central Exchange, Inc. Our previous decision therefore directed that the suit be treated as an adversary action in the bankruptcy proceeding. Initially the district court referred the case to the bankruptcy court, but the reference was withdrawn and the case returned to the district court, pursuant to 28 U.

The district judge gave two independent grounds for granting judgment as a matter of law for the defendants. The first was that there was insufficient evidence of proximate cause to allow a reasonable jury to render a verdict for the plaintiff, and the second was that there was likewise insufficient evidence of a breach of fiduciary duty.

These grounds turn out to be intertwined. Ordinarily the issue of duty would precede that of cause, but no matter. City of New York, S. Securities Investor Protection Corp. What the courts are trying to do by intoning these words is to focus attention on whether the particular contribution that the defendant made to the injury for which the plaintiff has sued him resulted from conduct that we want to deter or punish by imposing liability, as in the famous case of Palsgraf v.

The plaintiff was injured when a heavy metal scale collapsed on the railroad platform on which she was standing. The scale had buckled from damage caused by fireworks dropped by a passenger trying, with the aid of a conductor, to board a moving train at some distance from the scale. She sued the railroad; it would have been unthinkable for her to sue the scale's manufacturer, even though if heavy metal scales did not exist she would not have been injured.

No one would think the scale's manufacturer should be liable, because no one would think that tort law should try to encourage manufacturers of scales to take steps to prevent the kind of accident that befell Mrs. The railroad was a more plausible defendant; its conductor had tugged the passenger aboard while the train was already moving.

But how could he have foreseen that his act would have triggered an explosion, as distinct from a possible injury to the boarder? If an accident is so freakish as to be unforeseeable, liability is unlikely to have a deterrent effect. Coming closer to our case, the defendants cite our decision in Movitz v. First National Bank of Chicago, F. The plaintiff had bought a building in Houston in reliance on what he claimed was the defendant's misrepresentation of its value.

Had it not been for the misrepresentation he would not have bought it. Shortly after the purchase the Houston real estate market collapsed and his investment was wiped out. The misrepresentation had not caused that collapse but it had been a cause of the plaintiff's buying the building and thus had contributed to his loss. That would be as futile as making the manufacturer of the scale an insurer of Mrs. The present case is superficially similar to Movitz because it is possible that what did in Cadant and hence its common shareholders some at least of the preferred shareholders—such as Venrock and J.

Morgan—seem to have come out all right was not the defendants' alleged misconduct but the collapse of the dot-com bubble. But we disagree with his ruling in two respects. Second, there was enough evidence that the bursting of the dot-com bubble did not account for the entire loss to Cadant to make causation an issue requiring factfinding and therefore for the jury to resolve.

The dot-com bubble was primarily in the stocks of firms that marketed their goods or services over the Internet. Cadant did not, and anyway it was in the hardware business, the fortunes of which depend on the volume of Internet traffic, which continued to increase even after the bubble burst.

There may have been a crossover effect; the collapse of stock values, and the recession mild though it was that accompanied it, reduced the amount of venture capital available for technology companies generally, and so may have made it difficult for Cadant to obtain needed investment on reasonable terms. Our point is only that the effect of the bubble's bursting on Cadant was a jury issue, not an issue that the judge could resolve because the effect was incontestable. The first point—that the burden of proof on the issue of causation was on the defendants—is counterintuitive.

Ordinarily the burden of proving causation is on the plaintiff, since without an injury caused by the defendant there is no tort no matter how wrongful the defendant's behavior was. McNeil Consumer Healthcare, F. Delaware law, however, creates an exception for suits against directors of a corporation—an exception not to the requirement that there be proof of causation but to the requirement that the plaintiff prove causation rather than the defendant's having to prove absence of causation.

When a director is sued for breach of his duty of loyalty or care to the shareholders, his first line of defense is the business-judgment rule, which creates a presumption that a business decision, including a recommendation or vote by a corporate director, was made in good faith and with due care. But the presumption can be overcome by proof that the director breached his fiduciary duty to the corporation—his duty of loyalty and his duty to exercise due care in its performance.

Delaware law permits the shareholders to adopt and Cadant's shareholders did adopt a charter provision exculpating directors from liability in damages for failure to exercise due care, but does not enforce a provision exculpating them from liability for disloyalty, Emerald Partners v.

