Soliciting Murder is a Breach of Fiduciary Duty: Who Could Have Guessed?

Soliciting Murder is a Breach of Fiduciary Duty:  Who Could Have Guessed?

David Tingstad, blogging on the Beresford Booth website, has reviewed the decision of the Washington Court of Appeals in King and Mockovak Eye Center, Inc., P.S. v. Mockovak, No. 79290-3-I, 2020 WL 1952509 (Wn. App. April 13, 2020).  HERE IS A LINK to that review.

Cutting to the chase, one shareholder in a professional service corporation (hereinafter the “Bad Guy”) solicited the murder of the other (hereinafter the “Good Guy”) in order to collect on the life insurance policy on the Good Guy and thereby recover on the losses suffered by the jointly owned lasik eye surgery clinics.  Well, as often seems to be the case, the Bad Guy was talking not to a “Russian mobster” but rather to an FBI informant.

In an earlier decision, King and Mockovak Eye Center, Inc. v. Mockovak, No. 74544–1–I, 2017 WL 4898237 (Wn. App. Oct. 30, 2017), there was affirmed the trial court’s determination that soliciting the murder of your co-owner is a breach of fiduciary duty.  Someday I need to delve into the arguments made that it was not. As David noted, curiously there was no award of damages from this breach of duty.

This most recent opinion addressed the valuation of the Bad Guy’s interest in the LLC, the trial court accepting and the Court of Appeals affirming a determination of negative value to the effect that nothing would be paid to the Bad Guy.

Again, I commend David’s more detailed review to you.

Even If That is the Law for Corporations (Which it is Not), That is not the Rule for LLCs

Even If That is the Law for Corporations (Which it is Not), That is not the Rule for LLCs

      A recent decision from the Ohio Court of Appeals may be cited for two important principles. First, even if the officers and directors of a corporation owe fiduciary duties to the corporation’s creditors, that rule does not apply in the case of LLCs and, second, in corporations, fiduciary duties are not owed to the creditors. Custom Associates, L. P. v. VSM Logistics, LLC, No. 2019-P-0104, 2020 Ohio 2994, 2020 WL 2521261 (Ohio Ct. App. 11^th Dist. May 18, 2020).

      VSM leased property from Custom Associates. When it fell behind on lease and utility payments, Custom Associates filed suit against VSM and then, in an amended complaint, added Maurice Vaughn and William Niegsch as defendants, asserting that they, the President/CEO and CFO of VSM, owed “a fiduciary duty to VSM and VSM’s creditors not to waste corporate assets which could otherwise be used to pay corporate debts.” They alleged as well that Vaughn and Niegsch violated this fiduciary duty “by transferring assets of VSM to other business entities and individuals who are not creditors of VSM … to the detriment of VSM, *** leaving VSM with insufficient funds to pay its creditors.” Vaughn and Niegsch filed a motion to dismiss on the basis that they were not parties to the lease contract with Custom Associates and that it lacked standing to assert a breach of fiduciary duty claim in that those duties do not run to creditors. The trial court dismissed of Vaughn and Niegsch from the suit. Conversely, VSM never answered, and a default judgment was entered against it. In this appeal, Custom Associates asserted that Vaughn and Niegsch should not have been dismissed (presumably, it was unable to collect its judgment against VSM).

     On appeal, the plaintiffs relied upon a series of decisions involving business corporations for the proposition that the officers and directors of an insolvent company owe a fiduciary duty to the creditors “not to waste corporate assets that could be used to pay those creditors.” It argued as well that those same principles should be applied in the context of LLCs. These arguments were rejected on a pair of bases.

     First, in reviewing the prior law on business corporations, it was held that it did not stand for a fiduciary duty owed to (and enforceable by) creditors of a corporation, even in insolvency.

      Second, in turning to the language of the LLC Act, it was held that the language employed creates duties to the LLC, but “does not codify a fiduciary duty of members or officers to creditors of the LLC.”

      On that basis, the order dismissing Vaughn and Niegsch pursuant to the motion to dismiss was affirmed.

