An “Unremarkable” Securities Law Decision from the Sixth Court Of Appeals

An “Unremarkable” Securities Law Decision from the Sixth Court Of Appeals

      Only occasionally do cases applying the federal securities law come before the Sixth Circuit Court of Appeals. Therefore, any decision they render in the field is noteworthy simply for that fact. That said, substantively, and here utilizing the description of another commentator, a recent decision from the Sixth Circuit Court of Appeals affirming the dismissal of certain allegations of securities fraud is of itself “unremarkable.” Bondali v. Yum! Brands, Inc., No. 15-5064, CCH Fed. Sec. Rptr. ¶ 98603 (6th Cir. Aug. 20, 2015).

      Yum! Brands, through its KFC (f/k/a Kentucky Fried Chicken) restaurants, has a significant presence in China. The Chinese market is of course well known for issues of food safety. When reports surfaced to the effect that KFC restaurants for selling chicken that had been possibly adulterated with drug and antibiotic residues, sales weakened and the price of Yum! Brands stock fell. Bondali brought a securities class action against Yum! Brands and certain of its executives asserting that disclosures made with respect to food safety were misleading.  Those allegations were rejected by the trial court, and that rejection was in turn affirmed by the Sixth Circuit Court of Appeals.

       Ultimately, the securities fraud suit failed for a pair of reasons, either of which, of itself, would have been sufficient to justify dismissal. First, the plaintiff failed to identify any actionable misstatements by the company. Second, the plaintiffs failed to demonstrate the necessary degree of “scienter” (i.e., recklessness). Both are necessary as part of a successful claim for securities fraud.

      In the Complaint, the plaintiff’s pointed to a number of statements, alleging they are misrepresentations or were incomplete as to the food safety standards and protocols utilized in China as well as a failure to completely disclose the risks that arise from food safety issues. Rather than being misstatements, both the trial court and the Court of Appeals found that the descriptions of the protocols and procedures utilized by Yum! were accurate. No claim for securities violation could be based upon the assertion that the protocols and procedures could be different, broader, etc.

It is also difficult to see how Yum misled investors by describing its food quality and safety standards as “strict.”  The fact of the matter is Yum had multiple protocols in place to promote food quality and safety, including spot checks, supplier evaluations, and an auditing system.  Describing those protocols as “strict” was reasonably grounded in objective fact and, thus, is not “disproven” just because Yum could have strengthened its standards and protocols.  By pointing out the structural weaknesses of Yum’s standards and protocols, all the plaintiffs have done is shown that whether Yum’s standards and protocols could be described as “strict” is a question subject to reasonable debate. Slip op., at 9-10.

In addition, it was held that statements set forth in internal procedure manuals were not representations upon which a claim for securities fraud could be based.

      As to the required element of scienter, both courts found that the plaintiffs have failed to demonstrate that the corporate officers of Yum! knew or should have known that the statements being made were misleading.

And So Begin the Middle Ages

And So Begin the Middle Ages

 

        By a certain measure, today marks the anniversary of the date in 476 from which the “Middle Ages” may be dated. On this day, the last emperor of the Western Roman Empire, Romulus Augustus, who was little more than a child and was completely controlled by his father, Orestes, the Magister Militum of the Roman military, was deposed by Odoacer. Orestes had little standing to complain about the over-throw of his son's reign - Orestes had revolted against the prior emperor and put his son on the imperial throne.

        With Romulus' resignation the imperial regalia was packed up and shipped off to Byzantium. With this event, the Western Roman Empire ceased to exist, its fragments now under control of various “barbarian” tribes.

             The “eastern” Roman Empire centered at Constantinople (Byzantium) would survive another millennium until it fell to the Ottoman Turks in 1453.

Kentucky Supreme Court Addresses Nature of Sole Proprietorship

Kentucky Supreme Court Addresses Nature of Sole Proprietorship

      In a recent decision that was focused upon whether the proper parties to an action had been named, the Kentucky Supreme Court provided some useful guidance on the nature of a sole proprietorship. This “organizational form” receives very little either academic or judicial attention even as they are prominent in the economy. Sparkman d/b/a In-Depth Sanitary Service Group v. Console Energy, Inc., Nos. 2013-SC-000119-DG and 2013-SC-000831-DG (Ky. Aug. 20, 2015). This opinion is designated as “To Be Published.”

