DATE
June 17, 2013
Re: The Governance Implications of Hershey Trust, and Lemington Homes
Two recent developments are important resources for corporate counsel seeking to advise nonprofit boards on
corporate governance issues generally, and more particularly on problematic director conduct and the associated risk
of enforcement.
The Hershey Trust matter involved the settlement between several Hershey entities, and the Pennsylvania Attorney
General, of an investigation of a series of controversial real estate transactions and related governance issues.
Lemington Homes involved the decision of a federal district court, denying a motion to set aside a prior jury verdict -and both compensatory and punitive damages -- against the senior officers, and most of the board members, of a
once-prominent nonprofit nursing home.
That two such important developments arise in so close a time period is serendipitous but does not, in and of itself,
reflect any particular enforcement trend. Yet, the two developments are significant to the extent they focus of
important applications on the duties of care and loyalty. Thus, they present a timely and valuable
opportunity for counsel to brief the board and executive leadership on how a state attorney general and the
federal courts have interpreted the appropriate standards of fiduciary conduct.
I. HERSHEY TRUST
The Hershey settlement is notable for what it involved, for what it says about nonprofit governance, for what it says
about certain kinds of business risks. In many respects, this was the biggest corporate-related investigation of a
nonprofit in several years, and not simply because of Hershey’s status as one of the financially largest charitable
organizations in the country. The investigation took over two years to reach resolution; attracted substantial (mostly
negative) media attention; raised serious concerns about board member integrity and undoubtedly was a significant
distraction to the work of a major charity. It may be true that few charities mirror the Hershey organizational structure.
Still, there is nothing so unique about the underlying Hershey facts that should detract from the broader “lessons
learned” from the investigation and settlement.
And those “lessons learned” are at least four-fold: first, that the role of the attorney general in regulating charities
should never be taken lightly; second, that the standard for determining breach of fiduciary duty remains -appropriately -- high; third, that there is substantial room for improvement in most governance structures; and fourth,
it’s always worth asking whether the “optics” of certain business transactions are worth the associated risks.
Background. The parties to the Attorney General’s settlement included the Milton Hershey School, the Hershey
School Trust, and the Hershey Trust Company (“HTC”).
The School is one of the nation’s largest and most
prominent residential facilities for disadvantaged youth. The assets of the School are held by the charitable School
Trust, and the trustee of the School Trust is the HTC. Over the years, the operation of the School, and the
relationships and overlapping governance arrangements between the School, the School Trust and HTC have been
the subject of some public controversy, and periodic attention by the Attorney General.
©2013 McDermott Will & Emery. This communication may be considered attorney advertising.
Previous results are not a guarantee of future outcome.
mperegrine@mwe.com | MICHAEL W. PEREGRINE
The most recent controversy arose from a series of real estate transactions entered into by the School. The most
prominent of these included the purchase and development of a golf course (reportedly for $17 million), and the
purchase of an adjacent fruit roadside market for $8.6 million. The reason for the purchases was reportedly to obtain
“buffer property” between the student homes and the community. The transactions attracted media and then Attorney
General attention based on allegations regarding the appropriateness of the purchase price; concerns with conflicts of
interest between School and HTC governance and the Club investors; and excessive board compensation and
benefits. Further, a former Hershey board member made public additional allegations of impropriety, beyond the real
estate transactions, in a judicial petition that he ultimately withdrew. These additional allegations included matters
relating to financial management. The State announced its investigation in February of 2011. The investigation was
concluded on May 8, 2013 without a finding of breach of fiduciary duty. Notably, the settlement also included a
lengthy agreement between the Attorney General, and both the School and HTC, for the adoption of specific
governance reforms intended to support the School’s charitable mission.
Lessons Learned:
 The entire process speaks to enormous power and authority of the attorney general when it comes to the business,
operations and governance of a nonprofit organization. It is a very useful example of the willingness (and
obligation) of the attorney general to take action to protect charitable assets when there is concern that they have
been placed at risk. It is true that the budgets of many state attorneys general are significantly limited when it
comes to charity oversight; preventing the state to be as pro-active in terms of enforcement as it might prefer.
But nonprofit leadership should not underestimate the ability of the attorney general to take necessary action when
significant concerns arise with respect to the use of charitable assets. Recent controversies involving Sanford
Health, and Educational Housing Services, Inc., are further examples. Nonprofit boards underestimate the power
of the office of attorney general at their peril.
 The standard for proving breach of fiduciary duty in the nonprofit context remains, appropriately, high. In some
states, the standard is simple negligence (e.g., failure to use the degree of care of an ordinarily prudent person).
In other states it is gross negligence (e.g., deliberate disregard of the charity’s interests). Either way, it requires
more than allegations in a newspaper article or in a whistleblower complaint. There has been some criticism of the
settlement from public policy commentators (i.e., that it was too lenient). Yet, it is worth noting that after over two
years worth of investigation, the Attorney General did not find sufficient evidence to establish breach of fiduciary
duty with respect to any of the allegations -- whether they related to the real estate purchases, conflict of interest
disclosure, investment practices, political fundraisers, Hotel Hershey upgrades, board member compensation,
consultant contracts and certain other allegations. But much of the public reaction to the settlement has not
focused on this important determination.
