blumarbleImport laws and custom duties are not areas of the law into which I frequently (or lightly) venture, but I delve into these topics here and now because developments in these areas have served up yet another example where individual corporate officers have been held liable personally for matters that previously had been regarded exclusively as the source of corporate liability.

 

In September 16, 2014 en banc opinion (here), the United States Court of Appeals for the Federal Circuit held that a corporate official can be personally liable for unpaid duties and for (potentially massive) civil penalties in connection with  undervaluing merchandise imported by his company.

 

This decision is discussed in a September 18, 2014 memo from the Katten Muchin law firm entitled “Introducing Corporate Liability into Corporate Negligence: An Analysis of the Trek Leather Decision” (here) and in a November 2014  memo from the Kirkland & Ellis law firm entitled “Individual Found Liable for Violations of U.S. Import Laws” (here).

 

Background

Harish Shadadpuri is the President and sole shareholder of Trek Leather, Inc. Among other things, Trek imports men’s suits. The U.S Bureau of Customs and Border Protection (CBP) alleges that Trek was the importer of record of a 2004 shipment of men’s suits. The CPB alleges that by means of “false acts, statements and/or omissions” the company and its President “understated the dutiable value” of the shipment of suits, resulting in the underpayment of duties of $133, 605, in violation of the customs civil penalty statute, 19 U.S.C. Section 1592.

 

Section 1592 provides in pertinent part that “no person by fraud, gross negligence, or negligence” may “enter, introduce or attempt to enter or introduce any merchandise into the United States” by means of misrepresentations or omission.

 

The Court of International Trade had granted the government’s motion for summary judgment of liability as to both defendants. On appeal, the Federal Circuit had initially held that only importers of record and certain other indentified entities had the responsibility for making entry and that penalties under Section 1592 could only be imposed against those with that responsibility.

 

As the Katten Muchien memo summarized, in its initial decision the Federal Circuit had specified that “for the government to assess a penalty against an individual for violations stemming from entries filed by that individual’s import-of-record company, one of three activities had to arise: the government had to (1) ‘pierce the corporate veil’ to establish that the individual was in fact the importer-of-record; (2) establish that the individual him or herself was liable for fraud; or (3) establish that the individual was an aider and abettor of the company’s fraud.”

 

The individual sought en banc review of the Federal Circuit’s initial decision

 

The September 16, 2014 Decision

In a unanimous en banc decision written for the Federal Circuit by Judge Richard G. Taranto, the Court, setting aside the initial decision, held that the individual defendant could be held liable under the civil penalties statute for actions the Court found constituted the “introduction” of goods within the meaning of the statute.  The Federal Circuit held that the term “introduce” in Section 1592 is broad enough to include acts that extend beyond the formal filing of an entry for the importation of goods.

 

Specifically, the appellate court held that the term “introduce” was broad enough to “cover actions that bring good to the threshold of the process of entry by moving goods into CBP custody in the United States and providing critical documents (such as invoices dictating value) for use in the filing of papers for an anticipated release into the U.S. commerce.”

 

In finding the individual defendant liable, the appellate court was explicit that it was not piercing the corporate veil nor was it holding the individual liable simply because of his status as an officer of the company. Rather, the court stated that it was holding him liable for conduct it found to have violated Section 1592.

 

The appellate court affirmed the judgment against the individual for unpaid duties of $45,245 and penalties of $534,420, plus interest.

 

Discussion 

As I said at the outset, import law and customs duties are not within my usual bailiwick. However I am always concerned with issues affecting the potential liabilities of corporate directors and officers. What struck me in reading this opinion, and particularly, in reading the law firm memos, is that the upshot of the Federal Court’s en banc decision is that individual officers may now be held liable under the import laws for conduct that previously had been regarded exclusively as a potential source of corporate liability.

 

As the Kirkland memo puts it, under this decision, “any corporate officer, compliance officer, or customs broker helping prepare or send invoices to be used for CBP entry has potential liability for ‘introducing’ merchandise in violation of law.”

 

The Katten memo adds that by opening up the possibility of personal liability for “introducing” goods – while at the same time leaving the term “introduce” itself open to interpretation — the appellate court may be “opening exposure to personal liability for all sorts of individuals who are simply trying to do their job.” The law firm memo adds that personnel may find that “their ordinary routines are filled with activities that may be construed as ‘introducing’ merchandise into the United States,” for which “they could find themselves facing personal liability.”

 

This case obviously has important risk management implications. Companies and their personnel have significant incentives to ensure that procedures used are compliant with import law requirements.

 

Because of my lack of familiarity with this area of the law, I hesitate to attempt too may generalizations or conclusions. I note simply that, first, this development presents yet another area of personal liability for corporate officials ; and, second, that this development raises the possibility of individuals  being held responsible for liabilities that had previously been viewed as exclusively corporate. I note in that regard that the judgment against the individual here included not only a statutory penalty and interest, but also included the unpaid duties themselves, which to me clearly seems like a corporate rather than an individual responsibility.

 

From an insurance standpoint, it seems likely that the typical D&O Insurance policy would cover the defense fees and costs of an individual subject to an enforcement action of this type, However, most carriers would likely contend that the unpaid import duties as well as any civil penalties do not represent covered loss under their policies.

 

Speakers’ Corner: This week I will be in London to participate as a panelist and as a moderator at the Advisen European D&O Insights Conference (here), which will take place Wednesday at the Willis Building. If you will be at the conference, I hope you will make a point of saying hello, particularly if we have not previously met.

 

Break in the Action: There will be a brief interruption in the publication schedule for this site while I am on travel. The normal publication schedule will resume when I return to my office next week.

IFrancis Kean hi resn prior posts (most recently here), I have noted the growing problems involved with the increasing willingness of U.S. regulators to exert their regulatory and enforcement authority outside of the U.S. In the following guest post, Francis Kean of Willis examines a recent decision by the United States Court of Appeals for the Second Circuit in which the appellate court upheld the exercise of U.S. court jurisdiction under the U.S. Financial Anti-Terrorism Act against a financial institution domiciled outside the U.S. and involving alleged conduct taking place entirely outside of the U.S.

 

Francis Kean is executive director of Willis FINEX in London and the D&O expert for the WillisWire blog. This post was originally published November 7, 2014 on WillisWire (here).

 

I would like to thank Francis for his willingness to publish his article as a guest post on this site. I welcome guest post submissions from responsible authors on topics of interest to readers of this blog. Please contact me directly if you think you might be interested in submitting a guest post. Here is Francis’s guest post.

 

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I am indebted to John Blancett, partner of law firm SDMA for drawing my attention to a startling decision of the US Court of Appeal for the Second Circuit: Tzvi Weiss et al. v. National Westminster Bank Plc (judgment delivered 22nd September 2014). The case is striking and disturbing not just as fresh evidence that US long-arm jurisdiction is alive and well but also because it shows just how low the threshold test is for establishing liability against a financial institution which in the eyes of the US Courts might be said to have “… provided material support to a terrorist organization.”

 

The US Anti-Terrorism Act

The claim was originally brought against Natwest in the US District Court, for the Eastern District of New York under the US Financial Anti-Terrorism Act (ATA) on behalf of some two hundred US nationals (or their estates, survivors or heirs) who were victims of terrorist attacks launched in Israel by Hamas.

 

The ATA was introduced in the US expressly to provide a new civil cause of action in federal law for international terrorism. Not only does it provide extra-territorial jurisdiction over terrorist acts abroad against US nationals but it also confers jurisdiction on US courts for the conduct of financial institutions (or other organizations or individuals) anywhere in the world.

 

The Facts

The facts are simply stated. Between 1987 and 2007 Natwest provided banking services, first to the Palestine and Lebanon relief fund and then to its successor, the Palestine Relief and Development Fund (“Interpal”). In 2003 the United States Treasury Department Office of Foreign Assets Control (OFAC) designated Interpal a Specially Designated Global Terrorist (SDGT) on the basis that it “… has been a principal charity utilised to hide the flow of money to Hamas…”.

 

Following OFAC’s designation of Interpal as an SDGT, Natwest sought guidance from the Financial Sanctions Unit of the Bank of England and was told “… there are presently no plans to list [Interpal] under the Terrorism order in the UK” and “there is no need to take any further action…”. This stance was confirmed by both the UK Charity Commission and Special Branch. The Financial Sanctions Unit also told Natwest not to make any payments to or for the benefit of Hamas and that any suspicion of any such payments should be reported to the Charities Commission, the Bank of England and Special Branch.

