IN THE COURT OF CHANCERY OF THE STATE OF DELAWARE. GARY S. NITSCHE, derivatively on : behalf of MIDCOAST COMMUNITY BANK, : : Plaintiff, : :

Transcription

1 IN THE COURT OF CHANCERY OF THE STATE OF DELAWARE GARY S. NITSCHE, derivatively on : behalf of MIDCOAST COMMUNITY BANK, : : Plaintiff, : : v L. PETER TEMPLE, ROBERT R. AERENSON, : DAVID G. BULL, ROBERT DAYTON II, : DOMINIC M. GIOFFRE, RONALD E. SCHAFER,: THOMAS J. SHOPA, SR., JAMES BERG, : JAMES A. LADIO, and MICHAEL J. LUMIA, : : Defendants, : : and : : MIDCOAST COMMUNITY BANK, : : Nominal Defendant. : : C. A. No. : -VCG Court of Chancery Courthouse Courtroom No. The Circle Georgetown, Delaware Friday, May, 0 :0 p.m BEFORE: HON. SAM GLASSCOCK III, Vice Chancellor SETTLEMENT HEARING and RULINGS OF THE COURT New Castle County Courthouse 00 North King Street - Suite 00 Wilmington, Delaware 0 (0) -0

2 APPEARANCES: THAD J. BRACEGIRDLE, ESQ. Wilks, Lukoff & Bracegirdle LLC for Plaintiff S. MARK HURD, ESQ. Morris, Nichols, Arsht & Tunnell LLP for Defendants L. Peter Temple, Robert R. Aerenson, David G. Bull, Dominic M. Gioffre, Ronald E. Schafer, Thomas J. Shopa, Sr., James Berg, and Nominal Defendant MidCoast Community Bank DAVID G. HOLMES, ESQ. Cross & Simon LLC for Defendant Michael J. Lumia

3 0 0 MR. HURD: Good afternoon, Your Honor. THE COURT: Good afternoon. MR. HURD: It's a pleasure to be here in Georgetown, as always. THE COURT: I can't tell you what a pleasure it is to be up on the bench. I spent the last half hour unsuccessfully trying to change passwords on accounts and get a routing number entered into an account online, and it's just a pleasure to be dealing with you. So -- MR. HURD: We'll do our best to keep the pleasure going, Your Honor. THE COURT: -- just put an order in front of me, I'm liable to sign it. It's a pleasure to see you. MR. HURD: Additional vacation days for all court personnel. Your Honor, Mark Hurd on behalf of defendant MidCoast and the individual defendants, other than Messrs. Ladio and Lumia. I rise at this time, really, to make an introduction to the Court. It's Mr. Eric Hoerner, who is the chief executive officer of MidCoast. THE COURT: Welcome, Mr. Hoerner.

4 0 0 MR. HOERNER: Thank you. THE COURT: And I don't mean to give the impression that all the judges on the Court of Chancery are nuts. Just a little frustrated. But I'm okay. I'm doing well. MR. HURD: Your Honor might want to look into something called LastPass, or there are other software patch type things that do that, that manage all your passwords. They actually work reasonably well. THE COURT: I think what I want to look into has a top that draws with a corkscrew, but thank you. MR. HURD: Thank you, Your Honor. MR. BRACEGIRDLE: Good afternoon, Your Honor. THE COURT: Good afternoon. MR. BRACEGIRDLE: Thad Bracegirdle appearing -- THE COURT: Pleasure to see you, Mr. Bracegirdle. MR. BRACEGIRDLE: Likewise, Your Honor. Appearing on behalf of the plaintiff Gary Nitsche. And while it sounds like Your Honor's

5 0 0 technological issues are a tough act to follow, I will certainly do my best. Your Honor, we're here today at a hearing for the Court to consider a proposed settlement of this derivative action. Just by way of brief background, Your Honor, MidCoast Community Bank is a Delaware corporation that was formed in January of 00. The plaintiff, Gary Nitsche, purchased his shares in that corporation also in 00. And then, in August of 00, the bank underwent a restructuring whereby the Delaware corporation became a 00-percent-owned subsidiary of a holding company formed in Pennsylvania, and that is MidCoast Community Bancorp. And in that restructuring, all outstanding shares in MidCoast Bank were exchanged on a one-for-one basis for shares in the Pennsylvania holding company. Mr. Nitsche has owned shares of either MidCoast Bank or the holding company at all times since 00, and he confirmed that in the affidavit we've filed in support of this settlement in accordance with Rule.(c). So fast-forward, then, to March of 0. MidCoast, at that time, agreed to a stock-for-stock merger with Bryn Mawr Bank. And in

