Right Outcome, but the Court of Appeals is Confused as to the Business Judgment Rule

Right Outcome, but the Court of Appeals is Confused as to the

Business Judgment Rule

 

 

            In a recent decision the Court of Appeals correctly found that it would not second guess the decisions made by a board of directors as to how corporate assets should be applied to remedy existing problems.  At the same time, however, the Court was off base as to what is the Business Judgment Rule, and was off base as to who owes and who is the beneficiary of the fiduciary obligations in a corporation.   Davis v. Innwood Condominium Property Owners Association, Inc., No. 2013-CA-001221-MR, 2014 WL 2938486 (Ky. App. June 27, 2014).

 

            Davis owned a condominium in the Ironwood development, a low and fixed income complex. The property has in recent years faced a number of challenges including the need to expend some $100,000 in brick repairs in order to remedy a code violation, significant repairs to the heating system, and an increase in insurance premiums after a fire.  A special assessment of the owners was made in order to increase reserves.

 

            Davis, who at various times has served on the board of directors, brought suit alleging that the board had failed to satisfy the terms of the master deed as to a number of issues including exterior maintenance, limitations upon occupancy of units and failing to require background checks on occupants.  In addition, he alleged that the board had failed to maintain the property as a “first-class condominium.”  Collectively, he asserted that these failures, characterized as breaches of fiduciary duty, reduced the fair market value of his unit.

 

            After discovery, the trial court dismissed the complaint as being subject to the “business judgment rule”; this appeal followed.

 

            Davis’ argument was that the Master Deed set forth requirements, that even though some issues were being address the board was not requiring full compliance with those requirements, and a breach of fiduciary duty therefore resulted.  The Court of Appeals affirmed the trial court’s determination that the Business Judgment Rule precluded court intervention, it writing:

 

The business judgment rule is “a presumption that in making a business decision, not involving self-interest, the directors of a corporation acted on an informed basis, in good faith and in the honest belief that the action taken was in the best interests of the company.” Allied Ready Mix Co., Inc. ex. rel. Mattingly v. Allen, 994 S.W.2d 4, 8 (Ky.App.1998). The record below indicates that the Board sought guidance from its management company, Prudential Parks, and Weisberg Realtors in making decisions as to how to best address the issues raised by Davis. The record further reflected that the Board did not have all of the necessary funds at its disposal to immediately fix each of the problems raised by Davis. However, the Board, based upon the advice it received, in consideration of the financial status of the tenants and owners at Innwood, did vote to approve a Special Assessment for repairs and maintenance. By considering the economic standing of its residents and the problems at issue and making such a decision, this Court is not persuaded that the Board breached any fiduciary duty in this instance.

 

Finding there to be no assertion of fraud or conflict of interests that precludes the application of the Business Judgment Rule, the trial court’s dismissal of the complaint was upheld.

 

            That said, before the quoted language above the court misidentified the source of the Business Judgment Rule as being in the statutory formulae of the standards imposed upon corporate directors, those being KRS §§ 273.215 and 271B.8-300.  Sorry, but that is not the case.  Those cases recite the standards of performance and the standards of culpability imposed upon directors.  The Business Judgment Rule, in contrast, applies not to corporate directors but rather to the courts called upon to assess the actions taken by the directors, and creates a presumption against judicial review of decisions made by a corporate board.  In no manner is this presumption against judicial review “codified” in the the Kentucky statutes on business and nonprofit corporations.

 

            Another point, this one clearly dicta, in which the Court of Appeals was on less than a sound footing was in finding that there exists a fiduciary duty running from the corporation’s board to the individual owners thereof.  The Court of Appeals acknowledged that this determination is in contrast to that made in the then not final Ballard v. Willow Council of Co–Owners, Inc., 430 S.W.3d 229, 2013 WL 6134150 (Ky. 2013).  A motion for reconsideration in Ballard was denied on June 19, 2014, and that decision is now final. Hence the suggestion in Davis that a fiduciary duty is owed directly to the owners should be treated as moot.

The Importance of Maintaining Correct Registered Office/Registered Agent Information

The Importance of Maintaining Correct Registered Office/Registered Agent Information

       A decision rendered by the Kentucky Court of Appeals last week reinforces the importance of maintaining current registered office/agent information with the Kentucky Secretary of State, as well as current principal place of business information.  In this instance, a corporation failed to satisfy each of these obligations.  Ultimately, it was saddled with a default judgment, which judgment was not set aside on the basis of “excusable neglect.”  Bradford White Corp. v. Kentucky Farm Bureau Ins. Co., No. 2013-CA-001549-MR (Ky. App. July 25, 2014) (Not to be published).

      Kentucky Farm Bureau Insurance brought a subrogation claim against Bradford White Corporation based upon a defective water heater that Bradford White had manufactured.  Bradford White is a Pennsylvania corporation qualified to transact business in Kentucky.

