Board Sued for Failure to Monitor Finances in Weiss v. E-Scrub Sys., Inc.

In Weiss v. E-Scrub Sys., Inc., C.A. No. 13-710-GMS., 2014 BL 260961 (D. Del. Sept. 19, 2014), Stanley Weiss, a New Jersey citizen brought a derivative suit on behalf e-Scrub, a Delaware Corporation against four persons alleged to have been directors, Ralph Genuario, Maija Harkonen, John Packard, and Elizabeth Richardson as defendants. Two of the defendants, Richardson and Packard, moved to dismiss. 

The complaint alleged that the defendants breached their fiduciary duties due to the board’s failure to mitigate e-Scrub’s financial problems. Weiss asserted that the defendants violated their duties of good faith and loyalty by not using an adequate reporting system to manage e-Scrub’s finances. Weiss maintained that defendants knew of e-Scrub’s financial problems as of 2007, but failed to investigate. 

With respect to the right to maintain derivative suits, creditors replace shareholders after a corporation becomes insolvent and have the right to any residual value.  Consequently, creditors may have standing to bring this type of action. Standing, however, requires that creditors have that status at the time of the alleged breach of duty regardless of when it was noticed.  Furthermore, in order to prove a corporation’s insolvency, a plaintiff is required to allege facts that, if accurate, would make evident the fact that the corporation was insolvent. 

Weiss’s evidence of insolvency rested primarily on a statement by one of the defendants that the “stock was worthless”.  The United States District Court for the District of Delaware held this to be insufficient evidence of e-Scrub’s insolvency. Id. (“This statement is insufficient to show e-Scrub was bankrupt or had such insufficient assets that the business could not reasonably continue and succeed.”).  In addition, the court found that plaintiff had become a creditor “following the alleged wrongdoing”.  As a result, the court granted Packard’s and Richardson’s motion to dismiss. 

The primary materials for this case can be found on the DU Corporate Governance website.

Patrick Rohl