Joseph Swanson
Donald Kirk

An unfortunately frequent part of bankruptcy proceedings is the assertion of claims against the directors and officers of the failed company. In the following guest post, Joseph W. Swanson and Donald R. Kirk of the Carlton Fields law firm take a look at the kinds of claims these officials face, as well as the steps these individuals can take to try to avoid the claims in the first place. I would like to thank Joe and Donald for their willingness to publish their article as a guest post on my site. I welcome guest post submissions from responsible authors on topics of interest to this blog’s readers. Please contact me directly if you would like to submit a guest post. Here is Joe and Donald’s article.




Businesses and other organizations fail from time to time. That is a reality of our capitalist system. In the vast majority of these cases, the failure occurs despite the best efforts of the business’ senior management and board. Market forces, macroeconomic trends, or just bad luck are most often the cause of any particular business’ demise.


Unfortunately for the management and board, however, they may be blamed for the business’ failure. In a bankruptcy, the trustee, shareholders, employees, and other third parties frequently look to hold the directors and officers responsible. In many cases, this comes in the form of a breach of fiduciary duty or similar claim. These claims are all the more likely when the failed business had a significant D&O insurance policy in place. Although defending these claims can be stressful for the directors and officers, as discussed below, there are protections in place for the defendants and strategies that can mitigate that anxiety, reduce their exposure, and ultimately resolve the case.


The Failure of Oversight Claim


Directors and officers generally owe fiduciary duties to fulfill their positions with care, loyalty, and in good faith. These duties require directors and officers to (i) act with diligence and in an informed manner, and (ii) put the organization’s interests ahead of their own (i.e., avoid personal conflicts of interest). This is true whether the organization is for-profit or not-for-profit.


In the wake of a business’ failure, the duty of oversight is the fiduciary duty most often at issue.  As explained in In re Caremark International Inc. Derivative Litigation, 698 A.2d 959 (Del. Ch. 1996), a component of directors’ and officers’ fiduciary duties is an obligation to adequately oversee the organization, which includes establishing and monitoring compliance programs with regard to regulatory and legal obligations. In cases subsequent to Caremark, the courts have stated that for liability to attach under the duty of oversight, the directors and/or officers must have “utterly failed to implement any reporting or information system or controls,” or, with such a system in place, “consciously failed to monitor or oversee its operations.” See, e.g., Stone ex rel. AmSouth Bancorporation v. Ritter, 911 A.2d 362 (Del. 2006).


As Caremark itself recognized, a failure of oversight claim is “possibly the most difficult theory in corporation law upon which a plaintiff might hope to win a judgment.” Caremark, 698 A.2d at 967. To be viable, a Caremark claim requires conduct by the defendants that is more egregious than gross negligence, and that would mean an intentional failure to act despite a known duty to act. In other words, the plaintiff will need to show that the defendants knew they were not fulfilling their fiduciary duties.


Notwithstanding these exacting standards, plaintiffs routinely assert a failure of oversight claim against directors and officers. This may be because this claim, which resides within the duties of loyalty and good faith, generally falls outside any otherwise applicable exculpation provisions.


Fiduciary Duty Claims in Bankruptcy Proceedings


In a bankruptcy, particularly where the organization previously obtained a sizable D&O insurance policy, directors and officers may find themselves the targets of a duty of oversight claim. The trustee may contend that the failure by the directors and officers to monitor the organization and respond to various risks resulted in the organization’s demise. Further, the trustee will likely contend that the D&O insurance policy – and its proceeds – belongs to the estate for the benefit of its creditors.


In that situation, the directors, officers, and carrier can expect to receive a demand letter from the trustee’s counsel asserting a claim on the policy. To make things worse for the directors and officers, that claim may be in addition to other claims, such as for securities violations, fraud, and the like, asserted against those defendants by other parties.


Tips for Staying Out of the Crosshairs


The scenario outlined above is daunting for directors and officers of a failed organization. However, the following tips can not only help avoid the scenario in the first place, but can also mitigate the defendants’ risks and resolve the matter as efficiently as possible once a failure of oversight claim is asserted.