6 0 0 that proposed transaction, Bryn Mawr was to acquire MidCoast for approximately $ million in stock. And in that proposed transaction, the stockholders of Bancorp would have received publicly traded shares of Bryn Mawr Bank. Just a few months after that, in August of 0, Bryn Mawr announced that it had terminated the merger agreement with MidCoast. And just two weeks following that, Bryn Mawr -- I'm sorry. MidCoast terminated James Ladio, its CEO, and one of its founders. And what was not publicly known at that time, however, was that MidCoast was also being scrutinized by federal authorities who were investigating activities that were undertaken by Mr. Ladio and two other MidCoast officers, Michael Lumia and Brian Bailey. Ultimately, federal criminal charges were brought against Mr. Ladio and Mr. Bailey accusing them of bank fraud and money laundering. Mr. Ladio ultimately was sentenced -- he pled guilty and was sentenced to months in prison. And Mr. Lumia was charged by the FDIC and ultimately entered into a consent decree with that federal oversight body. The criminal allegations in those

7 0 0 matters are recounted in detail in our amended complaint, which incorporated the federal indictments at issue, but in summary, what they alleged was that beginning in July of 00, Mr. Ladio, Mr. Lumia, and Mr. Bailey conspired to use MidCoast's banking assets to fund Mr. Ladio's personal debt. And they did so by initiating fraudulent loans between MidCoast and its commercial borrowers, who then would separately lend those funds to Mr. Ladio. Mr. Ladio did this to pay off personal mortgages and lending facilities that he had been given by Wilmington Trust and which Mr. Ladio had defaulted on in early 00. Through these schemes, Mr. Ladio obtained a total of approximately $. million from two bank customers, both of which had been lent those funds by MidCoast through lines of credit. And in both cases, Mr. Ladio, with the assistance of Mr. Lumia and Mr. Bailey, had arranged in advance to borrow funds from those bank customers, who then applied for the lines of credit. Those applications went to an executive loan committee of the bank on which Mr. Ladio sat, and that committee approved those lines of credit with little or no scrutiny. Those bank

8 0 0 customers who obtained the lines of credit then transferred the funds to Mr. Ladio, who in turn gave promissory notes for those funds. And it was this conduct that prompted the federal investigations of MidCoast and also led to indictments against Mr. Ladio, Mr. Lumia, and Mr. Bailey. Move forward again, then, to 0, when Mr. Nitsche determined to investigate how these events could have happened at MidCoast Bank and, also, whether there was any connection to the termination of the Bryn Mawr merger. Certainly the timing of the events appeared to be more than coincidental. So to that end, on June of 0, my firm delivered, on Mr. Nitsche's behalf, a written demand to MidCoast to inspect the books and records pursuant to Section 0 of the general corporation law. And the purpose of that demand was to investigate board oversight of the bank's lending practices, as well as the facts that had been alleged in the federal indictments against the individual officers and the circumstances surrounding the terminated Bryn Mawr merger. In October of 0, my firm ultimately filed a complaint to compel MidCoast to produce the

9 0 0 books and records that had been requested in the demand, and the bank ultimately agreed to settle that action and produced to my firm over,000 pages of internal records, which included minutes of board meetings, minutes of the executive loan committee meetings, as well as copies of reports from outside advisors that the bank had engaged. And what we saw in those documents confirmed what we suspected; and that is, what we believed to have been weak internal controls over MidCoast's lending practices, an absence of effective oversight by the board of Mr. Ladio's activities, and some other facts, including that many of the directors had been on the board since 00, at the time the bank was founded and, also, that some of them had borrowed substantial funds from the bank for their personal businesses, a total of which was about $0 / million. And what the documents also told us, we believed, was that the executive loan committee was, in our view, ineffective. And one outside advisor that the bank had engaged determined this governing body employed what it called a rubber-stamp approval process and operated within a "totalitarian

10 0 0 0 environment" that was dominated by Mr. Ladio. THE COURT: A totalitarian environment? MR. BRACEGIRDLE: That was the word that the advisor used, in quotes. THE COURT: All right. MR. BRACEGIRDLE: And the bank also produced minutes from the executive loan committee showing the approval of the two loans Mr. Ladio used to obtain funds from bank customers, and those reflected that those particular transactions were approved summarily and without any questioning or scrutiny. Finally, the books and records that the bank produced to us gave us a reason to question the board's oversight of Mr. Ladio. It appeared that the board first learned of the criminal conduct by about August of 0. Then held a board meeting in September of 0 where Ladio was questioned about his loans, but apparently there was no disciplinary action taken against him. In fact, Ladio remained as CEO and a director of MidCoast up to and including the point when Bryn Mawr trust agreed to acquire the bank in March of 0.

