JOHN R. WILSON, TRUSTEE FOR FRANKLIN CAREER SERVICES, LLC V. BANKRUPTCY DAVID B. PAINE, ET AL. COURT -
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2008-SC-000905-CL
JOHN R. WILSON, TRUSTEE FOR
FRANKLIN CAREER SERVICES, LLC
V.
CERTIFICATION OF LAW
FROM U.S . BANKRUPTCY COURT
WESTERN DISTRICT OF KENTUCKY
NO. 06-30010
DAVID B. PAINE AND
JOHN NEWTON
RESPONDENT
OPINION OF THE COURT BY JUSTICE CUNNINGHAM
CERTIFYING THE LAW
Pursuant to CR 76 .37(1), this Court granted the certification request of
the United States Bankruptcy Court for the Western District of Kentucky to
answer the following question of Kentucky law:
I . Whether the equitable rule of adverse domination applies to toll
the statute of limitations set forth in KRS §§ 271B.8-330(3) and
27113 .6-400?
In certifying the question of law to this Court, the United States
Bankruptcy Court for the Western District of Kentucky provided a brief
explanation of the facts of the case .
On January 4, 2006, Franklin Career Services, Inc ., fdba Franklin
Career Services, LLC, fdba DDH, INC. ("hereinafter FCS") fled a Chapter 7
petition for relief under Title 11 of the United States Code. On December 21,
2007, Appellant, John R . Wilson, as Trustee in Bankruptcy for FCS and on
behalf of the Bankruptcy estate, filed suit against Capital Steel Ventures, Inc.,
a former parent company of FCS, and former officers and directors of FCS. The
Complaint alleged several counts of corporate malfeasance and sought recovery
of property as preferences and fraudulent transfers.
In Count Seven of his Complaint, Appellant alleged that unlawful
distributions were made to various officers and directors pursuant to KRS §
271B.8-330 . Appellant seeks to void those distributions on behalf of the
corporation using Trustee's equitable powers provided under the Bankruptcy
Code . Appellees, David B . Paine and John Newton, each filed Motions to
Dismiss Count Seven on the grounds that the actions were barred by the
statute of limitations in KRS § 271B.8-330(3) . Appellant responded to this
defense by raising the equitable tolling doctrine of "adverse domination ."
Because this issue involves a question of Kentucky law that has not been
addressed previously by this Court, the United States Bankruptcy Court for the
Western District of Kentucky requested certification of the aforementioned
question of law pursuant to CR 76 .37(1) .
KRS § 271B .8-330 provides in pertinent part: "A proceeding under this
section shall be barred unless it is commenced within two (2) years after the
date on which the effect of the distribution was measured under subsection (S)
or (7) of KRS 271B.6-400 ." It does not appear that Appellant filed his claim
against Appellees within the two-year limitations period.
Ordinarily, lack of knowledge of one's rights is insufficient to prevent
operation of statutes of limitation. Wilcox v . Sams, 213 Ky. 696, 281 S .W. 832
(1926) . However, when the complained of injury is not immediately
discoverable, courts steer away from the unfairness inherent in charging a
plaintiff with slumbering on rights not reasonably possible to ascertain. The
discovery rule, a means by which to identify the "accrual" of a cause of action
when an injury is not readily ascertainable or discoverable, was first
enunciated in Tomlinson v. Siehl, 459 S .W.2d 166 (Ky. 1970), and later refined
in Hackworth v. Hart, 474 S .W .2d 377 (Ky. 1971) . "[T]he statute begins to run
on the date of the discovery of the injury, or from the date it should, in the
exercise of ordinary care and diligence, have been discovered ." Id . at 379. This
rule entails knowledge that a plaintiff has a basis for a claim before the statute
of limitations begins to run . The knowledge necessary to trigger the statute is
two-pronged . One must know: (1) he has been wronged; and (2) by whom the
wrong has been committed. Drake v. B.F. Goodrich Co ., 782 F.2d 638, 641
(6th Cir. 1986) . See also Hazel v. General Motors Corp. , 863 F . Supp. 435, 438
(W.D .Ky. 1994) ("Under the `discovery rule,' a cause of action will not accrue
until the plaintiff discovers, or in the exercise of reasonable diligence should
have discovered, not only that he has been injured but also that his injury may
have been caused by the defendant's conduct.") . As such, the discovery rule
works as a "savings" clause or a "second bite at the apple." Queensway
Financial Holdings Ltd . v . Cotton 8s Allen, P.S.C . , 237 S .W.3d 141, 148 (Ky.
2007) .
The doctrine of adverse domination shares the same theoretical
underpinnings as the discovery rule . Michael E. Baughman, Defining, the
Boundaries of the Adverse Domination Doctrine : Is There AnY Repose for
Corporate Directors? , 143 U. