Courtesy of CEB, we are bringing you selected legal developments in areas of California business law that are covered by CEB’s publications. This month’s feature is from the March 2023 update to Understanding Fiduciary Duties in Business Entities. References are to the book’s section numbers. The most significant legal developments since the last update include developments in such important topic areas as fiduciary duties in for-profit corporations, fiduciary duties in family businesses, breach of fiduciary duty litigation, and D & O insurance.
March 2023 Update
As reiterated by the court in Sheen v Wells Fargo Bank, N.A. (2022) 12 C5th 905, 927 (citation omitted), a bank or other financial institution “owes no duty of care to a borrower when the institution’s involvement in the loan transaction does not exceed the scope of its conventional role as a mere lender of money.” See §1.12.
Fiduciary Duties in General Partnerships
In Bandera Master Fund LP v Boardwalk Pipeline Partners, LP (Del Ch, Oct. 7, 2019, No. 2018-0372-JTL) 2019 Del Ch Lexis 1296, the court held that a claim that the general partner and its controllers violated their fiduciary duties failed to state a viable claim because the partnership agreement eliminated fiduciary duties (as allowed under Delaware law). See §2.64.
Fiduciary Duties in For-Profit Corporations
In Wong v Restoration Robotics, Inc. (2022) 78 CA5th 48, 74, the court held that the validity of provisions of a certificate of incorporation is an internal affair generally governed by the law of the state of incorporation. The court enforced the federal forum provision in the Delaware corporation’s certificate of incorporation and dismissed the case. See §4.4.
Interpreting the duty of care requires directors to exercise proper oversight over corporate affairs to ensure that corporate managers are carrying out their duties properly. See, e.g., In re Caremark Int’l, Inc. Derivative Litig. (Del Ch 1996) 698 A2d 959, 967. In Construction Indus. Laborers Pension Fund v Bingle (Del Ch, Sept. 6, 2022, No. 2021-0940-SG) 2022 Del Ch Lexis 223, *4, the court noted that “the lack of oversight … must be so extreme that it represents a breach of the duty of loyalty. This in turn requires a pleading of scienter, demonstrating bad faith.” See §4.19.
In Tola v Bryant (2022) 76 CA5th 746, 752, applying Delaware law in holding that the plaintiff had failed to establish demand futility, the court cited with approval the Delaware standards for Caremark claims in In re Caremark Int’l, Inc. Derivative Litig., supra. See §4.19.
The “entire fairness” test is used if the directors had actual conflicts of interest and, as a result, the challenged decision was not made by a disinterested and independent board majority. See Cede & Co. v Technicolor, Inc. (Del 1993) 634 A2d 345, 361; City Pension Fund for Firefighters & Police Officers v Trade Desk, Inc. (Del Ch, July 29, 2022, No. 2021-0560-PAF) 2022 Del Ch Lexis 183 (alleged self-dealing by controlling shareholder); In re Multiplan Corp. Stockholders Litig. (Del Ch 2022) 268 A3d 784 (inherent conflicts between SPAC’s fiduciaries and public stockholders). See §4.31.
Delaware courts analyze conflicted controller transactions implicating entire fairness by placing them into one of two categories: (1) when the controller is on both sides of the transaction, and (2) when the controller is competing with the common stockholders for consideration. In re Multiplan Corp. Stockholders Litig., 268 A3d at 809. See §4.53.
In Metro Storage Int’l LLC v Harron (Del Ch 2022) 275 A3d 810, the court held that a corporation’s president breached his fiduciary duties that he owed in that capacity as president by doing consulting work for a competitor, placing the interests of his other clients ahead of the company’s interest, failing to disclose his consulting activities, and sharing and using company confidential information for his own purposes. See §4.56.
Fiduciary Duties in Family Businesses
Outside the marital context, the authority to transact business on behalf of a family member is governed by agency principles. Rogers v Roseville SH, LLC (2022) 75 CA5th 1065, 1075 (arbitration could not be compelled because son lacked authority to sign on father’s behalf); Theresa D. v MBK Sr. Living LLC (2021) 73 CA5th 18, 27 (plaintiff’s daughter could not bind plaintiff to arbitration agreement as part of her admission to residential care facility absent durable power of attorney or similar authorization). See §6.49B.
In Bailey v MacFarland (2021) 5 F4th 1092, 1097, the court held that a wife’s fraud and conspiracy claims, which sought modification of her divorce decree, were within the domestic relations exception to federal diversity jurisdiction. See §6.53.