      This decision arose out of a question as to whether or not a verdict was legitimate in light of confusion as to the designation of certain of the parties, they being an individual, Keith Sparkman, his sole proprietorship for which no certificate of assumed name had apparently been filed, In-Depth Sanitary Service Group, and a corporation that Sparkman ultimately formed with his wife, In-Depth Sanitary Service Group, Inc. In the course of untangling the web of confusion, and ultimately determining that there was no error, the Court discussed the relationship of a sole proprietorship and the sole proprietor. Cutting to the chase, the Court observed:

Here Keith Sparkman and Group, his d/b/a entity, were essentially synonymous, given the legal status of a sole proprietorship. Slip op., at 7.

      Differentiating a sole proprietorship from a wholly owned corporation, citing therefore the decision rendered in Miller v. Paducah Airport Corporation, 551 S.W.2d 241 (Ky. 1977) for the proposition that “individual was not proper plaintiff even though he was sole owner of the corporation that was the real party in interest.”, the Supreme Court wrote:

A sole proprietorship is defined as “a business in which one person owns all the assets, owes all the liabilities, and operates in his or her personal capacity.” Blacks Law Dictionary (10th ED. 2014). A sole proprietorship, therefore, differs greatly from other business organizations such as corporations or limited liability companies (LLCs) even in cases where a business organization has only one shareholder or member. For example, the sole member of an LLC or sole shareholder of a corporation is not entitled to assert in his or her individual capacity the rights of the business organization. Turner v. Andrew, 413 S.W.3d 272 (Ky. 2013); Miller, 551 S.W.2d 241. An owner of a sole proprietorship, on the other hand, is liable in his or her personal capacity for the liabilities of the sole proprietorship, and may assert the rights of the sole proprietorship in his individual capacity. Slip op., at 12-13.

In support thereof, the Court also cited William Bardenwerper, 4A Ky. Prac. Methods of Prac., Part III: Business Organization, § 18:1.

      Addressing Sparkman’s failure to file a certificate of assumed name for “In-Depth Sanitary Service Group,”, the Supreme Court rejected the suggestion that the contracts entered into were by reason thereof in any manner deficient. Rather, the Supreme Court that wrote that:

As a sole proprietorship, Group’s contracts are Sparkman’s contracts; and Sparkman’s failure to comply with the assumed name statute does not invalidate those contracts as the Court of Appeals suggested. Slip op., at 15 (emphasis in original).

      While not cited in this opinion, the treatment of the sole proprietorship as set forth in this decision is consistent with the ruling issued in Kentucky Employers Mutual Insurance v. Ellington, 2015 WL 2340284 (Ky. May 14, 2015) (HERE IS A LINK to a review of that decision), wherein the Court held that the sole proprietor is not in turn an employee of his sole proprietorship.

      I do have a small quibble with the opinion with respect to assumed name filings. As set forth on page 13 of the slip opinion, it is stated that “To operate under an assumed name, Kentucky Revised Statute (KRS) § 365.015(2) stipulates that a party must first file a certificate of assumed name with the Secretary of State.” (Emphasis added). Strictly speaking, this is not true. All of business corporations, partnerships, LLCs, etc. do file certificates of assumed name with the Secretary of State. The exception to that rule is a sole proprietorship; certificates of assumed name for a sole proprietorship are filed with (and only with, the county clerk. KRS § 365.015(2). It’s a admittedly small quibble, but as the decision is focused upon the treatment of sole proprietorship’s, it’s an important one.

Kentucky Supreme Court Holds Producer Solely Responsible for Payment of Severance Tax

Kentucky Supreme Court Holds Producer Solely Responsible for Payment of Severance Tax

 

      On a request for certification of the law from the United States Court of Appeals for the Sixth Circuit, the Supreme Court of Kentucky held that the producer severing natural gas from the earth is solely responsible for payment of the severance tax.  In re: Appalachian Land Co. v. EQT Production Co., 2013-SC-000598-CL (Aug. 20, 2015).