 

Natwest subjected Interpal’s accounts to regular review and concluded in 2005 that some of the organisations receiving funds from Interpal were indeed suspected of having connections with Hamas. Natwest closed the last of Interpal’s accounts in March 2007. At no time was there any evidence that Natwest was aware of any Interpal payments either to Hamas or to any other organisations that were designated as terrorist organisations by the Bank of England or OFAC at the time of the payment.

 

The Court’s Decision

Natwest applied for summary judgment dismissing the victims’ claim on the basis that they could not show that it acted with the requisite knowledge to impose liability under ATA . The District Court dismissed the claim on this basis.

 

Perhaps unsurprisingly, based on the summary of Natwest’s actions above, the District Court concluded that there was insufficient evidence of any “..deliberate indifference as to whether Interpal funded terrorist activities….” After all, Natwest had expressly sought the views of the Bank of England and had also taken due account of the views of both the UK Special Branch and UK Charity Commission.

The surprise comes with the Court of Appeal’s decision overruling the District Court and finding in favour of the plaintiffs. This is how they summed up:

 

…we conclude that [the Anti-Terrorism Act’s] requirement is less exacting and requires only a showing that Natwest had knowledge that, or exhibited deliberate indifference to whether Interpal provided material support to a terrorist organisation, irrespective of whether Interpal’s support aided terrorist activities of the terrorist organisation. (Emphasis added)

 

What the Case Means

It seems (to me at least) that the difference between the two approaches could not be more significant. The focus of Natwest (and it may be said of the relevant UK authorities) was on the question as to whether Interpal could be suspected of “terror financing”.

 

By contrast, the US Court of Appeals has in effect said that Natwest’s focus should, for the purposes of the US Act at least, have been on the much broader question as to whether Interpal was “in any way financing a terrorist organisation”. In other words, if, for example, there was evidence that Interpal financed Hamas’ non-political and/or non-violent activities, that would be sufficient for the civil action for damages against Natwest to proceed. The fact that the UK authorities (and therefore perhaps understandably Natwest itself) may not have looked at this question in the same way was not an adequate defence to such civil liability under ATA.

 

Watch out!

The implications of this decision for companies anywhere in the world which do not follow precisely the same line as the US when it comes to the US ATA are sobering indeed.

 

Without wishing to finish on too apocalyptic a note, it is worth pointing out that the ATA does not just apply to financial institutions but to any and all organisations and individuals anywhere!

 

Update

11 November, 2014

Perhaps inevitably in the “Land of Litigation”, it wasn’t going to take long for others to catch on to the idea of trying to hold banks accountable for terrorist acts.

I spotted this piece in The New York Times of 10th November announcing new claims against HSBC, Barclays, Standard Chartered, the Royal Bank of Scotland and Credit Suisse following on from the NatWest case about which I blogged and another case involving Arab Bank. Although I haven’t seen the complaints themselves (and although they seem to focus on  Hezbollah, the Shiite militant group, as well as Iran’s Islamic Revolutionary Guard Corps-Qods Force rather than Hamas), they will undoubtedly  rely on the same US Anti-Terrorism Act.

It seems from the article that the claimants in this case will have an additional hurdle (or opportunity to extend the reach of the Act, depending on your point of view). This is because the Wall Street banks did not in these cases themselves make the transfers as opposed to allegedly facilitating them. Definitely one to watch!

 

– See more at: http://blog.willis.com/2014/11/us-long-arm-jurisdiction-creates-new-terrorism-headaches-for-banks-among-others/#sthash.FwXZGxLX.dpuf

marlyandThe question of whether or not a subsequent claim is interrelated with a prior claim — and therefore deemed first made at the time the earlier claim was filed – is a recurring D&O insurance coverage issue.  If the later claim is to be deemed first made at the time of the prior lawsuit, then the later claim is not covered under the claims made D&O insurance policy in force at the time the later claim arose.

 

In a November 7, 2014 opinion (here), District of Maryland Judge George Jerrod Hazel examined these recurring issues and determined that a 2010 action to enforce a judgment was interrelated with the 2006 adversary proceeding in which the judgment had been entered and therefore that the later action was not covered under the D&O policy in force at the time it was filed.  

 

Background

In 2002, Haymount Limited Partnership (HLP) retained International Benefits Group (IBG) to help HLP obtain financing for a real estate development project. HLP ultimately obtained financing but refused to pay IBG the finder’s fee IBG contended it was due. IBG claimed that HLP’s refusal to pay the finder’s fee forced IBG into bankruptcy. In 2006, IBG’s bankruptcy trustee filed an adversary proceeding in the District of New Jersey (the 2006 Adversary Proceeding) against HLP; its two general partners (Westminster and Haymount); Edward J. Miller, Jr., president of Haymount and Chairman of W.C. and A.N. Miller; and John A. Clark, vice president of Wesminter and president of the John A. Clark Company.

 

The trustee’s complaint in the 2006 Adversary Proceeding alleged conspiracy to deny IBG its finder’s fee; breach of contract; unjust enrichment; and tortious interference. On January 8, 2010, a judgment of $4.4 million was entered in the 2006 Adversary Proceeding against HLP and the others in favor of the Trustee.

 

On October 29, 2010, the Trustee filed a second action (the 2010 Action) in the District of New Jersey against several of the same defendants as had been named in the 2006 Adversary Proceeding, including HLP, Edward Miller and John Clark. The first paragraph of the 2010 Action stated that the suit was an “ancillary and adversary proceeding to recover and collect” the $4.4 million judgment entered the 2006 Adversary Proceeding. The complaint in the 2010 Action describes a number of actions the defendants allegedly took to transfer HLP’s assets in order to make them unavailable to satisfy the $4.4 million judgment. The complaint in the 2010 Action asserted claims against the defendants for fraudulent transfer, fraudulent conveyance, common law and statutory conspiracy, creditor fraud, and aiding and abetting.

 

In November 2010, W.C. and A.N. Miller Development Co. submitted notice of the 2010 Action to its D&O insurer, seeking to have the insurer pay its defense costs incurred in defending the 2010 Action. The carrier denied coverage for the claim, based on its assertion that the 2010 Action and the 2006 Adversary Proceeding involved interrelated wrongful acts and therefore that the 2010 Action is deemed under the policy to have been first made at the time the 2006 Action was filed. The insurance carrier argued that because the 2010 Action was deemed made in 2006, it was not first made during the coverage period of its claims made policy and therefore was not covered under the policy

 

Miller filed an action as against its D&O insurance carrier alleging that the insurer had breached its duties under the policy and seeking to recover the costs it incurred in defending the 2010 Action. The insurance carrier filed a motion for judgment on the pleadings and Miller filed a motion for summary judgment.

 

The D&O insurance policy provided that all “Interrelated Wrongful Acts” were considered one “Claim” for purposes of coverage. The Policy stated that “more than one Claim involving … Interrelated Wrongful Acts shall be considered one Claim which shall be deemed first made on … the date on which the earliest such Claim was first made.” The Policy defined “Interrelated Wrongful Acts” as “any Wrongful Acts which are logically or causally connected by reason of any common fact, circumstance, situation, transaction or event.”

 

The November 7 Opinion  

In his November 7 opinion, Judge Hazel granted the carrier’s motion for judgment on the pleadings and denied Miller’s motion for summary judgment, holding that the 2006 Adversary Proceeding and the 2010 Action involve Interrelated Wrongful Acts therefore that under the policy the two are deemed one Claim first made at the time the first action was filed. Because the subsequent lawsuit was deemed first made four years prior to the inception of the D&O insurance policy the 2010 Action  is not covered under the policy.

 

In reaching this conclusion, Judge Hazel rejected two arguments on which Miller sought to rely. First, he rejected Miller’s argument that because coverage under the D&O insurer’s policy for the 2006 Adversary Proceeding would have been precluded under the policy’s contract exclusion, it could be treated with the 2010 Action as a single Claim. Judge Hazel said the policy does not require a Claim to be covered in order for it to be treated the basis of an Interrelated Wrongful Act and therefore to be the basis of a single Claim. Judge Hazel also rejected Miller’s argument that the 2006 proceeding in bankruptcy was not a Claim within the meaning of the policy, finding that the 2006 Adversary Proceeding met the policy’s definition of the term Claim.

