Securities Law Attorney Not Liable for Alleged Fraudulent Sale of Securities

Securities Law Attorney Not Liable for Alleged Fraudulent Sale of Securities

      In a June 28 opinion of the Sixth Circuit Court of Appeals, it affirmed the dismissal of claims asserting that the attorney was personally responsible for alleged fraud in the sale of a series of oil and gas ventures.  Bennett v. Durham, No. 11-5782/5918 (6^th Cir. June 28, 2012). 

      Kentucky’s state securities law, referred to as the “blue sky” law, imposes liability upon persons who offer or sell a security in violation of the blue sky laws, upon each person controlling a seller and each partner, officer and director thereof.  In connection with allegations that interest in certain oil and gas ventures were sold pursuant to material misrepresentations and omissions, certain investors sued the companies at issue and their officers, and also sued the attorney who prepared the documents on behalf of the companies. 

      The attorney in question was not an officer, director or partner in any of the issuers, and it was undisputed that his services extended only to the preparation of documents and availability (utilized in a single instance) to answer questions presented by potential investors.  Importantly, the attorney did not either identify potential investors or solicit their individual investment.

      Carefully scrutinizing the language employed in the statute, the Sixth Circuit, as have a number of other courts that are surveyed in the opinion, determined that the preparation of documents does not constitute either offering or selling securities.  While the underlying securities may in fact have been fraudulent:

His [the attorney’s] clients sold the shares, and we do not attribute the transaction of a client to its attorney.  An attorney may draft an offering memorandum for his client, but that does not mean the attorney, as opposed to the client, offers to sell the securities.  The client and its broker-dealers sell the securities.  Slip op. at 4.

       The United States Supreme Court, in the Central Bank decision, determined that there is not “aiding and abetting” liability for breach of the securities laws.  This decision of the Sixth Circuit continues that philosophy and protects accountants, attorneys and other advisors to an issuer from liability for the actions of the issuer.

Which Act Controls – Limited Partnerships

Which Act Controls – Limited Partnerships

           Limited partnerships organized in Kentucky are governed by one of at least four statutes; determining which statute can be an involved process:

         Working in reverse chronological order we have:

·                     The Kentucky Uniform Limited Partnership Act (2006) (“2006KyULPA”);

·                     The Kentucky Revised Uniform Limited Partnership Act (“KyRULPA”);

·                     The Kentucky Uniform Limited Partnership Act (“KyULPA”); and

·                     The mix of statutes that preexisted KyULPA.

           KyULPA was a 1970 adoption of the 1916 Uniform Limited Partnership Act.  KyRULPA was a 1988 adoption of the 1985 Revised Uniform Limited Partnership Act.  2006KyULPA is a 2006 adoption of the Uniform Limited Partnership Act (2001).

           Determining which act controls a particular limited partnership is crucial as the acts provide sometimes differing rules for the right, duties and obligations of the general and limited partners.  The rule in corporations is that new statues are applied to corporations organized under the prior statute.  KRS § 271B.17-050(1).  The limited partnership acts do not have this “drag-in language.”  Rather, unless a LP organized under an older act elects to be governed by a new act, it remains governed by that older act.         

2006KyULPA had an initial effective date of July 12, 2006.  Ky. Rev. Stat. Ann. § 362.2-1205(1)(a); see also Op. Ky. Att’y Gen. 06-001 (April 19, 2006).  Every limited partnership formed on or after that day is governed by the new act. 

KyRULPA continues to govern all limited partnerships formed under KyRULPA, namely those formed on or after July 15, 1988 and prior to July 12, 2006 unless the limited partnership has elected to be governed by 2006KyULPA.  See Ky. Rev. Stat. Ann. § 362.521(1) (prior to amendment by 2006 Acts, ch. 149, § 238). 

Limited partnerships formed prior to July 15, 1988 are not governed by KyRULPA unless they have elected to be so by filing an amended and restated certificate of limited partnership.  Ky. Rev. Stat. Ann. § 362.521(1)-(2).  The prior limited partnership act, §§ 362.410-362.710, an enactment of the Uniform Limited Partnership Act (1916), was effective June 18, 1970 and applied to limited partnerships formed through July 14, 1988. 

