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10/28/2009 10:44:16 AM EST

The Responsible Corporate Officer Doctrine Receives New Attention

By Ted Zwayer

Posted by Ted Zwayer

Over sixty-five years ago, the United States Supreme Court articulated what has become known as the “Responsible Corporate Officer” doctrine. In United States v. Dotterweich, 320 U.S. 277, 64 S. Ct. 134; 88 L. Ed. 48 (U.S. 1943), the Supreme Court held that the president of a corporation could be found criminally liable under the Federal Food, Drug, and Cosmetic Act for shipping adulterated or misbranded drugs. The Supreme Court stated that criminal liability extended to anyone with “a responsible share in the furtherance of the transaction which the statute outlaws,” and that such liability went beyond the liability of the corporation.

“The statute makes ‘any person’ who violates [it] guilty of a ‘misdemeanor.’ It specifically defines ‘person’ to include ‘corporation.’ But the only way in which a corporation can act is through the individuals who act on its behalf. … If, then, Dotterweich is not subject to the Act, it must be solely on the ground that individuals are immune when the ‘person’ who violates [the statute] is a corporation, although from the point of view of action the individuals are the corporation.”

Thus, although the defendant, Dotterweich, “had no personal connection with either shipment of misbranded and adulterated drugs” and was only “in general charge of the corporation's business and had given general instructions to its employees to fill orders received from physicians”, he had “a responsible share in the furtherance of the transaction which the statute outlaws.”

The Supreme Court then elaborated on the responsible corporate officer doctrine forty years later in United States v. Park, 421 U.S. 658, 95 S. Ct. 1903; 44 L. Ed. 2d 489 (U.S. 1975), in which it upheld the conviction of the chief executive officer of a national grocery chain for violating the Federal Food, Drug, and Cosmetic Act because a food warehouse of the chain was contaminated by rodents. The Supreme Court set forth this standard in order to establish the liability of a responsible corporate officer:

“The Government establishes a prima facie case when it introduces evidence sufficient to warrant a finding by the trier of the facts that the defendant had, by reason of his position in the corporation, responsibility and authority either to prevent in the first instance, or promptly to correct, the violation complained of, and that he failed to do so. The failure thus to fulfill the duty imposed by the interaction of the corporate agent's authority and the statute furnishes a sufficient causal link. The considerations which prompted the imposition of this duty, and the scope of the duty, provide the measure of culpability.”

Without a great deal of fanfare or notice in legal circles, the responsible corporate officer doctrine has been applied during the past three decades, and in light of the corporate scandals of the past year, including the financial crisis, the Madoff Ponzi scheme, and the peanut salmonella scare, is it possible that the doctrine might become increasingly important? Two cases, one from the very end of last year and one from last month, provide some indication of where the doctrine stands today.

In People v. Roscoe, 169 Cal. App. 4th 829 (Cal. App. 3d Dist. 2008), the Court of Appeal of California held that the officers, directors, and shareholders of a family company were personally liable for $ 2,493,250 in civil penalties for a gasoline leak from an underground storage tank. The Court of Appeal held that the responsible corporate officer doctrine applied to Cal Health & Saf Code § 25299(a)(6) and thus subjected to liability as an operator “a corporate officer who has a responsible share in the furtherance of the transaction which the statute outlawed,” citing United States v. Dotterweich, “even where the corporation itself was also found to be the operator.” The doctrine was applicable because the defendants retained overall authority for company affairs, could have prevented or remedied promptly noticed regulatory violations, and did not exercise their responsibilities and power to discover, prevent, and remedy violations.

The defendants argued that the responsible corporate officer doctrine should not have been applied to create personal liability for them because it did not apply to civil cases, could not be applied to them because the company was the owner and operator of the tank, and could not be applied because there was no evidence of wrongful conduct. The Court of Appeal rejected all of those arguments, noting that United States v. Dotterweich permitted a corporate officer to be held “responsible” without “awareness of some wrongdoing.” The Court of Appeal then set forth the standard of proof that must be met.

“Three essential elements must be satisfied before liability will be imposed upon a corporate officer under the responsible corporate officer doctrine: (1) the individual must be in a position of responsibility which allows the person to influence corporate policies or activities; (2) there must be a nexus between the individual's position and the violation in question such that the individual could have influenced the corporate actions which constituted the violations; and (3) the individual's actions or inactions facilitated the violations.”