Fiduciary Duty Claim Dismissed In Absence of Proof That Defendant Was In a Position Giving Rise to a Fiduciary Duty

Fiduciary Duty Claim Dismissed In Absence of Proof That Defendant Was In a Position Giving Rise to a Fiduciary Duty

      In a recent decision from the Bankruptcy Court for the Western District of Kentucky (Judge Lloyd), there was dismissed on summary judgment a claim that the defendant in the adversary proceeding owed a fiduciary duty where the plaintiff had not shown that the individual was a director or officer of the subject company. In Re: Bullitt Utilities, Inc. (Keats v. Cogan), Case No. 15-34000(1)(7), AP No. 17-3070, 2020 WL 214761 (Bankr. W.D. Ky. Jan. 10, 2020). 

      This adversary proceeding arose out of the failure of Bullitt Utilities, Inc. The trustee asserted that Martin G. Cogan, identified by the court as “MC”, was a director/officer all Bullitt Utilities who breached his fiduciary duties in connection with its failure. In this instance, however, the suit was dismissed because there was a failure to demonstrate that MC was in fact a director or officer of the company. The primary evidence cited by the decision was the corporation’s annual report where, at one time, MC had been listed as a director, but then had been removed from that designation. The trustee relied upon certain meeting minutes that the court discounted. It was recited that the trustee had the burden of demonstrating MC’s status as an officer or director of Bullitt Utilities. The trustee failed to do so. In that the claim for breach of fiduciary duty was premised upon MC being an officer or director of Bullitt Utilities, the claim failed and was dismissed.

Who Is A Fiduciary to Whom?: Round II of Cho v. Kim

Who Is A Fiduciary to Whom?: Round II of Cho v. Kim

      In response to motions for en banc reconsideration, the opinion originally issued in Cho v. Kim, dated December 28, 2018 was withdrawn, and a substitute opinion issued on April 2, 2019. Jang Won Cho v. Kum Sik Kim, ___ S.W.3d ___, No. 14-16-00962-CV, 2019 WL 1442412 (Tex. Ct. App. Houston April 2, 2019).

      In this instance, the three investors, Cho, Kim and Lee, formed a corporation in which each was a one third shareholder and in which Cho was the sole director and officer. They as well formed a limited partnership in which each was a limited partner with their jointly owned corporation serving as the 1% general partner. In response to assertions that Cho owed fiduciary duties to each of Kim and Lee arising out of these business organizations, it was held that:

The parties created a corporation, Pandel, Inc., with each of the investors participating as a one-third shareholder. This circumstance does not give rise to a formal fiduciary duty because “a co-shareholder in a closely held corporation does not as a matter of law owe a fiduciary duty to his co-shareholder.”  Hoggett v. Brown, 971 S.W.2d 472, 488 (Tex. App.—Houston [14th Dist.] 1997, pet. denied). As Pandel, Inc.’s sole director, Cho owed fiduciary duties to Pandel, Inc. — but not to individual shareholders.  Id. (“A director’s fiduciary duty runs only to the corporation, not to individual shareholders or even to a majority of the shareholders.”). Kim and Lee do not purport to assert a derivative claim on behalf of Pandel, Inc.

When a holding company called Pandel Holdings, L.P. subsequently was created, it was established as a limited partnership among general partner Pandel, Inc. and limited partners Kim, Lee, and Cho. The agreement establishing the limited partnership provides that the general partner owes fiduciary duties. See Crenshaw v. Swenson, 611 S.W.2d 886, 890 (Tex. Civ. App.—Austin 1980, writ ref’d n.r.e.) (“In a limited partnership, the general partner acting in complete control stands in the same fiduciary capacity to the limited partners as a trustee stands to the beneficiaries of a the trust.”). The general partner was Pandel, Inc. — not Cho. Under the circumstances of this case, the existence of the limited partnership provides no basis for a formal fiduciary relationship as between Cho, Kim, and Lee.