 

Judge Hazel went on to reject Miller’s argument that at most the two actions involve a “common motive” (that is, the defendants’ purported desire to avoid paying the finder’s fee), rather than a “common scheme.” Judge Hazel concluded that the two actions did arise out of a “common scheme” that “was directed at a specific entity (IBG), that involved a single contract (the fee agreement), that arose out of the same real-estate transaction (the Haymount Project) and that sought a single outcome (precluding IBG’s monetary recovery for its involvement in the Haymount Project).” Thus, Judge Hazel concluded, the two actins “shared a common nexus – namely, an alleged scheme involving the same claimant, the same fee commission, the same contract, and the same real estate transaction.”

 

Judge Hazel also found that the two actions were “logically or causally” connected, as It was “entirely logical” that the bankruptcy Trustee would file an action to recover damages associated with the alleged actions taken to avoid payment of the judgment entered in the 2006 Adversary Proceeding, noting that if the defendants in the 2006 Adversary Proceeding had satisfied the judgment, the 2010 Action would not have been filed.

 

Miller had tried to argue that there were important differences between the two actions, contending that the two lawsuits arose during different time periods, included different legal claims and involved a number of different parties. Judge Hazel said that these differences — “as well as any other differences” — were “irrelevant” to the question of whether the two actions involved Interrelated Wrongful Acts. Judge Hazel said that “the relevant focus is not on any number of differences” between the two actions, but instead “the relevant focus is on the similarities between the two.” Indeed, he added “so long as a single fact, circumstance, situation, transaction, or event logically or causally connects” the two actions, they would be deemed Interrelated Wrongful Acts.

 

Discussion

Because the 2010 Action expressly related to efforts by the bankruptcy Trustee to enforce or to collect upon the judgment the Trustee had obtained in the 2006 Adversary Proceeding, it was always going to be difficult for Miller to establish that the two actions were not “logically or causally connected by reason of any common fact, circumstance, situation, transaction or event.” Indeed, because the complaint in the 2010 Action stated on its face that it was “an ancillary and adversary proceeding to recover and collect” on the judgment entered in the 2006 Adversary Proceeding, there would seem to be little basis on which to contend that the two actions were not “logically or causally connected” by a common fact, circumstance or situation.

 

But while the outcome here may not necessarily be surprising, there are some noteworthy aspects of Judge Hazel’s ruling. First, his observation that any differences between the two actions are irrelevant is striking. While the differences between the 2006 Adversary Proceeding and the 2010 Action may well not have been determinative here, that is a long way from saying that consideration of the differences between two actions would never be relevant.

 

Second, Judge Hazel’s reading of the Policy’s definition of the term Interrelated Wrongful Acts is quite broad; his emphasis that two actions would involve Interrelated Wrongful Acts “so long as even a single fact, circumstance, situation, transaction, or event logically or causally connects” the two underscores how broadly the policy’s definition of Interrelated Wrongful Acts could sweep. The breadth of this reading suggests that points of overlap between two actions could be very peripheral or even remote and still be sufficient to connect the two as interrelated. The breadth of this expansive reading seemingly raises the possibility that coverage for entire categories of litigation could be precluded simply because there may have been an earlier lawsuit filed.

 

My concern in this regard is based in part on Judge Hazel’s suggestion that any differences between two actions are irrelevant, and that all that matters are the similarities between the two. While I understand that a party seeking to establish that differences between two actions matter has the burden of showing the significance of the differences (particularly with respect to the question of whether the two actions share a common factual nexus), it seems to me to be too much to suggest the differences between two action are never relevant.

 

I find it interesting that Judge Hazel gave the definition of Interrelated Wrongful Act here such an expansive reading even though the definition lacked the wording sometimes found in similar definitions in other D&O insurance policies; that is, while the definition in this case provided that alleged wrongful acts are interrelated if they are connected “by reason of” a common fact or circumstance, other policies’ definitions provide further that the alleged wrongful acts are interrelated if they are “based upon, arising out of or in any way relating to” a common fact or circumstance. Judge Hazel gave the policy wording here an expansive meaning notwithstanding the absence of this broader definitional wording.

 

As I noted at the outset of this discussion, the interrelatedness analysis in this case arguably was fairly straightforward. The reason I have nevertheless dwelt on these issues at length is because all too often interrelatedness issues can be vexatious and even confounding, as I noted at length in a prior post. My concern is that the sweep of Judge Hazel’s generalizations about the interrelatedness issues – particularly his statement that any differences between two actions are irrelevant to the interrelatedness analysis –could be read in a way that could cause problems in other cases where the lines of analysis may not be as straightforward as they arguably were here.

caesersThis past week the annual PLUS International Conference took place at the sprawling Caesar’s Palace complex in Las Vegas. Given the mass of confusing pathways and corridors and vast distances between the various event venues at the hotel, it wouldn’t surprise me at all to hear that a few conference attendees are still wandering around inside the Caesar’s Palace grounds, dazed into a trance by the blaring music and the slot machines’ flashing lights. Just the same, it was unquestionably a very successful event.

 

The high point of the event for me was the presentation of the PLUS1 award to my good friend Aruno Rajaratnam, of the Ince & Co. law firm in Singapore, whom I interviewed in a Q&A I posted on this site last week. In the first picture below I am standing outside the conference ballroom with Aruno. The next picture shows Aruno delivering her acceptance speech. In the third picture, Aruno stands with incoming PLUS President Jim Skarzynski and immediate Past PLUS President Dave Williams. The final picture was taken at the dinner in celebration of Aruno’s award; shown from left to right in the picture are Dave Williams of Chubb; Aruno; Ann Longmore of Marsh; Shasi Gangadharan of Chubb (Singapore); Joe Montelone of the Rivkin Radler law firm; and me.

 

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The PLUS International Conference is always a good opportunity to reunite with old friends. In the picture below, I am standing with my former colleague and good friend, Diane Parker of AWAC, together with Robert Chadwick of the Campbell Chadwick law firm in Dallas.

 

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This final picture was taken at the opening night reception. From left to right, Corbette Doyle of Vanderbilt University; me; Pete Herron of Travelers; and Jeff Lattman of Beecher Carlson.

 

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burzinThe recent Satyam scandal and ensuing litigation put the duties of independent directors under scrutiny.  The recently enacted Companies Act of 2013 addressed a number of issues relating to the duties and liabilities of independent directors.  In the following guest post, Burzin Somandy of Somandy & Associates in Mumbai takes a look at the approach that had been taken under prior law with respect to independent directors’ duties and also at the standards that the Companies Act of 2013 has put in place. As discussed below, the primary purposes of the new Act’s provisions were to ensure transparency and independence.

 

Many readers will recall that Burzin is the author of the chapter about India in the recently published book, The Global Directors and Officers Desk Book (about which refer here). I would like thank Burzin for his willingness to publish his guest post on this site. I welcome guest post submissions from responsible authors on topics of interest to readers of this blog. Please contact me directly if you would like to submit a guest post. Here is Burzin’s guest post:

 

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Introduction:

The case law that has evolved under the erstwhile Indian Companies Act of 1956 and ancillary legislation which concerns the activities of a company has iterated that the Directors and Officers of a company can be held vicariously liable for the acts of the company, which liability may arise as a consequence of the involvement of the Directors and Officers in the act complained of, the breach of fiduciary duties, negligence or ultra vires acts.

 

However, the erstwhile Companies Act 1956 did not draw any distinction between a Director and an Independent Director. This concept was first introduced by the Securities and Exchange Board of India in the year 2000 under clause 49 of the Listing Agreement in respect of all companies who wished to list their shares on the stock exchange, whereby the term Independent Director came to be introduced. However, since there was no statutory recognition of this term under the erstwhile Companies Act of 1956, this led to a degree of confusion as to the extent of liability which could be fastened on an independent director wherein proceedings were initiated against the Board of Directors of a company. Post the Satyam scandal and the lawsuit that emanated thereafter, the role of Independent Directors has come under scrutiny, including in a host of judgments that have been pronounced by various courts on the extent of liability which could be fastened on an independent director for acts committed by a company or the remaining directors on the board of a company.  However, this raging controversy was ultimately laid to rest in the New Companies Act of 2013, which defines who an Independent Director is thereby providing statutory recognition to the concept of an Independent Director.

