Monday, November 25, 2013

Kentucky Supreme Court Identifies the Beneficiary of a Board’s Fiduciary Obligations

Kentucky Supreme Court Identifies the Beneficiary of a Board’s Fiduciary Obligations

      Last Thursday, the Kentucky Supreme Court issued its long-awaited decision in Ballard v. 1400 Willow Council of Co-Owners, Inc., a dispute that in part revolves around fiduciary duties among the members of the board of directors, the board of directors as a collegial body and the members of a nonprofit corporation.  In that the statute defining the fiduciary obligations of the directors of a nonprofit corporation (KRS § 273.315) uses the same formula as that utilized in the Kentucky Business Corporation Act (KRS § 271B.8-300(1)), this decision has application across both forms of business organization.  Ballard v. 1440 Willow Council of Co-Owners, Inc., 2010-SC-000533-DC (Ky. Nov. 21, 2013). 
      Ballard was the owner of a condominium in the 1400 Willow building.  Consequent to certain problems with exterior masonry, agreed by all to be a common element, the window frames in her condo began to rot out.  There was a dispute as to whether or not the rotting was of such a degree that there was a risk of the glass falling; the condominium board believed there to be an eminent risk, while Ballard’s consultant thought there to not be a problem.  During the pendency of a complaint for declaratory relief, workers employed by the condominium association (a/k/a the “Council”) entered the condominium and replaced the windows at a total cost of $65,000.  The Council as well filed a lis pendens on the title to the condominium as security for the amount it had expended.  Slip op. at 3.  Thereafter Ballard amended her complaint to claim damages for breach of contract, breach of fiduciary duty, promissory estoppel and punitive damages.  Some two years later she would again amend her complaint to assert that the lis pendens filed by the Council as well as a similar document filed with the Jefferson County Clerk constituted slander of title.
      At a trial that took place in September, 2007, the jury determined that the windows did need to be replaced and that the need for replacement was caused by the masonry problem.  The jury also found that (a) the Council failed to exercise “good faith and loyalty” to the condo owners including Ballard, (b) that she should be made whole on $54,000 of condo fees paid, and (c) that the lis pendens was a knowing and malicious false statement as to the title of her condo for which $75,000 would compensate her.  The jury declined to award punitive damages.
      The jury’s decision was appealed to the Court of Appeals, which reversed and remanded for a new trial.  The Supreme Court then granted discretionary review.

       Before going to what I find interesting in this decision, namely the discussion of fiduciary duties and contract law, it should be noted that this decision has important points on real property law.  First, the Supreme Court held that the statute of limitations on a claim of slander of title would be five years (KRS § 413.120) and in so doing reversed a prior decision holding it to be one year.  See slip op. at 11.  Turning to the actuality (or not) of the slander of title claim, while the Court reviewed a good deal of foreign law holding that the filing of a lis pendens has an absolute privilege, it ultimately held that the filing of a lis pendens has only a qualified privilege.  Slip op. at 16.  From there, in reliance upon the jury’s determination that the lis pendens was “false and knowingly and maliciously made,” the Court held that the qualified privilege was not available to the Council.
      The broader issue addressed by the Court is the nature of fiduciary duties, specifically who owes them and to whom they are owed.  While Ballard’s theory of the case appears to have changed over time, she ultimately asserted not a derivative action on the corporation’s behalf charging the directors with a breach of duty owed the entity but rather “she sued the [Council] as an entity for breach of its contractual obligations and common law fiduciary duties to her, individually.”  Slip op. at 20.  That attempted parsing of her claim ultimately failed as she relied upon a non-existent fiduciary duty.
[W]e cannot say that the Council had a fiduciary duty to the individual owners.  Ballard has not cited any Kentucky authority which provides that a nonprofit corporation has a fiduciary duty.  Rather, we believe it is the officers and directors that have a fiduciary duty, and that duty is to the nonprofit corporation.  See KRS 273.215.
Slip op. at 20.
      The Court continued its analysis of the point, making express that the duty is to the entity and not the individual members:
[T]he directors in this case only owed a fiduciary duty to the corporation.  Specifically, KRS 273.215 provides that a director shall discharge his duties “(a) In good faith; (b) On an informed basis; and (c) In a manner he honestly believes to be in the best interests of the corporation.”  (Emphasis added).  As correctly noted by the Court of Appeals, this is a reasonable interpretation because the co-owners in this case could have competing agendas, which may not be in the best interests of the Council.  Thus, the board of directors had a fiduciary duty to the Council as a whole and not to the individual unit owners, such as Ballard.

Slip op. at 21.  On that basis the jury’s award of $54,000 for breach of fiduciary duty was for breach of a non-existent duty, the Court of Appeal’s reversal thereof was upheld.

      Justice Noble, joined by Justice Scott, dissented as to the reversal of the finding of a breach of fiduciary duty.  Essentially, Justice Noble argued that the jury’s determination that the Council filed to “exercise good faith and loyalty” (slip op. at 27) equated to a breach of fiduciary duty.  The problem with this assessment was identified (but apparently not recognized) by Justice Noble when she noted the source of Ballard’s rights as a condo owner as to her particular unit, namely the “contractual rights and expectations” set forth in her deed and the Master Deed.  The failure was in not recognizing that contractual obligations are not fiduciary obligations, and that the obligation of “good faith and fair dealing” is contractual in nature.  See slip op. at 31 (“thus violating the general fiduciary duty – that ‘of good faith and fair dealing’ – contained in all contracts.”).
      Fortunately the majority opinion addressed this point, recognizing that “we cannot say that the jury’s find of a breach of fiduciary duty is equivalent to a finding of failing to act in good faith” (slip op. at 22), thereby properly separating the status-based gap filler that is the law of fiduciary duties from the contractual interpretation principle that is good faith and fair dealing.

No comments:

Post a Comment