Be Careful What You Wish For: Delaware Chancery Court Provides a Cautionary Tale Against Perfunctory Requests "For Other And Further Relief As The Court Deems Just And Equitable"

Thanks to Francis Pileggi, Delaware's premier blogger, for kindly alerting me to Nelson v. Emerson, 2008 WL 1961150 (Del. Ch., 5/6/08), in which Vice Chancellor Strine issued a well-crafted discourse on the interplay between Delaware's law governing corporate fiduciaries and federal bankruptcy law governing their conduct.  Francis wrote a long post quoting extensively from Vice Chancellor Strine's opinion, which I strongly recommend you first read, and will not repeat here.

Briefly, in this case, the company's former officer, director, and shareholder, wearing his tough guy hat as the company's major secured creditor, unsuccessfully challenged the company's bankruptcy filing in Chicago, with Bankruptcy Judge Jack B. Schmetterer issuing a lengthy opinion finding that (i) the former insider's claims should be only partially recharacterized as equity, but not equitably subordinated, and (ii) most importantly for purposes of this post, the debtor's chapter 11 filing was not in bad faith because there was a business to reorganize and the filing was a "rational reaction" to the creditor's threat to foreclose on debtor's business assetsRepository Technologies, Inc. v. Nelson (In re Repository Technologies, Inc.), 363 B.R 868 (Bankr. N.D. Ill. 2007) (pdf). 

District Court Judge Amy St. Eve, who's had one of the more interesting years as federal judge while overseeing the Tony Rezko and Lord Conrad Black of Crossharbour trials, heard the appeal in her spare time, and affirmed Judge Schmetterer's decision in its entirety.  Nelson v. Repository Technologies, Inc., 381 B.R. 852 (N.D. Ill. 2008) (pdf).  This opinion itself is worth reading for its reminder that "[b]ankruptcy is not a 'free-for-all' equity balancing act" and that dicta is defined by the Seventh Circuit (see my previous post entitled, Judge Posner's "Dictum" on "Dicta") as what a court "says" not what it "holds."  Id. at 867, 873.  As regards the latter point, Judge St. Eve concluded, "Nelson's argument that the Bankruptcy Court's language is dictum is defeated by his own motion requesting a finding of bad faith in support of dismissing [Repository]'s bankruptcy case."  Id., 381 B.R. at 873

After Judge St. Eve had ruled, Nelson backtracked and recrafted his theory of the case as a breach of fiduciary duty case instead of a bad faith bankruptcy case and filed a complaint in Delaware Chancery Court asserting that management breached its fiduciary duties to the corporation by filing bankruptcy in bad faith.  Adopting the standards for claim preclusion from the 7th Circuit, not Delaware (which were noted to be essentially the same as the 7th Circuit's), Vice Chancellor Strine held that Nelson was collaterally estopped from asserting a breach of duty claim based on management's alleged bad faith in filing the bankruptcy petition because, in the first instance, Judge St. Eve had already ruled in the district court case that Judge Schmetterer's finding on the bad faith issue was not "dicta."  As an aside, one has to wonder whether Nelson miscalculated by first having the District Court, not the Chancery Court, decide whether Judge Schmetterer's ruling was dicta.  Indeed, Judge St. Eve's own ruling looks a bit like dicta itself, since that ruling on dicta really wasn't essential to affirming Judge Schmetterer's decision.  But once she was asked to decide whether it was in fact dicta, and she did so decide, then Nelson was most definitely bound by that result.

Still, Vice Chancellor Strine covered his bases by not relying exclusively upon Judge St. Eve's holding that Judge Schmetterer ruling wasn't dicta, and instead undertook his own independent analysis of Judge Schmetterer's decision, drawing the following important two conclusions:

1.    "My ruling rests on the determination that the Bankruptcy Court's factual findings preclude any liability under Delaware fiduciary duty law. The directors of an insolvent company who, in good faith, undertake a strategy to benefit the company's equity holders cannot be held liable just because the strategy failed. The Bankruptcy Court has already determined that Repository's bankruptcy filing was a non-frivolous strategy and that it was partially successful. That precludes any finding that the Emersons breached their fiduciary duties by causing the Company to undertake that strategy."  Op., 2008 WL 1961150 at *2 (emphasis added).

2.    "More important, the Bankruptcy Court judge, knowing that Nelson had reserved the right to seek 'other and further relief as [the Bankruptcy Court] deems just and equitable,' had to decide the bad faith issue because two common types of such further relief, fee shifting and an order requiring the debtor's counsel to disgorge its fees [via a Rule 11 motion for sanctions], could have been premised on a finding that the bankruptcy filing and recharacterization action were frivolous and filed in bad faith.  The Bankruptcy Court therefore had to address this issue, which Nelson himself put in contention. Thus, Nelson is collaterally estopped from raising that issue here."  Op., 2008 WL 1961150 at *7 (emphasis added).


These conclusions raise two points worth remembering, one legal, the other strategic. 

  • First, that Delaware courts will rely upon exclusively bankruptcy based conclusions of law (here whether a bankruptcy case was filed in good faith as a matter of bankruptcy law) in determining whether there's been a breach of fiduciary duty under Delaware corporate law.
  • Second, Vice Chancellor Strine seized here on Nelson's seemingly perfunctory request at the end of his complaint "for other and further relief as the Court deemed just and equitable" (which probably accompanies 99.99% of all pleadings seeking affirmative relief in the United States) as a separate and independent basis for dismissing Nelson's complaint.  In so doing, he found that the bankruptcy court "had" to address the issue of whether the filing was in bad faith (instead of just dismissing the case based on an inability to reorganize) based on this open-ended request for relief "because two common types of such further relief, fee shifting and an order requiring the debtor's counsel to disgorge its fees, could have been premised on a finding that the bankruptcy filing and recharacterization action were frivolous and filed in bad faith."  Id.

How many times have people said they'll fulfill someone's wish when "hell freezes over"?  Well, here's a cautionary tale reminding us litigators slogging it out daily to "be careful what you wish for."  


Happy hunting, and thanks again Francis!

© Steve Jakubowski 2008

Written By:Francis Pileggi On May 12, 2008 7:59 AM

Steve,
Thank you for your insightful analysis of the case from a bankruptcy expert's perspective. I just noticed that, by coincidence, Judge St. Eve and Vice-Chancellor Strine, in an unrelated case, also were the jurists who heard cases in each of their respective courts in Chicago and Delaware against Lord Conrad Black (of Hollinger fame.)

Written By:Texas Bankruptcy Lawyer On October 18, 2008 10:56 PM

"The directors of an insolvent company who, in good faith, undertake a strategy to benefit the company's equity holders cannot be held liable just because the strategy failed."

This quote from Vice Chancellor Strine is very interesting to me, I would think intent would be extremely important in determining culpability, but in this case intent is disregarded because it was unsuccessful. I wonder how prevalent that line of thought is in other bankruptcy court rulings.

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