  1. Fulfill the Duty of Oversight


Ideally, the directors and officers will avoid a claim altogether by discharging their fiduciary duty of oversight. To do so, these individuals should implement a reporting system and controls suitable for their organization and then monitor that system and controls for any red flags. That system and controls generally include regular board meetings with presentations on compliance and other high-risk subjects relevant for the organization. The board meetings should include input from consultants, as needed, such as for capital campaigns, executive compensation, and other significant corporate transactions. Such meetings and presentations should be memorialized in minutes. Other hallmarks of a reporting system and controls are the use of outside auditors, and the establishment and monitoring of reporting hotlines. Where an organization is experiencing significant financial strain, the directors and officers should be especially diligent and mindful of any duties they may have to creditors. The bottom line is that a documented record of attentiveness to these issues can be the best defense to an attempt by a plaintiff to assign blame for the organization’s failure to the directors and officers.


  1. Obtain Sufficient Insurance Coverage


The directors and officers of any organization should consider the sufficiency of any D&O insurance policy that the organization obtains on their behalf. Issues to consider with any D&O insurance policy include the nature of claims to be covered, any exclusions to coverage, the retention amount, and the period within which any claim must be submitted to the carrier.  Where appropriate, directors and officers should consider purchasing tail coverage, which will permit them to report any claims made after the policy has expired. Directors and officers should be particularly cognizant of the sufficiency of their coverage in times of financial distress for the organization.


  1. Respond Vigorously but Efficiently to any Claim


If a claim is made against the directors and officers, they should seek counsel who will respond vigorously but efficiently to the allegations. Efficiency is particularly important where the D&O policy is a “wasting” policy, whereby defense costs erode the policy’s limits. It is important that defense counsel in these matters have the ability to efficiently manage what is often a dynamic situation with multiple constituencies that include not only the clients, but the trustee and her counsel, counsel for the carrier, and counsel for any other claimants.

Counsel’s investigation should gauge the seriousness of the allegations. The investigation should include targeted client interviews and with third parties, as well as targeted document review. In our experience, the ESI at issue in these matters can be significant, so it is important to develop a plan to locate and review key documents as efficiently as possible.


In responding to the allegations, defense counsel should never lose sight of the rigorous standard for a breach of oversight claim. Counsel should focus on whether any reporting system or controls were in place, and if so, whether the directors and officers responded to red flags.  The trustee and her counsel will likely contend that the mere fact of the organization’s failure is proof of a lack of oversight. That position, however, ignores Caremark and its progeny, which dictate that plaintiffs must link the organization’s collapse to the alleged lack of oversight.


  1. Consider Pre-Suit Mediation


We have seen an emerging trend where the trustee and her counsel will propose a pre-suit mediation in an attempt to resolve the claims against the directors and officers. This approach has several benefits that defense counsel should consider. First, by engaging in this process, defense counsel may be able to resolve the claims without a lawsuit being filed, which would otherwise publicly name the defendants. For obvious reasons, this can be very attractive to directors and officers of a failed organization. Second, the process is likely to be less expensive than full-blown litigation, which means that fewer policy proceeds will be spent on defense costs. Third, preparing for the mediation allows counsel to understand the allegations, and whether they have any basis, sooner. This puts defense counsel in a better position to advise their clients and the carrier about the merits of the claims. This is very helpful if the mediation fails to resolve the matter.


The failure of a business or other organization is a traumatic event for many constituencies, including the directors and officers. A breach of fiduciary duty claim only makes that situation worse for those individuals. By following these tips, however, directors and officers – and their counsel – can seek to avoid that claim in the first place. And, if a claim is asserted, these tips can help to reduce the exposure and achieve a resolution.



The authors frequently represent directors and officers in fiduciary duty and other complex, multi-party corporate governance litigation. Both authors practice out of Carlton Fields’ Tampa office. Swanson can be reached at jswanson@carltonfields.com, and Kirk can be reached at dkirk@carltonfields.com.