In January of this year, Judge Brendan L. Shannon of the United States Bankruptcy Court for the District of Delaware issued a decision addressing whether a debtor’s lenders had aided and abetted the directors of debtor, Fedders North America, Inc. (“Fedders”), in breaching their duty of care (read the Fedders’ Decision here). The aiding and abetting claim was one of several claims brought through an adversary action filed by the Official Committee of Unsecured Creditors (the “Committee”). The Committee’s complaint asserted sixteen causes of action against Fedders’ lenders. Of the sixteen, the only claim before the Court in the January decision was the one alleging the lenders aided and abetted Fedders’ officers in their breach of the duty of care. This post will look at the facts that gave rise to the Committee’s claims against the lenders, as well as the Court’s analysis in resolving the Committee’s claims.
Fedders filed for chapter 11 bankruptcy protection in Delaware on August 22, 2007 (the “Petition Date”). Approximately 10 years prior to the Petition Date, Fedders decided to expand its business from residential room air conditioning to commercial HVAC. To finance its expansion, Fedders incurred substantial secured debt. Fedders’ expansion and additional debt were not a success, though, and by 2007 Fedders had defaulted on its loans.
In March of 2007, Fedders entered in to replacement financing which it intended to use to pay off its prior debt and provide additional cash to finance its operations. Unfortunately, within two months of entering in to the replacement financing, Fedders was in default once again. Three months later the company filed for bankruptcy.
Committee’s Claim and the Lenders’ Response
One of the many claims alleged by the Committee was that Fedders’ lenders (the “Lenders”) aided and abetted Fedders’ directors in breaching its duty of care. In a prior motion to dismiss, the Lenders succeeded in having all claims dismissed as to them except the claim of aiding and abetting. Through a separate motion to dismiss, the Lenders now asked the Court to dismiss this final claim.
The Committee claimed that Fedders’ directors breached their duty of care in taking on new debt, yet failing to receive a “credible financial assessment” that Fedders could comply with the replacement financing. According to the Committee, the Lenders aided and abetted the directors in their breach as the Lenders “gave substantial assistance and encouragement to the [directors’] breaches of fiduciary duties.” Opinion at *11.
The Court began its analysis by looking at what is required to prove a breach of a duty of care. Citing Delaware law, the Court observed that a corporate director generally must commit gross negligence to breach his duty of care. Cargill, Inc., v. JWH Special Circumstances LLC, 959 A.2d 1096, 1113 (Del. Ch. 2008). Further, various kinds of behavior can rise to the level of gross negligence, though there is generally a finding that the directors and officers failed to inform themselves “fully and in a deliberate manner.” Opinion at *10, citing Cede & Co. v. Technicolor, Inc., 634 A.2d 345, 368 (Del. 1993).
Next, the Court looked at the requirements to establish a claim of aiding and abetting a breach of fiduciary duty. Again relying on Cargill, the Court listed the four requirements for aiding and abetting a breach: (i.) existence of fiduciary relationship; (ii.) proof of a breach by the fiduciary; (iii.) proof that a defendant, who is not a fiduciary, knowingly participated in a breach; and (iv.) a showing that damages to the plaintiff resulted from the concerted action of the fiduciary and the nonfiduciary. Opinion at *12, citing Cargill, 959 A.2d at 1125.
In considering the Lenders’ Motion to Dismiss, the Court focused on the third prong of the Cargill analysis – whether the Lenders knowingly participated in a breach of a fiduciary’s duty. Opinion at *14. Here, the Court noted that the loan from the Lenders to the Fedders included a borrowing base calculation based on Fedders’ inventories and accounts. The fact that the loan criteria was based on inventory, the Court found, “undercuts [the Committee’s] assumption that Fedders’ solvency was or should have been the focus of inquiry by the Lender[s] or the Insider Directors.” Opinion at *12. Finding that the Committee’s complaint did not allege any facts to demonstrate that the Lenders knowingly participated in a breach, the Court granted the Lenders’ Motion to Dismiss. In doing so, the Court found that dismissal was especially appropriate “where the loan documents, on their face, contradict the conclusory allegations made.” Opinion at *14.
The decision in Fedders serves as a reminder of the pleading standard necessary to overcome a challenge under Fed.R.Civ.P. 12(b)(6). Even more, the decision looks at what is required for a party to aid and abet a fiduciary in breaching a duty of care. To get past a motion to dismiss, a plaintiff must allege facts sufficient to show that the defendant knowingly participated in the fiduciary’s breach of duty.