Fiduciary Duty

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Last week’s Order in Gusinsky v. Flanders Corp., 2013 NCBC 46, should be required reading for lawyers thinking of suing the directors of a corporation in North Carolina over a merger transaction.  It provides guidance on the duties of directors in those transactions, whether the claims are derivative or direct, and lays down some heightened pleading requirements for some of those types of claims. 

You probably wouldn’t be surprised to have never heard of Flanders Corporation.  Flanders, based in Washington, NC, says it is the largest United States manufacturer of air filters.  It was publicly traded until its shareholders approved a sale of the company via a merger in May 2012.

That approval by the shareholders came nearly a year and a half ago, but it was only last week that the NC Business Court dismissed a shareholder class action challenging the merger.  In its Order, the Court dismissed the  claims by the Plaintiff (a trust) for breach of fiduciary duty and for aiding and abetting breach of fiduciary duty.

One claim of breach of fiduciary duty was an alleged failure to "maximize shareholder value" in the sale of the company, which Plaintiff claimed was a duty owed by the directors of Flanders to all shareholders.  The other was an alleged failure to disclose information material to the deal.

There Is Rarely A Fiduciary Duty Owed Directly From A Corporation’s Directors To Its Shareholders

In dismissing the claim, the Business Court underscored the principle that directors virtually never owe a fiduciary duty directly to shareholders.  The duty is owed to the corporation, not shareholders. Those claims therefore must be made derivatively, unless the circumstances of the "Barger rule" are met. (I’ve written about the Barger rule before).

It seems so obvious that this type of claim is derivative that you might be wondering how this class action plaintiff even argued its position.  All it made was a couple of pretty anemic arguments which Judge Jolly shot down.

One was that the General Statutes contemplate fiduciary duties owed directly to shareholders.  Plaintiff said that G.S. Section 55-8-30, which delineates the duties of directors, contains only one reference to a duty to the corporation and that the other duties prescribed therefore must be owed directly to shareholders.

That’s so wrong.  The North Carolina Court of Appeals held last year that:

The drafters [of the Business Corporation Act] recognized that directors have a duty to act for the benefit of all shareholders of the corporation, but they intended to avoid stating a duty owed directly by the directors to the shareholders that might be construed to give shareholders a direct right of action on claims that should be asserted derivatively.

Estate of Browne v. Thompson. __ N.C. App. __, 727 S.E.2d 573, 576 (2012)(quoting Russell M. Robinson, II, Robinson on North Carolina Corporation Law § 14.01[2] (7th ed.) (citing Official Commentary, N.C. Gen. Stat. § 55-8-30 (1989)).

The Plaintiff also failed in its argument that it met the requirements of the "Barger rule." Plaintiff struck out on that score because the Flanders directors owed no duty to the class Plaintiff that was personal to the Plaintiff.  The cases that the Plaintiff relied on were cases involving closely held corporations controlled by a majority shareholder.  Judge Jolly found them not to be apposite.

Judge Jolly also ruled that a claim alleging inadequate consideration in a merger transaction was a harm to the corporation itsself, not to shareholders individually.  He said that:

[t]his is so because a claim for inadequate consideration is, functionally, a claim for the diminution of the value of shares held by all Flanders shareholdrs.  Without more, the ‘lost value’ of all shares of Flanders’ stock does not describe an injury peculiar and personal to Plaintiffs.

Op. Par. 32.

You can probably guess the rest of this story.  If you can’t, remember that derivative claims require the prospective Plaintiff to make a demand on the corporation to pursue the claim before being allowed to file a complaint.  This Plaintiff made no demand.  As the Court observed, "A plaintiff’s failure to fulfill the statuory requirements for bringing a shareholder derivative action [is an] . . insurmountable bar [to recovery]." (quoting Allen v. Ferrera, 141 N.C. App. 284, 287, 546 S.E.2d 761, 764 (2000)).

So the first claim for breach of fiduciary duty for "failure to maxinize shareholder value" was dismissed.

Continue Reading Don’t Sue A North Carolina Board Of Directors Over A Merger Without Reading This Case

The Order Wednesday of last week in Patriot Performance Materials, Inc. v. Powell, 2013 NCBC 10 was appropriately timed for the day before Valentine’s Day.

Powell, the Defendant, had a 50% interest in several businesses with Henderson, one of the Plaintiffs.  He alleged in a third party complaint that Henderson, who shared the other 50% interest…

Do you have a client who says his associate embezzled a lot of his money?  Does he want to sue the Bank that held the funds, claiming that the Bank should have known that misdoings were afoot and blown the whistle?  You’d better tell him to think twice before bringing that claim to the Business Court, based on last week’s decision in Global Promotions Group, Inc. v. Danas Inc.

The Plaintiffs in Global had given one of the Defendants signature authority over their accounts at BB&T.  That Defendant later made unauthorized wire transfers from the accounts and deposited forged and unauthorized checks drawn on those accounts into their own accounts.  The total amount embezzled was more than $300,000.

The Plaintiffs said that BB&T should have discovered and prevented these transactions, but it was a claim looking for a cause of action that just couldn’t be found.

Judge Jolly first considered the North Carolina Uniform Fiduciaries Act, which states that a Bank can be liable for checks drawn by a depositor’s fiduciary only if "the bank pays the check with actual knowledge that the fiduciary is committing a breach of his obligation as fiduciary in drawing such check, or with knowledge of such facts that its action in paying the check amounts to bad faith."  N.C. Gen. Stat. §32-9.

Even if the Defendants were fiduciaries of the Plaintiffs (about which there was little discussion) Judge Jolly found nothing in the Complaint to support an allegation of bad faith, He said that "suspicious circumstances," with a "failure to make inquiry," were not "bad faith."  Op. ¶24.  A failure to make inquiry amounts to bad faith only if if it is "due to the deliberate desire to evade knowledge because of a belief or fear that inquiry would disclose a vice or defect in the transaction, – that is to say, where there is an intentional closing of the eyes or stopping of the ears.’"  (quoting Edwards v. Northwestern Bank, 39 N.C.App. 261 (1979)).

He held that the Plaintiffs had not alleged facts giving rise to a reasonable inference of either actual knowledge or the turning of a blind eye to the misconduct.  He went on to hold also that the Plaintiffs did not have a claim under what he termed the "more stringent" common law standards of care for banks.

On that "more stringent" standard, in trying to impose a fiduciary duty on BB&T, the Plaintiffs argued that the Bank and its employee had "exercised actual control over" the accounts and that they had placed a "special confidence" in the employee as a result.  They argued that the Bank’s employee therefore had a "responsibility to oversee their accounts."  Op. ¶32.

Not so, said Judge Jolly, who wrote that "all banks exercise some degree of custodial control over their
customers’ accounts; nonetheless, banks ordinarily do not owe fiduciary duties to their customers."  Op. ¶33. The Plaintiffs’ allegations did nothing more than merely establish the existence of an ordinary relationship between a bank and its customers, as all banks have a responsibility to safeguard their customers’ accounts."  Id.  Judge Jolly observed that "an ordinary relationship between a bank and its customers does not, without more, impose upon the Bank any special duties to its customers."  Op. ¶30.

After that, the other claims asserted by the Plaintiffs against BB&T fell like dominoes.Continue Reading Bank Not Liable For Embezzlement, Says NC Business Court

If a bartender serves a visibly intoxicated customer with even more alcohol and the customer then causes an accident while driving drunk, the bartender can be liable under North Carolina’s Dram Shop Act, N.C. Gen. Stat §18B-120, et seq.  But if a banker showers cash on a borrower to fund a  deal which goes bad…