The following is a case update written by Corey R. Weber, a partner at Brutzkus Gubner Rozansky Seror Weber LLP, analyzing a recent decision of interest:
The Nevada Supreme Court determined, based on a Nevada statute, that directors and officers of a corporation are not liable for acts or failures to act unless there is a breach of fiduciary duty involving intentional misconduct, fraud or a knowing violation of law. The Nevada Supreme Court did not address exclusions listed in the Nevada statute based on articles of incorporation or corporate governance documents providing for the liability involving other acts. Chur v. Eighth Judicial District Court in and for County of Clark, 458 P.3d 336 (NV. February 27, 2020).
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The Nevada Insurance Commissioner (the “Commissioner”) filed a complaint against the directors of Lewis & Clark LTC Risk Retention Group, Inc., including claims for gross negligence and deepening insolvency. The directors moved to dismiss the complaint and the Nevada district court denied the motion. The directors also filed a motion for judgment on the pleadings and the district court denied the motion, relying on Shoen v. SAC Holding Corp., 137 P.3d 1171, 1184 (NV. 2006) (“Shoen”). The directors then filed a motion for reconsideration and the district court denied the motion, finding that the Commissioner properly stated claims for breach of fiduciary duty and deepening insolvency; it applied a bifurcated approach requiring: (1) for duty of care claims, a showing of at least gross negligence; and (2) for breach of duty of loyalty claims, a showing of intentional misconduct, fraud or a knowing violation of law. The directors petitioned the Nevada Supreme Court for a writ of mandamus and to grant the motion for judgment on the pleadings.
The Nevada Supreme Court focused on the statutory language in Nevada Revised Statute (“NRS”) 78.138 and stated that “we disavow Shoen to the extent it implied a bifurcated approach to duty-of-care and duty-of-loyalty claims, and we give effect to the plain meaning of NRS 78.138. Accordingly, we conclude that NRS 78.138(7) provides the sole avenue to hold directors and officers individually liable for damages arising from official conduct.” The court therefore determined that “in order to state a claim against the Directors individually, the Commissioner must allege facts that when taken as true (1) rebut the business judgment rule, and (2) constitute a breach of a fiduciary duty involving ‘intentional misconduct, fraud or a knowing violation of law.’”
The court adopted the Tenth’s Circuit’s definition of intentional misconduct and knowing violation of law, stating that the director or officer “had knowledge that the alleged conduct was wrongful” in order to meet the standard.
The court stated that “the complaint focuses solely on gross negligence and alleges facts that purport to rebut the business judgment rule. Because knowledge of wrongdoing, as required by NRS 78.138(7)(b), is an appreciably higher standard than gross negligence” the court found that the district court erred in denying the motion for judgment on the pleadings. The Nevada Supreme Court granted the petition for writ of mandamus and instructed the district court to vacate its order and to enter an order granting the motion. However, the court stated that the district court had discretion to grant leave to amend the complaint.
At first glance the Nevada Supreme Court’s decision implies that gross negligence claims under state law cannot proceed against directors and officers because gross negligence does not meet the higher standard required by NRS 78.138(7) of intentional misconduct, fraud or a knowing violation of law. However, the decision does not quote the full text of NRS 78.138(7), which expressly includes exceptions that provide for greater liability in certain circumstances. One of those exceptions is “or unless the articles of incorporation or an amendment thereto, in each case filed on or after October 1, 2003 provide for greater individual liability…”
Therefore, if articles of incorporation or other corporate governance documents state that directors and officers are also liable for gross negligence in addition to intentional misconduct, fraud or knowing violation of law, that constitutes an exception expressly provided for in NRS 78.138(7).
The Nevada Supreme Court’s decision in Chur places increased importance on articles of incorporation and corporate governance documents in determining the extent of liability of directors and officers. From a public policy standpoint, corporations should ensure that directors and officers are liable for gross negligence and breaches of fiduciary duty that do not rise to the level of intentional misconduct, fraud or knowing violation of law. That is for the benefit of the corporation, its shareholders, and potentially creditors to the extent that the corporation is insolvent or unable to pay debts as they become due. It is in the interests of directors and officers, but not the corporation, to attempt to limit the potential exposure. Yet, the potential exposure for directors and officers is generally minimized by corporations purchasing directors and officers insurance coverage, which covers many acts of negligence and breaches of fiduciary duty. Subsequent to this decision, to the extent that corporations change their corporate governance documents to remove the ability of corporations to pursue claims for gross negligence or breaches of fiduciary duty that do not rise to the level of the Nevada statute, such acts may constitute breaches of fiduciary duty themselves (as changing the documents to limit liability would be in the interests of the directors and officers but not in the interests of the corporation), but the acts to limit the liability may end up not being actionable following Chur.
These materials were written by Corey R. Weber, a partner at Brutzkus Gubner Rozansky Seror Weber LLP, a member of the ad hoc group and the Chair of the CLA Business Law Section, with editorial contributions by the Hon. Meredith Jury (United States Bankruptcy Judge, C.D. Cal, Ret.), also a member of the ad hoc group. Thomson Reuters holds the copyright to these materials and has permitted the Insolvency Law Committee to reprint them. This material may not be further transmitted without the consent of Thomson Reuters.