 

The main spotlight of this article is to analyse the evolving concept of the recognition of an Independent Director in listed companies and the emerging trends in their liability exposure, including the sea changes brought about by the new Companies Act of 2013.

 

Background – Evolution of the concept of an Independent Director :

The severity of Independent Directors was recognized with the prologue of Corporate Governance. The Securities and Exchange Board of India specified the principles of corporate governance and thereby introduced clause 49 in the Listing agreement of the Stock Exchanges which was predominantly formulated for the improvement of corporate governance in all listed companies and which mandates the appoint of Independent Directors in all listed Companies in proportion to the number of directors on the Board of a company.

 

In spite of the fact that Clause 49 of the Listing Agreement characterizes the concept of an Independent Director, ambiguity persisted until the 2013 Companies Act was enacted, especially in light of the extent of liability of an Independent Director in the event of any contravention of law, as there was no distinction between Directors and Independent Directors in the Companies Act 1956 and since for the most part, it was perceived that Independent Directors were not involved in the day to day affairs and management of a company and were appointed to ensure appropriate corporate governance. Consequently, in legal proceedings filed against the Company and its directors for contravention of law, Independent Directors were faced with the herculean task of establishing their innocence in the acts complained of and that vicarious liability for the commission of an offence could not be attributed to them merely by virtue of their being directors in a company, especially given their lack of involvement in the day to day affairs or management of the company being prosecuted.

 

This controversy was substantially dealt with in two landmark judgements of the Supreme Court. In the case of K.K. Ahuja v. VK Vora[1], the Supreme Court observed that to be liable for the commission of an offence, a person should fulfill the legal requirement of being a person in law responsible for conduct of the business of the Company and also fulfill the factual requirement of being a person in charge of the business of the Company. Consequently, the Supreme Court provided a two-pronged test — the first prong being a legal, statute-based test, where it is required to be proven that a person is responsible to the company for the conduct of the business of the company. The second prong is a fact-based test, where through specific averments the complainant has to establish that the particular person was in-fact in overall control of the day-to-day business of the company. Both the prongs need to be complied with. Hence, if a person fails to satisfy the first test, he is not required to meet the second test. Similarly in the case of S.M.S. Pharmaceuticals Ltd. v. Neeta Bhalla and Another[2], it has been held by the Supreme Court that “The liability arises from being in charge of and responsible for conduct of business of the company at the relevant time when the offence was committed and not on the basis of merely holding a designation or office in a company.

 

These judgments came as a great relief to independent directors of companies who were facing prosecution alongwith other directors of companies merely by virtue of their being on the board, inconsequential to their involvement in the act complained of.

 

 Looking to the raging controversy on the liability of an independent director in the event of a complaint filed against a company and its directors and specifically post the revelation of the Satyam scam in January 2009 which raised serious doubts about the involvement of independent directors in the day to day working of a company, Independent Directors realised that their role was no longer going to be ceremonial which sparked a demand for better corporate governance. Corporate India during this period witnessed a marked increase in the number of resignations of Independent Directors from the boards of companies.  This period saw the issuance of a Circular[3] by the Ministry of Corporate Affairs, which sought to relieve non executive directors against penal action taken against them. This circular provided that directors should not be held liable for any act of omission or commission by the Company or by any officer of the Company which constitutes a breach or violation of any provision of the Companies Act, 1956 and which occurred without their knowledge attributable through the board process and without the consent or connivance of such director or where such director had acted diligently in the board process. The said circular, however, was issued in the context of action being taken by the Registrar of Companies for violation of provisions of the Companies Act 1956 and was not issued generically for all proceedings initiated against directors.

 

Should Independent Directors be held responsible if they did not smell a rat?

Independent directors are those not charged with the day-to-day affairs and management of the company and are usually involved in ensuring proper norms of corporate governance.

 

The recent scandals precisely ascertained the growing need for determining the liability of independent directors for prevention and detection of fraud, in view of the limited roles performed by them in the company. Under the 1956 Act and the judgements of the Supreme Court as referred above, an Independent Director can content that he should not be considered as an “officer in default” and consequently is not liable for the actions of the Board. The new Companies Act of 2013 however puts this controversy to rest and provides for the liability of an Independent Director to be limited to acts of omission or commission by a company which occurred with their knowledge, attributable through board processes, and with their consent and connivance or where they have not acted diligently. The said new Act thus saw a sea change and makes a considerable effort to bring the role of an Independent Director in line with the changing needs of corporate governance of India.

 

Another sea change are the provisions in the Companies Act which deals with the indemnification of a director. As per section 201 of the Companies Act, 1956, a company cannot indemnify a director till such time that she/he is found innocent by a court of law. However, section 197(3) of the Companies Act, 2013 provides that premium paid on an insurance policy shall be treated as part of the remuneration of a director only if such director is found guilty in respect of the violation for which indemnity is sought under a D & O policy. This would therefore mean that directors can now be indemnified and there is no prohibition on indemnification, as was the case with the Companies Act 1956.

 

Analytical review of Clause 49-Listing Agreement of the Companies Act, 1956 vis-à-vis Companies Act, 2013 :

Clause 49 of the Listing Agreement gives an inclusive definition of Independent Director, covering under its ambit non- executive directors who do not have a material pecuniary relationship with the company, its promoters, management and subsidiaries which may affect the independence of their judgment. Independent directors are those not charged with the day-to-day affairs and management of the company and are usually involved in ensuring proper norms of corporate governance. The Companies Act, 2013, sets to overhaul the provisions relating to Independent Directors and thus gives about a clear demarcation between a nominee director and an Independent Director.

 

Several other restrictions have also been built into the new act to ensure that there is no financial nexus between an independent director and the company. For instance, the new act prohibits independent directors from receiving stock options of the company. The Listing Agreement does not prohibit the issue of stock options. Rather it provides that the maximum limit on stock options to be granted to independent directors can be decided by a shareholders’ resolution. The new act limits the remuneration of independent directors to sitting fees, reimbursement of expenses for participation in the board and other meetings, and such profit-related commission as may be approved by the shareholders. This is yet another area of inconsistency with the Listing Agreement that will have to be clarified by the regulators.

 

 Conclusion:

The primary objective behind the new act’s provisions on independent directors are to ensure transparency and independence. The New Act casts great responsibility on the Independent Directors since it specifies that any decisions taken by the board in the absence of independent directors must be circulated to all directors and can be final only upon receiving ratification from at least one independent director. The Act has thus set high standards on the one hand and on the other ensured that Independent Directors are not privy to legal proceedings when they have no involvement in the act complained of.  It is expected that these changes would increase the pool of professionals into the stream of Independent Directors and restore the confidence in such persons to take up board positions knowing that they will not be frivolously prosecuted.

 

Reference :

[1] K.K. Ahuja v. VK Vora [(2005) SCC 89)]

[2] S.M.S. Pharmaceuticals Ltd. v. Neeta Bhalla and Another [(2009 (3) CC (NI) 194]

[3] (Circular no. 8/2011 No.2/13/2003/CL- V dated 25th March, 2011)

arunoOn Thursday November 6, 2014, at the Professional Liability Underwriting Society (PLUS) International Conference in Las Vegas, the PLUS1 Award will be conferred on my good friend, Aruno Rajaratnam. The PLUS1 Award is presented annually to a person “whose efforts have contributed substantially to the advancement and image of the professional liability industry.” I can’t think of anyone more deserving of this award than Aruno, one of the true legends of our industry.

 

Aruno, who is now with the Ince & Co. law firm in Singapore, has been a trailblazer and a leader in the professional liability insurance industry for nearly four decades. She has the distinction of having placed the first D&O insurance policy in Asia, and during her long and illustrious career she has served as an in-house claims manager, a loss adjuster, a specialist broker, a reinsurer, an underwriter and now as an Insurance /reinsurance lawyer. She has also been a mentor and a friend to an entire generation of industry professionals. It gives me a great deal of pleasure to see Aruno’s many contributions to our industry recognized through her receipt of the PLUS1 Award.

