Official Committee of Unsecured Creditors v. Baldwin (In re Lemington Home for the Aged)

Case No. 10-4456 (3d Cir. Sept. 21, 2011) (Precedential)
The Third Circuit reversed the decision of the United States District Court for the Western District of Pennsylvania granting summary judgment to the defendants, officers and directors of debtor Lemington Home for the Aged (“Home”) in an adversary proceeding commenced by the Home’s Official Committee of Unsecured Creditors (“Committee”). The adversary proceeding asserted causes of action for breach of the fiduciary duties of care and loyalty, and for deepening insolvency. Exercising plenary review, the Third Circuit found that genuine disputes of material facts existed on all claims and remanded the claims for trial. Specifically, the Third Circuit found that the defendants were not shielded from liability by application of the business judgment rule and the doctrine of in pari delicto, which bars a plaintiff from seeking redress for wrongful conduct in which the plaintiff was an active and voluntary participant. With respect to the business judgment rule, the Third Circuit found that the Committee advanced evidence that the directors did not exercise reasonable diligence, which precluded the application of the rule on summary judgment. With respect to in pari delicto, the Third Circuit found that the Committee advanced evidence showing that the officers’ and directors’ alleged breaches of their fiduciary duties benefitted their own self-interest and not the Home, and that this exception to the doctrine of in pari delicto precluded summary judgment. With respect to deepening insolvency, the Third Circuit found that the Committee made allegations of fraud sufficient to preclude summary judgment. Finally, the Third Circuit observed that although a cause of action for deepening insolvency has not been formally recognized by Pennsylvania state courts, and although the viability of deepening insolvency as an independent cause of action has been increasingly called into question by courts and commentators, the Third Circuit’s precedent in this regard can only be overturned by the Circuit en banc.
Procedural context:
The Committee commenced an adversary proceeding on behalf of the Home, after receiving approval from the Bankruptcy Court to do so, against the Home’s officers and directors alleging breaches of fiduciary duties and deepening insolvency. The defendants moved for summary judgment and that motion was granted by the District Court. The Committee then appealed to the Third Circuit.
The Home, originally founded in 1883 as a place of refuge for elderly members of the African-American community in Pittsburgh, filed a chapter 11 petition in April 2005, following many years of financial and operational troubles. The Home was insolvent in 1999, and “going concern” warnings accompanied the Home’s audits for fiscal years 2002 and 2003. The operational troubles, which included an Administrator who worked only part time, a Chief Financial Officer who failed to maintain a general ledger and other critical financial records, and a board of directors which lacked a Treasurer and exercised no meaningful oversight over the Home’s finances for two years, culminated in the deaths of two residents, apparently due to staff neglect. The board of directors also attempted to transfer the Home’s principal charitable asset to an affiliated entity on whose board the Home’s directors also sat.
Sloviter, Fuentes, and Vanaskie

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