Last month a federal court was asked to apply the responsible corporate officer doctrine to claims of conversion and deceptive trade practices under State of Washington law. The court found that the doctrine could be applied to such claims in Montclair United Soccer Club v. Count Me In Corp., 2009 U.S. Dist. LEXIS 83535 (W.D. Wash. Sept. 14, 2009), although the court was unable to rule on the liability of the corporate officer at that time because of an automatic stay that had been issued in the bankruptcy proceeding of the relevant corporations.

Defendant Count Me In Corporation (CMI) provided online registration and payment services to non-profit sports organizations such as plaintiff Montclair United Soccer Club. Defendant Drayton was the founder and CEO of CMI. CMI collected registration fees from plaintiff’s participants and then forwarded the fees to plaintiff, minus CMI’s transaction fees. When $ 117,000 owed to plaintiff was not remitted by CMI, plaintiff sued CMI, Drayton, and Arena Group, the parent company of CMI. Bankruptcy proceedings were then initiated by CMI and Arena.

CMI’s financial problems occurred because of the commingling of customer funds with the operating funds of CMI, and especially because client funds were spent for the development of a new software technology owned by CMI that was referred to as Rainier. Drayton was the CEO of CMI/Arena during the time period that plaintiff was not paid, and he had selected and hired both the President and the CFO of CMI/Arena, whom he blamed for the financial difficulties. As the court points out “It is undisputed that the most significant operating expense paid for by client funds was an upgrade in the Rainier software technology, in which Drayton now has a substantial ownership interest, and from which he is generating an annual salary of $ 180,000…. Drayton owns approximately 10% of Rainier Software, Inc., the company that purchased the bankruptcy assets of CMI/Arena, for $ 200,000.”

The court explained the responsible corporate officer doctrine as followed in Washington.

“Under Washington law, if a corporate officer participates in wrongful conduct, or with knowledge approves of the conduct, then the officer, as well as the corporation, is liable for the penalties….This rule is known as the ‘responsible corporate officer’ doctrine. It is distinct from piercing the corporate veil or alter ego theory, which applies when the corporate entity has been so disregarded by the corporate officer that there is a unity of ownership and interest, which causes the separate personhood to cease to exist.”

The court then noted the burden of proof that plaintiff was required to meet.

“In theory, then, Drayton may be held personally liable for conversion and deceptive trade practices of CMI/Arena so long as he participated in the wrongful conduct, or, with knowledge, approved of the conduct. The Court must therefore determine whether Plaintiff is entitled to summary judgment on these claims. To prove that Drayton should be held liable for conversion based on CMI's use of Plaintiff's funds to develop the Rainier software and to pay other operating expenses, Plaintiff must show that: (1) CMI converted Plaintiff's funds, and (2) Drayton participated in CMI's conversion of Plaintiff's funds, or, with knowledge, approved of that conduct.”

The court found that it was required to deny plaintiff’s motion for summary judgment because of the bankruptcy proceeding involving CMI/Arena.

“However, the instant case is subject to an automatic stay as to Defendant CMI because of pending bankruptcy proceedings in this district. The Court would violate the stay by considering issues presented by or related to the stayed case as to CMI. As such, the Court cannot at this time consider whether CMI did, in fact, commit the tort of conversion--as Plaintiff has alleged in its Amended Complaint--in order to decide whether Defendant is personally liable for participating in such conduct, or knowingly approved of it…. Accordingly, the Court must decline to consider this issue at present. For the same reasons, the Court cannot at this time pass on whether CMI violated Washington's Consumer Protection Act, the first step in determining whether Drayton can be held personally liable for participating in that alleged violation or knowingly approving of such conduct. Accordingly, the Court must at this time DENY without prejudice Plaintiff's motion as to these issues.”

Although the federal court was unable to rule on the merits of the claims involving the responsible corporate officer doctrine in Montclair United Soccer Club, that decision and the California decision in Roscoe demonstrate that the doctrine is alive and kicking at the present. As the lawsuits from the financial and liability scandals of 2008 and 2009 begin to percolate through the courts, the responsible corporate officer doctrine may make additional public appearances.