fiduciary duties in closely held entities: litigation strategies...
TRANSCRIPT
Fiduciary Duties in Closely Held Entities:
Litigation Strategies for Plaintiffs and
Defendants in Business Disputes
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WEDNESDAY, JUNE 13, 2018
Presenting a live 90-minute webinar with interactive Q&A
Jordan Segal, Mantese Honigman, Troy, Mich.
Ian M. Williamson, Mantese Honigman, Troy, Mich.
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Fiduciary Duties in Closely Held Entities:Litigation Strategies for Plaintiffs and Defendants in
Business Disputes_________________________________________________
Webinar Program with Interactive Q&A
Wednesday, June 13, 2018
Ian M. Williamson Jordan [email protected] [email protected]
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Fiduciary Duties in the Context of Business Entities
Entity Governance – Directors, Officers, Managers
Ownership – Majority or Controlling Owners
Agency and Employment
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Governing Fiduciary Duties – Who Sets the Rules?
• Statutes
• Common Law
• Written Agreements
Jurisdictionally Dependent
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Standard Corporate Fiduciary Duties
• Loyalty – implicated by self-dealing/conflicts of interest
• Care – fiduciaries must pay attention and make rational decisions
• Good Faith – deemed a sub-set of the duty of loyalty
• Confidentiality – fiduciaries cannot disclose sensitive information
• Disclosure – derived from duties of care and loyalty
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Who owes the duty – and to whom is it owed?
Corporations• Directors – duties to corporation, sometimes to shareholders
• Officers – duties to corporation, sometimes to shareholders
• Majority/Controlling Shareholders – may owe duties to minority or non-controlling shareholders
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Who owes the duty – and to whom is it owed?
Limited Liability Companies• Managers – duties to company, sometimes to members
• Members – duties to company if member-managed
• Majority/Controlling Members – may owe duties to minority or non-controlling members
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Statutory:
Delaware Limited Liability Company Act, § 18-110:
“In any case not provided for in this chapter, the rules of law and
equity, including the rules of law and equity relating to fiduciary
duties and the law merchant, shall govern.”
(See Gatz Properties, LLC v. Auriga Capital Corp., 59 A.3d 1206
(De 2012)
NY Bus Corp Law 717(a):
“A director shall perform his duties as a director, including his
duties as a member of any committee of the board upon which he
may serve, in good faith and with that degree of care which an
ordinarily prudent person in a like position would use under
similar circumstances.”
Cal.Corp.Code § 309:
“A director shall perform the duties of a director, including duties
as a member of any committee of the board upon which the director
may serve, in good faith, in a manner such director believes to be in
the best interests of the corporation and its shareholders and with
such care, including reasonable inquiry, as an ordinarily prudent
person in a like position would use under similar circumstances.”
Mich. Code Laws 450.4404
“A manager shall discharge the duties of manager in good faith,
with the care an ordinarily prudent person in a like position would
exercise under similar circumstances, and in a manner the
manager reasonably believes to be in the best interests of the
limited liability company.”
Common Law:
Managers and managing members of a Delaware limited liability
company (LLC) owe default fiduciary duties; passive members do
not. Feeley v. NHAOCG, LLC, 62 A.3d 649 (2012)
“We hold that, although majority stockholders have fiduciary
duties to minority stockholders qua stockholders, those duties
are not implicated when the issue involves the rights of the minority
stockholder qua employee under an employment contract. Riblet
Products Corp v Nagy, 65 USLW 2272; 683 A2d 37 (Del, 1996)
“As the majority shareholder of Uplift, a closely held corporation,
Lubinahad [owed] a fiduciary duty to plaintiff, a minority
shareholder” Gjuraj v Uplift Elevator Corp, 110 AD3d 540 (NY
2013)
“[i]n the case of a close corporation, which resembles a
partnership, duties of loyalty extend to shareholders, who owe one
another substantially the same duty of utmost good faith and loyalty
in the operation of the enterprise that partners owe to one another, a
duty that is even stricter than that required of directors and
shareholders in corporations generally” Intl Bhd of Elec
Workers Local No 129 Benefit Fund v Tucci, 476 Mass 553, 561; 70
NE3d 918, 926 (2017) (emphasis added)
“[A] shareholder in a close corporation owes a duty of loyalty to the
corporation and to the other shareholders. Rexford Rand Corp. v.
