More on to Whom Fiduciary Duties are Owed

More on to Whom Fiduciary Duties are Owed

      A recent decision from the Kentucky Court of Appeals, affirming the dismissal of a lawsuit alleging breach of fiduciary duties in a nonprofit corporation, turned on the question of to whom the duties were owed. Thompson v. Lake Cumberland Resort Community Association, Inc. No. 2016-CA-000145-MR, 2017 WL 4712520 (Ky. App. Oct. 20, 2017).

       This suit arose in connection with allegations by the plaintiffs as to the legitimacy of the board of a nonprofit corporation (i.e., had it been properly elected/appointed) and claims for breach of fiduciary duty by those on the board. With respect to the legitimacy of the board, the court had ordered a new election. The plaintiffs, however, continued to contest the legitimacy of that board, and, in consequence, the legitimacy of its determinations with respect to the discharge of the corporation’s assets, maintaining that “if the election was not proper under the By-laws of the Association, those expenditures were ultra vires.” 2017 WL 4712520, *1.

      As noted by the Court of Appeals, while this litigation was pending, the Kentucky Supreme Court issued its opinion in Ballard v. 1400 Willow Council of Co-Owners, Inc., 430 S.W.3d 229 (Ky. 2013). In that decision, the Supreme Court held that the fiduciary duties owed by the directors of a nonprofit corporation are owed to the corporation itself, and not to the individual members thereof.  HERE IS A LINK to my review of that decision.

       From there, the court parsed the various allegations made by the plaintiffs, finding that they could only the brought derivatively as any breach of the duties would have been of duties owed the corporation. In particular, the court focused upon the wording of the Nonprofit Corporation Act and where it provides for either an action for injunctive relief or an action for damages. Ultimately, the court determined that the authority cited provided for injunctive relief, but not damages. For example, the court wrote:

The Thompsons assert that Del Spinas had numerous conflicts of interest, causing the Thompsons damages that rose to the level of ultra vires acts, as stated under Kentucky Revised Statutes (KRS) 273.173. However, KRS 273.173 provides for injunctive relief where a member seeks to stop an unauthorized act by the board, it does not include an action for damages. The statute then sets out the conditions under which the corporation, but not individual members, could void such an action. Because the cause of action lies with the Board and not the individual members, the Thompsons do not have any claim under KRS 273.173. 2017 WL 4712520, *3.

      That may not, however, be the end of the story. The Thompson’s have filed with the Kentucky Supreme Court a petition for discretionary review. In that petition, they paint a story significantly different than that described by the Court of Appeals noting, for example, that there have been no ongoing dispute with respect to the validity of the election above referenced.  The petition for discretionary review also, inter alia, points out the need for allowing suits such as this to proceed on a derivative basis so that the directors and officers of nonprofit corporations may be held liable for breaches of fiduciary duty. The necessity of the court recognizing derivative actions in nonprofit corporations, notwithstanding the fact that there is no “derivative action” provision in the Kentucky Nonprofit Corporation Acts, was a point I addressed in an article titled Who Will Watch the Watchers?: Derivative Actions in Nonprofit Corporations. HERE IS A LINK to that article.