Hampshire Group, Limited v. Kuttner: A Tee Hee Analysis (Criticizing the Board)

The Vice Chancellor in this case was not happy having to address the issues of officer liability.  As the case noted in the very first sentence:  "This is an unfortunate case in which it is clear that the parties have spent far more money investigating and litigating over certain matters than those matters involved." 

Some of his ire was directed at the board, who he blamed for apparently allowing the matter to fester.  The board was, according to the opinion, quite deferential to the CEO. 

• The outside directors of [the company] were aware of [the CEO's] idiosyncrasies and taste for high living, and they indulged it. A good example is that [the CEO] replaced his company car, a Lamborghini, with another modest vehicle, a Ferrari. As we shall see, the board was either unwilling to or unable to actually direct [the CEO] even when they wanted to do so, and this case largely arose when the board’s hand was forced by the Internal Review Memorandum in June 2006 from relatively new employees.

Although this case involved allegations against two officers, the court observed that the fault associated with the CEO's reimbursement of expenses really rested with the board. 

• That this matter is in litigation is, in the first instance, a failure of Hampshire’s board. Under the corporation’s personnel policy (the “Personnel Policy”), expense reports are due, at the latest, two weeks after an employee incurs an expense. . . . For over a decade, the [company] board knew that [the CEO] was not complying with corporate policies and had a large backlog of unsubmitted expense reports. The board also knew that given his role as the leader of a fashion company and his flamboyant nature, [the CEO] would purchase samples of fashion products for use in the business, engage in business travel, and wine and dine clients. . . . The board had the power to require [the CEO] to submit his expense reports, to set a deadline disallowing reimbursement after a certain date, or even to fire [the CEO] if he continued to be delinquent in filing his reports. But instead of exercising that power, the board members just begged [the CEO] to submit his reports. At every board meeting, the board pleaded with [the CEO] to “[p]lease, please, get th[o]se expenses in.”

The court, therefore, seemed dismayed at the board's refusal to exert tighter oversight of the CEO.  Yet that is exactly the system that the Delaware courts have put in place.  The statement about the Lamborghini and Ferrari may demonstrate a certain profligacy by the CEO but it does not demonstrate that the board actually knew or condoned the act.  And, given cases like Amlyn, it is not clear that the board had any duty to ask about the particular car selected by the CEO.

As for the reimbursements, its relatively remarkable to suggest that the board of directors had an obligation to supervise the CEO and require submission of reimbursement forms.  To the extent resting with the board, those types of responsibilities are typically delegated to others, largely absolving the board of responsibility. 

The criticism of the board's behavior in this case is easy enough since the law suit involved officers.  Saying the same thing in a case involving directors and imposing liability for failing to adequately supervise the CEO would no doubt increase the diligence of the board.  No such Delaware case exists.

Finally, the opinion takes the board to task in the context of the investigation of the officers' behavior.  After having been notified by employees of potential impropriety by officers, the Vice Chancellor finds fault with the board for failing to start an investigation that included the board itself.  The outside advisers "were given wide latitude and a huge budget to investigate the issues in the Internal Review Memorandum" but did not authorize the advisers "to consider what role the board played in the matters raised in the Memorandum."

That a board would limit an investigation as narrowly as possible is again a result of the law in Delaware.  There is nothing in the case law that requires a board put on notice of possible impropriety to do anything more than examine the particular impropriety alleged. 

Whatever the criticism of the board's behavior in this case, the board appears to have been acting within the duties set out by the Delaware courts.  To the extent unhappy with the meagerness of these duties, the courts have the power to change them.  It will require, however, more than harsh sounding dicta.    

The opinion in Hampshire Group Limited v. Kuttner is posted on the DU Corporate Governance web site.