A limited partnership existing on July 11, 2006, whether formed under KyRULPA or prior law, may elect to be governed by 2006KyULPA by filing an amended and restated certificate of limited partnership.  Ky. Rev. Stat. Ann. § 362.2-1204(2).  From July 12, 2006, a limited partnership formed under pre-KyRULPA law may elect to be governed by KyULPA, but may not elect to be governed by KyRULPA.  See Ky. Rev. Stat. Ann. § 362.521(2) as amended by 2006 Acts, ch. 149, § 238.

        From and after July 12, 2006, Kentucky has:

·                     Limited partnership formed prior to June 18, 1970 that remain governed by the then existing limited partnership law;

·                     Limited partnerships formed on or after June 18, 1970 and prior to July 15, 1988 that remain governed by KyULPA;

·                     Limited partnerships formed after July 15, 1988 and prior to July 12, 2006 that are governed by KyULPA;

·                     Limited partnerships formed prior to July 15, 1988 that have elected to governed by KyRULPA;

·                     Limited partnership formed on or after July 12, 2006 that are governed by 2006 KyULPA; and

·                     Limited partnerships formed prior to July 16, 2006 that have elected to governed by 2006 KyRULPA.

Is this clear?

One of These Things is Not Like the Other: Stock v. Asset Purchase Agreements

One of These Things is Not Like the Other: Stock v. Asset Purchase Agreements

      Lauder v. Lauder, an unpublished ruling of the Kentucky Court of Appeals, highlights, on the one hand, the need for careful drafting of agreements within corporations and, on the other, an appreciation for the fact that while a contract may give certain rights, it does not follow that it gives other rights.  Lauder v. Lauder, 2008 WL 1757529 (Ky. App. April 18, 2008) (discretionary review denied March 11, 2009).

      Jasper and Sheila Lauder, husband and wife, were the owners of Carlton-Lauder Funeral Home, Inc. as well as the owners of the improved real property from which the corporation operated.  They would ultimately gift 16% of the stock of the corporation to their son Brian, retaining to themselves the balance of 84%.  In 1997, Jasper, Sheila and Brian entered into a stock purchase agreement providing, inter alia, rights of first refusal with respect to any proposed transfer of shares to a third party.

      Ultimately, Jasper and Sheila determined that the corporation should sell all of its assets to certain third parties, and to that end entered into an asset purchase/sale agreement.  Brian filed suit against his parents and the corporation (the opinion does not address whether the suit was direct, in which case it should have been dismissed ab initio, or derivative), asserting that Jasper and Sheila had misappropriated corporate assets, they being used to improve the real property they owned in their individual names and also in satisfaction of other personal expenses, asserting as well that the:

The act of selling the corporate assets violated “the purpose, intent, and terms of” the Stock Purchase Agreement.  2008 WL 1757529, *2.

      The Circuit Court granted Jasper, Sheila and the corporation summary judgment, from which Brian appealed, including on the basis that “a party to a buy-sale agreement regarding stock cannot circumvent the agreement by selling all of the corporation’s assets.”

            Ultimately rejecting the assertion that the asset sale violated his rights under the stock purchase agreement, the Court of Appeals wrote:

Brian acknowledged in his response to Jasper and Shelia’s motion for summary judgment that the stock purchase agreement made no mention of the sale of assets.  However, he mistakenly equates the sale of the corporation’s assets with the sale of stock.  The stock purchase agreement does not control the sale of the corporate assets.

By selling its assets, the corporation did not sell its stock; rather, compensation was received by the corporation in exchange for the assets it sold.  This money was retained by the corporation used to pay corporate debt.  The remaining balance is in a corporation account.  Brian did not dispute this assertion.  Thus, the claims that the sale of assets violated the stock purchase agreement lacks merit.  2008 WL 1757529, *3.