Ancel, 48 F.3d 1215 (7th Cir, 1995) (applying Illinois law, and
quoting Hagshenas v. Gaylord, 199 Ill.App.3d 60, 145 Ill.Dec. 546,
552 (1990)).
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Who owes the duty – and to whom is it owed?
Partnerships/Agents• General Partners – duties to company and other partners
• Employees/Agents – may owe duties to the company
• Key managerial employees
• Employees acting as agents
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Controlling Documents can Impact Fiduciary
Relationships
Bylaws
Articles of Incorporation or Organization
Shareholders’ Agreements
Operating Agreements
Partnership Agreements
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Exculpatory ClausesDelaware – 8 Del. C. 1953, Sec. 102(b)(7)
…the certificate of incorporation may also contain any or all of the following matters:
(7) A provision eliminating or limiting the personal liability of a director to the corporation or its stockholders for monetary damages for breach of fiduciary duty as a director, provided that such provision shall not eliminate the liability of a director: (i) For any breach of the director’s duty of loyalty to the corporation or its stockholders; (ii) for acts or omissions not in good faith or which involve intentional misconduct or a knowing violation of law; (iii) under sec. 174 of this title; or (iv) for any transaction from which the director derived an improper personal benefit.
California – Corp Code Section 204(a)(10)
…The articles of incorporation may set forth:
(a) Any or all of the following provisions, which shall not be effective unless expressly provided in the articles:
(10) Provisions eliminating or limiting the personal liability of a director for monetary damages in an action brought by or in the right of the corporation for breach of a director’s duties to the corporation and its shareholders, as set forth in Section 309, provided, however, that (A) such a provision may not eliminate or limit the liability of directors (i) for acts or omissions that involve intentional misconduct or a knowing and culpable violation of law, (ii) for acts or omissions that a director believes to be contrary to the best interests of the corporation or its shareholders or that involve the absence of good faith on the part of the director, (iii) for any transaction from which a director derived an improper personal benefit, (iv) for acts or omissions that show a reckless disregard for the director’s duty to the corporation or its shareholders in circumstances in which the director was aware, or should have been aware, in the ordinary course of performing a director’s duties, of a risk of serious injury to the corporation or its shareholders, (v) for acts or omissions that constitute an unexcused pattern of inattention that amounts to an abdication of the director’s duty to the corporation or its shareholders….
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Fiduciary Duties Based on Ownership or Control
• Can be based on common law or statutes
• Differs based on jurisdiction
• May be an issue of fact in a dispute
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Context-Specific Fiduciary Duties
• Agency Duties
• Employees as Fiduciaries
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Common Claims for Fiduciary Breach
• Self-Dealing
• Usurpation of Opportunities
• Waste of Company Assets
• Ill-Advised Mergers or Sales
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Defending Against Common Claims for Fiduciary Breach
Key Questions:
• What is the origin of the duty?
• To whom is the duty owed?
• Are there any exculpatory provisions in applicable contracts?
• Is indemnification available?
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Which Jurisdiction’s Law Will Apply?
• The Internal Affairs Doctrine recognizes that only one state should have the authority to regulate a corporation’s internal affairs – the state of incorporation. VantagePoint Venture Partners 1996 v Examen, Inc, 871 A2d 1108, 1112 (Del 2005).
• This doctrine is generally accepted throughout the country.
