Many owners of Kentucky business entities believe that other owners are answerable for their actions based on fiduciary duty principles, including duties of care and loyalty. But exactly how answerable are they? Recent cases involving a significant fall out between the owners of several affiliated entities have led courts to grapple with the scope of fiduciary duties in business relationships.
A Kentucky federal district court recently issued an opinion in one of a string of cases about claims between two owners involved in several businesses. In this opinion, the district court dismissed several breach of fiduciary duty claims that one owner (Jones) filed against the other (Griffin).
According to the allegations, Jones and Griffin created a limited liability company, each owning half, with Jones as the operator and Griffin as a passive owner and financing source. Over the years, several related entities were created, most co-owned by Jones and Griffin directly or indirectly. Griffin claimed to have lost about $75 million due to his business dealings with Jones based on money transfers among the businesses and other alleged improprieties. Jones, in turn, alleged that Griffin demanded increased ownership interests in the businesses and harmed them by pressuring them to transfer millions of dollars to Griffin. Jones also alleged that Griffin interfered with attempts to rework corporate debt and other obligations in an effort to force Jones to relinquish his ownership interests, ultimately injuring the companies.
Jones claimed that Griffin owed him fiduciary duties and breached those duties. The district court ruled, however, that Griffin did not—as as a matter of law—owe Jones fiduciary duties because of the form and structure of the parties’ business entities.
For example, as to an LLC owned 50 percent each by Jones and Griffin, the district court explained that the scope of who owes fiduciary duties depends on whether a company is member-managed or manager-managed. This LLC was manager-managed, and Jones was the manager. As the manager of a manager-managed LLC, Jones owed fiduciary duties. But members in manager-managed LLCs do not owe fiduciary duties. As a member, Griffin could have owed duties if it had been a member-managed LLC, but that was not its structure.
Similarly, as to a corporation owned 50 percent each by Jones and Griffin, the Court explained that because Griffin only was a stockholder he owed no fiduciary duties to either Jones or the corporation under Kentucky law. This example gets more complicated considering a recent Kentucky Court of Appeals case involving the same affiliated companies. In that case, the roles were reversed. Griffin alleged a corporate officer—Jones’s wife Sarah—breached fiduciary duties owed to him by transferring money had Griffin invested among affiliated businesses and ultimately by distributing his invested funds to Jones and herself. But the Court of Appeals wrote that common-law and statutory fiduciary duties owed by the directors, corporate officers, or even a managing member of an LLC run “directly to the corporation [or LLC] and the shareholders/members as a whole” and not to the individual shareholder/member. Thus, Griffin, personally, could not assert a claim against Sarah for breach of fiduciary duty because she did not owe him a fiduciary duty. Although the Court of Appeals case is not final—Griffin has asked the Kentucky Supreme Court to review it—it speaks to the current limits on fiduciary duty claims.
Many owners may be surprised to learn that Griffin, who contributed millions of dollars as a shareholder/member, did not owe fiduciary duties to the person running the companies’ daily operations—and that Sarah, an officer of a closely-held entity into which Griffin invested millions of dollars, did not owe Griffin a fiduciary duty, either. Breach of fiduciary duty has long been considered one of the strongest claims available to owners who have been wronged by corporate insiders. The Griffin v. Jones saga offers several takeaways for owners wanting to protect themselves:
- Understand who owes fiduciary duties when forming a business. Consider the entity’s form (e.g., corporation v. LLC) and understand the authority given to positions within the entity on the front end. For example, many owners have no problem with family members of other owners serving as officers. While that may work when everything is going well, you do not want to first learn that certain individuals owe no fiduciary duties to you after issues arise.
- Consider other ways to ensure that decision-makers owe and follow duties. Duties can be created by contract in many instances where the law does not automatically create them. Every organization, no matter the size, may benefit from contracts with its employees, officers, managers, and other decision-makers. The more authority or access an individual has, the more important it is to have a contract providing recourse should they harm your interests.
- Understand whether duties owed are to you individually or only to the business or its owners as a whole. As the Griffin Court of Appeals case shows, an owner may have trouble enforcing duties in Kentucky if they are owed to the business, not to individuals. An individual owner also may have difficulty causing the company to enforce its rights, especially when the wrong-doers are related to other owners.
- Continue to evaluate your organizational structure and change it when it makes sense. Many businesses continue with the same structure and operating documents for decades. But the law changes, as does the size and purpose of your business and the individuals involved. Most organizations would benefit from a periodic review by counsel, as well as a review when important changes happen, such as new officers.
- Consider implementing buy-sell terms for the business at its inception. Everyone thinks that a business relationship will be positive and fruitful when it begins, but things do not always work out as intended. Making advance arrangements to permit a well-planned corporate divorce may spare you significant time, expense, and frustration.
The Griffin v. Jones dispute has led to multiple lawsuits in Kentucky and elsewhere. Among other things, it has allowed courts in Kentucky to clarify fiduciary duty law involving business entities. Business owners should seek legal counsel to understand the deals they strike on the front end to avoid foreseeable problems on the back end. When unforeseen problems arise, business owners should make counsel their first call.