PRECEDENTIAL
UNITED STATES COURT OF APPEALS
FOR THE THIRD CIRCUIT
____________
No. 10-4456
____________
In re: LEMINGTON HOME FOR THE AGED
OFFICIAL COMMITTEE OF UNSECURED CREDITORS,
ON BEHALF OF THE ESTATE OF LEMINGTON HOME
FOR THE AGED,
Appellant
v.
ARTHUR BALDWIN; LINDA COBB; JEROME
BULLOCK; ANGELA FORD; JOANNE ANDIORIO; J.W.
WALLACE; TWYLA JOHNSON; NICOLE GAINES;
WILLIAM THOMPKINS; ROY PENNER; MELODY
CAUSEY; JAMES SHEALEY; LEONARD R. DUNCAN;
RENEE FRAZIER; CLAUDIA ALLEN; EUGENE
DOWNING; GEORGE CALLOWAY; B. J. LEBER;
REVEREND RONALD PETERS
___________
On Appeal from the United States District Court
for the Western District of Pennsylvania
(D.C. Civil Action No. 2-10-cv-00800)
District Judge: Honorable Arthur J. Schwab
___________
1
Argued July 11, 2011
Before: SLOVITER, FUENTES and VANASKIE,
Circuit Judges.
(Filed: September 21, 2011)
Robert S. Bernstein, Esq.
Kirk B. Burkley, Esq.
Nicholas D. Krawec, Esq. Argued
Krawec Bernstein Law Firm, PC
707 Grant Street
Suite 2200, Gulf Tower
Pittsburgh, PA 15219-0000
Counsel for Appellants
Mark R. Hamilton, Esq. Argued
Philip J. Sbrolla, Esq.
Cipriani & Werner
650 Washington Road
Suite 700
Pittsburgh, PA 15228
Todd M. Raskin, Esq.
Mazanec, Raskin & Ryder
100 Franklin‟s Row
34305 Solon Road
Cleveland, OH 44139
Counsel for Appellee Arthur Baldwin
2
Suzanne B. Merrick
Thomas, Thomas & Hafer
301 Grant Street
One Oxford Centre, Suite 1150
Pittsburgh, PA 15219-0000
Counsel for Appellee James Shealey
___________
OPINION OF THE COURT
___________
VANASKIE, Circuit Judge.
The Committee of Unsecured Creditors (“the
Committee”) on behalf of the Estate of the Lemington Home
for the Aged (“the Home”) appeals the District Court‟s
decision to grant summary judgment in favor of defendants,
the officers and directors of the Home, on the Committee‟s
breach of fiduciary duty and deepening insolvency claims.
The District Court found that summary judgment was
appropriate because the business judgment rule and the
doctrine of in pari delicto barred recovery on the breach of
fiduciary duty claims, and because the Committee was unable
to demonstrate a material issue of fact concerning whether the
defendants committed the fraud necessary to support a claim
of deepening insolvency. Because our independent review of
the record discloses genuine disputes of material facts on all
claims, we will vacate and remand for trial.
3
I.
The Home, a nonprofit corporation, has a storied place
in history. As the city of Pittsburgh grew in influence as an
industrial and manufacturing center in the 19th century, its
diverse population swelled. By 1870, the city had a
population of 86,076, a 74% increase in just ten years.
Among this population were about 2,000 African-Americans,
mostly free blacks who had been born in the North, a few
post-Civil War migrants from the South, as well as some
runaway slaves and their descendants. Many of these people
did not share in the industrial prosperity enveloping the city,
struggling both to make ends meet and to secure the civil
rights guaranteed to them by the Constitution.
In 1877, Mary Peck Bond, a daughter of Pittsburgh
African-American abolitionist and minister John Peck, is said
to have discovered that her friend, former slave and then-
centenarian “Aunt Peggy,” was living alone in squalor in a
damp basement. Together with friends, Mrs. Bond worked to
raise funds to provide a place of refuge for elderly members
of the African-American community. This effort‟s first
incarnation, “The Home for the Aged and Infirm Colored
Women,” was incorporated and dedicated on July 4, 1883.
Eventually, this facility would become known as the
“Lemington Home for the Aged,” also known as “Lemington
Center.” The Home was affiliated with Lemington Elder
Care Services, with which it had an interlocking Board of
Directors. In 1983, the Home was relocated to a facility on
Lincoln Avenue in Pittsburgh, and expanded to about 180
beds.