 

Because she has spent her career in Asia, many readers of this blog may not be acquainted with Aruno and her many contributions. I thought it would be a good idea to interview Aruno for this blog, in the form of a Q&A. I would like to thank Aruno for her willingness to participate in this Q&A, and to congratulate her again on the award. Here is the the Q&A (my questions are in boldface). Be sure to check out the news clippings below the Q&A.

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1. You have had a long and storied career in the professional liability insurance industry. How did you first wind up in the industry? 

 

AR: I need to tell you a little background story first to set the scenario on my career.

I was born and brought up in a tiny village in North Malaysia. My parents were immigrants from the old Ceylon and we are called Ceylonese Tamils as a race.

We are a minority race in Malaysia and in Singapore too.

It was literally the norm for every Ceylonese Tamil child to be brought up to aspire to be a lawyer, doctor, accountant, engineer or a teacher if you are a female.

My village had electricity for only 12 hours a day. A rich neighbour had a television and allowed us to watch PERRY MASON for 1 hour a week. It was an awe inspiring experience.

I started dreaming about being a lawyer though I never met one in my village or the country!

I then met an American Peace Corp Teacher, Richard Johannessen, from Oregon, USA in my final year in school.

He became my mentor (still is my mentor) and opened my eyes to a whole world outside my village and school……he convinced me that I was smart and had talent and to look far.

That is how I went to Law School in Singapore.

When I completed law school and was admitted to practice as an advocate and solicitor in Singapore in FEB 1975, I was asked to do very uninteresting legal work.

Someone in my law firm told me about a new Insurance Co-Operative called NTUC INCOME that was looking for a trainee for their claims division.

I was told 90 people turned up for the interviews. After 3 rounds, I got the job.

When I wrote to my family in Malaysia to tell them of my new job, they had no clue as to what general insurance was….and still today do not really understand what I did and still do!

Even today, I am still asked to explain what I do at every family gathering we have.

And that was how it all began………..

 

2. I know that during your many years in the industry, you have worked on some very interesting matters and been involved in some of the landmark developments in the expansion of the industry in Asia. What are some of the most interesting matters and landmark developments in which you have been involved?  

 

AR: After a few years of doing motor, workmens’ compensation, marine cargo and personal lines claims, I joined an international Broker, Heath Langeveldt Rollins (A subsidiary of the UK C E Heaths) and had my very first experience of dealing with Medical Malpractice, Lawyers, Surveyors and Construction claims. The experience was tremendous and I started making a name for myself as a tough negotiator.

My very first claim involved a brain surgery that went wrong. The surgeon and the hospital (my client) were sued. We could not get any surgeon in the country to testify…the medical profession was a close knit group and would not testify against each other at that time. We finally had to bring in a surgeon from Holland to testify if the local surgeon did the right surgery. It was an emotional case as in the end, the victim got pittance. It made me very sad.

In 1982, one of the big US Insurers started holding workshops in Malaysia, Singapore and Hong Kong on the D&O Policy. I was fascinated with this product and spent a lot of time doing my own research.

It was a difficult sell in Asia and many brokers did not really understand it enough to talk to their clients.

I joined Citicorp Insurance Brokers (now called Locktons) in 1986 and sold the very 1st D&O policy in Asia.

It used to take me about a year to 18 months to convince a client to purchase the D&O Policy as nearly all companies in Asia believed that their Ds + Os cannot be sued!

It was a tough and uphill task. I used to term this period as the elephant’s gestation period!

I finally placed more and more D&O policies during the next few years (beating every other Broker)  and earned the nickname “D&O QUEEN” from my rival brokers!

In fact one of the brokers said ”The D&O Train came into town and only Aruno got on to it!”.

At the same time, my then Boss, Ian Lancaster, told me to work on a project to convince the Law Society of Singapore Executive Committee that they should consider a Mandatory Professional Liability Program for all their members.

After 2 years and several rounds of Broker presentations, we won the tender in 1989.

I was privileged to draft the policy, implement and manage this very prestigious project from inception.

My reputation gained momentum in Asia and apart from placing more D&O Policies, I also implemented and managed a few more Professional Liability Schemes around Asia for engineers, realtors, accountants, life agents, travel agents, stockbrokers, computer professionals.

I then earned the nickname “THAT SCHEME / SCHEMING LADY” from my rival brokers!

When I was the Deputy Financial Lines Regional Head in AIG, my staff from all over Asia would call me “Mother Of Financial Lines” and would actually send me a Mother’s Day Card every year.

Years later, when I worked for the same Boss in Marsh and Willis, Roger Wilkinson, he would introduce me all over Asia as “MRS. FINPRO” (in Marsh) and “MRS. FINEX’ (in Willis).

These days, most of the Asian industry folks call me ‘GRANDMOTHER OF FINANCIAL LINES.” 

 

3.  In your many different roles, you have been a mentor for so many people. Who were your mentors and who were the people who were most influential in your career?  

 

AR: I have to go back a little to my Law School days when I did not have money for the fees and the books.

The President of the Singapore Rotary Club, Keki Medora, gave me a scholarship and also gave me a monthly pocket money from his own funds.

A mysterious gentleman (who heard about my dire straits) would leave new law books every year (for 4 years)  at my hostel reception counter  for me  with a note: “Do not look for me to thank me / I don’t need any thanks….just make sure you pass your exams  and then pass on these books to the next needy person”.

Then when I started my first day at the claims job in NTUC INCOME, my GM, Tan Meng Siang, told me: “In this job it is easy to be bribed by the insureds and the motor repairers. Even if you take a million dollars, you are telling the world you have a price and can be bought. You should be ‘priceless’ as a true professional!

At my next job in CE Heaths, my MD, Peter Comerford, told me on the first day: “You have come here as a professional……………I am going to give you a long rope. It is your prerogative to manage your responsibilities well or to hang yourself!”

Later, when I joined Reliance National as the Asian MD, my Boss, Joseph Graziano, told me ‘You must be firm as a leader, but remember that it does not hurt to also be nice.”

When Reliance National had to be put into run off, I was in a quandary.

Chubb Asia’s then former Head, Chris Giles and the CSI Asia Head, Steve Blasina, both came to my rescue and gave me a year’s consultancy project to draft all their Asia Pacific CSI Policies.

That was a wonderful gesture as it kept me still involved in the Professional Liability Market and still in the Asian  limelight.

Last but not least, I owe a lot to Elizabeth Kennedy, who is a good friend and a great Public Relations professional. She was instrumental in keeping me and my achievements in the news all over Asia. She made me famous!

On another note, I wish to say  I have always been a great believer in imparting knowledge and mentoring  / training as many young people as possible.

I started doing training courses for the Financial Lines people from 1985 and still conduct a number of workshops all over Asia in a year.

I have been berated by some former bosses for ‘training the enemy’ but I believe it is good to have more trained professionals around for the industry to progress. 

 

4. As a result of the many roles you have served, you have worn many hats. How would you compare your experiences as an in-house claims manager, a loss adjuster, a specialist broker, a reinsurer, an underwriter and now as an Insurance /reinsurance lawyer? What are your views of the various roles?

 

AR: Yes……. I have served many roles in the industry and am glad I did that….. though some people  would say I was job hopping!

I have done the right thing and can now speak with some authority about the various roles in the industry.

I am now often teased that the only role I have not done is to be a Regulator!

After 40 years of various insurance /legal industry experience, I would say that the reinsurance role is the best!

It is a B2B business and you do not have to deal with unreasonable (and sometimes really horrible) direct insureds or risk managers.

If God gave me back my life, I would never ever want to be a Loss Adjuster! It was my worst experience and you get badly treated by really ‘power crazed / stupid claims mangers’!

The most challenging and really tough role but also very rewarding was that of a broker.

Brokers have the best overview of the markets and definitely have better knowledge of what sells and what does not.

It is a pity we do not practice the concept of ‘quantum meruit’ in insurance broking as we do with legal work.

Brokers do a lot more work for the insureds than any others in the industry  but can get ‘kicked’ out without any payment for the  work done!

I found that very painful to bear …..coupled with the fact that clients had no loyalty or  proper appreciation of ‘true professionalism’.

They take your work and hand over to another broker without any qualms.

I also find it sad that in many Asian countries, except for Hong Kong, brokers are not free to go around the world to get the best coverage  and terms for their clients.