2019 WL 1442412, *7.

      Being unable to prove a formal fiduciary relationship based upon the corporation or the limited partnership, Kim and Lee sought to impose upon Cho an informal fiduciary relationship on the basis of that they were all members of a close-knit Korean community and that they entered into the business relationship with Cho because of a pre-existing special relationship of trust that arose out of that communal relationship. As recounted by the court:

We reject Kim’s and Lee’s contention that this testimony provides some evidence of circumstances giving rise to an informal fiduciary relationship existing before and apart from the transaction at issue in this litigation — and with it their suggestion that an informal fiduciary relationship necessarily exists among all persons of shared Korean heritage who understand the importance of “hierarchy in the Korean society.” See Schlumberger Tech. Corp., 959 S.W.2d at 176-77 (“But not every relationship involving a high degree of trust and confidence rises to the stature of a fiduciary relationship.... We recognize that the Swansons testified that they trusted and relied on Schlumberger.... However, mere subjective trust does not, as a matter of law, transform arm’s length dealing into a fiduciary relationship.”) (citing  Crim Truck & Tractor Co., 823 S.W.2d at 595); see also  Atrium Boutique v. Dallas Mkt. Ctr. Co., 696 S.W.2d 197, 199-200 (Tex. App.—Dallas 1985, writ ref’d n.r.e.) (trial court properly disregarded jury finding that appellant shared a confidential relationship with appellee based on testimony that parties’ families were acquainted through school and “had a very friendly, respectful relationship with each other;” informal fiduciary duty did not arise based on testimony from appellant’s co-owner that “I trusted them. I respected them. I had known the family for 20 years and I respected them and I felt like they were a family like our family, a close-knit family, good family, good people.”).

We also note that, “particularly in the business arena, trust and reliance alone are not sufficient ingredients to create a fiduciary relationship.” Gregan v. Kelly, 355 S.W.3d 223, 229 (Tex. App.—Houston [1st Dist.] 2011, no pet.) (citing  Crim Truck & Tractor Co. v. Navistar Int’l Transp. Corp., 823 S.W.2d 591, 594-95 (Tex. 1992), superseded by statute on other grounds as noted in Subaru of Am., Inc. v. David McDavid Nissan, Inc., 84 S.W.3d 212, 225-26 (Tex. 2002) ). “A person is justified in placing his confidence in the belief that another party will act in his best interest ‘only where he is accustomed to being guided by the other party’s judgment and advice and there exists a long association in a business relationship as well as a personal friendship.’ ” Ferrara v. Nutt, 555 S.W.3d 227, 243 (Tex. App.—Houston [1st Dist.] 2018, no pet.) (quoting Areda v. S-W Transp., Inc., 365 S.W.3d 838, 841 (Tex. App.—Dallas 2012, no pet.) ); see  Lee v. Hasson, 286 S.W.3d 1, 14 (Tex. App.—Houston [14th Dist.] 2007, pet. denied).

Id., *10.

      The court rejected that this structure created an informal fiduciary relationship, citing the Schlumberger decision for the principle that “mere subjective trust does not, as a matter of law, transform and arms-length dealing into a fiduciary relationship.” Id.

      The trial court verdict against Cho based upon breach of fiduciary duty was thereby set aside as no such duty existed.

      The balance of the opinion addressed a variety of other theories for recovery, including misrepresentation and fraud. Much of the discussion in the case turns upon the wording of the jury instructions and deficiencies in objection thereto. The ultimate judgment for those actions against Cho was $352,000,600. Also, the Court of Appeals awarded punitive damages in the amount of $1,057,800. Prejudgment interest was awarded as well.

Jury Decision Reversed When Instructions Were Inconsistent With the Operating Agreement

Jury Decision Reversed When Instructions
Were Inconsistent With the Operating Agreement

      In a recent decision from North Carolina, a jury decision with respect to breach of fiduciary duty in an LLC was reversed where the jury instructions were inconsistent with the operating agreement. Claudio v. Sellers, No. COA18-636, 2019 N.C. App. LEXIS 288 (N.C. Ct. App. March 26, 2019).

      This decision turned upon whether a particular member, Wilson, owed fiduciary duties to the other members of an LLC. North Carolina follows the rule that a majority shareholder in a corporation owes a fiduciary duty to the minority members in the corporation, and that rule has been carried over to the law of LLCs. Ergo, a majority member of an LLC owes fiduciary duty to the minority member. It was on that basis that this decision was rendered. However, the operating agreement defined a “majority (i.e., that threshold of the members required to act) as 67% of the members. While Wilson was more than a 50% member, be was not a 67% member. 