4
Almost immediately from the time of its relocation in
1983, the Home was beset with financial troubles. In its first
year at the new facility, the Home operated at a loss of
$429,000. Although an initial projection had indicated that
the Home would profit, this was based on “the Center being
aggressively marketed to produce . . . a more even mix of
Medicare, Medicaid, and private pay patients.” (Id. at 271.)
Instead, “95% of [the Home‟s] patients receiv[ed] Medicaid,
4.5% Medicare and 0.5% private payors.” (Id.)
This stagnation continued through the 1980s and into
the 1990s. Because the Home‟s financial condition was
rapidly deteriorating, the City of Pittsburgh, Allegheny
County, and several private foundations periodically assisted
to keep the Home in operation. By late 1986, the Home was
again maintaining its own operations, but had $4 million in
deferred mortgage debt.
Unfortunately, the Home‟s financial condition again
deteriorated. The U.S. Department of Health and Human
Services implemented a month-long ban on new admissions
in September, 1998. A comprehensive long-range plan
formulated at the Home‟s direction by Hershberg Salter
Associates in 1997 found that the Home had image problems
within the community, and recommended, among other
things, that it should hire an Administrator, a “quality human
resources staff,” and outside specialists. (Id. at 280-81.)
Defendant Melody L. Causey was hired as the Home‟s
Administrator in September, 1997. By 1999, the Home was
5
insolvent. “Going concern” warnings1 accompanied audits
for fiscal years 2002 and 2003.2 As of June 30, 2002, the
Home‟s total liabilities exceeded total assets by $1,941,959,
and total liabilities exceeded total assets by $1,675,397 at the
end of the 2003 fiscal year. In 2001, a study funded by the
Pittsburgh Foundation recommended that the Board replace
Causey with a “qualified, seasoned nursing home
administrator,” (A. 1179) and “review, revamp and re-staff
each department” (A. 1214). The Foundation provided a
grant of more than $175,000 to hire a new Administrator.
Causey, however, decided to use the grant for other purposes.
In December of 2002, Defendant James Shealey
became the Home‟s Chief Financial Officer. Shealey failed
to maintain a general ledger, and the Home‟s financial and
billing records were in deplorable condition. In March of
2004, the Board was informed that employee insurance
premiums were not paid even though payroll deductions had
been made for that purpose.
Beginning in 2003, the Home was cited for numerous
deficiencies “primarily as a result of staff failing to document
services rendered.” (Id. at 1355.) Causey commented that
“we continue to employ staff that should no longer be
employed by our organization” and “in the last eighteen
months, the nursing department alone caused the facility to
receive[] 22 nursing care deficiencies.” (Id. at 1527.)
According to Causey, in April or May, 2004, she informed
1
The “going concern” notices are intended to warn
that the “continued viability of an enterprise is in doubt.” (A.
6.)
2
The Home‟s fiscal year ended on June 30th.
6
the Board of Directors that, due to health problems, she had
been placed on part-time work status by her physicians.
According to her administrative assistant, she was absent
from the Home for periods of up to six or eight weeks at a
time. She was not replaced, although state law required the
Home to employ a full-time, licensed administrator.
From November of 2003 to January of 2005, the Board
position of Treasurer was vacant. The Treasurer was to chair
the Board‟s Finance Committee. There is evidence that there
was no meaningful oversight of the Home‟s financial
operations during this period.
In May of 2004, Causey recommended that the Home
file for bankruptcy. The Board opted to pursue other options
at that time. One of the options was obtaining a $1,000,000
loan from the Lemington Home Fund, which was
administered by the Pittsburgh Foundation. Approval of the
loan was conditioned upon the Board having a viability study
conducted. The Board declined to pursue such a study.
The Home‟s problems came to a head on July 26,
2004, when resident Terry Norwood, who suffered from
advanced diabetes, was found unresponsive without a pulse.
Although he had an advanced directive which specified that,
if he ceased to breathe, he should be resuscitated, no such
action was taken. Instead, a nurse left a message on a
physician‟s pager. Because of this death, the Pennsylvania
Department of Health cited the home for neglect, placed the
Home‟s license on provisional status, and provided a 90-day
window for the Home to correct its deficiencies.
The Home‟s accounting firm declined to continue to
work for the Home in the Fall of 2004 due to non-payment of
7
its bills. A medical records and billing consultant terminated
her services in August of 2004 due to non-payment.
