In re Tower Air, Inc.
| Citation | 416 F.3d 229 |
| Decision Date | 03 August 2005 |
| Docket Number | No. 04-3633.,04-3633. |
| Parties | IN RE: TOWER AIR, INC., Debtor. Charles A. Stanziale, in his capacity as Chapter 7 Trustee of Tower Air, Inc., Appellant v. Morris K. Nachtomi; Steven L. Gelband; Stephen A. Osborn; Henry P. Baer; Leo-Arthur Kelmenson; Eli J. Segal; Terry V. Hallcom. |
| Court | U.S. Court of Appeals — Third Circuit |
John L. Reed (argued), Matt Neiderman, Duane Morris LLP, Wilmington, Delaware, John J. Soroko, Duane Morris
LLP, Diane E. Vuocolo, Philadelphia, Pennsylvania, for Appellants.
Bruce E. Jameson (argued), Prickett, Jones & Elliot, P.A., Wilmington, Delaware, Robert M. Kaplan, Robson Ferber Frost Chan & Essner LLP, New York, New York, Rodney M. Zerbe, Dechert LLP, New York, New York, P. Gregory Schwed, Loeb & Loeb, New York, New York, for Appellees.
Before NYGAARD, SMITH, and FISHER, Circuit Judges.
How far will the federal courthouse door swing open for a direct suit against corporate directors and officers for breaches of fiduciary duties? That is the difficult question presented in this case, which pits our federal notice pleading regime against Delaware's more restrictive notice pleading requirements. The appellant, Charles Stanziale, is the trustee of a bankrupt airline, Tower Air, Inc. He claims that Tower Air's directors and officers drove the company into insolvency by indifference and egregious decisionmaking. The District Court ruled that Stanziale failed to allege sufficient facts in his multi-count complaint to rebut Delaware's presumption that corporate fiduciaries act within the bounds of business judgment, which the State defines quite broadly. We conclude that the District Court erred by applying Delaware's stricter Chancery Rule 8 pleading standard, which does not apply in federal court. Under our federal notice pleading standard, we hold that Stanziale states four claims that, if proved, would overcome the protections of Delaware's business judgment rule.
A Delaware corporation principally operating from New York, Tower Air was founded in 1982 by defendant-appellee Morris Nachtomi as an international charter airline.1 The company soon expanded into domestic and international scheduled passenger service, and by 1988 Tower Air's signature route, which accounted for roughly one-quarter of its revenue, was scheduled passenger service from New York to Tel Aviv. By 1999, Tower Air maintained and operated fourteen Boeing 747s and employed more than 1,400 people worldwide.
Nachtomi served as Chairman of the Board and Chief Executive Officer of Tower Air from 1989 until 2000. Nachtomi also sat as a director from 1982 until 2000, and, except for six months in 1998, he was the company's president between 1986 and 2000. Nachtomi and his family owned a substantial majority of outstanding common stock and a controlling interest in Tower Air. As a result, the other defendant-appellees served at Nachtomi's pleasure, and Nachtomi controlled the firm's management and operations.2
In the mid-1990s, Tower Air hit turbulence. In 1996, the company lost twenty million dollars. Nevertheless, the company expanded its international passenger service, adding an Athens route in 1997. The next year, Tower Air added a route to Santo Domingo, Dominican Republic, because Nachtomi's daughter expressed personal interest in having the airline do so. Though that route never turned a profit, Tower Air flew to Santo Domingo until 2000. Meanwhile, Nachtomi ran Tower Air's Tel Aviv office with no oversight by the firm's other officers or directors. The Tel Aviv office kept separate financial records and its own bank account, making it virtually impossible for Tower Air's officers in New York to audit the Tel Aviv books. Eventually, the Tel Aviv office accumulated significant debt, and creditors forced Tower Air's Israeli operations into liquidation.
While his airline needed cash in the late-1990s, Nachtomi cut ticket prices so low that the company would not profit on certain flights even if its planes were full. At around the same time, Nachtomi and his co-directors failed to ensure that used passenger tickets were processed for payment from credit card companies and other third parties. After Tower Air filed for bankruptcy, unprocessed tickets valued at one million dollars were found in the company's U.S. offices. Failure to process those tickets hurt Tower Air's cash flow and impeded its ability to pay creditors. Further, Tower Air's directors did nothing when, in June 1998, Nachtomi and another officer received reports from Tower Air's Director of Safety of several serious incidents earlier that year, including a ground collision involving a Tower Air plane. Apparently, no one told the directors of these reports, or of negative maintenance reports, including failure to record aircraft servicing efforts and maintenance and repair needs.