 The Reform Agreement has implications beyond just Hershey governance, but to nonprofit governance generally.
It may be fair to assume that the Reform Agreement is meant to address the state’s concerns with those aspects
of Hershey governance that the state found lacking. But the larger nonprofit sector can fairly interpret the Reform
Agreement as a checklist of nonprofit governance issues with which the state will have a strong interest in
monitoring. These include the use of overlapping directors with a nonprofit corporate system; reasonable levels
of director compensation; the process by which conflicts of interest are both disclosed and evaluated; controls
with respect to major acquisitions; carefully controlled and documented travel and entertainment expense
reimbursement rules for leadership, and application of higher competency and expertise standards in the selection
of board members. The relevance of these issues transcend the Hershey settlement.
 The entire controversy is a reminder to nonprofit boards that discretion, and further review, may be the better
choice when considering a transaction the board knows may invite significant controversy. Corporate reputation
is an asset the board must protect, and it is the responsibility of the board to take into consideration the potential
“optical implications” when evaluating a transaction or business decision. This is not to suggest that the Hershey
boards knew in advance that the various real estate transactions were going to raise such scrutiny; nothing in the
settlement documents would suggest that to be the case. Yet, from a larger perspective, it would seem that the
overall transaction costs -- in terms of dollars, reputational “hit” and distraction -- was very substantial. This
concept of “total cost” is worthy of board consideration when confronted with a decision involving the risk of public
attention or controversy. Because charitable assets will be “in play”, it can be important to ask the question “will
this be worth the risk?”
II. LEMINGTON HOMES
This case, and its related decisions, are notable for their guidance on breach of fiduciary duty and “deepening
insolvency” claims under state law.
Background. The controversy arose from the financial demise of a historically prominent home for the aging in the
African-American Community of Pittsburgh. The Home had, over a period of time, encountered substantial difficulties,
leading to insolvency in 1999, and eventual closure of the Home and commencement of voluntary Chapter 11
bankruptcy proceedings. The breach of fiduciary duty and deepening insolvency actions were commenced by the
official committee of unsecured creditors. The federal district court granted a summary judgment motion of the
officers and directors, on the basis that the business judgment rule and the doctrine of in pari delicto precluded any
fiduciary duty exposure, and that the absence of evidence of fraud precluded any claim for deepening insolvency.
This summary judgment ruling was vacated by an important 2011 decision of the Third Circuit Court of Appeals, that
remanded the case for trial. In its ruling, the Third Circuit held that there remained in dispute material issues under all
of the claims, and that (under Pennsylvania law) the business judgment rule was unavailable in the presence of
negligence. The subsequent trial resulted in a jury verdict and damages against 13 of the 15 former board members
and two of the former officers, with respect to the breach of duty and deepening insolvency claims.
In the instant case, the federal district court determined that sufficient evidence existed to support the verdicts, on the
grounds that the officers and directors violated their duty of care owed to the Home and contributed to the Home’s
deepening insolvency. Amongst the conduct determined to have constituted negligence/breach of fiduciary duty
included failing to ensure that the Home was properly managed (auditors’ warnings notwithstanding), allowing board
functions to devolve into “disarray”; failing to be attentive to indications of operational and financial problems, and
possibly encouraging the transfer of Home assets to an affiliated but separate legal entity.
Lessons Learned:
The detailed decision of the federal court -- especially when read together with the 2011 Third Circuit decision -raises governance-level “warning flags” that:
 Courts will, indeed, uphold compensatory and even punitive damages against individual directors and officers;
 Application of the Business Judgment Rule has its limitations;
 The ability of directors to rely on the advice and direction of corporate officers is a weak reed of defense when the
directors have reason to doubt the accuracy or reliability of officer reports (the element of so-called “unreasonable
blindness”;
 Ignoring advice of counsel can have painful implications for directors, especially in situations of operational
distress;
 Some states do indeed recognize a cause of action for “deepening insolvency” that may go hand-in-hand with
breach of fiduciary duty claims; and
 Periods of organizational distress -- whether operational, financial or regulatory -- are breeding grounds for
subsequent breach of fiduciary duty claims.
Overall Observations:
It is rare that two matters, each with great significance to the governance of nonprofit organizations, are released
within such proximity to one another. As such, they provide a meaningful premise from which to brief the officers and
directors of large nonprofit organizations with respect to (a) examples of fiduciary conduct that may be interpreted as
problematic; and (b) expectations of proper corporate governance standards and structures. None of the
controversial nature of each of these two developments, the unique nature of the respective nonprofit corporations
nor the alleged individual conduct should make them any less relevant or significant to nonprofit boards and their
leadership teams.