      Service was attempted on Bradford White not less than four times including at the registered office/agent it identified on its filings with the Pennsylvania Secretary of State and as well through the Kentucky Secretary of State via the registered office/agent identified on the Certificate of Authority.  All of these efforts were unsuccessful, the certified mail containing the summons and the complaint being in each instance returned as undeliverable.  The trial court issued a default judgment against Bradford White.  Ultimately, by some mechanism not recounted in the decision, Bradford White became aware of the default entered against it and sought to have the default judgment set aside on the basis of “excusable neglect.”

      The Court of Appeals, affirming the trial court on an abuse of discretion standard, was having none of an argument of “excusable neglect.”  Rather the Court of Appeals found that Bradford White had repeatedly failed to update its address, as well as its registered office/agent information, with the Pennsylvania and Kentucky Secretaries of State.  Ultimately:

Bradford White’s lack of actual knowledge [of the lawsuit] was not caused by the plaintiff, Secretary of State, or the post office.  Rather, it was caused by Bradford White’s willful ignorance or negligence.

       The lesson is simple – a company obligated to maintain registered office/agent information with the Secretary of State, as well as current information as to the principal place of business address, is rendering itself subject to a default judgment if it fails to do so.  The failure to keep those records current will not be a defense to the failure to receive actual notice of a suit.

      All that said, the Court of Appeals did somewhat (greatly) overstate the effect of a certain statute.  Essentially, the Court described the failure to maintain current registered office/agent and principal office address information as being “criminal,” citing KRS § 14A.2-030(2).  This is an overstatement of the statute.  That provision provides for misdemeanor treatment of the execution and delivery to the Secretary of State for filing of a document when it is known that the contents thereof are not true.  This provision applies only at the time information is filed; it is inapplicable to the obligation to keep information current.

Western District Considers Citizenship of a Donative Trust; Restricts Citizenship to that of the Trustees

Western District Considers Citizenship of a Donative Trust;

Restricts Citizenship to that of the Trustees

 

In a recent decision, the Judge Russell of the Western District considered how to assess, for purposes of diversity jurisdiction, the citizenship of a donative trust.  He determined that only the citizenship of the trustee, and not as well the citizenship of the trusts’ beneficiaries, would be pertinent.  Watkins v. Trust Under Will of William Marshall Bullitt, Civil Act. No. 3:13-CV-01113-TBR, 2014 WL 2981016 (W.D. Ky. July 1, 2014).

 

            Watkins, a beneficiary of the Bullitt Trust, brought suit on a number of grounds including breach of fiduciary duty and  against PNC Bank, the Trust’s trustee. PNC removed to federal court, and Watkins sought a remand, arguing that there should be attributed to the trust the citizenship of its Kentucky domiciled beneficiaries.  Were that done diversity would be lacking.  PNC argued that only the citizenship of the trustee should be considered in determining the trust’s citizenship.

 

            The Court began by reviewing the competing rulings of Carden v. Arkoma Associates, 494 US 185 (1990) (citizenship of an unincorporated association determined by reference to the citizenship of all of the members therein) and Navarro Savings Association v. Lee, 446 US 458 (1980) (in suit brought by trustees in their individual capacities, only the citizenship of the trustees would be relevant in determining citizenship) and noted that the subject trust was a traditional donative (and not a business trust).  From there Judge Russell determined that as the Bullitt Trusts lacks independence but is “dependent upon PNC to own and manage its property for the benefit of the beneficiaries,” only the citizenship of the trustees would be relevant.

 

            This holding is consistent with certain rulings of other courts while it is at the same time in opposition of other rulings – it does not appear that a majority rule has yet emerged.  Reviews of those other rules can be found HERE and HERE. 

Court of Appeals Refuses to Adopt Outsider Reverse Piercing

Court of Appeals Refuses to Adopt Outsider Reverse Piercing

      In a recent decision, the Court of Appeals rejected an effort by a judgment creditor to effect an outsider reverse pierce of a corporation in order to secure assets that would be applied to satisfy a debt of the sole shareholder. Williams Estate v. William C. Oates Estate, No. 2012-CA-000327-MR, 2014 WL 2937773 (Ky. App. June 27, 2014).

      Cecil Williams, in August, 1990, loaned $62,500 to William Oates. While the loan was unsecured, apparently Oates told Williams that he owned a piece of residential real estate. No mortgage was filed, however against that real estate. In actuality, Oates did not own the house; rather, it was owned by William C. Oates Realty Co., Inc., of which Oates was the sole shareholder. Oates never repaid Williams the borrowed $62,500. Ultimately, when Williams brought suit, he was awarded a default judgment. However, he was never able to collect thereon. That judgment was subsequently renewed so that it would not become subject to the 15 year statute of limitations of KRS § 413.090. Ultimately the corporation was administratively dissolved after Oates' death, and its assets were distributed to Oates’ heirs. In turn, Williams sought to recover those assets from the heirs in order to satisfy the debt.  In addition, Williams sought to have the corporate existence set aside ab initio, thereby treating the corporation's assets as those of Oates individually.

      Both of these arguments were rejected.

      With respect to the suggestion that the corporation had never really existed, the court relied upon KRS § 271B.2-030(1), which provides that the existence of the corporation begins when the articles of incorporation are filed with the Secretary of State. The court noted as well that the corporation had filed, for several years, the necessary annual reports with the Secretary of State, and tax returns had been filed.  From this the court determined that the corporation had “established its corporate existence.”

