Kentucky Now Has Public
As of today, public benefit
corporations may be organized in the Commonwealth of Kentucky. This new
organizational form, essentially a special form of a business corporation, will
afford corporations, their owners and their management greater flexibility with
respect to the application of corporate assets to purposes that may not
directly benefit the bottom line and shareholder wealth, but which provide
benefits to of the broader community.
With this new legislation,
Kentucky joins the majority of the states (including Delaware) that have
statutes to this effect.
Court of Appeals Confirms
that Corporate Directors Owe Their Duties to the Corporation
In a decision rendered last
week, the Kentucky Court of Appeals has affirmed the rule, previously laid down
in Ballard v. 1400 Willow Council of Co-owners,
Inc., it relying upon KRS § 273.215, that the directors of a corporation owe
their fiduciary obligations to the corporation, not to the individual members
thereof. Flint v. Jacobs, No.
2015-CA-000489-MR, 2017 WL 2713456 (Ky. App. June 23, 2017).
Ed Flint, brought this action
against Fred Jacobs, the latter having been the president of the Board of
Directors of Coach House, Inc., a condominium association organizes as a
nonprofit corporation. Flint has previously sued Coach House not less than four
times, with each of those suits dismissed and those dismissals affirmed on
appeal. In this instance, amongst other claims including conspiracy and
discrimination, Flint alleged that Jacobs breached a fiduciary obligation owed
by Jacobs to Flint.
In affirming the dismissal of
Flint’s lawsuit generally and in particular this claim, in reliance upon the Ballard v. 1400 Willow, decision, the
Court of Appeals wrote:
Directors of a condominium
association's non-profit corporation owe a fiduciary duty only to the corporation,
not to the individual condominium association members.
of Appeals Clarifies Statute of Limitations for
Claims of Breach of Fiduciary Duty
In a decision rendered
last Friday, the Kentucky Court
of Appeals clarified how the statute of limitations for
the breach of fiduciary duty is to be applied. Most importantly, the Court held that a discovery rule does not apply with respect to allegations of breach of fiduciary duty. Middleton v. Sampey, No. 2015-CA-001029-MR, 2017 WL 2605224
(Ky. App. June 16, 2017).
This dispute arose out of the operation and management of Hardscuffle,
Inc. and its subsidiary, American Life and Accident Insurance
Company of Kentucky. In August, 1999, American Life and Hardscuffle entered into a share exchange agreement
consequent to which American Life became a wholly-owned subsidiary
of Hardscuffle. Thereafter, in January, 2000, Nancy Lampton and James Sampey (Sampey being the then trustee of certain trust to which the plaintiff
is a remaindermen beneficiary) entered into an agreement pursuant
to which they would vote all of their shares as a block.
Sometime thereafter (the exact date is not detailed in the opinion), the plaintiffs
filed a derivative action
and the other board members alleging
the companies. That derivative complaint
in July, 2013 for “failure to establish they made a pre-suit demand on the board or that a demand would have been futile.” Another suit was then filed in December, 2014. Those suits were as well dismissed on grounds of standing and collateral estoppel.
The Court of
affirm the dismissals on the basis of on the statute of limitations, never reaching the questions of standing and collateral estoppel
upon which the trial court relied.
Specifically, the Court found that all of the claims for breach of fiduciary duty were barred by the five-year statute of limitations set
forth in KRS § 413.120(6). In support of the application
of this statute, the Court cited Ingram v. Cates, 74 S.W.3d 783, 787 (Ky. App. 2010). As the lawsuit
was brought 15 years after the voting
agreement was entered into, and seven years after the expiration of certain stock options that were included therein, dismissal on the basis of the five-year statute
was held to be appropriate.
Responding to that argument, the plaintiffs had
they did not become aware of the existence
of that voting agreement
until June, 2010, and that a December, 2014 filing was within the statue limitations if
rule were applied. While noting that certain statutes of limitation
do contain a discovery rule, such as those for medical malpractice
or claims of professional
the Court of
Appeals observed as well that the courts are reluctant to apply a discovery rule outside of the General Assembly
doing so. On that basis, no discovery rule
to the statute of limitations set
forth in KRS § 413.120(6).
