In an opinion out of the United States Bankruptcy Court for Delaware, known as the In re Cyber Litigation, No. 20-12702, 2023 Bankr. LEXIS 2584, 2023 WL 6938144 (Bankr. D. Del. Oct. 19, 2023), innocent directors were found to have defrauded investors based on one director having cooked the books and being in control of the Board of Directors.
Drivetrain LLC and Fraud
Here, a majority of the Board of Directors had approved a tender offer based on fabricated financials prepared by a director who for all practical purposes exercised control (the “Controlling Director”) over the remaining directors (“Innocent Directors”). Based on these financials, Drivetrain, LLC raised $72,000,000 in a tender offer of which the “innocent” directors received $2.2 million in connection with the repurchase of their shares. As a result of the tender offer, the Innocent Directors were found to have received over $2.2 million for their shares in Drivetrain.
After the fraud was revealed, the debtor (Drivetrain) filed bankruptcy and confirmed a plan. Per the confirmed plan, a liquidating trust was created. The liquidating trust sued the Innocent Directors alleging that the $2.2 million they received in exchange for their stock was a fraudulent conveyance, i.e. the transfer of the funds paid to the Innocent Directors was made with the intent to hinder, delay, or defraud creditors, or in the alternative, the transfer was made without the debtor receiving reasonably equivalent value while the debtor was insolvent or the transfers rendered the debtor insolvent.
In essence, the plaintiffs alleged that the tender offer was an exchange of the company’s cash for shares in a company that was actually deeply insolvent, making the shares worthless. The purpose of the transaction, plaintiffs alleged, was to defraud the investors (who were the company’s creditors).
The Controlling Director’s Intent
In this case, it was uncontested that the debtor was insolvent at the time of the transfer, that financials were false and that the Controlling Director intended to defraud. The issue was whether the Controlling Director’s intent to defraud could be imputed to the Innocent Directors. Here, the Court stated:
The innocence of various of the company’s board members does not mean that intent to defraud may not be imputed to the debtor. It is true that under Delaware law, which applies here, the intent of a transaction requiring board approval turns on the intent of a majority of the members of a company’s board. And it is true that here, a majority of the board was unaware of the fraud, having themselves been deceived by Rogas [the Controlling Director]. The question of imputation boils down to asking whether, notwithstanding the involvement of innocent board members, the debtor’s decision to make the challenged transfers was still caused by Rogas’ fraud. To that end, the law has long recognized that when Person A controls Person B, Person A’s intent may be imputed to Person B. And there can be no stronger case for the application of that principle than where Person A tricked or deceived Person B into voting in favor of a transaction. In such a case, the involvement of Person B is insufficient to break the causal chain between the person with fraudulent intent and the decision of the company. Because it is undisputed that this is what happened here, Rogas’ fraudulent intent can fairly be imputed to the company.
Drivetrain, LLC v. DDE Partners, LLC (In re Cyber Litig. Inc.), No. 20-12702, 2023 Bankr. LEXIS 2584, *5-6, 2023 WL 6938144 (Bankr. D. Del. Oct. 19, 2023) (emphasis added).
What makes this case all the more interesting is that Ernst & Young — an accounting firm, the Kroll firm — a firm specializing in forensic investigation, and the law firm Crowell and Moering were all three charged with investigating the whistleblower complaint. They all conducted investigations prior to the tender offer and none found fraud.
So, the question that could be asked: What more could the Innocent Directors have done if three firms, retained to review and opine on the debtor’s financial condition, could not find anything suspicious even after a whistle blower complaint? Perhaps it comes down to one director having an outsized role over the other directors and under such circumstances — directors beware.
