- International Practice
- Securities Regulation
- Climate Change
- Financial Institutions
- Labor and Employment
- Strategic Communications
- Corporate and Securities
- Financial Restructuring
- Educational Institutions
- Private Funds
- Intellectual Property
- Public Finance
- White Collar Defense
- Environmental Strategies
- Internal Investigations
- Real Estate and Projects
Risks for In-House Counsel on the Rise
May 12, 2008
Can the GC be held liable when a corporation's officers engage in fraudulent conduct?
General Counsel may be held liable when a corporation's officers engage in fraudulent conduct, even when the general counsel is not aware of and does not participate in the wrongdoing. This was the holding in Miller v. McDonald (In re World Health Alternatives, Inc.), No. 06-10166, 2008 Bankr. LEXIS 1012 (Bankr. D. Del. Apr. 9, 2008), a recent bankruptcy case out of Delaware.
In Miller, the bankruptcy trustee sued nine officers on several counts, including breach of fiduciary duty, corporate waste, negligent misrepresentation, and aiding and abetting fraud. One of these corporate officers, Brian Licastro, was both Vice President and General Counsel of World Health Alternatives, Inc. Licastro moved to dismiss the claims against him on the basis that he neither participated in, nor had any knowledge of, the alleged fraudulent conduct. The bankruptcy court held that the trustee's claims against Licastro should not be dismissed because Licastro could be held accountable even if he did not know about the fraud or did not personally participate in the fraud.
Can a breach of fiduciary duty claim against general counsel be sustained based on failure to monitor?
According to the court in Miller, fraudulent conduct is not necessary for liability to arise. A breach of fiduciary duty claim against general counsel, for instance, can be sustained based on the general counsel's failure to implement and/or utilize "an adequate monitoring system … to safeguard against corporate wrongdoing." Id. at *29. Many general counsel are often also corporate officers, and as such they owe fiduciary duties to the corporation. As part of this fiduciary duty, officers must ensure that a corporate information and reporting system is implemented. In addition to implementing such systems, officers must monitor the systems and report potential risks or problems to the board. Lack of knowledge and failure to take action will not absolve officers of liability for a corporation's fraudulent conduct. The Miller case suggests that affirmative acts are often required to avoid liability.
The claim against Licastro for waste of corporate assets was also sustained even though Licastro argued that he was not involved in any wasteful activities. According to the court, it did not matter that Licastro was not a financial officer. Because the complaint alleged that Licastro, as VP of operations and general counsel, allowed and knew or should have known about the corporate waste, the court refused to dismiss the claim.
What action can General Counsel take to avoid liability?
An example of an express affirmative duty is the duty of a general counsel to inspect the truthfulness of SEC filings. See 17 C.F.R. Part 205 (Jan. 29, 2007). The court in Miller held that Licastro, as the in-house general counsel and the only lawyer in top management during the relevant period, "had a duty to know or should have known of the corporate wrong doings and [should have] reported such breaches of fiduciary duties by the management." Miller, 2008 Bankr. LEXIS 1012, at *32.
A proper claim against in-house general counsel for negligent misrepresentation does not require actual knowledge either. Where, as in Miller, the misrepresentations are press releases and SEC filings, the in-house general counsel should review these matters and should undertake an examination of the company's affairs to ascertain the trustfulness of these disclosures. Id. at *44. Failure to take these affirmative steps will subject the in-house attorneys to potential claims for negligent misrepresentation.
The Miller holding should be a warning to all in-house lawyers, and particularly to general counsel, who feel insulated from liability. Participation and knowledge are not required for general counsel to be held accountable for corporate wrong-doings. A general counsel serving as an officer of a corporation is charged with the duty to take affirmative steps to monitor fraudulent activities. Moreover, mere monitoring is insufficient; reporting and other corrective actions are necessary to avoid liability. Thus, in-house lawyers should proceed with caution, as they may be held accountable for failing to maintain and promote corporate integrity.