Kentucky Now Has Public Benefit Corporations

Kentucky Now Has Public Benefit Corporations

      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

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.

Kentucky Court of Appeals Clarifies Statute of Limitations for Claims of Breach of Fiduciary Duty

Kentucky Court 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 allegations of 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 against Lampton and the other board members alleging mismanagement of the companies. That derivative complaint was dismissed without prejudice 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 Appeals would 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 of limitations was held to be appropriate.

      Responding to that argument, the plaintiffs had alleged that 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 a discovery 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 negligence, 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 was applied 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 the application 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 Rights Act.

      The Court of Appeals did not address the doctrine of adverse domination and its impact upon any statute of limitations defense.

Fear and Loathing and Warning Labels

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

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:

Westgate has 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 (citations omitted).

      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 decision.

Case on Redemption from Businesses Could Have Raised a Variety of Issues, But It Looks Like It Will Not

Case on Redemption from Businesses Could Have Raised a Variety of Issues, But It Looks Like It Will Not

       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.

The Cinelli Rule

      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.

Damages

      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 payment.

Piercing the Veil

      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 assertion.

      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 case.

Conversion

      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.

Contracts in English

      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?

The Answer

      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 of Arbitration

US Supreme Court Holds That “Sacred” and “Inviolate” Right to Jury Trial is Subject to Waiver in Favor of Arbitration

      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 rule, finding:

A rule 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.