      Turning to the effort to pierce the veil, the court noted that the plaintiff was attempting to do a “reverse pierce.” Citing Turner v. Andrew, 413 S.W.3d 272, 277 (Ky. 2013), “reverse piercing” was described as “a theory in which the creditor of an individual who was the sole member of the corporation seeks to pierce the veil to obtain corporate assets to satisfy the member’s personal debt.” It was notes as well that the Turner court had stated that it is unclear whether Kentucky recognizes reverse piercing.  In this decision, the Court observed that the plaintiff had failed “to provide any thoughtful insights were compelling arguments as to why this concept should be adopted in the Commonwealth.”

       Last, and perhaps alluding to the rule of White v. Winchester Land Development that contractual creditors are in the position to protect themselves by contract, it was observed that “a loan for the sum of money at issue should have been secured when it was originally made.”

Kentucky Ban on Same-Sex Marriage Held Unconstitutional

Kentucky Ban on Same-Sex Marriage Held Unconstitutional

      By statute and Constitution, Kentucky has laws providing, inter alia, that it will not recognize same-sex marriages performed in other states and that same-sex marriages may not be performed in Kentucky.  Earlier this year, Judge Heyburn declared unconstitutional that aspect of Kentucky law providing that Kentucky will not recognize same-sex marriages performed in other jurisdictions.  That decision is currently being appealed to the Sixth Circuit Court of Appeals in concert with similar rulings from other states throughout the Sixth Circuit. 

      Since Judge Heyburn’s initial decision, additional Plaintiffs have joined the case.  Specifically, these new Plaintiffs desire to be married in Kentucky; they are not married under the laws of any foreign jurisdiction.  Yesterday, Judge Heyburn held that those aspects of Kentucky law precluding a same-sex marriage are unconstitutional.  Ergo, Kentucky has no legitimate basis for denying marriage licenses to same-sex couples.  The issuances of those marriage licenses will not, however, commence immediately; Judge Heyburn has stayed his ruling until the Sixth Circuit can consider the issue.

       Of concern primarily to attorneys involved in due process analysis, Judge Heyburn did not find that sexual orientation creates a protected class.  Rather, it was not ultimately necessary to engage in that analysis as under even the highly differential rational basis analysis, the prohibition of marriage licenses to same-sex couples failed: “Kentucky’s laws banning same-sex marriage cannot withstand Constitutional review regardless of the standard.  The Court will demonstrate this by analyzing Plaintiffs’ challenge under rational basis review.” Slip op. at 14.

      Before Judge Heyburn (and as well argued to the Sixth Circuit), the state of Kentucky has argued that restricting marriage to heterosexual couples insures a balanced birthrate, that being necessary for Kentucky’s long term economic viability.  This argument has been widely lampooned, including HERE. 

      In response, the Court wrote:

This Court will begin with Defendant’s only asserted justification for Kentucky’s laws prohibiting same-sex marriage: “encouraging, promoting, and supporting the formulation of relationships that have the natural ability to procreate.”  Perhaps recognizing that procreation-based arguments have not succeeded in this Court, nor any other Court post-Windsor, Defendant adds a disingenuous twist to the argument:  traditional marriages contribute to a stable birth rate which, in turn, ensures the state’s long-term economic stability. 

These arguments are not those of serious people.  Though it seems almost unnecessary to explain, here are the reasons why.  Even assuming the state has a legitimate interest in promoting procreation, the Court fails to see, and the Defendant never explains, how the exclusion of same-sex couples from marriage has any affect whatsoever on procreation among heterosexual spouses.  Excluding same-sex couples from marriage does not change the number of heterosexual couples who choose to get married, the number who choose to have children, or the number of children they have.  The Court finds no rational relation between the exclusion of same-sex couples from marriage and the Commonwealth’s asserted interest in promoting naturally procreative marriages.  Slip op. at 15.

He went on to observe “that Kentucky’s laws do not deny licenses to other non-procreative couples reveals the true hypocrisy of the procreation-based argument.” Slip op. at 16.

      Responding to the likely suggestion by some that allowing same-sex marriage in some manner impinges upon their rights, Judge Heyburn wrote:

Sometimes, by upholding equal rights for a few, Courts necessarily must require others to forebear some prior conduct or restrain some personal instinct.  Here, that would not seem to be the case.  Assuring equal protection for same-sex couples does not diminish the freedom of others to any degree.  Thus, same-sex couples’ right to marry seems to be a uniquely “free” constitutional right.  Hopefully, even those opposed to or uncertain about same-sex marriage will see it that way in the future.  Slip. op at 19.

      From there Judge Heyburn delivered the punch line, namely:

IT IS HEREBY ORDERED THAT to the extent Ky. Rev. Stat. §§ 402.005 and .020(1)(d) and Section 233A of the Kentucky Constitution denies same-sex couples the right to marry in Kentucky, they violate the Equal Protection Clause of the Fourteenth Amendment to the United States Constitution, and they are void and unenforceable.