Insurance regulations forbid a broker from freely seeking terms outside the country.

This is no doubt from a market protectionist standpoint … even though a number of these countries are members of WTO and signatories to the GATS and should have Freedom of Services.

 

5. Your background and experiences in the Asian Financial Lines market are varied and deep. What do you think professionals in the U.S. and U.K. markets need to know about the Asian insurance market?  

 

AR: There are varying stages of development in Asia with regard to Financial Lines products like D&O, POSI, EPLI, Standalone Entity,  PI/E&O, BBB, Commercial Crime, Medical Malpractice Liability + Medical Defence Unions  , Cyber Liability , Multi-Media Liability, IP / Patent Infringement, Mandatory Professional Liability Schemes, etc.

I have always assessed the Asian markets as to how ‘developed’ they are not by the large premium base but by the availability of these Financial Lines products locally.

On this basis, the more ‘developed’ countries are Singapore, Malaysia, Hong Kong and India.

The second tier countries are China, Taiwan, Japan, Korea,.

The third tier ones would be Sri Lanka, Vietnam, Philippines, Thailand and Indonesia.

The fourth tier would be Myanmar, Cambodia, Bangladesh, Laos and East Timor.

The different languages, local /customary practices, strict policy registration regimes and legal systems can be a very challenging prospect for someone from USA or UK.

At the moment there seems to be a serious price war with a lot of capacity available in the market.

New companies from USA, Bermuda, UK and Europe are setting up in Asia  but they just ‘poach’ employees from the companies already operating in the market…….it seems to be a big round of musical chairs.

I am actually concerned that there is a lack of local talent in the Financial Lines arena……….and not many companies seem to invest in training.

I believe there should be more product development and less strict policy registration requirements. 

 

6. Many of the members of PLUS are young and are just starting out in the industry. Based on your experiences, what advice would you give to someone just beginning their career?  

 

AR: I have often advised the people I mentored and trained over the years that they should really stay and forge a career in Financial Lines.

This is the only Insurance sector with very exciting and challenging products.

The policies are always evolving to cater to new challenges.

The coverages actually stretch across all industries.

They must always keep abreast of happenings around the country and the world …..it is a global village.

 

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blumarbleAn ever-present anxiety for globally-active non-U.S. companies is the possibility that they might find themselves having to deal with litigation in U.S. courts. This concern is warranted because certain attributes of the U.S. legal system – including the absence of loser pays attorneys’ fee model and the availability of discovery and jury trials – provide substantial incentives for prospective plaintiffs to try to pursue their claims against foreign companies in U.S. courts.

 

However, there have been a number of significant recent legal developments that have reduced the ability of plaintiffs to subject foreign companies to litigation in the U.S. In addition, the possibility that corporate adoption of fee-shifting bylaws might mitigate the effects of the absence of a “loser pays” model has recently gained significant momentum.

 

These two subjects – the recent U.S. judicial developments affecting the exposure of foreign companies to U.S. litigation and the upsurge in the adoption of fee-shifting bylaws – are the topics of two recent legal surveys, discussed below.

 

Litigation in U.S. Courts against Foreign Companies 

 

An October 2014 U.S. Chamber of Commerce Institute for Legal Reform publication entitled “Federal Cases from Foreign Places: How the Supreme Court Has Limited Foreign Disputes from Flooding U.S. Courts”(here) takes a look at “the current and swiftly shifting legal landscape of federal claims by foreign plaintiffs in the federal courts.” The organization’s October 21, 2014 press release about the publication can be found here.

 

In the introduction to the publication, which contains a series of four essays by leading legal practitioners about recent developments in this area, the editors suggest that “the tide” against attempts to have U.S. courts adjudicate disputes that arose overseas “might finally be receding.” As detailed in the essays, several recent court decisions “restrict the territorial reach of U.S. laws and impose more rigorous standards for demonstrating personal jurisdiction over defendants.”

 

The first of the four essays in the publication, entitled “Morrison at Four: A Survey of Its Impact on Securities Litigation” and written by George Conway III of the Wachtell Lipton law firm, takes a look at the effects of the U.S. Supreme Court’s 2010 decision in Morrison v. National Australia Bank. Conway also summarized his essay about Morrison in an October 29, 2014 post on the Harvard Law School Forum on Corporate Governance and Financial Regulation (here).

 

As Conway notes, the U.S. Supreme Court’s decision in Morrison “reemphasized the presumption against extraterritoriality,” and reestablished “the traditional understanding that Congress ordinarily legislates with respect to domestic, not foreign, matters,” consistent with principles that would “avoid the interference with foreign regulation that the extraterritorial application of U.S. law would produce.”

 

Conway also notes that lower courts applying Morrison have effectively extinguished “two species” of cases that had ensnared foreign companies in U.S. lawsuits for damages under the federal securities laws. First, Morrison has put an end to so-called “f-cubed” cases, involving claims by foreign domiciled plaintiffs who purchased their shares in foreign companies on foreign exchanges. Second, Morrison has also put an end to “f-squared” cases, involving the claims of U.S. plaintiffs who purchased their shares in foreign companies on foreign exchanges.

 

Conway then goes on to review more recent cases where the lower courts have applied Morrison to cases involving other kinds of transactions, such as derivative securities transactions. As discussed here, in its August 2014 decision in the securities class action lawsuit involving Porsche, the Second Circuit held that a domestic transaction is a necessary but not necessarily a sufficient condition for a claim to fall within the territorial scope of Section 10(b).

 

Conway concludes by noting that as case law under Morrison continues to develop, courts will “increasingly face the harder cases, the marginal cases, cases in which the question whether the proposed application of law is extraterritorial is less clear and that turn on thorny factual disputes about where particular events occurred.” These difficult cases will “pose interesting questions of line-drawing and fact-finding,” but their difficulty should not undermine the “the wisdom of the presumption against extraterritoriality.”

 

The U.S. Chamber of Commerce’s publication concludes with an afterword noting that despite important recent developments, “plaintiffs’ attorneys continue to try to drag nonresident companies into their favorite forums” and that “opportunities for global forum shopping endure.” Nevertheless, the editors conclude, the recent legal developments outlined in the publication “should help courts and defendants more efficiently week out international lawsuits that never should have been imported into the United States in the first place.”

 

Developments Involving Fee-Shifting Bylaws

 

One of the most significant recent developments in the world of corporate and securities litigation has been the rising numbers of companies adopting fee-shifting bylaws. These moves followed quickly after the Delaware Supreme Court’s May 2014 ruling in the ATP Tour, Inc. v. Deuscher Tennis Bund case (discussed here) upholding the validity of a non-stock organization’s bylaw requiring an unsuccessful litigant in an intra-corporate dispute to pay his adversary’s legal fees. Many companies have moved to adopt similar bylaws even though legislation is pending in the Delaware legislature to restrict the use of fee-shifting bylaws to non-stock companies. As I recently noted, an increasing number of IPO companies completing their public stock offerings have these types of provisions in their bylaws.

 

The widespread adoption of fee-shifting bylaws could work a fundamental change in what has been called the “American Rule,” which provides that in the U.S. each party to a lawsuit bears its own costs. The fee-shifting bylaws institute something closer to the “loser pays” model that prevails in many countries outside of the U.S. 

 

The recent rise and implications of fee-shifting bylaws is the subject of a “roundtable” in the November 2014 issue of the Bank and Corporate Governance Law Reporter (here). The roundtable includes a series of four essays discussing the fee-shifting bylaw phenomenon.

 

The first essay is by Columbia Law School Professor John C. Coffee Jr. and entitled “Fee-Shifting and the SEC: Does it Still Believe in Private Enforcement?” The essay is the written form of testimony Coffee provided at an October 9, 2014 SEC Investor Advisory Committee. The essay was previously published in an October 14, 2014 post on The CLS Blue Sky Blog (here).

 

In his essay, Coffee notes that as a result of the sudden upsurge in the adoption of fee-shifting bylaws, corporate law is now in the midst of a period of “rapid change,” and he notes that the pace of the change is “accelerating.” Coffee clearly has concerns with this development, and he contends that even if Delaware acts to limit the restrict the adoption of fee-shifting bylaws, the SEC should still act to curtail the adoption of these types of measures.