      Obviously, in retrospect, the son realized that while he had negotiated with his parents an agreement that, should they determine to sell their stock, he would have a right of first refusal with respect thereto, he had not negotiated for an agreement that the corporation could not itself sell its assets without affording him at least a right of first refusal with respect to being the purchaser.  Equally obvious, his efforts to argue that an individual right to acquire stock in a corporation should be read to as well bind the corporation as to a sale of its assets was unavailing.

Upcoming from the Ky Supreme Court - More on Arbitration

Upcoming from the Kentucky Supreme Court –

Agent’s Ability to Bind Principal to Arbitration

      In Beverly Enterprises, Inc. v. Ping, the Court of Appeals reversed a determination by the trial court denying a motion to compel arbitration.  Beverly Enterprises, Inc. v. Ping, No. 2009-CA-001361-MR (Ky. App. July 23, 2010) (Not To Be Published).

      Alma Duncan was admitted to a long-term nursing facility maintained by Beverly Enterprises.  On her mother’s behalf, Ping signed the nursing facility’s document and as well a separate Alternative Dispute Resolution Agreement.  By its terms, the agreement provided that it would be governed by and interpreted in accordance with the Federal Arbitration Act.  See id., slip op. at 6, fn. 5.  At the time of doing so, Ping presented to the facility a copy of the General Power of Attorney from her mother.  After her mother passed away, Ping, now as executrix of her mother’s estate, filed a lawsuit against Beverly Enterprises alleging negligence with respect to her mother’s care.  Beverly answered and sought enforcement of the ADR agreement, which motion was denied by the trial court. 

      On the basis that the Power of Attorney did not specifically set forth authority to enter into the ADR agreement, the trial court found it to be unenforceable.  In turn, the Court of Appeals reviewed the language of the General Power of Attorney held by Ping and determined that its scope included the ability to enter into the ADR agreement.  The Court of Appeals also rejected the trial court’s determination that there had been fraud in the execution of the agreement, finding that the agreement to arbitrate was open and obvious, that no contrary statements had been made as to its legal effect and further that there was included a right to seek the advice of counsel and the ability to revoke the agreement within thirty days of its making.

      Ping’s brief to the Supreme Court reasserts each of the bases rejected by the Kentucky Court of Appeals, beginning with the assertion that the trial court, under the Alley Cat holding, does not have the ability to compel arbitration.  She also makes the curious argument that, as the healthcare facility stood in a judiciary relationship with its patient, there was a breach of its fiduciary duties in presenting the ADR Agreement, it having enticed Ms. Duncan “to waive her constitutional rights in order to receive medical care.”  Appellant’s Brief to the Kentucky Supreme Court filed August 8, 2011, page 19. 

      Oral arguments were heard on February 15, 2012.

Upcoming from the Ky Supreme Court - (Un)Reasonable Liquidated Damages

Upcoming from the Kentucky Supreme Court –

 (Un)Reasonable Liquidated Damages

      The Kentucky Supreme Court has granted discretionary review in Patel v. Tuttle Properties, LLC, wherein it will consider a ruling of the Court of Appeals upholding, on summary judgment, the loss of an earnest money deposit made in connection with a proposed assets sale.  Patel v. Tuttle Properties, LLC, No. 2010-CA-001544-MR (June 17, 2011) (Not To Be Published).

      As recounted by the Court of Appeals, Patel entered into an asset purchase and sale agreement pursuant to which he would acquire a convenience store and the related real property for a purchase price of $450,000.  In connection with entering into the asset purchase and sale agreement, Patel, the purchaser, deposited into escrow $125,000 as earnest money.  The agreement provided that the closing on the transaction would take place within 120 days and further provided that the earnest money deposit would be (i) applied to the purchase price or (ii) refunded if the closing did not place absent the fault or breach by Patel.  However, only six days after the asset purchase agreement was signed, Patel advised the sellers that he was having trouble securing financing.  In connection therewith, the asset purchase agreement was amended to provide, inter alia, that the earnest money deposited would be transferred from escrow to the sellers to be ultimately applied to the total purchase price or refunded if the closing did not take place other than due to default or breach by Patel.  The scheduled closing date of 120 calendar days after October 12, 2006 was not altered.  Ultimately, Patel was not able to secure the necessary financing, and for that reason did not closed on the acquisition.  Patel filed suit to recover the $125,000.  The trial court awarded the sellers summary judgment to the effect that there was no obligation to refund the earnest money deposit.

