Corporate Governance

Hampshire Group, Limited v. Kuttner: A Tee Hee Analysis (Liability of Officers for Breach of Fiduciary Obligations)

By J Robert Brown Jr.

We are discussing Hampshire Group Limited v. Kuttner.  The case addresses the fiduciary obligations of officers.   

Officer liability has become an interesting area of development.  The Delaware Supreme Court held in Gantler v. Stephens, 965 A.2d 695  (Del. 2009) that officers have the same fiduciary obligations as directors.  See Id. at 708-709 ("That issue--whether or not officers owe fiduciary duties identical to those of directors--has been characterized as a matter of first impression for this Court.  In the past, we have implied that officers of Delaware corporations, like directors, owe fiduciary duties of care and loyalty, and that the fiduciary duties of officers are the same as those of directors.  We now explicitly so hold.").

Given that directors are rarely, if ever, found to have violated their fiduciary duties, the extension, at first blush, seems both reasonable and insignificant.  In fact, it has proved to be a fertile area of litigation.  Unlike directors, officers with identical fiduciary duties confront much greater risk of liability for two reasons.  First, as Gantler notes, the waiver of liability provision (Section 102(b)(7)) in Delaware extends to directors but not officers.  Officers cannot, therefore, hide behind a provision in the articles that eliminates liability for breaches of the duty of care.

Second, directors unaware of misbehavior can rarely be sued successfully.  Indeed, it has been called the hardest case to make in the fiduciary duty context.  Moreover, as the Delaware courts in San Antonio Fire & Policy v. Amylin concluded, directors have no real duty to ask for more information even when confronted with a transaction that would disenfranchise shareholders.  In short, ignorance, and even deliberate ignorance, is a defense. 

Its likely a defense for officers as well.  As a practical matter, however, they have a tougher time escaping knowledge.  They are involved in the day to day activities of the company and will have plenty of knowledge about what is going on inside the company.  There will be instances where officers know of and even participated in the wrongdoing.  In those circumstances, Delaware trial courts are going to have a much more difficult time dismissing the case. 

That was, in a nutshell, what happened in Hampshire Group.  Ultimately, the court concluded that one officer "knowingly caused [the company] to treat as reimbursable business expenses what was in fact concealed compensation to the [subsidiary's] executives" and "breached his duty of loyalty by participating in and permitting to continue an improper program whereby sweaters without market value were doled out to particular employees, who then gave them to charities and took personal tax deductions for the donation."  Two officers "breached their fiduciary duties by approving tuition payments that were improperly recorded as charitable donations."  Finally, the two officers "filed certain certifications regarding the integrity of Hampshire's financial statements and internal controls for the periods in which they knew that the books of the company were false."

As long as this approach remains in place, officers of Delaware corporations will confront a real risk of liability, even if the courts limit the application to breaches that were knowingly made. 

Full post as published by The Race to the Bottom on August 09, 2010 (boomark / email).