      The review of this decision by Erica Horn and Maddie Schueler can be found AT THIS LINK.

Court of Appeals Disposes of Derivative Claims Brought on Individual Basis

Court of Appeals Disposes of Derivative Claims Brought on Individual Basis

      In an August 14 decision, the Kentucky Court of Appeals dismissed, under the rubric of lack of standing, a series of what were determined to be derivative claims that had been brought individually by a shareholder. Ultimately, the court determined that the shareholder lacked standing to bring claims based upon fiduciary duties that, to the extent they existed, were owed to the business organization and not the individual investor. Griffin v. Jones, No. 2014-CA-000402-MR, 2015 WL 4776300 (Ky. App. Aug. 14, 2015).

      David Griffin invested, at the solicitation of Charles Jones, husband to defendant Sarah Jones, $2,000,000 for a 50% ownership interest in Integrated Computer Solutions, Inc. There followed thereafter a series of investments in additional entities organized and controlled by either Charles or Sarah Jones, that total investment, a combination of loans and equity, coming to approximately $29,000,000. It was alleged, however, that Charles and Sarah Jones, in their control of these various entities, caused them to co-mingle their assets and ultimately transfer them to a LLC, CA Jones Management Group LLC, a company in which Charles Griffin was the sole member. Griffin ultimately brought suit against Sarah (this decision does not discuss any claim made against Charles Jones) alleging:

1.      breach of fiduciary duty owed to him, personally;

2.      fraud by omission;

3.      misappropriation; and

4.      unjust enrichment.

The trial court dismissed all of these claims without explanation, and the Court of Appeals would review them under the assumption that the Circuit Court adopted the reasoning employed by Sarah Jones in her motion to dismiss.

      Foreshadowing the theme of the decision, the Court of Appeals wrote that “a proper ground for dismissing the balance of Griffin’s claims was his lack of standing.” Slip op., at 4.

Breach of Fiduciary Duty

      With respect to the claim for breach of fiduciary duty, Griffin alleged that Sarah Jones, in her capacity as a officer of the corporations in which he invested, owed to him a fiduciary duty. For example, he alleged that:

As Secretary of ICS, Sarah Jones owed fiduciary duties to ICS and its shareholders - including Griffin. It is black letter law that corporate officers owed to the corporation and to its shareholders fundamental duties of care and loyalty… Slip op., at 5.

      Responding to this assertion, the Court of Appeals wrote that “Kentucky law does not support that Sarah owed Griffin fiduciary duties under the facts alleged in his complaint.” Slip op., at 7.

      Rather, the court noted that both the common law and statutory fiduciary obligations imposed upon members of the board of directors and corporate officers run to the benefit of the corporation. In the context of an LLC, court noted that, by statute, the duty of loyalty owed in a limited liability company is to “‘account to…the company.’” Slip op., at 8, n. 1.

      Ultimately, in that any alleged breach of fiduciary duty, if indeed it took place, involved a breach of an obligation owed to the business entity, and not to Griffin individually, he lacked standing to bring those claims.

      Another interesting point raised in this decision is the deference to be afforded a plaintiff’s assertion that a fiduciary duty existed. As recited by the Court of Appeals:

It appears Griffin is arguing the Circuit Court was required to believe Sarah owed him direct fiduciary duty in the contexts he describes above because his complaint alleged that she did, and because factual allegations in a complaint must be taken as true whenever a court considers the propriety of granting a CR 12.02 Motion to Dismiss. Slip op., at 7.

      This assertion was categorically rejected by the Court of Appeals. Rather, the assertion that a legal duty exist is a legal conclusion and therefore “any statements in Griffin’s complaint regarding legal duties Sarah may have owed him under the facts of this case are entitled to no deference whatsoever, the court observing that, “[W]hether a legal duty exist is purely a question of law [.]”, Bartley v. Commonwealth, 400 S.W3d 714, 726 (Ky. 2013) and “It is the duty of courts to declare conclusions, and of the parties to state the facts from which legal conclusions may be drawn.”, Rosser v. City of Russellville, 208 S.W.2d 322, 324 (Ky. 1948).