     The Court of Appeals upheld the summary judgment on the basis that:

It is undisputed that the only reason the sale was not completed was Patel’s failure to secure financing.  The failure of the sale being solely Patel’s fault or breach, the award of summary judgment was entirely appropriate.

      Patel argued, but the Court of Appeals panel rejected, a claim that the loss of the earnest money deposit constituted an unreasonable liquidated damage or a penalty, citing United Services Auto Ass’n v. ADT Sec. Services, Inc., 241 S.W3d 335 (Ky. App. 2006).  However, in a dissent by (Senior) Judge Isaac, he argued that the summary judgment should be overruled on the basis that there were insufficient findings to determine whether the standards of United Services had been satisfied.

      Discretionary review was granted on May 16.  It does not appear that any of the briefs have yet been filed with the Court, and as of this time oral arguments have not been scheduled.

Upcoming From the Kentucky Supreme Court - Class Action Arbitration

Upcoming From the Kentucky Supreme Court - Class Action Arbitration

       In Schnuerle v. Insight Communications Co., L.P., 2010 WL 5129850, 2010 KY LEXIS 288 (Ky. 2010), the Kentucky Supreme Court struck down a waiver of class action arbitration set forth in a consumer contract.  In striking down that waiver, the Kentucky Supreme Court relied upon the Discover Card decision of the Ninth Circuit Court of Appeals.  After the Kentucky Supreme Court made its ruling, in ATT Mobility LLC v. Concepcion, 563 U.S. _____ (2011), the United States Supreme Court upheld waivers of class action arbitration and specifically overruled the Discover Card decision.

      The question of class action arbitration waivers in Kentucky is therefore again pending before the Kentucky Supreme Court.  Oral arguments on the case took place in February 2012.

The Battle of Chalons

The Battle of Chalons

      Today marks the anniversary of the Battle of Chalons in 451, between the Huns under the command of Attila versus the combined forces of the Roman Empire and the Visigothic Empire, it under the command of its King, Theodoric I.  The western forces were under the command of magister militum Flavius Aetius. 

      While Theodoric would himself fall in battle, the western forces were successful in defeating the Huns, forcing them to retreat from their efforts to expand their empire to include the former Roman province (portions of it had already withdrawn from it) of Gaul.

      The hero of the day was clearly Falvius Aetius.  He had been appointed magister militum (essentially “supreme commander” of all Roman military forces) by Valentinian III, a particularly weak (and in this era that is saying something) emperor.  While Boethius is oft identified as the last gasp of the Roman Empire’s (or at least its western components’) intellectual life, Flavius Aetius can equally be described as the last of the great western Roman generals. 

      Only three years after Chalons in September, 454, Aetius was assassinated by Valentinian.  Within the year, Valentinian would in turn be assassinated by friends of Aetius while Valentinian’s guard watched; the members of the guard had been followers of Aetius.

Trustees Not Personally Liable for Fraudulent Conveyance of Assets into Trust

Court Rejects Herculean Effort to Hold Trustees Personally Liable

For Trust Settlor’s Alleged Fraudulent Conveyances

      A recent effort by a creditor to hold the trustees personally liable for certain alleged fraudulent conveyances accomplished by the trust settlor has been rejected.  GATX Corp. v. Addington, 2012 WL 1621363 (E.D. Ky. May 9, 2012).

      GATX Corporation leased coal-mining equipment from Appalachian Fuels pursuant to a master lease agreement.  Larry Addington, a 30% shareholder in Energy Coal Resources, Inc., it being a member of Appalachian Fuels, signed a joint and several guaranty of Appalachian’s fuel obligations under the master lease agreement to GATX, that liability capped at $5 million.  On May 15, 2009, GATX sued Larry for his obligations under that guaranty agreement, which suit was ultimately resolved pursuant to an Agreed Judgment against Larry in the amount of $2,900,000.  GATX agreed to forbear collecting until November 16, 2011.  The Agreed Judgment was not, however, resolved by that day, and suit was filed by GATX against Larry on November 17, 2011.

