Thursday, December 22, 2011

Fiduciary Standards for Corporate Directors

Kentucky Court of Appeals Hold That Business Corporation Act Sets Forth
An Exclusive Standard for Director Fiduciary Obligations

       Last Friday, the Court of Appeals issued an important decision on the interpretation of fiduciary duty provisions of the Business Corporation Act. The New Lexington Clinic, P.S.C. v. Cooper, ___ S.W.3d ___, 2011 WL 6260442 (Ky. App. Dec. 16, 2011).

        Cooper, a physician and director of The New Lexington Clinic (the “New Clinic”), while still a director, entered into negotiations with Baptist Hospital with respect to moving his practice. He entered into a letter of intent to make that move, and as well began negotiating, on Baptist’s behalf, with other New Clinic employees about likewise moving. After the move was announced, the New Clinic brought suit against Cooper and others alleging breach of various fiduciary duties, citing in support thereof Steelvest and Aero Drapery. The complaint did not, however, cite the Kentucky Business Corporation Act and specifically KRS § 271B.8-300. Summary judgment was granted the defendants on the basis that the New Clinic sought to bring its action under now defunct common law claims rather than relying upon the statutory standards set forth in KRS § 271B.8-300. Ultimately, the summary judgment has been reversed on the basis that the complaint was sufficient to set forth a claim for breach of fiduciary duty and on the basis that insufficient discovery had been completed prior to the dismissal.

       In my mind, the most important aspect of the case is the Court’s explication of the relationship of the common law fiduciary duties and the statutory standards. To that end, the Court wrote:

"At issue is whether KRS 271B.8-300 supplants the common-law claim as the circuit court found, or whether the common-law claim remains viable for the reasons articulated by NLC. We must conclude that the General Assembly intended for KRS 271B.8-300 to apply in all circumstances where money damages are sought in a claim of breach of fiduciary duty against a corporate director. The Legislature stated in clear and unambiguous language that “any action taken as a director, or any failure to take any action as a director, shall not be the basis for monetary damages . . . unless . . . [t]he director has breached or failed to perform the duties of the director’s office in compliance with this section[.]” (Emphasis added). KRS 271B.8-300(5). Using mandatory “shall” language, the General Assembly went on to state in section (6) that a “person bringing an action for monetary damages . . . shall have the burden of proving by clear and convincing evidence the provisions of subsection (5)(a) and (b) of this section, and the burden of proving that the breach or failure to perform was the legal cause of damages suffered by the corporation.” (Emphasis added).

In examining whether this language evinces the Legislature’s intent to supplant the competing common-law claim of breach of fiduciary duty, we look to James, supra, which held that a common-law claim may not be repealed by implication, and that the statutory intent to abrogate the common law must be clearly apparent. KRS 271B.8-300(5) provides that any action taken as a director or any failure to take action as a director shall not be the basis for a claim of monetary damages unless the director breached a duty under this section. In enacting this section, the Legislature cast a wide net which addresses any claim for monetary damages arising from a director’s alleged breach of fiduciary duty. The conclusion is bolstered by the inclusion of section (6), which sets out the mandatory burden of proving a breach by clear and convincing evidence — a burden which the parties acknowledge is greater than that of the common-law claim. Aside from this heightened burden of proof, KRS 271B.8-300(5) tracks the common law very closely. The Legislature has merely meticulously set forth the claims and remedies available under common law. We cannot say that the change in the burden of proof indicates an intent to abrogate the common-law claim entirely. Rather, it merely increases the burden of proof."

     Ergo, the General Assembly having comprehensively and in exclusionary language addressed the subject matter, the prior common law has been supplanted.

        This decision having been rendered just last week, there is no word yet on whether one side of the other will seek review by the Kentucky Supreme Court.

      IMHO, should there be an appeal, the decision of the Court of Appeals with respect to the exclusivity of KRS § 271B.8-300 should be upheld. As I have written previously (see, e.g., my posting with respect to the 1400 Willow v. Ballard, Sept. 29, 2011), the common law of fiduciary obligations is and should be applicable only where there exists a gap or where it is intended by the legislature, such as in the case partnerships, that the common law still apply. Where, in contrast, the legislature has comprehensively addressed the topic, such as here addressing the standards by which culpability for a breach of a duty is assessed, it is the statutory language that must control. However, the ultimate decision of the Court of Appeals (and the trial court) needs to be reversed.  While it is true that the statute is the exclusive recitation of the direcotor's fiduciary duties, it is exclusive as to actions taken as a director or any failure to act as a director.  Drs. Cooper et al.were not acting as directors when they engaged in discussions of joining a competing venture, decided to do so, and solicited company employees to leave with them to thereafter compete with the New Lexington Clinic.  As such the question is not whether 271B.8-300 is exclusive (which it is within its scope of application), but whether it is applicable as to conduct not on behalf of the venture.  To that latter question the answer is no.

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