Tuesday, March 19, 2013

Kentucky Supreme Court Hears Oral Arguments in New Lexington Clinic v. Cooper

Kentucky Supreme Court Hears Oral Arguments in New Lexington Clinic v. Cooper

      On March 14, the Kentucky Supreme Court heard oral arguments in New Lexington Clinic v. Cooper (now styled Baptist Physicians Lexington, Inc. v. New Lexington Clinic, P.S.C.).  This case, may lay down numerous important principles of law governing Kentucky business corporations.
      To briefly recap the facts to date, several director/employees of a medical practice entered into negotiations to create a new practice liaisoned with an existing healthcare network.  While still directors of the existing venture, the physicians solicited other doctors and professional staff to move to the new venture.  Also, at least one of the director/employee physicians shared with the new venture certain internal financial reports of the existing practice.  After the director/employees resigned and left, suit was filed charging them with breach of fiduciary duty.  The complaint did not reference KRS § 271B.8-300, which recites the fiduciary duties of a director of a Kentucky business corporation.
      Anne Chestnut, representing the defendants, argued (at least) a pair of themes:
·                     KRS § 271B.8-300 sets forth the only fiduciary duties of a director of a Kentucky business corporation and also specifies the threshold of culpability for assessing damages against a director; and
·                     there is no causal linkage between any violation that may have occurred and the damages now claimed by the plaintiff.
      The plaintiffs, represented by Tom Miller, argued that:
·                     under the modern rules of civil procedure, it is not necessary to cite the statutory basis of a claim;
·                     even if KRS § 271B.8-300 is the exclusive statement of a director’s fiduciary duties and the limits on a monetary claim for breach of those duties, the limits do not apply when the violation of duty does not take place in the course of discharging the duties of a director; and
·                     the summary judgment granted the defendants was premature.
      It was my impression that the Justices have spent a good deal of time studying this case.  That said, and applying Samuel Mayer’s rule that “I never make predictions, especially about the future,” I would be hard pressed to hazard a guess as to the Court’s ultimate ruling or the alignment of any individual justice.
      Issues such as the necessity of demonstrating causation of damages and the sufficiency of the discovery before summary judgment was granted are all points above my pay grade.  I can, however, speak to issues of fiduciary duty.
      I begin initially by agreeing with both Anne Chestnut on behalf of the defendants and Tom Miller on behalf of the plaintiffs.  As Anne argued, there really can be no question that KRS § 271B.8-300 was intended by the General Assembly to constitute the exclusive recitation of the duties of a director of a Kentucky business corporation, including the standard of culpability and the imposition of the burden of proof.  See KRS § 271B.8-300(1) (standard of conduct); id. § 271B.8-300(5)(b) (standard of culpability for monetary damages from breach of duties); and id. § 271B.8-300(6) (allocation of burden).  These statutory provisions entirely identify the burdens of a corporate director in the discharge of his or her obligations as such and the requirements for a challenge thereto, supplanting any prior common law to the contrary.

      At the same time, Tom is correct that these limitations as to culpability and burden of proof are not applicable with respect to all charges against an individual merely because he or she happens to be a director.  He referenced at length Judge Coffman’s ruling in Gundaker/Jordan American Holdings, Inc. v. Clark, 2008 U.S. Dist. LEXIS 80907 (E.D. Ky. 2008),  and argued that as the organization of a competing business is never part of the discharge of a director’s obligations, conduct of this nature falls outside the protections of the statute.  See also KRS § 271B.8-300(1) (“A director shall discharge his duties as a director ...”).  To provide an example that was begun by Tom in the course of his argument, but not completed in order to respond to a question from the Court, a director who embezzles money from the corporation is not, while executing the embezzlement, acting in the discharge of his or her obligations as a director.  As such, when the corporation brings an action against the director for what is indisputably theft, conduct manifestly “not in the best interest in the corporation” (KRS § 271B.8-300(1)(c)), the director cannot raise as a defense the obligation of the corporation to demonstrate that his or her conduct was wanton or willful.  KRS § 271B.8-300(5)(b).
      Cases like this are, however, somewhat closer than a case of embezzlement would be.  It could be said that an aspect of a director’s obligations of good faith and to act in the best interest of the corporation necessitate an obligation to protect the confidentiality of company financial information; from there it could be argued that the inappropriate dissemination of that information is a breach of the statutory duty of loyalty for which the protections of KRS §§ 271B.8-300(5), (6) apply.  Against this argument is the fact that seeking to utilize company financial information to benefit a different venture is not an action in the discharge of a director’s duties, so the statute should not control.  My feeling is the latter position is correct. 
      Under this analytic structure, Steelvest and Aero Drapery can be reconciled and exist alongside the statutory standard when a director is acting outside his or her capacity as a director, such as leaving one venture to accept employment with another.  At the same time, the statutory limitations of KRS § 271B.8-300 will alone be applicable (i.e., excluding any prior law) when the board is exercising its oversight function with respect to a corporation; for example, approving a merger or sale of substantially all corporate assets, or approving the terms by which the corporation will enter into a conflict of interest transaction with an entity controlled by a director.  See also Ridley v. Sullivan, No. 2009-CA-000712-MR (Ky. App. May 20, 2011) (Not to be Published) (corporate officer would be denied indemnification otherwise provided to officers by KRS 271B.8-510 where his actions involved intentional misconduct for improper personal benefit and were not within the scope of his employment as a corporate officer).
       With respect to the question of damages, I must disagree with both Mr. Miller and Ms. Chestnut.  The plaintiffs are arguing that they should be allowed to proceed with discovery in order to calculate damages and demonstrate them to a finder of fact.  Conversely, the defendants argue, in the absence of a demonstration of causation between the alleged breach and any damages that might be sought, that there is no need to proceed further (it is not clear to me whether or not Ms. Chestnut’s position is based upon KRS § 271B.8-300(6) and its allocation of the burden of proof).  As indicated above, I do not believe that KRS §§ 271B.8-300(5), (6) are relevant to this case in that the actions at issue were not taken in the discharge of director obligations.  Ergo, the burdens imposed by these statutes for the plaintiff to clearly demonstrate that the director’s conduct was wanton or willful and to prove causation are inapplicable to the dispute.

      Absent KRS §§ 271B.8-300(5), (6), under the traditional law of fiduciary duties as exemplified in trust law, in the event of a fiduciary’s breach of its obligations to the beneficiary (in this instance the corporation), the fiduciary must pay over to the trust all of the benefits derived from the transaction tainted by the breach of duty, with the fiduciary bearing the burden to show that not all of the proceeds thereof should be surrendered.  Such an in terrorem imposition of liability serves an important policing function with respect to fiduciaries and appropriately relieves the beneficiary of an obligation to demonstrate damages.

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