Delaware judge tells directors: You can run, but liability follows
4/29/2013
By Tom Hals
newsandinsight.thomsonreuters.com
WILMINGTON, Del. (Reuters) - For the second time this year, a judge has warned independent directors of a Delaware corporation with Chinese operations that their personal wealth can be at risk in shareholder lawsuits even after they resign their directorships.
Many Delaware-chartered Chinese companies rushed to list stock on U.S. stock exchanges in recent years through reverse mergers, but have since been dogged by plummeting share prices and questions about their accounting.
As a result, the Chinese companies have attracted a flurry of lawsuits from investors.
On Thursday, Vice Chancellor Sam Glasscock of Delaware Chancery Court refused to dismiss a lawsuit that seeks to hold current and former directors of Fuqi International Inc responsible for widespread accounting problems.
In his 45-page opinion, Glasscock said that the resignation by two independent directors, Eileen Brody and Victor Hollander, in protest over mismanagement did not necessarily protect them from liability.
"I do not prejudge the independent directors before evidence has been presented, but neither are those directors automatically exonerated because of their resignations," Glasscock wrote.
In February, the court's chief judge, or chancellor, Leo Strine, said in a bench ruling that independent board members had a duty to be more than "dummy directors," after they chose to quit rather than sue the chairman of Puda Coal.
Puda Coal's chairman, Ming Zhao, was alleged to have transferred the company's main assets to a company he controlled, leaving Puda virtually worthless.
"The rulings show that independent directors when faced with difficult and seemingly insurmountable obstacles may not automatically escape liability by simply resigning," Tariq Mundiya, a partner with Willkie Farr & Gallagher in New York said on Friday.
In his ruling, Glasscock noted that despite the resignations in protest against management, the independent directors could still be liable for past conduct, Mundiya said.
FUQI'S PATH
Both cases involve a claim that the defendants breached their duty to oversee the corporation, which carries one of the toughest standards for plaintiffs to meet. If the allegations are proven at trial, the directors could be personally liable for monetary damages.
Fuqi International followed the trajectory of many Chinese companies.
It listed its shares on Nasdaq through a reverse merger and in 2009 it raised $120 million through a public stock offering. Less than a year later, the company said it found accounting errors and uncovered transfers of cash out of the company totaling more than $130 million to entities that Fuqi has yet to verify were legitimate businesses. Fuqi has said the cash was recovered.
Fuqi's audit committee started to investigate, but its work stalled when management stopped paying the lawyers and accountants hired by the audit committee. The company said the lack of payment stemmed from a dispute with its insurer.
In protest, Brody and Hollander resigned from the board.
George Rich, a Fuqi shareholder, brought a derivative lawsuit seeking to recover from the directors the costs incurred by the accounting problems, an SEC investigation and the delisting of its stock from the Nasdaq.
To get past a motion to dismiss, Rich had to prove the directors utterly failed to implement a reporting system or consciously failed to oversee a company's operations, both very high standards.
"The board of directors may have had regular meetings, and an Audit Committee may have existed, but there does not seem to have been any regulation of the company's operations in China," Glasscock wrote in his ruling on Thursday.
His language mirrored that of Strine in February. "You're not going to be able to sit in your home in the U.S. and do a conference call four times a year and discharge your duty of loyalty," Strine had said. "That won't cut it."
Larry Hamermesh, a professor at that Widener University School of Law in Wilmington said the rulings make clear independent directors cannot quit in the face of a daunting challenge, but he said it left an unanswered question.
"I'm not sure what you would do. I would think that resigning in the face of a clear inability to perform one's duties as a director is probably the only viable choice."
The case is George Rich Jr v. Yu Kwai Chong, Delaware Court of Chancery, No. 7616._________________________________________
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