A decision this week from U.S Court of Appeals in Philadelphia provides good reason for directors to resign from poorly managed companies to avoid personal liability, even if someone else is making the mistakes.
The case indirectly stands for the proposition that board members can be liable for not firing incompetent managers.
A nursing home went into bankruptcy after being cited for deficiencies three times more often than other facilities. The official creditors’ committee got permission to sue officers and directors for “breach of fiduciary duties and deepening insolvency.”
The evidence at trial laid blame largely on the shoulders of the chief administrator and the chief financial officer, and on the board for not replacing them. A jury saddled the executives and board members with $2.3 million in damages for increased losses. The managers were hit for an additional $750,000 in punitive damages.
The Philadelphia appeals court upheld the awards. That court previously predicted Pennsylvania would recognize a lawsuit alleging deepening insolvency. The appeals court defined the claim as injury to a company “from the fraudulent expansion of corporate debt and prolongation of corporate life.”
The award for deepening insolvency was justified because there was evidence the board concealed a decision to close the home for three months, according to the court. The judgment was also supported by an e-mail from the home’s bankruptcy lawyer, who warned there wasn’t a sale customary in Chapter 11s, according to the opinion. The lawyer also said “nobody has had the opportunity to bid, and we have no meaningful financial records,” according to court filings.
In his Jan. 26 decision for the three-judge appeals panel, U.S. Circuit Judge Thomas Ignatius Vanaskie said there was ample evidence of deepening insolvency shown by conduct that damaged the home’s “financial ability after it had already become insolvent.”
The case is Official Committee of Unsecured Creditors v. Baldwin (In re Lemington Home for the Aged), 13-2707, U.S. Court of Appeals for the Third Circuit (Philadelphia).
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