As claims against Sampey arose as well in his capacity as a trustee, the Court considered
of the statute of limitations
under the Kentucky Uniform
Trust Code and under prior law, holding that the prior law applied to these claims and finding them likewise to be time-barred.
The Court as well rejected a suggestion that
the “continuing violation
doctrine” should toll the statute of limitations, finding it to be limited to claims under the Kentucky Civil
The Court of Appeals did not address the doctrine of adverse domination
and its impact upon any statute of limitations
Fear and Loathing and Warning Labels
Recently I came across the enclosed “warning” label on, of all things, a doormat. It provides:
Important things you should know
about your new doormat. Warning: Do not use mat as a projectile. Sudden acceleration to dangerous speeds may
cause injury. When using mat follow
directions: Put your right foot in, put your right foot out, put your right
foot in and shake it all about. This mat
is not designed to sustain gross weight exceeding 12,000 lbs. If mat begins to smoke, immediately seek
shelter and cover head. Caution: If
coffee spills on mat, assume that it is very hot. This mat is not intended to be used as a
placemat. Small food particles trapped
in fibers may attract rodents and other vermin.
Do not glue mat to porous surfaces, such as pregnant women, pets and
heavy machinery. When not in use, mat
should be kept out of reach of children diagnosed with CFED (Compulsive Fiber
Eating Disorder). Do not taunt mat. Failure to comply relieves the makers of this
doormat, Simply Precious Home Décor, and its parent company, High Cotton, Inc.,
of any and all liability.
LLC Allowed to Intervene
in Action for Charging Order Against Member’s Interest in That LLC
In a recent (and questionable)
decision out of Iowa, an LLC was allowed to intervene in an action in which a
charging order was sought against the interest of one of the LLC’s members. DuTrac Community Credit Union v. Hefel, No.
15-1379, 2017 WL 461211 (Iowa Feb. 3, 2017).
This decision reviews and
largely rejects a number of challenges made to the entry of charging orders in
support of the collection of certain bank debts for a real estate development
project that never happened. On the upside, the court easily disposed of the
argument that, as the LLC’s operating agreement prohibited, without consent,
the transfer of an ownership interest, a charging order would violate the
operating agreement. The court correctly noted that the charging order attaches
only the distributions, and does not vest in the holder of the charging order
any rights of a member.
However, the court did allow
the LLC to intervene in the action seeking the charging order against the
member’s interest in the company. On this argument, the court found that the
LLC, Westgate, had standing, it writing:
a specific interest in the outcome of the litigation - namely, the amount of
proceeds that would be dispersed to DuTrac under the terms of the charging
order. The alleged injury is specific to Westgate, as it deals with Westgate's
disbursements and is not one that is the same for the population in general.
Second, the potential injury is not conjectural or hypothetical because it
deals with concrete, monetary amounts. Westgate has standing. 2017 WL 461211,*4
This determination is at best
questionable. The distributions, to which the charging order would attached,
are those funds that the company has already determined will be distributed to
the members. It is only at the time that a distribution is declared that the
charging order attaches to any funds. That attachment takes place only after
the LLC has determined that it does not need those funds for its operations or
to satisfy the claims of its creditors. Here, in effect, the court allowed the
LLC to have standing as to the disbursement of funds it has, in application,
already determined to give away. For that reason, this is a questionable
Case on Redemption
from Businesses Could Have Raised a Variety of Issues, But It Looks Like It
Earlier this year, a lawsuit
was filed in Bullitt Circuit Court in connection with the failure to fully
perform on a written agreement to redeem an individual from a variety of
corporations and LLCs. A significant number of questions are raised by this
complaint. Patel v. 28 Vansh Inc.,
No. 17-CI-00349 (Bullitt Circuit Court, complaint filed April 10, 2017).
Hirenkumar Patel (“Patel”),
with two other individuals, was a shareholder or member in a variety of corporations
and LLC. The other shareholders/members
were Kalpesh Patel (“Kalesh”) and Mayur Patel (“Mayur”). The three of them
entered into agreement pursuant to which Patel would receive $825,000 in return
for his one third ownership interest in each of the companies. This agreement
was written in Gujarati; a certified translation of the documents, as well as a
copy of the original, were tendered with the complaint. It is further alleged
that $440,000 of the purchase price has been tendered and received, but that
the defendants refused to make good on the balance. From there, this
wide-ranging complaint has been filed.