Parties may stipulate to the scope of a private judge’s authority to resolve limited issues with the case. Stipulations for the appointment of a temporary judge are construed narrowly; a temporary judge may only hear subsequent proceedings that are its “direct progeny” and not those considered “ancillary.” See Orange County Dep’t of Child Support Servs. v Superior Court (2021) 129 CA4th 798, 807; Gridley v Gridley (2008) 166 CA4th 1562, 1580. See §6.72.
A party who declines to participate in court-ordered mediation is bound by any consequences that result from the failure to participate. See Breslin v Breslin (2021) 62 CA5th 801, 806 (party’s failure to participate in noticed mediation, attendance at which was prerequisite to evidentiary hearing, waived that party’s right to evidentiary hearing and determination of factual issues). See §6.73.
In Falcon Brands Inc. v Mousavi & Lee (2022) 74 CA5th 506, 522, the court held that extortion was committed because the attorney threatened to make public accusations of criminal misconduct if the settlement demand was not met. See §6.73A.
Obligations of Broker-Dealers
Broker-dealers must act in the best interest of their clients at all times. See Regulation Best Interest, 17 CFR §240.15l-1, available at https://www.sec.gov/rules/final/2019/34-86031.pdf. Regulation Best Interest enhances the broker-dealer standard of conduct beyond the previous suitability standard, in an attempt to align it with retail customers’ expectations of how their broker-dealer will act. Specifically, the regulation requires broker-dealers to (1) act in the best interest of the retail customer at the time an investment recommendation is made, and (2) disclose and address conflicts of interest that exist between the broker-dealer and its client. Importantly, Regulation Best Interest establishes a standard of conduct that cannot be satisfied through disclosure alone. Said differently, conflicts of interest must be mitigated or, in certain instances, eliminated completely, rather than simply disclosed. See §7.26.
Fiduciary Duty Litigation
In Henley Fin., Ltd. v Goyette & Assocs., Inc. (ED Cal, Feb. 24, 2022, No. 20-cv-01834) 2022 US Dist Lexis 35208, *22, the court held that “[a]n escrow holder is an agent and fiduciary of the parties to the escrow.” See §8.5.
In Beaver v Omni Hotels Mgmt. Corp. (SD Cal, Mar. 29, 2021, No. 20-cv-00191) 2021 US Dist Lexis 59805, the court found a fiduciary duty arising out of an agency relationship. See §8.5.
An aiding and abetting claim may be attacked at the pleading stage if the complaint fails to allege “actual knowledge” and “substantial assistance or encouragement” by the aider and abettor. Su v Henry Global Consulting Group (CD Cal, Jan. 3, 2022, No. 20-cv-02235) 2022 US Dist Lexis 736, *9. See §8.11.
In Beaver v Omni Hotels Mgmt. Corp., 2021 US Dist Lexis 59805 at *15, a Fed R Civ P 12(b)(6) motion was denied because the complaint alleged substantial assistance by the defendant real estate brokers in a resort rental program. Defendants allegedly “did nothing to manage or supervise the rental program. Instead, they ignored their professional responsibilities and enabled Omni to perpetrate its scheme to self-deal.” The court held that a plaintiff is not required to allege actual knowledge and substantial assistance elements with particularity. See §8.11.
Recent cases distinguish a defendant’s aiding-and-abetting-based liability from liability based on civil conspiracy. See §8.13. But even under this modern approach, the plaintiff must allege a fiduciary relationship between the plaintiff and a third party, or else the complaint is subject to dismissal under Fed R Civ P 12(b)(6). Genfit S.A. v Cymabay Therapeutics (ND Cal, Jan. 21, 2022, No. 21-cv-00395) 2022 US Dist Lexis 11460. See §8.12.
In True Gentlemen’s Jerky, Inc. v 1KIV TGJ Holdings, L2C (ND Cal, Aug. 16, 2022, No. 21-cv-04073) 2022 US Dist Lexis 146603, the court confirmed that there is no fiduciary relationship between a borrower and lender. See §8.35.
A statute may expressly or impliedly establish the absence of a fiduciary relationship. Phillips 66 Co. v Bananzadeh (ED Cal, Apr. 5, 2022, No. 21-cv-01747) 2022 US Dist Lexis 65042 (no fiduciary duty created under Petroleum Marketing Practices Act (15 USC §§2801–2841)). See §8.37.