      In this instance, it was asked of the jury whether a fiduciary duty was owed and, had in turn been breached. Where, however, the jury was not advised that it took a 67% vote of the members to constitute a majority, the jury instruction was erroneous.  Whether Wilson owed a fiduciary duty should have been a jury question. 

Kentucky Court of Appeals Issues Decision Addressing Matters Including Wrongful Interference with Expectation of Inheritance and Fiduciary Duties in LLCs

Kentucky Court of Appeals Issues Decision Addressing Matters Including Wrongful Interference with Expectation of Inheritance and Fiduciary Duties in LLCs

 

      In a decision rendered the last Friday of March, the Kentucky Court of Appeals addressed a number of issues raised in a lawsuit that arose out of certain intra-family disputes. While the entirety of the decision should be reviewed, it is noteworthy for at least two points. First, it rejected a cause of action for expectation of inheritance. Secondly, it addressed the proper jury instruction with respect to an allegation of breach of fiduciary duty in an LLC. Dickson v. Shook, ___ S.W.3d ___, 2019 WL 1412497 (Ky. App. March 29, 2019).

      The opinion's lead-in paragraph set the stage, namely:

This intra-family dispute began with Appellee Mary Louise (Mollie) Dickson Shook’s allegations of wrongdoing by her mother, Appellant Roberta M. Dickson, and her brother, William Dickson (Bill), regarding Bill’s management of a closely held family business entity, and allegations of Roberta’s interference with Mollie’s expectancy interest in the estate of her father, Stanley Dickson.

      After a recitation of the unfortunate internecine falling out in this family, the Court of Appeals considered a number of items, two of which I will here highlight.

      The first question involved the question of a claim brought under the theory of a “wrongful interference with devise/expectation of inheritance.” Addressing the viability of such a claim, the court wrote:

There is no Kentucky Supreme Court opinion regarding the tort of interference with an expectation of inheritance. However, since 2003, this Court has explicitly stated in several unpublished opinions that Kentucky does not recognize such a tort. “On all questions of law the circuit and district courts are bound by and shall follow applicable precedents established in the opinions of the Supreme Court and its predecessor court and, when there are no such precedents, those established in the opinions of the Court of Appeals.” SCR 1.040(5). Although not binding precedent, “unpublished Kentucky appellate decisions, rendered after January 1, 2003, may be cited for consideration by the court if there is no published opinion that would adequately address the issue before the court.” CR 76.28(4)(c).  2019 WL 1412497, *5 (citations omitted).

      From there, the court would go on to hold:

We expressly hold that Kentucky does not recognize the cause of action known as tortious interference with inheritance or gift, or as Mollie expresses it in this litigation, wrongful interference with devise. Id., *6

      In that the trial court below had instructed the jury with respect to this cause of action, one which is ultimately nonexistent, there is a presumption of prejudice and that portion of the trial court's verdict was reversed.

      Still in the context of estate litigation, the Court of Appeals provided guidance as to why certain claims need to be brought in the District Court, and not in the Circuit Court. On that basis, portion of the jury verdict below were reversed in that the Circuit Court never had jurisdiction.

      Speaking for myself, the most interesting part of this decision deals with the jury instruction given in connection with an allegation that the plaintiff’s brother, William “Bill” Dickson, mismanaged an LLC in breach of his fiduciary obligations under the LLC Act. Specifically, the trial court had instructed the jury to find for the plaintiff if they believed that Bill, in managing the LLC, failed:

To always exercise the utmost good faith in the best interests of the company and the best interests of Mollie, as a member, in conducting the affairs of the family business, managing its property and handling matters related to the operations of Glen Oak, LLC, including the duty to exercise sound and reasonable business judgment to protect and further the financial interests of Mollie[.] Id., *15.

      This jury instruction was rejected on the basis that it did not recite the standard applicable to an LLC’s member. In this instance, the operating agreement did not modify the fiduciary duties. As such, the statutory default controlled, and the jury instruction needed to conform to that statutory default. “Appellees have not cited any provision in the operating agreement that would make the KRS 275.170(1) standard of care inapplicable. We have read the agreement for ourselves and find none. The statute therefore applies.” Id. at *15-16.The court wrote:

However, this is not the standard of care established by the legislature to guide juries in measuring the line between actionable conduct and acceptable conduct by a limited liability company manager. KRS 275.170(1). Bill argues the instruction was fatally flawed because it did not incorporate the statutory language of KRS 275.170. We agree.