Another resident, Elaine Carrington, died at the Home
on December 17, 2004, under circumstances suggesting
neglect. Because of this death, the Pennsylvania Department
of Health conducted another investigation. Among other
things, the Department noted that “[a]n administrator, or a
designee, is not present on the premises on a 24-hr. basis. In
the administrator‟s frequent absence, staff are confused as to
whom is to be in charge of the PC Unit.” (Id. at 1379.) The
Department further noted that “[t]he Administrator failed to
report . . . the unusual death of resident EC on 12/19/04” (id.
at 1385) and it “determined that the Administrator, Mel
Causey, lack[ed] the qualifications, the knowledge of the PC
regulations and the ability to direct staff to perform personal
care services as required” (id. at 1393.)
At the time of these incidents, records indicate that the
Board itself was in disarray. Minutes of Board meetings were
incomplete or non-existent. Administrator Causey noted in a
deposition that minutes were never kept of executive sessions,
at which compensation, among other issues, was discussed.
Attendance at Board meetings was often below 50%.
Although the Board‟s by-laws required a Finance Committee
with the Board Treasurer as chairperson, the position of
Treasurer remained unfilled. Instead, the Board relied on the
advice of Chief Financial Officer Shealey, although, as Board
Chair Arthur Baldwin noted in his deposition, the Board was
aware as early as December 2004 that Shealey was not
maintaining financial records.
At its meeting on January 6, 2005, the Board
considered options in case a proposed merger with the
8
University of Pittsburgh Medical Center did not occur. The
Board considered two options: bankruptcy and restructuring.
At this meeting, the Board voted “to close the nursing home
and assisted living entities,” “to retain Eva P. Mitchell,
community services [sic] and, if possible, Lemington
Residential Corporation #2,” and “to continue pursuing
UPMC for a possible merger/acquisition of Lemington.” (Id.
at 1371.)
The Board did not approve the filing of a bankruptcy
petition for another three months. Instead, at its January
meeting, the Board “agreed to stop admissions to [the nursing
home and assisted living facility] immediately.” (Id. at
1372.) At this meeting, the Board further noted that it was
“informed that Mel Causey ha[d] been working from home on
a part-time basis for several months and, as such, was not in
control of the activities that were taking place at the
facilities.” (Id.) The Board voted to terminate Ms. Causey.
In March, 2005, the Board hired Elizabeth Garrett as an
administrator. The Board informed Ms. Garrett that, because
it had decided to declare bankruptcy, the facility would not be
receiving new patients.
Handwritten notes from a Board meeting held on
March 15, 2005 indicate discussion of plans to transfer the
Home‟s principal charitable asset, the Lemington Home
Fund, held by the Pittsburgh Foundation, to Lemington Elder
Care, an affiliated entity. The members of the Home‟s Board
were also directors of Lemington Elder Care. By March 17,
2005, the Pennsylvania Department of Health determined that
the Home‟s deficiencies had been corrected. On March 24,
2005, a document called the “Lemington Elder Care
Transition Action Plan” was created, which, among other
9
things, provided for the “Lemington Elder Services
restructuring process,” to “Close Lemington Nursing Home
and Assisted Living Facilities,” “Obtain funding to assist with
the transition and restructuring of Lemington Elder Care,”
“Enlist all possible selling options of the Lemington Nursing
Home and Assisted Living Facility,” “Conduct Bankruptcy
Filing of Lemington Nursing Home & Assisted Living
Entities,” and “Restructure Lemington Elder Care to include
Community Services, Eva P. Mitchell and HUD #2 Project.”
(Id. at 812-815.) Consistent with the plan to shift the Home‟s
principal charitable asset to Lemington Elder Care, on May
27, 2005, Chairperson Baldwin drafted a letter to be signed
by the Pennsylvania Secretary of Aging, requesting that the
Pittsburgh Foundation provide
financial assistance to be used by Lemington
Center for legal counsel, communications
support, insurance and the services of a
turnaround expert in order to orchestrate a
caring, orderly and safe transition for its nursing
home and assisted living residents as
Lemington Center discontinues nursing home
and assisted living services and works through
bankruptcy reorganization.
(Id. at 808.)
On April 13, 2005, the Home filed a voluntary Chapter
11 petition in the United States Bankruptcy Court for the
Western District of Pennsylvania. The Committee of
Unsecured Creditors was appointed two weeks later. In early
May, W. Terrence Brown was hired by one of Lemington‟s
creditors to investigate the company‟s financial situation.
