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In re Tower Air

August 3, 2005


On appeal from the United States District Court for the District of Delaware District Court No. 01-403 District Judge: The Honorable Kent A. Jordan

The opinion of the court was delivered by: Smith, Circuit Judge.


Argued June 29, 2005

Before: NYGAARD, SMITH, and FISHER, Circuit Judges.


How far will the federal courthouse door swing open for a direct suit against corporate directors and officers for breaches of fiduciary duties? That is the difficult question presented in this case, which pits our federal notice pleading regime against Delaware's more restrictive notice pleading requirements. The appellant, Charles Stanziale, is the trustee of a bankrupt airline, Tower Air, Inc. He claims that Tower Air's directors and officers drove the company into insolvency by indifference and egregious decisionmaking. The District Court ruled that Stanziale failed to allege sufficient facts in his multi-count complaint to rebut Delaware's presumption that corporate fiduciaries act within the bounds of business judgment, which the State defines quite broadly. We conclude that the District Court erred by applying Delaware's stricter Chancery Rule 8 pleading standard, which does not apply in federal court. Under our federal notice pleading standard, we hold that Stanziale states four claims that, if proved, would overcome the protections of Delaware's business judgment rule.


A. Facts

A Delaware corporation principally operating from New York, Tower Air was founded in 1982 by defendant-appellee Morris Nachtomi as an international charter airline.*fn1 The company soon expanded into domestic and international scheduled passenger service, and by 1988 Tower Air's signature route, which accounted for roughly one-quarter of its revenue, was scheduled passenger service from New York to Tel Aviv. By 1999, Tower Air maintained and operated fourteen Boeing 747s and employed more than 1,400 people worldwide.

Nachtomi served as Chairman of the Board and Chief Executive Officer of Tower Air from 1989 until 2000. Nachtomi also sat as a director from 1982 until 2000, and, except for six months in 1998, he was the company's president between 1986 and 2000. Nachtomi and his family owned a substantial majority of outstanding common stock and a controlling interest in Tower Air. As a result, the other defendant-appellees served at Nachtomi's pleasure, and Nachtomi controlled the firm's management and operations.*fn2

In the mid-1990s, Tower Air hit turbulence. In 1996, the company lost twenty million dollars. Nevertheless, the company expanded its international passenger service, adding an Athens route in 1997. The next year, Tower Air added a route to Santo Domingo, Dominican Republic, because Nachtomi's daughter expressed personal interest in having the airline do so. Though that route never turned a profit, Tower Air flew to Santo Domingo until 2000. Meanwhile, Nachtomi ran Tower Air's Tel Aviv office with no oversight by the firm's other officers or directors. The Tel Aviv office kept separate financial records and its own bank account, making it virtually impossible for Tower Air's officers in New York to audit the Tel Aviv books. Eventually, the Tel Aviv office accumulated significant debt, and creditors forced Tower Air's Israeli operations into liquidation.

While his airline needed cash in the late-1990s, Nachtomi cut ticket prices so low that the company would not profit on certain flights even if its planes were full. At around the same time, Nachtomi and his co-directors failed to ensure that used passenger tickets were processed for payment from credit card companies and other third parties. After Tower Air filed for bankruptcy, unprocessed tickets valued at one million dollars were found in the company's U.S. offices. Failure to process those tickets hurt Tower Air's cash flow and impeded its ability to pay creditors. Further, Tower Air's directors did nothing when, in June 1998, Nachtomi and another officer received reports from Tower Air's Director of Safety of several serious incidents earlier that year, including a ground collision involving a Tower Air plane. Apparently, no one told the directors of these reports, or of negative maintenance reports, including failure to record aircraft servicing efforts and maintenance and repair needs.

In the meantime, Tower Air's jet engines were deteriorating. At first, Tower Air cannibalized its own engines to generate spare parts. In 1998, however, Nachtomi directed that Tower Air lease or buy new engines because, at least initially, doing so would be cheaper than repairing old engines. The directors agreed at a special meeting to borrow fifty million dollars in part to buy eight new jet engines. That meeting's minutes reflect no discussion of the need for new engines, the state of the old engines, or the financial impact of buying new engines. Later that year, the directors authorized Nachtomi to lease four new engines. Again, the board did not discuss the need for new engines, the state of the old engines, or the financial ramifications of buying and leasing versus repairing. Late in 1998, the board authorized the purchase of three new jet engines for more than eight million dollars.*fn3 Meanwhile, Tower Air borrowed heavily against its existing engine stock to finance operating expenses and to pay off old debt. By 2000, eleven out of nineteen of Tower Air's planes were out-of-service. By contrast, seventeen out of twenty planes were in service in 1998.

Tower Air's fiscal descent culminated in a voluntary petition for Chapter 11 relief in 2000. Stanziale was appointed trustee for the company's bankruptcy estate. He remained trustee when the bankruptcy was converted from Chapter 11 to Chapter 7 in late-2000. In June 2001, Stanziale sued Tower Air's directors and officers for monetary and punitive damages, and other relief, as Tower Air's representative and for the benefit of its creditors and other parties in interest. In October 2001, Stanziale filed the Amended Complaint before us, which, in addition to the facts recounted above, ...

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