11 0 0 And there was no evidence that we saw that anybody disclosed Mr. Ladio's activities to Bryn Mawr Trust until July of 0, by which time federal regulators were investigating the bank, and the bank's offices had been visited by agents from the FBI and the IRS. Bryn Mawr ultimately sought to terminate the merger agreement on the grounds that MidCoast had knowingly breached representations and warranties in that agreement. So based on these facts, Mr. Nitsche authorized my firm to file a derivative and class action complaint alleging claims for breach of fiduciary duty against the MidCoast directors for what we allege was sustained and systemic bad-faith failure to exercise oversight. Now, the defendants moved to dismiss that original complaint, alleging a variety of defenses, some of which were based on the fact that Bancorp, the holding company, was a Pennsylvania corporation, and Pennsylvania, as we have learned, has stricter rules than Delaware with respect to such issues as the ability of stockholders to bring direct claims, as well as certain demand requirements that must be fulfilled before a stockholder can pursue a

12 derivative suit. 0 0 And so to address some of these arguments, my firm filed an amended complaint that removed the class action direct claims and also factually supplemented the derivative claims. The defendants renewed their motion to dismiss against that amended complaint, again raising some -- what we believed to be some unusual issues arising from the bank holding company structure and, again, the potential application of Pennsylvania law to the derivative claims. And the most significant issue that we recognized in that -- raised by that motion, and one that appeared, to us, to be of first impression in Delaware, was the application of Pennsylvania law to derivative claims in a situation when the shareholders' stock in the Delaware subsidiary was exchanged through a reorganization during the time period of the conduct in question. Now, Pennsylvania law does not allow for demand excusal, so that issue potentially could have been case dispositive. We believe that we had sound arguments in our favor, but of course, there was no way to predict how that issue of first impression

13 0 0 might have been decided by this Court, and perhaps by the Delaware Supreme Court. Additionally, we recognize there is a challenge in this case, whereas we were essentially alleging Caremark claims. And while we believe that the facts established a breach of fiduciary duty for lack of oversight, we certainly acknowledge that those types of claims typically are very difficult to prove. And also, Your Honor, we learned during motion practice that MidCoast's directors and officers and insurance carrier had denied coverage for the claims. And therefore, even if we had succeeded on the merits, we faced the prospect of having to collect judgment against the individual defendants for the company's benefit. So for these reasons, we began engaging in good-faith settlement negotiations with the defendants on therapeutic measures that could be implemented at the bank to address the issues we had raised in our complaint. And MidCoast agreed to implement a series of corporate governance reforms that we believe will help prevent the very kinds of conduct that led to the claims alleged in this case. And just by way of brief summary, Your

14 0 0 Honor, the first of those is the holding company has agreed that it will propose and recommend, at its next annual stockholders meeting in September, a stockholder vote that would amend the charter to eliminate the classified board. So the upshot of that will be when the current classes of directors serve out their terms by 00, all directors on the board will be up for annual election every year. The second reform is the bank's directors and the members of the executive loan committee will undergo training by the end of this year on the best practices for loan underwriting and credit administration. Third, the bank and the holding company will adopt policies that mirror the NASDAQ requirements for independent directors and audit committees. And those particular requirements are reflected and found in NASDAQ Rule 0. We provided the Court with a copy of that rule for Your Honor's convenience, in support of the settlement. Very briefly, Your Honor, those -- that NASDAQ rule has a requirement for a majority of directors on the board to be independent, and the rule has strict requirements for a director to qualify as

15 0 0 independent. There are additional requirements in that rule for audit committee members, which include there are minimum standards of proficiency with accounting standards. And then the fourth reform, and one that we think is, really, directly relevant to our claims here, is that on top of those independence requirements, the bank has agreed that to be deemed independent, a director also may not either individually or through affiliates have outstanding loans with the bank in excess of percent of the bank's total loan portfolio. Currently, that number would constitute a threshold of about $. million, and three of the directors, at the time that we filed the amended complaint, had loans in excess of that amount. Plus, the bank has agreed that in the aggregate, independent directors on the board may not hold loans in excess of percent of the bank's total portfolio. So we believe that this particular reform addresses directly one of the main concerns that was raised by the derivative complaint. And that is that the directors' ability to access more than $0 million of loans, in our view, compromised their