Fraud by Omission

      Having determined that no fiduciary duty existed for the benefit of Griffin, the court was able to dismiss the fraud by omission claim on the basis that there existed no obligation to make disclosure. “Griffin has premised the first element of his fraud by omission claims, once again, upon the notion that Sarah owed him a direct fiduciary duty of disclosure by virtue of her status as an officer and by virtue of his status as a shareholder, member, or creditor of those entities. As previously discussed, however, she did not.” Slip op., at 11-12 (footnote omitted).

      In addition, the court commented upon Griffin’s implication that the funds invested remained somehow his and that he had a right to be advised as to the disposition of same. Rejecting that notion, the Court of Appeals wrote:

First, he appears to assume that he has a direct interest to assert to a fraud by omission claim because the money he either invested in or loaned to ICS, SEB, and CBR remained his money. But it did not remain his money. Rather, it became an asset of those entities. C. Owens v. C.I.R., 568 F. 2d 1233, 1238 (6th Cir. 1977) (“[S]tock in a corporation represents an ownership interest in a going business organization; the stockholders do not own the corporation’s property.”). Slip op., at 11.

Misappropriation

      With respect to a claim that Jones had misappropriated Griffin’s assets, the court reiterated that the funds allegedly misappropriated belonged to the business organizations and not to Griffin, and as well the fact that, if funds were misappropriated from the corporation, it is to the corporation that any redress is owed.

Unjust Enrichment

      With respect to Griffin’s claim for unjust enrichment against Jones, finding that this claim “Laid bare, this is simply an impermissible attempt to convert a derivative claim into a direct claim to nothing more than an exercise in semantics; it is another way of asserting that Sarah, in her role of corporate officer, indirectly injured him (an investor in shareholder) by misappropriating corporate assets.” Slip op., at 15. This assertion was rejected on the authority of 2815 Grand Realty Corp. v. Goose Creek Energy, Inc., 656 F. Supp.2d 707, 716 (E.D. Ky. 2009), which stands for the proposition that the diminution in the value of stock consequent to an injury to the corporation is a direct injury only to the corporation and, as to a shareholder, is derivative in nature.

      This opinion has been ordered “To Be Published,” and is a welcome addition to (i) the long line of decisions which, inter alia, strictly apply the direct versus derivative distinction in Kentucky law and (ii) those decisions which make clear that the beneficiary of fiduciary duties owed by corporate directors and officers, as well as the duty of loyalty owed in LLCs, as to the business organization itself and not to its constituent investors.

An Interesting (and Questionable) Decision on the Priority of Charging Orders

An Interesting (and Questionable) Decision on the Priority of Charging Orders

      A recent decision from the Colorado Court of Appeals addressed the question of which of two charging orders would first be enforced with respect to the judgment-debtor’s interest in an LLC. In this instance, ultimately it was the second awarded charging order that was given first priority with respect to distributions. McClure v. JP Morgan Chase Bank, N.A., No. 14CA1774 (Colo. Ct. App. August 13, 2015).

      In July, 2013, an Arizona court awarded Chase a judgment of approximately $20 million against Reginald Fowler. In November of that same year, that Arizona court issued charging orders in favor of Chase against Fowler’s interest in three Colorado LLCs. Those charging orders were served on three LLCs in December 2013, the same month in which the Arizona judgment was domesticated in Colorado.

      In March 2014, an Arizona court awarded a $1.5 million judgment in favor of the McClure’s against Fowler. In April, 2014, the McClure’s domesticated their Arizona judgment in Colorado.  Between May and July 2014, the Colorado District Court issued charging orders in favor of the McClures against Fowler’s interest in those same three Colorado LLCs with respect to which Chase held charging orders issued by the Arizona court.

      Finally, in August, 2014, the Colorado District Court domesticated the charging orders issued by the Arizona court in favor of Chase.

