When representing entities (primarily LLCs and corporations), keep in mind they act through their authorized agents. Typical examples of authorized agents include presidents, CEOs and managers. If the agent commits fraud, that fraud can be imputed to the entity and its directors / managers.
In order to commit fraud, you must have the necessary intent. However, entities cannot form an intent. Rather, because entities can only act through their officers, directors or managers, an entity’s intent is determined by imputing the intent of its agents to the entity. A recent case out of Delaware bankruptcy court highlights the danger to a board of directors arising out of that principle.
In In re Cyber Litigation Inc. (US Bankruptcy Court – DE 2023) a “cyber-fraud prevention company” committed a massive fraud that escaped the notice of Ernst & Young, the Kroll Firm and Crowell and Moering.
Here are the facts: Adam Rogas formed NS8, Inc. (the “Debtor”) to assist consumers with cyber -fraud prevention. Using fabricated financial statements and customer subscriber numbers, Rogas convinced a majority of the board of directors of the Debtor to vote in favor of a $72 million investment from a group of new investors. The Debtor used the funds to buy back his stock and the stock of others serving as directors.
Prior to the $72 million investment, however, the firms of Ernst & Young, the Kroll Firm and Crowell and Moering were retained to investigate a whistleblower complaint about the Debtor. None reported instances of fraud or wrongdoing.
Shortly after the $72 million was paid to investors, Rogas’ fraud was revealed, and he went to prison.
The Debtor filed for bankruptcy, and a trustee sued to get the money paid to the director / shareholders back. The directors claimed they did not commit fraud because they had no knowledge of Rogas’ scheme.
The bankruptcy court ruled that Rogas’s fraudulent intent was imputed to the Debtor, even though none of the other directors had knowledge of Rogas’ fraud. The Debtor’s decision to accept the $72 million and buy stock back was caused by Rogas’ fraud. As a result, the Debtor committed actual and constructive fraudulent conveyances
Directors and managers must do their own work. While they may be able to rely on the reports of certain experts, they cannot be “controlled” by an officer (such as Rogas). If a president of a corporation or a general manager of an LLC commits fraud, your company may be liable for that fraud. Your lack of knowledge will not protect you. Sometimes, ignorance is not bliss. Beresford Booth Lawyers are committed to delivering exceptional legal services with a focus on transparency, integrity, and personalized attention. Our team has the expertise and dedication to support your business’s success. Please contact Beresford Booth at info@beresfordlaw.com or by phone at (425) 776-4100 to discuss how we can help.