 

As Coffee sees it, the adoption of these kinds of bylaws has several faults. First, he says, the bylaws often are one-sided in that they reimburse successful defendants but not successful plaintiffs, and they require fee-shifting even in cases that were reasonable or even meritorious but that were lost on a technical legal defense. He also notes the perverse incentives the bylaws create, in that the stakes for an unsuccessful plaintiff increase the harder and the longer the plaintiff fights, possibly encouraging early settlements of meritorious cases.

 

Coffee also sees the bylaws as inconsistent with Congressional attitudes against fee-shifting in class action cases, which, Coffee contends, evince a preference for two-sided fee-shifting subject to judicial review rather than an automatic system of one-way fee-shifting.

 

Coffee concludes by saying that “Delaware alone cannot solve the problem” because even if Delaware restricts the practice, other states might allow it (as, for example, Oklahoma already has), which could trigger a “race to the bottom.” Coffee states that unless the SEC acts, these kinds of provisions “could become prevalent.”

 

Coffee suggests that there are a number of steps the SEC could take, including, for example, refusing to accelerate the registration statements of companies that have fee-shifting bylaws (as the agency previously has done with companies that have bylaws with mandatory arbitration clauses). He also suggests that the agency could require registrants to state in the registration statements that the SEC believes the federal securities laws are inconsistent with fee-shifting bylaws. The SEC could also require disclosure of these kinds of bylaws in companies’ risk factors, “thereby raising the ‘embarrassment cost’ to the issuer.”

 

In the second essay in the roundtable, Widener Law School Professor Larry Hamermesh argues that while fee-shifting bylaws may have a legitimate purpose of “deterring litigation,” the Delaware legislature should preclude broad bylaws adopted after shareholders have invested because those shareholders did not consent to the bylaw adoption and because the bylaws run against traditional shareholder expectations to be able to enforce fiduciary obligations.

 

In the third essay, the rountable editor, Neil Cohen, argues that shareholder “consent” to fee-shifting bylaws can only be determined by shareholder vote. He also argues that shareholder should have a legal remedy when wrongdoing occurs but that a fee-shifting bylaw could prevent meritorious cases from being filed. In order to allow meritorious cases to proceed but to discourage frivolous lawsuits, Cohen suggests that the Delaware legislature require that fee-shifting bylaws are invalid after plaintiffs have survived a motion to dismiss and requiring that defendants should be required to pay plaintiffs fees when plaintiffs prevail.

 

In the roundtable’s final essay, former SEC Chairman Harvey Pitt suggests that fee-shifting bylaws should remain the province of state law and of the board. He suggests that the Delaware legislature should require boards to appoint special committees to consider a host of key factors and to enlist the assistance of experts in order to arrive at fair bylaws. Pitt also argues that a shareholder vote should be required for the adoption of a fee-shifting bylaw and that one-sided fee shifting should not be allowed.

 

Special thanks to Neil Cohen for sending me a link to the fee-shifting roundtable. 

 

arcp_logoEarlier this week I wrote about the accounting scandal that has hit the UK-based grocer, Tesco, and the securities class action lawsuit against the company that followed in its wake. Now another company has reported accounting irregularities – and the company involved has also been hit with a securities class action lawsuit.

 

On October 29, 2014, before the markets opened, real estate investment trust American Realty Capital Properties issued a press release (here) in which it disclosed the existence of an accounting error and subsequent cover-up relating to its financial statements for this year’s first two quarters. The company announced that adjusted funds from operations had been overstated for the first quarter. (“Adjusted funds from operations” is a key metric of a REIT’s performance and cash flow.) The press release stated that the “error was identified but intentionally not corrected,” and that other adjusted funds from operations and financial statement errors “were intentionally made,” resulting in an overstatement of adjusted funds from operations and understatement of net loss for first three and six months of the year. In the press release, the company also said that its audit committee is investigating the company’s 2013 financial statements as well.

 

The company further announced that the company’s audit committee’s discovery of these accounting errors had forced the resignation of Brian Block, the company’s CFO, and Lisa McAlister, the company’s chief accounting officer.  

 

An October 30, 2014 Wall Street Journal article about these developments (here) reported that the SEC intends “to launch an inquiry into the accounting irregularities” at the company. According to the Journal article the total amount by which the adjusted funds from operations was overstated in the first quarter was $12 million, or 8.8%, and for the second quarter was $10.9 million, or 5.6%. The Journal article also quotes a statement from the company’s CEO that the audit committee began its investigation of the company’s accounting in September after “an employee altered the company’s audit committee about the irregularities.”

 

When I read the Journal article, I wondered how long it would be before plaintiffs’ lawyers filed a securities class action based on these developments at the company. I didn’t have to wait long to find out the answer.

 

Within a few hours, on October 30, 2014, plaintiffs’ lawyers filed a securities class action lawsuit in the Southern District of New York against the company. Block, and McAlister. A copy of the complaint in the action can be found here. The complaint relies heavily on the company’s October 29 press release and also cites the Journal article cited above. The complaint also relies heavily on the fact that the company released its now withdrawn first quarter financial results on May 8, 2014, just days before the company’s May 28, 2014 secondary offering, in which the company raised net proceeds of approximately $1.59 billion.  The plaintiff’s lawyers October 30, 2014 press release about the complaint can be found here.

 

Another sharholder filed a second complaint yesterday, as well, The second complaint, which can be found here, names deendants the company’s founder and its CEO as wel as Block and McAlister.

 

It is interesting to note that in this case, as was also the case with Tesco, the account problems first came to light as a result of an internal whistleblower. As I also noted with respect to Tesco, it is interesting that the whistleblower chose to report the concerns internally rather than reporting the issue to the SEC and potentially lining up a whistleblower bounty payment.

 

In any event, this new  lawsuit along with the one filed against Tesco late last week represent the latest examples of a something that I think we will be seeing a lot more of — that is, securities class action suits being filed after a whistleblower’s revelation of accounting or other improprieties. As I noted in an earlier post (here), particularly in light of the incentives that the Dodd-Frank whistleblower bounty provides, we will likely see many more securities suits following after whistleblower reports.

 

One final thought has to do with larger patterns in securities class action lawsuit filings. The ebb and flow of securities class action lawsuit filings is the source of a great deal of discussion as commentators (including even this blog) attempt to explain what may be driving a reported increase or decrease in the number of securities class action lawsuit filings. One thing is for sure about the number of lawsuits, if more companies are reporting accounting miscues, there will be more lawsuits. While it is far too early based solely on this case and the Tesco case to proclaim that there has been an increase in the number of companies reporting accounting problems leading to lawsuits, it is nevertheless interesting  to note that these two high-profile accounting-related suits have arisen in quick succession.

 

The problems at the two companies are obviously entirely unrelated, but if there were to be more companies reporting accounting issues (perhaps as a result of increased whistleblower activity), it could certainly lead to an accompanying upsurge in securities suit filings.  

drc2Here at The D&O Diary we read everything so you don’t have to. It was in this spirit that we read the article on page C-3 of yesterday’s Wall Street Journal that in the print version was entitled “Congo Opening Its Doors to Agribusiness” (here) and that contained the single most astonishing sentence I have ever read in my entire life.

 

The article states: “The Democratic Republic of Congo plans to lease farmland covering an area larger than France in an attempt to attract capital and technology capable of boosting jobs and food productivity in one of the world’s poorest countries.”

 

Larger than France? What? What in the world are we talking about here?

 

Let’s put this in perspective — the next sentence in the article says “Congo may lease as much as 650,000 square kilometers (247,000 square miles) or more than one quarter of the central African nation.”  For those Americans that have never traveled around France, let me use a point of comparison that may be more meaningful — 247,000 square miles is an area only slightly smaller than the state of Texas.

 

And because I know that even this comparison still doesn’t mean anything to people on the East Coast of the United States (who think it is a long way from Manhattan to Connecticut), let me add further than we are talking about a geographic area larger than the combined size of the states of New York, Pennsylvania, Ohio, Michigan and Virginia, with a lot left over. We are talking about a massive amount of real estate.

 

How can they possibly have a slug of arable farm land larger than the geographically largest country in Europe that they (and in this instance who really is “they”) can just lease out? Doesn’t it seem likely that if there is farmland of any value that someone is already farming it? Might not the current farmers object to, say, for example, the Chinese, coming in and agribusinessing their farmland? As I said before — what?