10
According to Brown‟s report, Shealey “admitted that the
general ledger and accounting system had not been
maintained „for some time‟ because of lack of staff and
trained staff.” (Id. at 878.) Furthermore, Mr. Brown reported
that he was unable to obtain “records of any checks written,
deposits made, bank statements or bank statement
reconciliations for any month of the current fiscal year. . . . I
do know that accounting records problems go back to at least
November 2003 and I do not know if the accounting system
itself was maintained after November 2003.” (Id. at 879.)
Importantly, Mr. Brown also related that “[t]he billing clerk
also admitted and Mr. Shealey confirmed that no Medicare
billings had been submitted to Medicare since at least August
2004. . . . I estimate that during this period there were
approximately 2,000 unbilled Medicare patient days.” (Id.)
On June 9, 2005, the Bankruptcy Court directed the
Debtor-in-Possession to obtain a viability study from
PrimusCare, a company previously hired by the Debtor. In its
report dated June 22, 2005, PrimusCare first noted that “[t]he
facility cannot operate in its current condition . . . and without
an influx of anticipated Medicare Recovery Funds would be
insolvent by the beginning of August. . . . Claim recovery
efforts are currently underway.” (Id. at 1582.) Among other
things, PrimusCare further opined that
[t]he overall knowledge of the Department
Heads appears to be limited. Many have been
placed into positions without solid training on
the main functions of their duties. Basic
internal controls are missing in many key areas
including census tracking, accounts receivable,
accounts payable, payroll, and resident trust
11
accounts. . . . Without these key internal
controls in place the facility is unable to
monitor and track financial performance.
(Id. at 1594.)3
PrimusCare also highlighted a number of positive
factors for the Home, including a high local population of
senior citizens, support from local government officials and
families, and local hospital interest in referring patients to the
Home. Consequently, PrimusCare concluded, if the Home
improved its image, recruited and developed qualified staff,
and secured approximately $2 million in working capital
needed to make necessary reforms, it could achieve the 90%
occupancy rate necessary to continue operations. PrimusCare
suggested that some of the necessary funding could be
obtained by, among other things, collecting approximately
$500,000 in unpaid Medicare reimbursements, appealing to
government sources for rate relief, and re-working the
Home‟s debt structure and the collective bargaining
3
This lack of records was underscored in a later e-mail
detailing PrimusCare‟s efforts to reconstruct the Home‟s
financial records: “The indicated available funds from
[Medicare claims] . . . is substantially less than the amount
estimated due [to] our discovery of the following: 1[.] The
census data was not accurate. . . . 2. A number of the patients
did not have appropriate documentation . . . . it is hard to
appreciate the lack of any viable financial structure. Virtually
all information we have sought in order to complete the
claims for submission has required painful searching an[d]
searching in order to construct/reconstruct the information
required.” (A. 1849.)
12
agreement. Notably, PrimusCare recommended that “board
members with for-profit, long term care management
experience” should be added, that “[e]ngaging a seasoned,
long term care management company with local and diverse
management experience is essential,” and that “[r]ecruitment
of key personnel with tremendous experience is vital.” (A.
1596.)
The Home delayed filing its Monthly Operating
Reports for May and June until September 2005. If they had
been filed, they would have shown that the Home received
nearly $1.4 million in Nursing Home Assessment Tax
payments.
At a Bankruptcy status conference held on June 23,
2005, no one expressed any interest in funding or acquiring
the Home. Consequently, the Bankruptcy Court approved
closure of the Home and the transfer of its residents to other
facilities.
On November 27, 2005, the Bankruptcy Judge granted
the Committee‟s motion to commence an adversary
proceeding against the Home‟s directors and officers. On
August 27, 2007, the Official Committee of Unsecured
Creditors filed its Second Amended Complaint on behalf of
the Debtor, asserting causes of action against the directors
and officers for breach of the fiduciary duties of care and
loyalty and for deepening insolvency. On September 10,
2010, the directors and officers filed a Joint Motion for
Summary Judgment. On October 25, 2010, the District Court
granted the motion, finding that the business judgment rule
and the doctrine of in pari delicto applied to preclude the
Committee‟s breach of fiduciary duty claims. The District
Court also found that, even considering the evidence in the
13
light most favorable to the Committee, the Committee would
be unable to show that there was fraud necessary to support a
claim of deepening insolvency. This appeal followed.4
II.
Our review of a District Court‟s grant of summary
judgment is plenary. Official Committee of Unsecured
Creditors of Allegheny Health, Educ. and Research Found. v.
PricewaterhouseCoopers, LLP, 607 F.3d 346, 351 (3d Cir.
