The top officials at Treasury have already set aside all of the broad governmental powers available (claiming we are a "nation of laws"), so let’s look at the United States purely as an angel investor which saw a large company faltering and swooped in with an 80% equity investment. Uncle Sam has just learned about the following (AIGFP is the “Financial Products” division of AIG, the morons responsible for wiring the global economy to explode by writing trillions of dollars in undercapitalized “credit default swap” policies):

In the first quarter of 2008 [a few months prior to the equity purchase], AIGFP adopted a retention plan for about 400 employees that provided guaranteed payments to employees if they worked through specified payment dates (or either resigned for good reason or was terminated without cause before the relevant dates). At the time, AIGFP was expected to have a valuable, on-going role at AIG. The plan was implemented because there was a significant risk of departures among employees at AIGFP, and given the $2.7 trillion of derivative positions at AIGFP at that time, retention incentives appeared to be in the best interest of all of AIG’s stakeholders. The program was evidenced by a written plan distributed to employees and by individual agreements executed by them.

For senior management the plan provides that 2008 and 2009 compensation will be 75% of 2007 expected compensation levels. Other participants are set at the full 2007 level. This resulted in a $313 million total for 2008 and a $327 million total for 2009 (because some employees who had other guaranteed compensation for 2008 were excluded for that year).

Frustratingly, had AIG merely gone bankrupt instead being saved by the investment, then these would likely be voidable by the trustee as excessive insider transactions under 11 USC § 547. (Indeed, if AIG goes bankrupt soon, we’re still within the “1 year and 90 days” window to use § 547.)

At the moment, we don’t have the text of the contracts, and so can’t determine if any of the doctrines listed in this exhaustive Concurring Opinions post would apply. Personally, I think commercial impracticability / frustration of purpose are realistic options here given AIG’s total dependence upon the government’s grace.

But let’s assume the contract is, on its face, iron-clad, properly drafted, formed, accepted, and with all conditions met.

What’s a cheated shareholder to do?

Unsurprisingly, American International Group, Inc., was incorporated in Delaware, the least-shareholder-friendly jurisdiction in the country (which is why management loves it), so we’ll look to Delaware law.

Generally, prior to launching a derivative suit on behalf of the company, a shareholder must send a demand letter to the board of directors, demanding they, in this instance, not go through with the transaction. Here, however, a court would likely find the demand letter requirement excused as “futile” given AIG CEO Edward Liddy’s letter to Treasury Secretary Geithner asserting that AIG intended to go through with the payments despite his complaints.

So we’re past the first hurdle, and can sue on behalf of AIG, as shareholders at the time this payment is being made. But the bar is set quite high for us. Unsurprisingly,

The AIG certificate of incorporation has a § 102(b)(7) clause that insulates AIG’s directors from liability for monetary damages for any harm flowing from their gross negligence. See Malpiede v. Townson, 780 A.2d 1075, 1095-96 (Del. 2001) (affirming the dismissal of a duty of care claim where the corporation’s charter had an exculpatory provision).

We’ll get to the source of this quote in a minute. For now, "gross negligence" isn’t even enough to sue a director.

So who do we sue and what do we allege?

Like most plaintiffs, we start hobbled by a lack of information. What the heck does the white paper mean that “This amount is due pursuant to a retention plan entered into in early 2008?” Entered into by whom, and with whom, after what process?

Talking Points Memo points us to the NY Daily News regarding how AIGFP functioned:

Company auditor Joseph St. Denis became concerned about the Financial Products unit, but [Joseph Cassano, head of AIG Financial Products] barred him from checking.

St. Denis later quoted Cassano as saying, "I have deliberately excluded you … because I was concerned that you would pollute the process."

St. Denis would recall Cassano saying he did not want to be promoted even further up the corporate ladder "because it would separate [him] from the money." St. Denis would remember Cassano telling him "AIG’s corporate management was "scared to death" of him."

Oh my. That’s not much of an internal process at all. It sounds like they’re just running a criminal organization in there, or at the very least had inadequate internal controls that were too easily bypassed by the insiders.

