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A federal judge’s refusal to grant a jury trial to director defendants and officers accused by a bankruptcy trustee of breaching their fiduciary duties has been reversed by the 2nd U.S. Circuit Court of Appeals. Overturning a multimillion-dollar verdict issued by Judge Robert W. Sweet of the Southern District of New York, the circuit instructed the judge to hold a jury trial after finding that the action was not equitable in nature because it constituted a suit “at law” within the meaning of the Seventh Amendment. The ruling, written by 2nd Circuit Judge Joseph M. McLaughlin, means that director and officer defendants in Pereira v. Farace, No. 03-5053, will have a second chance to prevail in defending claims that they mismanaged assets of Trace International Holdings. Trace was a privately held corporation whose assets consisted of stock in three companies, Foamex International Inc., United Auto Group Inc. and CHF Industries Inc. Its majority shareholder and chief executive officer, Marshall Cogan, was accused of exhausting Trace’s capital through a series of transactions that included large salaries for himself retroactively approved by the board, a loan to himself to cover a buyback of stock from Dow Chemical Co. (part of $13 million in loans he took from the company), and a $1 million 60th birthday party for himself at the Museum of Modern Art. Bankruptcy filing The company filed for Chapter 11 reorganization in 1999 and, in 2000, the bankruptcy court converted the case into a Chapter 7 liquidation. John Pereira was appointed trustee and replaced the company’s creditors as plaintiff in an action against Trace’s directors and officers-board members Andrea Farace and Frederick Marcus, Trace officer and attorney Philip Smith, and Trace officer and certified public accountant Karl Winters. Pereira charged that all of Trace’s officers and directors breached their fiduciary duties and the directors had violated Delaware corporation law provisions prohibiting the payment of dividends while insolvent or where the payments create insolvency, or the redemption of stock when a corporation’s capital is impaired or will be impaired. The defendants demanded a jury trial, but Sweet found that the allegations against them did not constitute actions “at law” because actions for breach of fiduciary duty were historically equitable and Pereira was seeking restitution. Sweet then conducted a 12-day trial that ended with a finding that the defendants were liable for mismanaging the company because they disregarded corporate governance procedures and turned a “blind eye” to Cogan’s actions-all of which amounted to a breach of fiduciary duties. He also found them liable for improper issuance of dividends and for allowing Dow to redeem stock. The judge held Marcus liable for $37.4 million, Farace liable for $27.3 million, Smith liable for $21.4 million and Winters liable for $21.4 million. Only Winters settled with the trustee prior to the appeal. Among the “sandstorm of claims on appeal,” McLaughlin said for the 2d Circuit panel, was that “the underlying action was legal and the remedy sought was compensatory damages, not equitable restitution.” “Although Rule 2 of the Federal Rules of Civil Procedure grandly proclaims that ‘there shall be one form of action to be known as ‘civil action’ thereby causing the merger of law and equity, the distinction ‘retains its viability’ today,” McLaughlin said. “By preserving the right to a jury trial only in ‘suits at common law,’ the Seventh Amendment of the United States Constitution perpetuates the law/equity dichotomy,” the judge said further.

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