United States: 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.


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.

Originally published on Kentucky Business Entity Law

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.

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