      In December 2008, Larry converted a previously existing revocable trust into an irrevocable trust for the benefit of his brother Maxwell.  Stephen and Robert Addington, both brothers of Larry, served as co-trustees of the irrevocable trust.  Larry conveyed into it three pieces of real property located in Boyd County, those transfers taking place on the same day the trust was reorganized into its irrevocable form.  Shortly thereafter, on January 2, 2009, he contributed $1 million in cash to the irrevocable trust.  Almost two years later, November 18, 2012, the irrevocable trust acquired title to the three vehicles, but the opinion does not specify whether they were purchased with the cash conveyed to the trust or were separately transferred to the trust from Larry’s name.

      On January 26, 2012, Larry Addington filed for personal bankruptcy protection under Chapter 11, thereby effecting a stay of the suit brought against him by GATX under the original Agreed Judgment.

      GATX, in the suit filed November 17, 2011, in addition to suing Larry for breach of the Agreed Judgment, filed suit as well against Stephen and Robert, co-trustees of the trust, alleging a variety of claims based upon participation in alleged fraudulent conveyances by Larry.  These claims were, ultimately, unavailing and were dismissed on Rule 12(b)(6) motion:

GATX has presented numerous legal theories in pursuit of a viable legal theory by which it might hold Stephen and Robert liable in their individual capacities.  In GATX’s Complaint, it alleged that Stephen and Robert are directly liable, and for aiding and abetting Larry Addington in fraudulently conveying property in violation of KRS §§ 378.010 and 378.020….  GATX asserted that the Complaint also pled a sufficient factual basis to support additional legal theories, naming conspiracy to effectuate fraudulent transfers and simple fraud.  Continuing its quest for a viable legal theory, GATX filed a Motion for Leave to Amend Its Complaint (and subsequently filed a proposed Amended Complaint) with yet another legal theory – negligence per se under KRS § 446.070.  However, despite these continued efforts, GATX has failed to assert a viable legal theory against Stephen or Robert in their individual capacities for which relief may be granted.  2012 WL 1631363, *4.

As for breach of the Kentucky statute of fraudulent conveyances, the Court noted that it is applicable to only a transferor or a transferee.  Neither Stephen nor Robert was, in their individual capacity, either a transferor or transferee of the property.  Rather, Larry was the transferor and the trust was the transferee.  “Thus, Stephen and Robert were not ‘transferees’ and therefore cannot be directly liable for violating the fraudulent conveyance statutes.”  2012 WL 1621363, *7.

      Acknowledging that Kentucky courts have not directly addressed the issue, it was stated that Kentucky would likely follow the “overwhelming majority of states” that have held that there exists no claim for aiding and abetting a fraudulent conveyance.

Therefore, to the extent that GATX has pled that Stephen and Robert aided and abetted a fraudulent conveyance, that claim is dismissed.  Furthermore, GATX has requested leave to amend its complaint so that it may assert this claim if it was not property pled in the original complaint.  Having concluded that such a claim is not viable as a matter of law, it would be futile to grant GATX’s motion to the extent it wishes to assert a claim for aiding and abetting a fraudulent transfer.  2012 WL 1621363, *9.

      The Court as well disposed of arguments that GATX should be allowed to amend its Complaint, there asserting claims based upon either fraud by misrepresentation or fraud by omission, detailing the elements of those causes of actions and finding the necessary factual predicates to be missing.  The Court as well rejected the suggestion that Kentucky would recognize a cause of action for conspiring to effect a fraudulent conveyance.