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Defending Against Claims Brought By or On Behalf of Entities
• Business Judgment Rule
•Fairness of Interested Transaction
•Opportunities Outside Line of Business
•Ratification by Disinterested Parties
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Defending Against Claims Brought By orOn Behalf of Individuals
• Majority/Controlling Shareholder Duties or Claims of Unfair and Oppressive Conduct
• Disguised Derivative Claim
• Lack of Direct or Individualized Injury
• Actions Permitted by Written Agreement
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Derivative Claims• “[W]hether a stockholder’s claim is derivative or direct ... must turn solely on the following
questions: (1) who suffered the alleged harm (the corporation or the suing stockholders,individually); and (2) who would receive the benefit of any recovery or other remedy (thecorporation or the stockholders, individually)?” Tooley v. Donaldson, Lufkin & Jenrette, Inc.,845 A.2d 1031, 1033 (Del.2004).
• Mismanagement or Waste of Corporate Assets is a “classic derivative claim” Winston v.Mandor (Del.Ch.1997) 710 A.2d 835, 845; Schuster v Gardner, 127 Cal App 4th 305, 316–17(2005)
• Requirements:
• Continuous Ownership Requirement. Only shareholders of a corporation can bring aderivative suit. Most jurisdictions require that the shareholder owns stock in the companyat the time of the inciting action and continuously throughout the resolution of the lawsuit.
• Notice/ Demand. A shareholder must show that he attempted to bring the problem to theattention of company’s directors, but they chose not to pursue the action. Often,procedural rules require that the initial pleading state with particularity the efforts made inthis regard. In some cases when the action alleges misconduct on the part of boardmembers, this requirement may be relaxed, since it is not expected that people wouldvoluntarily sue themselves (“Futility”).
• Remedy. In federal court, once a derivative action has been filed, it may only be voluntarilydismissed or settled with approval of the court, which must inform the shareholders of sucha proposed action ahead of time. In nearly all jurisdictions, any damages or other proceedscollected as a result of a successful shareholder derivative lawsuit are retained by thecorporation, rather than the shareholder who initiated the suit.
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Compensatory Remedies -Fiduciary Breach Claims by Entities
• Monetary Damages Paid to Entity
• Disgorgement of Profits – Usurpation
• “Faithless Servant” – Recovery of Compensation
• Exemplary Damages in Some Jurisdictions
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Compensatory Remedies -Fiduciary Breach Claims by Individuals
• Monetary Damages Paid to Shareholder or Member
• Buyout of Oppressed Shareholder or Member (sometimes deemed equitable remedy)
• Exemplary Damages in Some Jurisdictions
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Potential for Injunctive Relief• Fact-specific – monetary damages insufficient
• Requesting party shows immediate and irreparable harm
• Using company information or assets to compete
• Impending transactions that cannot easily be reversed
• Threatened termination of employment or other valuable contract rights
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Potential Equitable Relief• Accounting
• Imposition of Constructive Trust
• Dissolution of Entity
• Statutorily Enumerated Remedies
• Removal of director or officer
• Alteration of Articles of Incorporation or Bylaws
• Forced redemption of shares
• Forced buyout of one party by another party
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Litigation Strategies for Plaintiffs
• Map out applicable fiduciary relationships – who owes which duties to whom?
• Determine whether potential or asserted claims are derivative claims
• Assess need for injunctive relief
• Act to preserve electronic communications or other evidence
• Entity Plaintiffs – consider terminating defendant’s fiduciary role
• Entity Plaintiffs – identify any self-dealing or breach of duty of loyalty
• Individual Plaintiffs – assess availability of oppression claims
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Litigation Strategies for Defendants
• Map out applicable fiduciary relationships – who owes which duties to whom?
• Determine whether potential or asserted claims are derivative claims
• Assess availability of Business Judgment defense
• Determine whether interested transactions are demonstrably fair
• For claims of self-dealing – assess possibility for ratification
• Identify and review potentially applicable written agreements
• If Dissenters’ Rights are available, determine and justify fair value
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