One interesting question will
be whether the agreement, which itself includes only four sentences, one of
which reading in its entirety “We both want to get out of this business
happily.”, is sufficient to satisfy statute of frauds. For example, none of the
subject companies are identified for example, the Kentucky Court of Appeals
held in 2015, that an option to purchase a business and the related real
property was unenforceable as it failed to identify all of the material terms.
Specifically, in that instance, where the option failed to identify description
of real property, leaving that to pearl evidence, the option was insufficiently
specific to be enforced. See Rosemary Hubbs
Brewer v. John M. Parsons 2007 Revocable Trust, No. 2013-CA-001309-MR (Ky. App. March 27, 2015); HERE IS A LINK to my review of that decision.
In the course of the complaint,
it is alleged that the plaintiff is entitled to damages of $10 million. See Complaint
¶ 14. Curiously, the prayer for relief seeks damages of only $5 million. See Prayer
for Relief, ¶ b, but then goes on to seek $5 million of exemplary/punitive
damages Prayer for Relief ¶ c. But this is a breach of contract action, and the
plaintiff's damages should conceptually be limited to the amount he should have
received ($825,000) and the amount he has received ($440,000). Prejudgment
interest on the amount due and owing should adequately account for the delay in
A generalized assertion is made
against the eighteen business ventures at issue, alleging a claim for piercing
the veil against each of the basis that they are the alter egos of the
defendants. Frankly, I'm confused by this assertion. Initially, the various
corporations and LLCs are not parties to contract at issue. Second, as recently
clarified by the Six Circuit Court of Appeals, piercing is a remedy, not a
cause of action. See In re Howland; HERE IS A LINK to my discussion of the piercing aspect of that
decision. The various corporations and LLCs should not be parties to this
lawsuit unless and until there is a judgment against the defendants that cannot
be satisfied from their individual assets. At that time, if necessary, the various
business ventures may properly be brought into the action. Too, if appropriate under
piercing theory, access additional assets from which the plaintiff's judgment
may be satisfied.
Breach of the Duty of Loyalty
The complaint, at ¶ 30, alleges
that the defendants owed the plaintiff a fiduciary duty of undivided loyalty, a
duty that rose as their positions as “officers, directors, and/or shareholders
of the Company.” I have, at least initially, only three problems with this
First, many of the companies
are themselves LLC's, and neither the defendants are an officer, director or
shareholder of those LLC's. If the defendants owe you a duty of loyalty in
those companies, it is not consequent to being an officer, director or
shareholder thereof. Rather, assuming
each is a Kentucky LLC and that the fiduciary duties therein are defined by the
LLC Act (i.e., they have not been
modified in a written operating agreement), even if either of the Defendants
are subject to a fiduciary duty of loyalty, and that duty is owed to the LLC and
not enter say the members. See KRS § 275.170. As such, any effort to allege a
breach of the duty of loyalty, it being owed to the LLC, must be brought under
derivative basis. This is not, however, a derivative action, but rather a
direct action. Hence, the assertions of a breach of the duty of loyalty, vis a
vie any of the LLCs, fails by its own terms.
With respect to the assertion
that a fiduciary duty arose because the defendants were “shareholder,”, the
suggestion that shareholders in a Kentucky Corporation owe to one another
fiduciary duties has been rejected. See Griffin
v. Jones and Conlon v. Haise; HERE IS A LINK to my discussion of Griffin v. Gross - HERE IS A LINK to my discussion of Conlon v. Haise. In consequence, the
allegation that any fiduciary obligations arose out of the defendants positions
as shareholders in any of the corporations likewise fails.