      In response to questions regarding which charging orders should first be satisfied with respect to Fowler’s distributions from the LLC, the Colorado trial court would hold that those in favor of the McClure’s had priority as they “were the first enforceable charging orders served on the [LLCs] and, hence, they have priority over [Chase’s] Arizona charging orders.” Slip op., ¶ 5.

      On appeal, the crux argument made by Chase was “that the district court erred when it ruled that Chase’s Arizona charging orders were unenforceable in Colorado until what they were domesticated in Colorado.” Slip op., ¶ 9. This argument would ultimately be rejected by the court.

      Essentially, the court looked to the Colorado enactment of the Uniform Enforcement of Foreign Judgments Act and determined that “a charging order is a judgment subject to Enforcement Act.” Slip op., ¶ 13. Hence, enforcement of the Arizona issued charging orders was conditioned on domestication in Colorado “Specifically, to enforce a foreign charging order against a Colorado LLC based on domestication, the creditor would have to domesticate the charging order and not just the judgment on which the charging order is based. This is so because the charging order - unlike the judgment which it is based - requires the Colorado LLC to take action, namely, to pay LLC distributions to the judgment creditor.” Slip op., ¶ 14.  From there, as to priority, the court would determine that:

We hold that the priority of charging orders issued against Colorado LLCs is determined by first-in-time service of charging orders enforceable in Colorado. Charging orders that are enforceable in Colorado include both those issued by Colorado courts as well as foreign charging orders that have been domesticated in Colorado courts. Slip op., ¶ 17.

      This ruling as to priority and focus upon domestication in the state in which the LLC organized is based upon the Colorado Court of Appeal’s treatment of the LLC’s interest, an intangible, as being located in Colorado irrespective of the location of the judgment debtor, the court citing in support thereof In re Blixseth, 484 B.R. 360, 369 (B.A.P. 9^th Cir. 2012) and Koh v. Inno-Pacific Holdings, Ltd., 54 P.3d 1270, 1272 (Wash. Ct. App. 2002). But is that actually the case? Other courts have held that the intangible interest in an LLC (or in a partnership for that matter; they both use charging orders as a remedy) travels with the owner. It was on this basis that the Florida court, in Wells Fargo Bank, N.A. v. Barber, 2015 WL 470589 (M.D. Fla. Feb. 4, 2015), was able to undertake a conflicts analysis to determine whether Florida or the law of Nevis, the jurisdiction in which a particular LLC owned by the judgment-debtor was organized, would control. Furthermore, the court seemed to treat the charging order as a judgment against the LLC (this is a point as well addressed by Jay Adkisson in his column on this decision; HERE IS A LINK to that column). That is not, however, the case. While the LLC is obligated to comply with the terms of the order once it has notice thereof, there is no “judgment” against the LLC.  Rather, the charging order is only a lien on the distributions made as to the judgment-debtor’s interest in the LLC.  That a charging order is not a judgment against the LLC is evidenced by the fact that it need not even received notice of the hearing in which the charging order is sought. Were the LLC a party to the charging order, the absence of notice to it of that hearing would be a manifest violation of due process.

     Life would have been far simpler had Court of Appeals simply held that the charging orders will be enforced in the order in which they are granted, with the LLC afforded some protection based upon when it first has notice (if the LLC is notified of the second issued charging order first, and then diverts a distribution to that judgment-creditor before receipt of the first entered charging order, the LLC should not be criticized), but clearly life is not going to be so simple for us. Hopefully future courts will adopt the more streamlined approach based upon the acknowledgment that the charge order is not a judgment against the LLC.

More on Same-Sex Marriage and Rowan County

More on Same-Sex Marriage and Rowan County

 

      As has been widely reported, yesterday the US Supreme Court denied a stay to the Rowan County Clerk in her effort to avoid issuing marriage licenses to same-sex couples.  The highly regarded ScotusBlog reports (as of last evening) on the status of the dispute.  HERE IS A LINK TO THAT REVIEW.

 

      As of this morning, various news outlets reports that marriage licenses still may not be had in Rowan County.