2010). Summary judgment is governed by Rule 56 of the
Federal Rules of Civil Procedure, which provides that “[t]he
court shall grant summary judgment if the movant shows that
there is no genuine dispute as to any material fact and the
movant is entitled to judgment as a matter of law.” Fed. R.
Civ. P. 56(a). A material fact is “[a] fact[] that might affect
the outcome of the suit under the governing law.” Anderson
v. Liberty Lobby, Inc., 477 U.S. 242, 248 (1986). For an issue
to be genuine, “all that is required is that sufficient evidence
supporting the claimed factual dispute be shown to require a
jury or judge to resolve the parties‟ differing versions of the
truth at trial.” Id. at 248-49 (quoting First National Bank of
Arizona v. Cities Serv. Co., 391 U.S. 253, 288-89 (1968)
(internal quotation marks omitted)).
Because Appellants have brought claims for breach of
fiduciary duty as well as for deepening insolvency, we will
examine whether summary judgment is appropriate for each
of these in turn.
4
In this bankruptcy adversary proceeding, the District
Court had jurisdiction pursuant to 28 U.S.C. §§ 1331 and
1334(b). We have jurisdiction pursuant to 28 U.S.C. § 1291.
14
A.
Pennsylvania law, which codifies the fiduciary duties
owed by directors and officers of a corporation, provides as
follows for directors:
A director of a nonprofit corporation shall stand
in a fiduciary relation to the corporation and
shall perform his duties as a director . . . in good
faith, in a manner he reasonably believes to be
in the best interests of the corporation and with
such care, including reasonable inquiry, skill
and diligence, as a person of ordinary prudence
would use under similar circumstances. In
performing his duties, a director shall be
entitled to rely in good faith on information,
opinions, reports or statements, including
financial statements and other financial data, in
each case prepared or presented by any of the
following: (1) One or more officers or
employees of the corporation whom the director
reasonably believes to be reliable and
competent in the matters presented. (2)
Counsel, public accountants or other persons as
to matters which the director reasonably
believes to be within the professional or expert
competence of such person. . . . (b) Effect of
actual knowledge. – A director shall not be
considered to be acting in good faith if he has
knowledge concerning the matter in question
that would cause his reliance to be unwarranted.
15
15 Pa. Cons. Stat. Ann. § 5712(a)-(b) (2011). The standard of
care for officers is set forth as follows:
[A]n officer shall perform his duties as an
officer in good faith, in a manner he reasonably
believes to be in the best interests of the
corporation and with such care, including
reasonable inquiry, skill and diligence, as a
person of ordinary prudence would use under
similar circumstances.
Id. § 5712(c). These fiduciary duties are owed not only to the
corporation and its shareholders, but also to the creditors of
an insolvent entity. See Citicorp Venture Capital, Ltd. v.
Comm. of Creditors Holding Unsecured Claims, 160 F.3d
982, 987-88 (3d. Cir. 1998). Certainly, then, it is material
whether the directors‟ reliance upon the information provided
by one or more officers or employees was in “good faith,”
and whether there was a reasonable basis for relying upon
officers and employees of the corporation. It is likewise
material whether the officers have exercised “reasonable
inquiry, skill and diligence” in performing their duties.
In support of its claim of a breach of the duty of due
care, the Committee contends that the Board relied on
Administrator Causey‟s judgment, notwithstanding that it was
aware that she was working part-time in violation of state-law
requirements, and had a string of deficiencies on her watch.
Furthermore, the Committee asserts that the Board failed to
follow its established governance structure in not appointing a
treasurer and a finance committee. It thus did not discover
Shealey‟s complete failure to maintain financial and billing
records and his failure to bill Medicare for over $450,000 in
16
payables during one year. The Committee likewise argues
that, by eschewing their responsibilities, Causey and Shealey
breached their duty of due care. As to the duty of loyalty, the
Committee contends that the Board and its officers breached
their duty in that the Board “consciously chose to close the
home so that the [Lemington Home Fund, a charitable
lending source] could be diverted to Elder Care [another
organization which had an interlocking Board of Directors
with the Lemington Home],” (Appellant‟s Br. at 33), and that
the officers were dually employed by both the Home and
Elder Care, with CFO Shealey allegedly commingling funds
of the entities.