With respect to the assertion
that fiduciary duties are owed by the officers and directors of the
corporation, that is entirely true. However it is as well true that those obligations
are owed not to the individual shareholders, but rather to the corporation as a
distinct legal entity. This rule has been identified in cases including Ballard v. 1800 Willow and Griffin v. Jones. HERE IS A LINK to my
discussion of Ballard v. 1800 Willow -
HERE IS A LINK to my discussion of Griffin
v. Jones. In that those duties are owed only to the corporation, and not to
the shareholders individually, they may be enforced only by means of a
derivative action. In that this suit is brought as an individual, not a derivative,
action, the allegations based upon a breach of the duty of loyalty must fail. For
an application of this rule, see the 2016 decision of the Kentucky Court of
Appeals in Adcomm v. Jones; HERE is a link to my discussion of that
There is as well an allegation
that the defendants have been converting assets from the various business
organizations. The injury suffered consequent to conversion, if in fact those
assets have been diverted, is suffered by the corporations and LLCs. As such,
those claims need to be brought in a derivative action, and not a direct
action. See, e.g., KRS § 275.337(1).
In consequence, the allegations of conversion should be dismissed.
Kentucky has a statute, KRS § 446.060(2),
which provides that contracts must be in English. As the agreement here at
issue was not written in English, is it enforceable by a Kentucky court?
As this posting was being drafted, the defendants filed an answer.
It avoided the issues identified above, asserting rather that the
plaintiff has in fact been fully paid and has no claim for a deficiency.
US Supreme Court Holds
That “Sacred” and “Inviolate” Right to Jury Trial is Subject to Waiver in Favor
Last m onth, the United States
Supreme Court issued an opinion reversing a decision of the Kentucky Supreme
Court with respect to the enforcement of arbitration agreements. The Kentucky
Supreme Court had held that certain agreements to arbitrate disputes arising
out of care in nursing homes were not subject to arbitration because the powers
of attorney, pursuant to which the admission documents were executed, did not
specifically reference a right to enter into arbitration agreements on behalf
of the principal. Rather, it held, that only a specific authority in the power
of attorney to enter into arbitration would be effective to waive the “sacred”
and “inviolate” right to a jury trial as enshrined in the Kentucky Constitution.
The United States Supreme Court rejected that analysis, holding that an
agreement to arbitrate could not be treated as different than any other
agreement entered into on behalf of the principal pursuant to a power of
attorney. Kindred Nursing Centers Limited
Partnership v Clark, No. 16-32 (U.S.
May 15, 2017).
Under federal law and
specifically the Federal Arbitration Act (the “FAA”), agreements to arbitrate
disputes are fully enforceable on the same terms as is any other agreement. Put
another way, courts are not allowed to single out agreements to arbitrate for
special scrutiny or limitation. It may not do so directly and it may not do so
indirectly. For example, in AT&T Mobility
LLC v Concepcion, 563 U.S. 333, 342 (2011), the Supreme Court rejected a
hypothetical law that declared invalid any contract that “disallow[ed.] in
ultimate disposition [of the dispute] by a jury.”
It was on that basis that the
court struck down the Kentucky ruling, finding that its decision served “to
safeguard a person’ ‘rght to access the courts and to trial by jury.’”.
The Court also rejected the
assertion that the FAA’ policy in favor of the enforcement of agreements to
arbitrate should not apply with respect to the formation of the contract to
arbitrate. In effect, while acknowledging that the FAA would require the
enforcement of an agreement to arbitrate, they argued that the FAA did not
apply to whether a contract to arbitrate had been entered into, that being
exclusively a point of state contract law. The Supreme Court rejected this
selectively finding arbitration contracts invalid because improperly formed fairs
no better under the Act than a rule selectively refusing to enforce those
agreements once properly made.
This decision by the US Supreme
Court is yet another in a line of decisions in recent years reinforcing the
enforceability of agreements to arbitrate. Within the Commonwealth of Kentucky,
the Supreme Court has clearly rejected the significant number of decisions in
which, on a variety of bases, agreements to arbitrate nursing home and other
healthcare disputes, those agreements having been entered into via powers of attorney,
are invalid. In consequence, it should be expected that many of those disputes
will now go to arbitration. There is, however, an additional cost that must be
recognized. While the decedent's claim against the healthcare facility may now
be resolved in arbitration, claims of spouses and children for consortium
losses will continue to be litigated in state court, those claims not being
subject to the decedent’s agreement to arbitrate.