 

While contemplating this, you will want to stop everything you are doing and watch the new video from the group OK Go. Many readers may be familiar with the group’s prior videos including their iconic treadmill video. With this new video the group has outdone themselves. Watch this video and be prepared for things to get way more complicated and astonishing than you think at the beginning that they could possibly be.

 

This video won’t answer any questions about farmland in the Congo, but the choreography will blow you away. While you are sitting gape-mouthed over the precision of the people movement, use of props, and optical illusions, take a moment to contemplate the camera work. The video was filmed as single, continuously shot long-take that I will not spoil for you by describing how it finishes. (You must watch it ALL THE WAY TO THE END.)  I haven’t the slightest idea how the filming of this video was physically possible. The song itself is light and inconsequential. The video, however, is astounding.  

 

The third astonishing thing: Madison Bumgarner. To pitch five shutout innings on two days rest in the seventh game of the World Series? Astonishing. Is there anything better in sports than the seventh game of the World Series, a one-run lead, bottom of the ninth, two outs, runner on third base, and two strikes on the batter? Amazing. By the way, the poor guy from Chevrolet that gave Bumgarner the MVP award probably will calm down, say, in a month or two. With therapy.

ibioLike everyone else, I have been following the Ebola outbreak news with a mixture of horror and fascination. I never in a million years imagined that I would have occasion to write about the Ebola outbreak on this blog. Perhaps due to a lack of imagination on my part, I never foresaw that there might be an Ebola outbreak-related D&O claim. As it turns out, though, late last week plaintiffs’ lawyers filed a securities class action lawsuit against iBio, Inc. for allegedly misrepresenting its role in manufacturing an experimental Ebola vaccine.

 

As reflected in their October 24, 2014 press release (here),  plaintiffibiocomplaint lawyers have filed a securities class action lawsuit in the United States District Court for the District of Delaware against iBio and its Chairman and CEO, Robert B. Kay. The complaint (a copy of which can be found here) was filed on behalf of investors who acquired the company’s shares during an unusually short class period – that is, between October 13, 2014 and October 23, 2014, during which period there was a flurry of media activity about the company’s ostensible involvement in the manufacture of ZMapp, an experimental Ebola virus fighting drug.

 

There is a shortage in the supplies of ZMapp, which is manufactured by Mapp Pharmaceutical and Kentucky BioProcessing. The federal government is helping the current manufacturers of ZMapp to find additional facilities affiliated with Texas A&M to increase the supply of ZMapp. Caliber Biotherapeutics is affiliated with the Texas A&M center and is one of the companies being considered to help manufacture additional supply of ZMapp.

 

The gist of the complaint’s allegations is that the defendants allegedly misrepresented the company’s relationship with Caliber.  The plaintiff alleges that the defendants misled investors by suggesting that iBio’s relationship with Caliber has to do with ZMapp production. The complaint alleges that “in truth, iBio’s relationship with Caliber does not concern the production of ZMapp.”

 

In the complaint’s substantive allegations, the first alleged statement to which the complaint refers is from an October 11, 2014 newspaper article, which stated (and was quoted verbatim in the complaint) as follows:

 

Caliber Biotherapeutics “is by far the largest facility in the world” for producing pharmaceuticals in tobacco plants, said Robert Kay, CEO of iBio Inc., a Newark, Delaware-based biotechnology company that owns one of the technologies used to make drugs in tobacco plants. “If anybody is going to produce this, it is almost axiomatic it has to be with Caliber involved.” Caliber didn’t immediately return a phone message left at its offices.

 

The complaint alleges that iBio issued an October 16, 2014 press release captioned “iBio Responds to Inquiries About its Role in Emergency Response to Ebola Virus Disease Outbreak” (here). The press release describes iBio’s relationship with Caliber, noting that the company has a licensing agreement with Caliber to collaborate on commercial opportunities for recombinant antibodies and antibody-related proteins. In a separate paragraph, the press release also states that iBio has offered to assist the U.S government in connection with manufacturing drugs that address the Ebola outbreak.

 

The complaint also refers to an October 17, 2014 online article that cites an unnamed iBio spokesperson as having said that “any lab that wants to make ZMapp vaccine using plant-based technology would have to license it from iBio; Caliber has License from iBio”

 

The complaint alleges that iBio’s representations about its “purported involvement in the emergency response to the Ebola virus outbreak” were misleading because “iBio’s relationship with Caliber had nothing to do with the production of ZMapp or combating the Ebola virus.” The complaint quotes extensively from two Seeking Alpha articles dated October 20, 2014 (here) and October 23, 2014 (here) which raise questions about iBio’s supposed involvement in the production of Ebola-related drugs, and point out that its license with Caliber is not in connection with Ebola drugs but instead, according to iBio’s prior SEC filings, relates to an oncological indication. After the publication of the first Seeking Alpha article, the company’s share price fell 32%, and the share price fell an additional 8% after the second article.

 

On first reading of the complaint, I wondered why it had referenced the October 11, 2014 newspaper article, because the article doesn’t say anything suggesting that iBio is involved with producing the Ebola medication or that iBio’s license relationship with Caliber has to do with Ebola. Then I read the stock purchase certification the plaintiff attached to the complaint. It shows that the plaintiff bought iBio shares on October 14, 2014 (7872 shares @1.89/share), October 17, 2014 (8400 shares @ 2.29/shre) and again on October 17, 2014 (15050 @ 2.20/share). Now I know that the complaint refers to the October 11 newspaper article in order to try to take the beginning of the class period back to a time prior to the plaintiff’s first purchase of iBio shares on October 14.

 

The first statement by iBio that the complaint cites in which the company referred to its relationship with Caliber is the October 16 press release. Unless the plaintiff can come up with some other statements from the company prior to October 16, the plaintiff will have difficulty pushing the start of the class period before October 16.

 

In addition, it is not going to be easy for the plaintiff to make of the October 16 press release what he attempts to make of it in his complaint. The press release itself does not say that iBio’s relationship with Caliber has anything to do with the Ebola drug. The press release does, two paragraphs after the mention of iBio’s license relationship with Caliber, refer to the iBio’s offer to help the federal government with the Ebola drug. The plaintiff is in effect seeking to argue that the subsequent reference in the press release is connected to the earlier reference to Caliber. The difficulty the plaintiff will have is that, as the complaint itself states, the company’s own prior SEC filings state that iBio’s licensing relationship with Caliber relates to an oncological indication.

 

In preparing this blog post, I trolled through a lot of the chatter that has been taking place on various Internet investment sites about the available alternatives for Ebola medication. It is obvious that there is a segment of the investment marketplace convinced there is money to be made out of the Ebola outbreak, by trying to pick the winners on the Ebola drug derby. Whatever one might make of this macabre attempt to attempt to profit from the Ebola outbreak, it is clear that among the companies that got caught up in the frenzy was iBio. Indeed, that appears to explain the plaintiff’s purchase of iBio shares. Where the plaintiff may struggle in this lawsuit, at least based on the allegations presented in the complaint, is showing that the iBio got caught up in the frenzy because of statements by iBio itself.

 

The one statement on which the plaintiff seeks rely that comes closes to linking iBio up to the Ebola drug efforts of  Caliber is the October 17 Internet article that supposedly said that an “iBio Spokesperson Says Any Lab the Wants to Make ZMapp Vaccine Using Plant-Based Technology Would have to License it from Bio; Caliber has License.” Even this statement doesn’t quite deliver the alleged misrepresentation on which the plaintiff purports to rely (that is, that Caliber’s license arrangement with iBio has to do with Ebola). For what it is worth, I wasn’t able to find this statement on the website to which the complaint refers, and even then, I am not sure how far the plaintiff will be able to get relying on a third party’s account of what an unidentified spokesperson may have said.

 

The Ebola outbreak presents a complicated and frightening public heath threat and involves a terrible affliction for the individuals infected by the virus. I never anticipated that a D&O claim would be among the things that would follow in the wake of the outbreak. Having failed to foresee the possibility this claim, I am not going to attempt to predict whether there will be other Ebola-related D&O claims. As long as I have been doing this, nothing should surprise me any more. I will say, it is always something new and different.