The evidence produced by the Committee is such that
a fact-finder could conclude that the Home‟s directors did not
have a reasonable basis to believe that Causey and Shealey
were reliable and competent. In this regard, the evidence of
the numerous deficiencies, the death of a resident in the
summer of 2004 that resulted in the placement of the Home‟s
license on probationary status, the staff and operational
deficiencies noted in the PrimusCare report, the fact that
members of the Board knew that Causey was not working full
time, and Shealey‟s failure to maintain even rudimentary but
essential accounting records would enable a fact-finder to
conclude that the directors had breached their fiduciary duty
of care. This same evidence would support an inference that
Causey and Shealey did not exercise “such care, including
reasonable inquiry, skill and diligence, as a person of ordinary
prudence would use under similar circumstances.” Finally,
the evidence presented by the Committee pertaining to plans
to divert the Lemington Home Fund to Lemington Elder Care
suffices to create a triable issue on the duty of loyalty claim.
17
The District Court, however, found that the business
judgment rule as well as the doctrine of in pari delicto applied
to shield the directors and officers from liability. We
disagree, and will discuss each of these doctrines to illustrate
why they are inapplicable here.
1. Business Judgment Rule
Pennsylvania law provides that “[a]bsent breach of
fiduciary duty, lack of good faith or self-dealing, any act as
the board of directors, a committee of the board or an
individual director shall be presumed to be in the best
interests of the corporation.” 15 Pa. Cons. Stat. Ann.
§ 5715(d) (emphasis added). As explained in Cuker v.
Mikalauskas, 692 A.2d 1042, 1048 (Pa. 1997):
The business judgment rule should insulate
officers and directors from judicial intervention
in the absence of fraud or self-dealing, if
challenged decisions were within the scope of
the directors‟ authority, if they exercised
reasonable diligence, and if they honestly and
rationally believed their decisions were in the
best interests of the company. It is obvious that
a court must examine the circumstances
surrounding the decisions in order to determine
if the conditions warrant application of the
business judgment rule.
Id. at 1048. As we have observed, “underlying the [business
judgment] rule is the assumption that reasonable diligence has
been used in reaching the decision which the rule is invoked
to justify.” Miller v. American Tel. & Tel. Co., 507 F.2d 759,
18
762 (3d Cir. 1974). “Factors bearing on the board‟s decision .
. . include whether the board . . . was disinterested, whether it
was assisted by counsel, whether it prepared a written report,
whether it was independent, whether it conducted an adequate
investigation, and whether it rationally believed its decision
was in the best interests of the corporation.” Cuker, 692 A.2d
at 1046. “Whether the duty of care has been met is a question
of fact to be determined by an examination of all the
circumstances in the case.” Wolf v. Fried, 373 A.2d 734, 735
(Pa. 1977).
The District Court relied upon the fact that the Board
was assisted by counsel, conducted several meetings, and
pursued various options before approving the bankruptcy
filing. To be sure, this is the type of evidence that could
support application of the business judgment rule as a matter
of law. But it is countered by evidence that the Board
received numerous red flags as to the competence and
diligence of Causey and Shealey. The fact that the Board
eschewed a viability study also calls into question the
adequacy of a pre-bankruptcy investigation. And finally,
there is the evidence that the directors favored Lemington
Elder Care over the Home. Where, as here, there is evidence
to support a rational conclusion that the directors did not
exercise reasonable diligence, application of the business
judgment rule cannot be decided on a summary judgment
motion.5 See Keyser v. Commonwealth Nat’l Fin. Corp., 675
F. Supp. 238, 259-61 (M.D. Pa. 1987).
5
The District Court erroneously held that the
presumption of the business judgment rule is overcome only
by evidence of gross negligence. The District Court cited a
19
2. In pari delicto
In pari delicto, expressed in its most basic form,
prohibits courts from “lend[ing] their good offices to
mediating disputes among wrongdoers.” Bateman Eichler,
Hill Richards, Inc., v. Berner, 472 U.S. 299, 306 (1985). For
the doctrine of in pari delicto to apply in Pennsylvania, “the
plaintiff [must] be an active, voluntary participant in the
wrongful conduct or transaction(s) for which it seeks redress,
and bear „substantially equal [or greater] responsibility for the
underlying illegality‟ as compared to the defendant.” Official
Comm. of Unsecured Creditors of Allegheny Health Educ. &
Research Found. v. PricewaterhouseCoopers, LLP, 989 A.2d
313, 329 (Pa. 2010) (quoting Bateman Eichler, 472 U.S. at
306-07).
With respect to in pari delicto in a bankruptcy context,
“the „trustee stands in the shoes of the debtor and can only
assert those causes of action possessed by the debtor.