We don’t have to look far to figure out if we can sue for that. Just a month ago, the Delaware Court of Chancery (New Castle) refused to dismiss a shareholder complaint against AIG because,

The Complaint fairly supports the assertion that AIG’s Inner Circle led a — and I use this term with knowledge of its strength — criminal organization. The diversity, pervasiveness, and materiality of the alleged financial wrongdoing at AIG is extraordinary. The proposition that Matthews and Tizzio, who the Complaint fairly alleges were directly knowledgeable of and involved in much of the wrongdoing, did not also know that AIG’s internal controls were inadequate and too easily bypassed is not, for present purposes, an interpretation to ground a Rule 12(b)(6) dismissal order on. Indeed, for present purposes, it is inferable that even when Matthews and Tizzio were not directly complicitous in the wrongful schemes, they were aware of the schemes and knowingly failed to stop them. In that regard, I find it inferable that Matthews and Tizzio were aware of misconduct that should have been brought to the attention of AIG’s independent directors (including the Audit Committee) but chose to conceal their knowledge, despite having a fiduciary duty to speak."

Am. Int’l Group, Inc. v. Greenberg, No. C.A. No. 769-VCS, 2009 Del. Ch. LEXIS 15, at *77–78 (Del. Ch. Feb. 10, 2009). For more, see the Delaware Corporate & Commercial Litigation Blog which, alongside The D&O Diary and the Harvard Law School Corporate Governance Forum, sets the bar for reporting on these cases.

In that suit, Greenberg, Matthews and Tizzio were all directors, who are the normal targets of shareholder suits, because their actions are generally insured by policies previously paid for by the company.

But we’re not limited to them — recent amendments to 10 Del. C. § 3114 assure us jurisdiction in Delaware over directors, trustees, members and officers of all corporations incorporated in Delaware. It’s not clear exactly what Cassano’s position was, but the "head" of anything is generally an officer of some sort. So we’ve got him, even if he’s never set foot in Delaware. At the very least, we can sue whatever directors or officers were involved in this transaction — several hundred million dollars doesn’t walk out the door without someone blessing it.

Then what? Assuming even we can’t prove outright fraud by these 400 employees, we still have the blatant breach of fiduciary duty by excluding the auditor. As such, the whole plan, even as it relates to "innocent" parties, can be reformulated under Delaware law:

The glaring problem with the defendants’ argument is again a category error — this is not a contract case involving the reformation of a contract to effectuate the parties’ intent; it is a fiduciary duty case, and this court has broad discretion to remedy breaches of fiduciary duty, including reformation when, as here, that is appropriate to remedy a fiduciary violation. See, e.g., Thorpe v. CERBCO, Inc., 676 A.2d 436, 445 (Del. 1996) (‘Delaware law dictates that the scope of recovery for a breach of the duty of loyalty is not to be determined narrowly.’); Taylor v. Jones, 2006 Del. Ch. LEXIS 100, 2006 WL 1510437, at (Del. Ch. May 25, 2006) (noting that a resulting trust may be an appropriate remedy even though the prerequisites to a resulting trust under the modern, majority approach were not present and that this court’s ‘historical readiness to adapt to the circumstances of each case and craft appropriate remedies . . . should not be lightly discarded or circumscribed’); Cantor Fitzgerald L.P. v. Cantor, 2001 Del. Ch. LEXIS 70, 2001 WL 536911, at (Del. Ch. May 11, 2001) (awarding fee shifting in as a remedy for a breach of the duty of loyalty despite an express contractual provision providing otherwise and explaining that ‘when the facts demonstrate behavior as egregious as that here, the Court’s normal deference to pre-negotiated partnership agreement provisions will yield to a conscientious effort to craft an appropriate remedy’)."

GPC XLI L.L.C. v. Loral Space & Communs. Consol. Litig. (In re Loral Space & Communs. Consol. Litig.), C.A. No. 2808-VCS, C.A. No. 3022-VCS, 2008 Del. Ch. LEXIS 136, at *7–123–5–3–124 n.161 (Del. Ch. Sept. 19, 2008).

If we are a "nation of laws," why not use some of them?

UPDATE Steven M. Davidoff at DealBook gets it:

This was not a boilerplate contract. Rather, it was highly negotiated. And it was highly negotiated to pay retention fees at high levels without regard to performance. This is obviously shocking. But it makes me wonder: perhaps one area of direction here should be actually looking at who negotiated this and why?

It strikes me that the A.I.G. financial products division received an unbelievably sweet deal. Did its managers slip it under the radar? Did the managers act in good faith? And who at A.I.G. signed off on this and did they focus on the risks and rewards? Yet more avenues for possible litigation.

But of course, this is all merely a diversion for what should be the main focus: Where did the $170 billion go that taxpayers spent on A.I.G and why, and what we are going to do with A.I.G. going forward.