“[W]here statutes are applicable, trial courts must instruct in statutory language.”  Farmland Mut. Ins. Co. v. Johnson, 36 S.W.3d 368, 390 (Ky. 2001) (citation and internal quotation marks omitted). Kentucky limited liability companies are creatures of statute and thus governed by applicable provisions of the Kentucky Revised Statutes.  Turner v. Andrew, 413 S.W.3d 272, 275 (Ky. 2013). KRS 275.170 plainly states the standard of care for managers of limited liability companies, as follows:

Unless otherwise provided in a written operating agreement:

(1) With respect to any claim for breach of the duty of care, a member or manager shall not be liable, responsible, or accountable in damages or otherwise to the [LLC] or the members of the [LLC] for any action taken or failure to act on behalf of the [LLC] unless the act or omission constitutes wanton or reckless misconduct.

KRS 275.170(1) (emphasis added in original).

     

       Speaking only for myself, this instruction with respect to fiduciary duties in LLCs has application not only in the conclusion of the litigation, but also at its inception. I regularly see complaints involving LLCs claiming that a member or manager, in breaching their fiduciary duty, has violated something akin to a “obligation of utmost good faith” or some other aspirational standard that is not consistent (i.e., is different from) either the standard set forth in that particular operating agreement or, by default, the LLC Act. For example, in a complaint filed last November in Jessamine Circuit Court, it was alleged that a member of an LLC owed to the company and the fellow members:

Duties of utmost good faith, fairness, honesty, full disclosure, accounting, safekeeping of company property, and loyalty, which required him to act in their best interests and to share any business opportunities closely related to the existing or prospective activity of the company, which it had the financial legal ability to undertake, and to not profit or benefit from such opportunities without the informed consent of his principals.

 

I wonder whether, in reliance upon this decision, complaints alleging the breach of a standard that is different from that imposed should be subject to a motion to dismiss.

      There is another aspect of the decision that is noteworthy and, frankly, that I find confusing. With respect to the subject LLC, Glen Oak, Mollie, the plaintiff in this action, was not directly a member. Rather, she owned her interest through an apparently single-member LLC, Dickson Oaks. However, Mollie, the individual, was permitted to recover at the trial court level a claim against Bill for breach of the operating agreement. Just to be clear, Mollie was never a party to that operating agreement; rather, Dickson Oaks, her LLC, was a party to the operating agreement.

      The Court of Appeals let this distinction pass, observing:

“It is the law in this jurisdiction that no stranger to a contract may sue for its breach unless the contract was made for his benefit.” Sexton v. Taylor County, 692 S.W.2d 808, 810 (Ky. App. 1985). That is to say, “one for whose benefit a contract is made may maintain an action thereon in his own name even though the undertaking is not directly to or with him.”  Aetna Ins. Co. v. Solomon, 511 S.W.2d 205, 208 (Ky. 1974).

The proof supports the conclusion that Dickson Oaks was created for Mollie’s sole benefit, and Glen Oak, in turn, was created for the benefit of its four owners, including Mollie through Dickson Oaks. Consequently, though better practice would have been to list Dickson Oaks as the party entitled to recover for breach of the operating agreement, the trial court’s decision to permit Mollie to recover was at most harmless error. Id., *17.

      I find this determination confusing in that on the prior page the court had cited Turner v. Andrew, 413 S.W.3d 272 (Ky. 2013), wherein it was held that a claim for injury to the property of an LLC could not be brought by the LLC’s sole member, but had to be brought by the LLC itself. Also, while Dickson Oaks may have been organized for Mollie's convenience, I struggle to see how it necessarily follows that a contract to which Dickson Oaks was a party, that bing the Glen Oak operating agreement, was necessarily for the benefit of the sole member in Dickson Oaks. There seems to be a conflict between this decisions “better practice” and the strict lines drawn between an LLC and its members by the Turner v. Andrew decision and the numerous provisions of the LLC Act that, cumulatively, provide the LLC and its member are separate and distinct. Nonetheless, this may be all dicta because the court would go on to find that the jury should never have been instructed with respect to the breach of operating agreement claim consequent to a directed verdict already granted on that point.