16 0 0 ability to objectively and competently oversee and discipline Mr. Ladio, as the bank's CEO. So in total, Your Honor, both the plaintiff and the defendants believe and submit that these reforms provide more than an adequate basis on which to settle and release the derivative claims in this action. So in compliance with the Court's scheduling order, MidCoast distributed notice of the settlement to stockholders on March of this year, and then again on March 0th, after we learned that some stockholders had received an incomplete copy of the notice, and MidCoast filed an affidavit from Brian Novacich attesting to these facts. Since the dissemination of the notice, no objections to the settlement have been filed with the Court, and also, no stockholders have appeared in court today for this settlement hearing. THE COURT: Let me ask Madame Clerk to go out and call the matter in the well of the courthouse to make sure no disgruntled stockholders are lurking about. I suspect the answer will be in the negative, but for the record, I'd like her to try. (Ms. Kruger briefly left the courtroom.)

17 0 0 MS. KRUGER: No response, Your Honor. THE COURT: Thank you. The clerk has called the matter in the well of the courthouse. No one has appeared. So please proceed. MR. BRACEGIRDLE: Thank you, Your Honor. So in summary, the parties submit that the proposed settlement meets all the requirements of Rule. and request that it be approved by the Court. I'm prepared to move on to the fee application, unless Your Honor has any questions about the substance. THE COURT: Why don't you let me ask Mr. Hurd, I assume you have nothing to add at this point? MR. HURD: That is correct, Your Honor. Nothing to add from the defendants. THE COURT: All right. Thank you. Mr. Holmes, anything from your client's point of view? MR. HOLMES: Nothing to add, Your Honor. THE COURT: All right. Thank you. Counsel, before we go on to other

18 0 0 issues, let me pass on the settlement. As you're aware, I need to evaluate the settlement. Because of the agency problems involved, this settlement, it seems to me, is a creative settlement, given what was before the parties. It's clear that there were great problems at the corporation, but oversight claims are notoriously difficult. This would have required a showing of bad faith. There was a question as to standing as Delaware stockholders pursuing Delaware law or Pennsylvania stockholders pursuing Pennsylvania law that would have made this particularly difficult. I'm not so sure -- it depends on what you believe about short-termism or not -- whether a staggered board is a good or a bad thing, but it's clear to me that, with respect to the other three elements of the settlement, they are clearly a benefit to the corporation and the stockholders thereof. And so for all those reasons, I think, under the rule, I must approve the settlement. MR. BRACEGIRDLE: Thank you, Your Honor. So separate from and following the parties' agreement on the substantive terms of the settlement, the bank negotiated and agreed to pay up

19 0 0 to $00,000 as reimbursement of costs and payment of attorneys' fees. As I explained in my supporting affidavit filed with the Court, my firm has expended a total of hours on this matter on a contingent-fee basis, and this work included preparing the demand for books and records and litigating to enforce that demand. This time that was expended has an approximate value of $0,000. And so when added to the $, of expenses incurred by Mr. Nitsche and my firm, we believe this reflects that the fee award being requested includes practically no premium and reflects a reasonable fee that is consistent with this Court's precedent in cases where settlements have been achieved through therapeutic, rather than monetary, benefits. And those cases that we cite are in our supporting brief. The Court has not hesitated to award some premiums on counsel's time to reflect the risk of a contingent fee, but under the proposal here, essentially my firm will be not getting any bonus on our time. THE COURT: And I assume this was a contingent fee case; correct? MR. BRACEGIRDLE: Yes, it was, Your

20 0 0 0 Honor. If I didn't say that, yes, it was. And yeah, in terms of the costs, originally, Mr. Nitsche had reimbursed some of the costs himself, about,000 or so, in connection with the 0 aspects, and there was about,000 or so in costs that my firm bore. And then, finally, Your Honor, we request that the Court authorize payment to Mr. Nitsche of a $,000 incentive award to be paid from the overall attorneys' fee being paid to my firm. We believe that it's merited here because this is an atypical derivative case. This is not a situation where the corporation is publicly traded with many thousands of stockholders throughout the country. MidCoast Bank, or the holding company now, has approximately 0 stockholders. It's a local, Delaware-based community bank. Mr. Nitsche is a member of the community in Wilmington where the bank is located. He himself is an experienced and prominent attorney in the community, and he was more involved in this matter than perhaps most representative plaintiffs. He assisted us in formulating the pleadings, discussing strategy, fact investigation,