No Kentucky Court has been asked to determine whether a claim for conspiring to effect a fraudulent conveyance is recognized as a matter of Kentucky law.   However, the majority approach appears to be in line with the goals of Kentucky’s fraudulent conveyance statutes; therefore, Kentucky would likely adopt the majority approach.  Like the fraudulent conveyance statutes at issue in Efessiou and S. Prawer & Co., the purpose of Kentucky’s fraudulent conveyance statutes is to “put the creditors back in the same position they would have enjoyed immediately prior to the voidable conveyance.”  Mattingly v. Gentry, 419 S.W.2d 745, 747 (Ky. 1967).  To fulfill this purpose, the plain language of both statutes allows the creditor to void the fraudulent conveyance.  However, neither the plain language of the statutes or Kentucky case law suggests that a defendant can be personally liable for fraudulently conveying property.  Therefore, as the court held in Efessiou, a plaintiff may not circumvent the limitations of the fraudulent conveyance action by bringing a civil conspiracy claim seeking an in personam judgment.  2012 WL 1621363, *14.

The Court went on to explain how the notion of conspiracy is itself analytically impossible and as well rejected a claim that there can be negligence per se in a claim for fraudulent conveyance.

Shareholders Are Not Fiduciaries

Shareholders Are Not Fiduciaries

I have written, and the Louisville Law Review has accepted for publication, Shareholders are not Fiduciaries – A Positive and Normative Analysis of Kentucky Law.

This article considers a seemingly simple question – is the statement “shareholders in a Kentucky business corporation stand in a fiduciary relationship with one another” an accurate statement of the law?  In fact it is not. 

          As is detailed therein, as a matter of positive law:

·         no Kentucky court has held there to be a fiduciary relationship among shareholders save in one narrow fact situation, and that decision may now be invalid consequent to intervening developments in the controlling statute; and

·         in comparing the Business Corporation Act to other of Kentucky’s business organization statutes, each addressing inter-owner fiduciary duties, the absence of a statutory inter-shareholder duty must evidence the absence of such obligations. 

Turning to a normative analysis, the absence of inter-shareholder fiduciary obligations is correct as:

·         the inter-shareholder relationship lacks the features of a fiduciary relationship;

·         the imposition of fiduciary duties among shareholders does violence to the statutory construct of majority control of the corporate enterprise;

·         the existence of such duties would do violence to a consistent form in which, by statute, fiduciary obligations are imposed upon only those charged with the day to day management of the venture; and

·         there are a variety of alternative structures in which, if desired, inter-owner fiduciary duties do exist. 

This article concludes with a review of how perceived cases of oppression may be addressed through contractual (as contrasted with fiduciary) remedies.

            The working draft of the article can be accessed through SSRN.  LINK

Controlling Law For Standing to Bring a Derivative Action

The Law of the Jurisdiction of Incorporation Governs the

Ability to Bring a Derivative Action

      The Delaware Chancery Court recently addressed the law governing the ability to bring a derivative action.  Microsoft Corp v. Vadem, Ltd., No. 6940-VCP (Del. Ch. Apr. 27, 2012). 

      Vadem, Ltd. is a corporation incorporated under the laws of the British Virgin Islands.  Microsoft is a shareholder in Vadem.  On Vadem’s behalf, Microsoft sought to bring a derivative action, which action was filed in the Delaware Chancery Court.  The Court looked to the law of the British Virgin Islands to determine whether Microsoft had standing to bring a derivative claim on Vadem’s behalf.  Under the law of the British Virgin Islands, the bringing of a derivative action requires the consent of the High Court of the British Virgin Islands.  No such consent had been received.  On that basis, the derivative action was dismissed.

      Kentucky has a non-uniform statutory provision that dictates this same result.  KRS § 271B.7-400(6) provides that:

In any derivative proceedings in the right of a foreign corporation, the matters covered by this section shall be governed by the laws of the jurisdiction of incorporation.

A plaintiff seeking, on behalf of a corporation organized in a particular jurisdiction, must be familiar with and in a position to satisfy all of the requirements imposed by the laws of that jurisdiction.  Where those requirements are not satisfied, the suit should be summarily dismissed by the court.

