Fraud in Employment, Bankruptcy, Twombly and Iqbal?

In a recent Seventh Circuit decision, Employers that were looking to discharge employment agreements and stock options were provided additional support.  The 7th Circuit recently, upheld the district court’s dismissal of fraud claims by a former employee.  Jack Smith a sold controlling interest in his medical testing company together with related patents and intellectual property to Dade Behring Inc., a closely held corporation. 

Smith became an employee of the company and received options to buy 20,000 shares of Dade Behring.  Soon the relationship soured, Smith signed an agreement to end his employment accept 1.4 million in cash, and retained his stock options with an exercise price of $60 per share.  The companies stock was valued at $11 per share.  Three months later the Company later filed for Chapter 11 bankruptcy. 

The Chapter 11 reorganization was successful and the new company’s stock was valued at $76 per share.  Smith sued from fraud to try to get shares of the reorganized companies stock for his options in the company that filed for Chapter 11 bankruptcy.  The Seventh Circuit affirmed the dismissal, because there was nothing fraudulent in the bankruptcy proceedings.

The complaint merely stated that the common owners of the new company failed to disclose the likelihood of the reorganized company being successful during Smith’s negotiations with Dade.  The Court stated there is a duty of candor based on a special relationship between the parties, but it did not exist here.  The owners did not have to disclose the possibility of the reorganized company being successful three months prior to filing for Chapter 11 bankruptcy. 

Interestingly, the Seventh Circuit did not rely on Twombly (stating its 12 (b) (6) standard was limited to complex cases) or Iqbal (stating it  was distinguishable due to the qualified immunity for public officials). 

Either way, Employers and owners of newly reorganized companies are more insulated from fraud claims of employees of a predecessor company. 


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