21 0 0 and he participated in all major decisions, including the settlement terms that are being presented today. And so, based on that, we ask that Mr. Nitsche receive what we think is a relatively modest award in recognition of his efforts and participation. And again, we believe this is consistent with the Court's precedent in other cases where similar awards have been granted to representative plaintiffs. So that's all that I have on the fee application, unless Your Honor has any questions. THE COURT: No, I do not. Let me ask Mr. Hurd and Mr. Holmes if there's anything they wish to add at this time. MR. HURD: Nothing, Your Honor. THE COURT: Thank you. MR. HOLMES: I have nothing to add, Your Honor. THE COURT: All right. Thank you. As you're aware, this Court employs the factors laid out by our Supreme Court in the Sugarland case. I'm not going to go through all of them, because it seems quite obvious to me that this fee is reasonable. It is, as has been stated, barely over the firm's hourly amount. It's a contingent-fee case. There's almost

22 0 0 no benefit flowing to the firm above having sold its labor, and nothing flowing for the risk which was taken. Once again, I look at what was achieved. It's true, it's therapeutic, but it seems to me that the therapeutic benefit is not only substantial, but it's directly related to the gravamen of the underlying case. And so it is appropriate that, benefit having been worked on behalf of the company, that there be a fee award. Given the fact that it is a very modest, if any, premium, as I've said, over the implied hourly rate, given the firm's usual billing rate, that's an easy decision. I'm going to grant the fee awarded. That leaves whether Mr. Nitsche should receive $0,000 of that $00,000 fee. It's quite true that we have awarded fees to litigants who have achieved a benefit on behalf of the corporation in addition to what their attorneys have done. I'll be quite honest with you. I'm not sure I have to even rule on it. Having awarded the $00,000, if you want to give it all to Mr. Nitsche, that really wouldn't bother me. I'm sure it would bother the other partners at your firm, but it wouldn't bother me.

23 0 0 But if I stop jesting for a minute, I will state that it's clear to me that he, from what you've told me, contributed to this result. It's a good result, and therefore, it's appropriate and I approve it. Is there anything else before I address the order itself? MR. BRACEGIRDLE: Just one thing for the record, Your Honor. THE COURT: Yes. MR. BRACEGIRDLE: I think in Your Honor's statements just then you mentioned $0,000. The requested incentive fee is actually $,000. THE COURT: Oh. All right. So it's and? Is that how it -- MR. BRACEGIRDLE: Correct, Your Honor. THE COURT: All right. Well, I wouldn't want to push Mr. Nitsche into a higher tax bracket. MR. BRACEGIRDLE: Exactly. And you don't want me to get sideways with my partners either. THE COURT: No, I don't. I don't. Especially after joking around about it. All right. So I have signed the

24 0 0 order. I have filled in the fee amount at $00,000, with $,000 for Mr. Nitsche. I'm handing this back to the clerk. What else can we profitably do here this afternoon? MR. BRACEGIRDLE: I believe that concludes all the issues for this case, Your Honor. THE COURT: All right. Well, thank you for the presentation. It was very helpful, as was the submission. I think this is, given all the factors here, a good outcome for the company and its stockholders. And as I've said, I think it was a creative way to address the problems, so I congratulate both sides on reaching the result that I think is beneficial. If there's nothing else, I'm just going to wish you a good trip back. It was a pleasure to meet you, sir. Good to see you again. Thank you all. MR. HURD: Thank you, Your Honor. MR. BRACEGIRDLE: Thank you, Your Honor. (Court adjourned at : p.m.)

25 CERTIFICATE 0 I, JULIANNE LaBADIA, Official Court Reporter for the Court of Chancery of the State of Delaware, Registered Diplomate Reporter, Certified Realtime Reporter, and Delaware Notary Public, do hereby certify the foregoing pages numbered through, contain a true and correct transcription of the proceedings as stenographically reported by me at the hearing before the Vice Chancellor of the State of Delaware, on the date therein indicated. IN WITNESS WHEREOF, I have hereunto set my hand at Wilmington this rd day of August, 0. 0 /s/ Julianne LaBadia Julianne LaBadia Official Court Reporter Registered Diplomate Reporter Certified Realtime Reporter Delaware Notary Public