In the meantime, Tower Air's jet engines were deteriorating. At first, Tower Air cannibalized its own engines to generate spare parts. In 1998, however, Nachtomi directed that Tower Air lease or buy new engines because, at least initially, doing so would be cheaper than repairing old engines. The directors agreed at a special meeting to borrow fifty million dollars in part to buy eight new jet engines. That meeting's minutes reflect no discussion of the need for new engines, the state of the old engines, or the financial impact of buying new engines. Later that year, the directors authorized Nachtomi to lease four new engines. Again, the board did not discuss the need for new engines, the state of the old engines, or the financial ramifications of buying and leasing versus repairing. Late in 1998, the board authorized the purchase of three new jet engines for more than eight million dollars.3 Meanwhile, Tower Air borrowed heavily against its existing engine stock to finance operating expenses and to pay off old debt. By 2000, eleven out of nineteen of Tower Air's planes were out-of-service. By contrast, seventeen out of twenty planes were in service in 1998.
Tower Air's fiscal descent culminated in a voluntary petition for Chapter 11 relief in 2000. Stanziale was appointed trustee for the company's bankruptcy estate. He remained trustee when the bankruptcy was converted from Chapter 11 to Chapter 7 in late-2000. In June 2001, Stanziale sued Tower Air's directors and officers for monetary and punitive damages, and other relief, as Tower Air's representative and for the benefit of its creditors and other parties in interest. In October 2001, Stanziale filed the Amended Complaint before us, which, in addition to the facts recounted above, alleges that the defendants breached their fiduciary duties of loyalty, good faith, and due care, grossly mismanaged Tower Air, and wasted corporate assets.
The Amended Complaint lists seven counts. Count One alleges that Tower Air's directors breached their fiduciary duty to act in good faith by consistently declining to repair Tower Air's older engines in lieu of leasing or buying new engines. According to the Amended Complaint, these decisions caused Tower Air to incur significant losses and merited no business judgment protection because they were taken in bad faith.4 Count Two alleges that Tower Air's officers also breached their fiduciary duty to act in good faith by leasing or buying new jet engines, by failing to tell the directors about maintenance problems, and by failing to address the maintenance problems.5 Count Three alleges that Tower Air's directors breached their fiduciary duty to make decisions in good faith when they approved multi-million dollar leases and purchases without consideration. Count Three also alleges that the directors failed to keep themselves adequately informed regarding the daily management of Tower Air by ignoring Tower Air's maintenance problems, letting Nachtomi run the Tel Aviv office independently, not reviewing Nachtomi's decision to fly the Santo Domingo route, and failing to establish management controls to ensure that used tickets were processed.
Count Four alleges that the officers breached their fiduciary duty to act in good faith or to keep themselves adequately informed by: failing to process used airline tickets, cutting airline fares to unprofitable levels, failing to oversee and control Tel Aviv operations, establishing and maintaining the Santo Domingo route "purely to please" Nachtomi's family, ceding all management and control to Nachtomi, failing to address operations and maintenance problems, failing to maintain jet engines, and failing to inform the board of the foregoing problems. Count Five repeats the allegations of Counts One to Four, and labels the acts and omissions by Tower Air's officers "gross negligence and mismanagement." Count Six repeats the allegations of Counts One to Five, and labels the acts and omissions by Tower Air's directors "corporate waste." Count Seven repeats the allegations of Counts One to Six, and labels the acts and omissions by Tower Air's officers "corporate waste."
The District Court ruled that the Amended Complaint failed to state a claim in light of Delaware's business judgment rule. In Delaware, the District Court explained, the business judgment rule is a "presumption that directors making a business decision, not involving self-interest, act on an informed basis, in good faith and in the honest belief that their actions are in the corporation's best interest." Stanziale v. Nachtomi, No. 01-403, 2004 WL 878469, at *3 (D.Del. Apr.20, 2004). According to the District Court, a plaintiff may overcome that presumption by alleging self-dealing or by pleading "with particularity" facts showing that the challenged decision was not the result of a valid business judgment. Id.
Because Stanziale alleged no facts showing self-dealing, the District Court considered whether Stanziale alleged specific...
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