Delaware Court Corrects Error in LLC Agreements' Waterfall Provisions

Delaware Court Corrects Error in LLC Agreements' Waterfall Provisions

Chancery Reforms Scrivener’s Error; Imposes Attorneys’ Fees on Attorney/Party Who Stayed Knowingly Silent about Mistake

Chancery Reforms Scrivener’s Error; Imposes Attorneys’ Fees on Attorney/Party Who Stayed Knowingly Silent about Mistake

The Hidden Dangers of Providing Indemnity – Loss of Insurance Coverage

The Hidden Dangers of Providing Indemnity – Loss of Insurance Coverage

      A recent decision has highlighted a hidden danger inherent in agreeing to provide indemnity to corporate officers and directors, namely the possible invalidity of the insurance policy purchased to fund that indemnity obligation.  Lake Cumberland Resort Community Association, Inc. v. Auto Owners Insurance Co., No. 2010-CA-001725-MR, 2012 WL 1758108 (Ky. App. May 18, 2012) (Not to be Published).

      The Lake Cumberland Resort Community Association (the “Association”) purchased a directors and officers policy from Auto Owners.  The Association, a nonprofit corporation, provided in its articles of incorporation (this provision is not from the opinion but rather from the articles as posted on the Secretary of State’s website):

The Association shall indemnify its directors and officers and may indemnify its employees and agents, to the fullest extent permitted by law, from and against any and all of the expenses or liabilities incurred in defending a civil or criminal proceeding, or other matters, including advancement of expenses prior to the final disposition of such proceedings and amounts paid in settlement of such proceedings, and the indemnification provided for herein shall not be deemed exclusive of any other rights to which those indemnified may be entitled under any by-law, article, agreement, vote of Members or disinterested directors or otherwise, both as to action in his or her official capacity and as to action in another capacity while holding such office, and shall continue as to a person who has ceased to be a director, officer, employee or agent, and shall inure to the benefit of the heirs, executors and administrators of such a person and an adjudication of liability shall not affect the right to indemnification for those indemnified.  The foregoing right of indemnification shall be in addition to and not exclusive of all other rights to which such director or officer of the Association may be entitled.

      Disenchanted members of the association filed suit objecting to the manner in which the association was being managed, including pleas that the board be replaced and that the incumbent directors be required to provide an accounting of all expenditures and seeking the recovery of funds for which a proper accounting could not be made. Auto Owners provided a defense, but as well intervened in the action, seeking a determination that an exclusion to coverage existed and in fact it had no obligation to provide coverage.  Auto Owners prevailed on summary judgment, and this appeal followed.

The decision turned upon a policy exclusion as to:

Any claims for which your officer of director receives indemnity from [the community association] or has a right to be indemnified by [the community association]

(Bracketed language is as it appears in the opinion.)   Clearly the Association’s articles of incorporation provided indemnity to its officers and directors.  Auto Owners argued “that this policy provision clearly excludes coverage of claims for which an officer or director of the community association receives indemnity from the association or has a right to be indemnified by the association.”  In turn the Association argued that the “indemnity exclusion cannot be enforced because it renders the coverage provided by the policy completely illusory and contravenes public policy” and “defeats their reasonable expectations for coverage.” 

 

 

      Finding in favor of Auto Owners, the Court of Appeals wrote:

The exclusion for indemnity in the policy endorsement was triggered solely by the provisions of the community association’s own articles of incorporation.  While corporations, both for-profit and non-profit, are authorized by statute to include indemnity provisions like the one utilized by the community association in this case, they are not required to indemnify their directors and officers.  In this case, the community association chose to indemnify its directors and officers in its articles of incorporation.  The community association and its board were in the best position to review the corporate documents – including the articles of incorporation – at the time that they contracted for and purchased their insurance policy.  The community association remained at liberty to amend the articles at any time to eliminate the indemnification of its directors and officers in light of the clear and unambiguous indemnity exclusion in its insurance policy.  Had it done so, it could have prevented the triggering of the exclusion about which it now complains.  Under the circumstances, we cannot agree that the exclusion renders the policy’s coverage illusory or that it contravenes public policy in any manner.  Nor can we agree that it defeated any reasonable expectations for coverage because of the clear and unambiguous nature of its language. (emphasis in original).

      It is manifest that those representing companies buying D&O coverage need to be sure that limitations such as this are not in the policies.  At the same time there remains unresolved the question of how the rule of this case will be applied vis-à-vis the mandatory indemnification provisions (e.g., KRS § 271B.8-520) of the various acts.