In Ebert v. Dejoria (In re Latitude Sols., Inc.), a bankruptcy trustee sued a company’s former officers for breach of fiduciary duty. No. 18-10382, 2019 U.S. App. LEXIS 13060 (5th Cir. April 30, 2019). The trustee asserted that LSI was a sham company set up to fail from the outset and a vehicle for the officers to participate in a securities-fraud scheme known as “pump-and-dump,” while the officers claimed LSI was legitimately founded to develop and commercialize technology capable of remediating contaminated water. LSI was a publicly traded company that began operating in 2009 and developed patented technology for treatment of wastewater in the oil and gas industry. LSI was a speculative venture that eventually filed for bankruptcy in November 2012. After a jury trial, the jury found that an officer, Cowan, breached his fiduciary duties to the company, and awarded damages. Cowan appealed.
The Fifth Circuit held that the trustee had to prove: 1) that a fiduciary relationship existed; 2) that Cohen breached his fiduciary duty to LSI; and 3) that Cohen’s breach resulted in injury to LSI or benefitted him. The first element was not in dispute, and Cohen’s fiduciary duty required a duty of loyalty and duty of care to LSI.
The trustee’s case began by alleging an elaborate pump-and-dump scheme of LSI’s stock and wide scale fraud, but by the time the case was submitted to the jury, her argument was based entirely on alleged improper conduct related to a contract, the Jabil contract. The court quoted from the trustee:
[T]he fraud, the improper conduct, was entering into the Jabil contract in May 2011. That’s what inevitably caused this company to collapse, that’s what caused the damages, and that was the impetus of why or purpose of this fraudulent scheme was to enter into that Jabil contract, make a big splash, make it seem like this was a legitimate business when it had no hope for survival.
Id. The court noted the following evidence to support the trustee’s claim:
Cohen took on Appel as an advisor and spoke to him daily; Cohen sent Appel non-public information, including lists of shareholders and stock sales on a weekly basis; Cohen dealt personally with Jabil; prior to the Jabil contract, Cohen had not told anyone at Jabil about Appel’s conviction for securities fraud manipulation; LSI had no idea whether the machinery from the Jabil contract would work; LSI had no business plan, or leads to monetize the equipment from the contract, but Cohen and Appel drafted LSI press releases together to generate good news and publicize it; and while still a director, Cohen sold his stock in LSI for $400,000 because he “needed to have some money in the bank.”
Id. The court noted that the officer contended that his conduct was protected by the business judgment rule:
In Texas, the “rule . . . protects corporate officers and directors, who owe fiduciary duties to [a] corporation from liability for acts that are within the honest exercise of their business judgment and decision.” Sneed v. Webre, 465 S.W.3d 169, 173 (Tex. 2015) (citation omitted). Negligent, unwise, inexpedient, or imprudent actions are protected so long as “the actions [are] ‘within the exercise of their discretion and judgment in the development or prosecution of the enterprise in which their interests are involved.’” Id. at 178 (quoting Cates v. Sparkman, 73 Tex. 619, 11 S.W. 846, 849 (Tex. 1889)) (footnote omitted). The jury charge, however, instructed the jury on both what is required to show a breach of fiduciary duty, along with the parameters of the business judgment rule. Given Cohen’s actions, a reasonable jury could weigh the evidence, consider the business judgment rule, but conclude that Cohen breached his fiduciary duty to LSI.
Id. The court then disagreed with an argument that the trustee had to have expert testimony regarding the alleged pump-and-dump securities fraud scheme. The court also found that there was sufficient evidence to support the jury’s damages findings. “Considering the jury found Cohen liable for a breach of fiduciary duty based on an alleged pump-and-dump scheme and improperly propping up LSI by entering the Jabil contract for nefarious purposes, there is legally sufficient evidence for a reasonable jury to award $400,000 in damages.” Id.