[Conversely,] [t]he trustee is, of course, subject to the same
Delaware Supreme Court case which held that “under the
business judgment rule director liability is predicated upon
concepts of gross negligence.” Aronson v. Lewis, 473 A.2d
805, 812 (Del. 1984) (overruled on other grounds).
Pennsylvania, however, recognizes directors‟ and officers‟
liability for negligent breach of fiduciary duty. See, e.g., Wolf
v. Fried, 373 A.2d 734, 735 (Pa. 1977) (“[E]ven in the
absence of fraud, self-dealing, or proof of personal profit or
wanton acts of omission or commission, the directors of a
corporation may be held personally liable where they have
been imprudent, wasteful, careless and negligent and such
actions have resulted in corporate losses.”).
20
defenses as could have been asserted by the defendant had the
action been instituted by the debtor.‟” Official Comm. of
Unsecured Creditors v. R. F. Lafferty & Co., 267 F.3d 340,
356 (3d Cir. 2001) (quoting Hays & Co. v. Merrill Lynch,
Pierce, Fenner & Smith, Inc., 885 F.2d 1149, 1154 (3d Cir.
1989)).
As the District Court noted, however, there is an
exception to the applicability of in pari delicto, when the
complained-of action did not actually benefit the corporation.
Thus, although “principals generally are responsible for the
acts of agents committed within the scope of their authority,”
PricewaterhouseCoopers, 989 A.2d at 333, “where an agent
acts in his own interest, and to the corporation‟s detriment,
imputation generally will not apply,” id. at 334. This
“adverse interest” exception was set forth succinctly in
Lafferty as follows: “Under the law of imputation, courts
impute the fraud of an officer to a corporation when the
officer commits the fraud (1) in the course of his
employment, and (2) for the benefit of the corporation.” 267
F.3d at 358. As to whether an officer‟s conduct is motivated
by self-interest and benefits the corporation, the Pennsylvania
Supreme Court has outlined that “the appropriate approach . .
. is best related back to the underlying purpose of imputation,
which is fair risk-allocation, including the affordance of
appropriate protection to those who transact business with
corporations.” PricewaterhouseCoopers, 989 A.2d at 335.
Here, the District Court found that, because the
“defendants[] [did not] receive any personal benefit from its
[sic] decision to close Lemington,” the adverse interest
exception to the doctrine of in pari delicto did not apply. (A.
21.) The Committee has presented considerable evidence that
21
the alleged breaches of fiduciary duty were from the
defendants‟ self-interest and did not benefit the Home. For
example, the Committee has presented evidence that the
officers and directors were simultaneously affiliated with both
the Home and Lemington Elder Care, and thus stood to
benefit from a transfer of the Home‟s principal charitable
asset to Lemington Elder Care. The Committee also sets
forth that Shealey served as a Trustee of Mt. Ararat Church‟s
community-outreach entity during the time that this entity
was being pursued by the Board as a possible purchaser of the
Home. The Committee also argues that Causey resisted the
Pittsburgh Foundation‟s recommendation to replace her with
another individual, and that Shealey neglected to maintain
any financial records during his tenure. Thus, it is clear that
the alleged actions of the directors and officers were not only
harmful to the corporation, but also advanced their own self-
interest. The principles of fair risk allocation, moreover,
would likely counsel against the Home‟s assumption of the
risk that its directors and officers would consistently engage
in actions so completely contrary to its benefit.
Because the Committee has tendered sufficient
evidence that the directors‟ and officers‟ alleged breaches of
fiduciary duty did not benefit the Home but instead benefited
their own self-interest, the applicability of the “adverse
interest” exception presents a genuine issue of material fact.
Summary judgment on this basis is therefore inappropriate.
B.
Finally, it is necessary to deal with the claim of
deepening insolvency. This cause of action has not been
formally recognized by Pennsylvania state courts. Lafferty,
22
267 F.3d at 349. Nevertheless, relying on “decisions
interpreting the law of other jurisdictions and on the policy
underlying Pennsylvania tort law,” this Circuit has found that
“the Pennsylvania Supreme Court would determine that
„deepening insolvency‟ may give rise to a cognizable
injury.”6 Id. We further clarified the mechanics of this cause
of action in In re Citx Corp., 448 F.3d 672 (3d Cir. 2006).
