Business Judgment Rule Misapplied with Respect to Contract Formation

Business Judgment Rule Misapplied with Respect to Contract Formation

      In a recent decision from the Federal District Court for the Eastern District of Kentucky, the business judgment rule was misapplied in order to support a determination that a contract existed. Taylor v. University of the Cumberlands, Civ. No. 6:16-CV-109-GFVT, 2017 WL 512643 (E.D. Ky. Fed. 7, 2017).

       This dispute arose out of efforts by James Taylor, the former President of the University of the Cumberlands, and his wife to enforce against the University certain deferred compensation arrangements providing for, by way of example, continued salary payments through the second to die of James and Dina Taylor, car allowances, phone allowances and a residence. Seeking to avoid these obligations, the University asserted that the agreement was unenforceable in that it lacked consideration. Initially, the Court rejected the suggestion that the only consideration provided by the Taylors was past performance, which cannot constitute consideration for a contract. Rather, the Court found that each of the Taylors undertook prospective obligations, thereby satisfying the consideration requirement.

      But then the Court continued the analysis by noting that:

In contract issues such as these there is a presumption of universal application “that an admitted and duly executed writing is supported by a legal consideration, and the burden is cast on the one executing it to overcome that presumption.” Shrout’s Adm’r v. Vaughan, 204 S.W.2d 969, 970 (!947). Seeing that the disputed agreement has been signed by the Chairman of the Board of Trustees, an authorized representative of the University, both Plaintiffs, and a notary public, this presumption shall apply. The Plaintiffs further argue that the business judgment rule should apply, and the court should not question “adequacy of consideration” as to the Taylor Agreement, as the “Court is ill-equipped to second-guess the Board of Trustees regarding their determination of the value to the University of its continued association of the Taylors.” [R. 15 at 15.] Without citing authority, the Defense merely states that “the multitude of cases regarding the business judgment rule ... have no application to this Motion, which presents a purely legal question regarding the Disputed Agreement’s enforceability.” [R. 17 at 9.]

The Plaintiffs cite to an unpublished Kentucky Court of Appeals opinion, Davis v. Innwood Condo. Prop. Owners Ass’n, which finds that “the business judgment rule is codified for non-profit corporations” in the Kentucky Revised Statutes. Davis v. Innwood Condo. Prop. Owners Ass’n, No. 2013-CA-001221-MR, 2014 Ky. App. Unpub. LEXIS 500, at *10-11 (Ct. App. June 27, 2014). Seeing that the Defense does not cite authority to contest application of the business judgment rule in this context, and under belief that the University Board members entered into this agreement with “an informed basis, in good faith and in the honest belief that the action taken was in the best interests of the [University],” the business judgment rule may apply in this context. Id. (citing Allied Ready Mix Co Inc. ex. Rel. Mattinglyv. Allen, 994 S.W.2d 4, 8 (Ky. App. 1998)). 2017 WL 512643, ** 5-6.

      All of which is very interesting, but the business judgment rule has absolutely no application to determine whether there was consideration for a contract. The business judgment rule is in the nature of a policy of judicial abstention pursuant to which a court will not review a decision of the board of directors that does not involve a potential breach of the duty of loyalty absent a prima facia showing gross negligence or willful misconduct by the board. While the business judgment rule would have application in a challenge to whether the board made a proper decision in entering into the agreement with the Taylors, it has absolutely no application to the validity of the contract between the University (here a non-profit corporation) and the Taylors.