But does Delaware law govern the issue? Cadant's articles of incorporation in both Maryland and Delaware said that its directors would be exempted from liability for breaches of fiduciary duty to the fullest extent permitted by state law—and the two states' laws are, or at least may be, different.

An unpublished decision by the Fourth Circuit interprets the term in the Maryland statute as including fraud, Hayes v. Crown Central Petroleum Corp. App'x , 4th Cir. The negotiations leading up to the first bridge loan took place in the fall of and the loan was approved by Cadant's board on January 10, —nine days after Cadant's reincorporation in Delaware took effect.

Some of the plaintiff's strongest evidence of the disloyalty of the conflicted directors concerns Copeland's actions during the negotiation of the first loan, and the plaintiff argues that that loan initiated the events which led to the desperation sale of the company to Arris. We cannot apply both states' law to the first bridge loan, and so we fall back as did the court in the only factually similar case we've found, Demoulas v. Demoulas Super Markets, Inc. The answer to both questions is Delaware.

The board would have assumed that, certainly from that day forward, the duties of the directors relating to both that loan and the second bridge loan would be governed by Delaware law. Apart from the board's refusal to sell the company to ADC Telecommunications, moreover—an act squarely governed by Maryland law and exempted from liability by that law because it was concluded before reincorporation was resolved upon, let alone accomplished—most of the disloyal acts of which the plaintiff complains occurred while Cadant was a Delaware corporation, and most that occurred earlier occurred after the board had decided that Delaware law made a better fit with Cadant than Maryland law did.

So Delaware had a greater regulatory interest than Maryland in the governance of Cadant's internal affairs in the critical period in which the events giving rise to this lawsuit occurred. In a case like this, everything. That's another way of saying that the disloyal acts had no effect on the shareholders—no causal relation to their loss. An alternative mode of rebuttal would be to prove that despite evidence of disloyalty, the directors had been loyal; and then the business-judgment rule would spring back in and insulate the directors from liability.

The disloyalty of the defendant directors must be assumed because the judge aborted the trial, and so the defendants have to prove that their misconduct had no causal efficacy because Cadant made as good a deal as it would have done had the defendants been loyal.

The defendants think it heresy to excuse a plaintiff from having to prove causation and to make them prove its absence. But not only is this unambiguously the Delaware rule in a case like this; shifting to the defendant the burden of proof on causation is common in other areas of law, such as employment discrimination. Mary's Honor Center v. The shift makes sense in cases governed by the business-judgment rule, which creates such a commodious safe harbor for directors that overcoming it requires the plaintiff to make a very strong showing of misconduct.

Misconduct however great can be rendered harmless by a supervening event such as the bursting of a commodity bubble, as in Movitz. But as that is exceptional, it makes sense to place the burden of proving supervening cause on the defendant; indeed that is where the burden of proving supervening cause a cause that wipes out the defendant's responsibility for the plaintiff's injury usually rests. Heartwood 88, LLC, No. March 24, ; Roberts v. Actually there's enough proof that the alleged misconduct caused loss to Cadant's shareholders to make the issue of causation one for the jury no matter which side has the burden of proof.

Cadant couldn't hold out for a comparable deal because of the terms of the bridge loans.

Delta financial liquidating trust

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3 Comments

  1. Misconduct however great can be rendered harmless by a supervening event such as the bursting of a commodity bubble, as in Movitz. Morgan would be entitled to be paid twice the amount of their investment in the company, to the prejudice of the common shareholders. The first was that there was insufficient evidence of proximate cause to allow a reasonable jury to render a verdict for the plaintiff, and the second was that there was likewise insufficient evidence of a breach of fiduciary duty.

  2. It may therefore make sense to reconsider on remand whether bifurcating liability and damages is the best approach to take in this case. The paragraph included in Section 4. The district judge granted the motion with a brief oral statement of reasons, precipitating this appeal.

  3. It may therefore make sense to reconsider on remand whether bifurcating liability and damages is the best approach to take in this case. The paragraph included in Section 4. A director may tell his fellow directors that he has a conflict of interest but that he will not allow it to influence his actions as director; he will not tell them he plans to screw them.

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