There, we stated that “deepening insolvency” in Pennsylvania
is defined as “an injury to [a debtor‟s] corporate property
from the fraudulent expansion of corporate debt and
prolongation of corporate life.” 448 F.3d at 677. For such a
claim to succeed, it is necessary to demonstrate that the
directors‟ actions caused the deepening of insolvency. Id. at
678. We also concluded that fraud is necessary to support a
6
As Appellees have noted in their brief, courts and
commentators have increasingly called into question the
viability of “deepening insolvency” as an independent cause
of action. See, e.g., In re Global Service Group LLC, 316
B.R. 451 (Bankr. S.D.N.Y. 2004). Even if our precedent is
erroneous, however, it can only be overturned by this Court
en banc. See In re Merck & Co. Sec. Litig., 432 F.3d 262,
274 (3d Cir. 2005) (“precedential cases cannot be overruled
unless by the Circuit en banc”). Consequently, we are bound
in our decision to follow Lafferty, which recognizes
deepening insolvency as an independent cause of action in
Pennsylvania. Moreover, because no party argued that the
concept of deepening insolvency may not apply to, or may
involve a different standard for, a non-profit corporation, we
will not address that issue. See United States v. Albertson,
645 F.3d 191, 195 (3d Cir. 2011) (“[W]e usually refrain from
addressing an argument or issue not properly raised and
discussed in the appellate briefing.”) (citation omitted).
23
claim of deepening insolvency, and that “a claim of
negligence cannot sustain a deepening-insolvency cause of
action.” Id. at 681.
In Pennsylvania,
[a]s a general rule, fraud consists in anything
calculated to deceive, whether by single act or
combination, or by suppression of truth, or a
suggestion of what is false, whether it be by
direct falsehood or by innuendo, by speech or
silence, word of mouth, or look or gesture. It is
any artifice by which a person is deceived to his
disadvantage.
In re Reichert’s Estate, 51 A.2d 615, 617 (Pa. 1947).
The Committee alleges that fraud “is apparent in the
Board‟s failure to disclose to the creditors and the Bankruptcy
Court the Board‟s decision made in January 2005 to close the
Home and deplete the patient census, while delaying the
bankruptcy filing until April 2005,” (Appellant‟s Br. at 38),
and in “strategically omitting from the Monthly Operating
Reports required by Debtors-in-Possession substantial fees
paid post-petition to attorneys, accountants, and other
consultants to transition the Home‟s resources to Elder Care,”
(id. at 39.). The Committee points out that as early as
January, 2005, the Board had apparently voted to cease
admitting new patients. Without new patients and the
governmental and insurance support that they would bring, it
would be nearly impossible for the Home to generate the
income needed to operate. The Committee also notes that a
consultant stated that
24
[f]rom my 2005 meetings with Arthur Baldwin
it became clear to me that he was determined to
shut the Lemington nursing facility down and
had no interest in listening to or discussing any
ideas or plans which could lead to its continued
operation. . . . Unknown to me at the time was
that the Lemington Board had already decided
to shut down the home.
(A. 893.) The Committee also noted that a February 24, 2005
memorandum from the United Way of Allegheny County
reflects that Chairperson Baldwin had already informed
county officials that the Home would file for bankruptcy,
“which will lead to the closing of Lemington long-term care
and assisted living,” and result in the transfer of its residents
to other county facilities. (A. 798.) The Committee further
points out that Attorney Robert Sable wrote a letter to
Highmark Blue Cross Blue Shield, provider of health
insurance for the Home, on March 30, 2005, advising them
that employee health care coverage was needed for “only an
additional 60 days until the transition can take place.” (A.
1916.) The Committee thus asserts that, although the Board
knew that its actions would cause further deterioration of the
Home‟s finances to the detriment of its creditors, by its
silence, the Board consciously defrauded the Home‟s
creditors by implementing these policies and delaying the
filing of bankruptcy for a period of four months.
Furthermore, with respect to the officers, the Committee
alleges that, inter alia, the officers continued to commingle
the Debtor‟s funds with related entities, continued to breach
their fiduciary duties, continued to do business with vendors
although they knew that the Home was insolvent, failed to
collect Medicare receivables, upheld the policy of no patient
25
admissions, and directed the post-petition transfer of Debtor‟s
kitchen and catering equipment, among other items, to related
entities.
Considering this evidence in the light most favorable
to the Committee as the non-moving party, we find that there
is a genuine issue of material fact as to whether the directors
and officers fraudulently contributed to deepening the
insolvency of the Home. Summary judgment is therefore
inappropriate with respect to the Committee‟s deepening
insolvency claim.
III.
For the foregoing reasons, we will vacate the District
Court‟s grant of summary judgment on the breach of
fiduciary duty and deepening insolvency claims, and will
remand for trial on these issues.
26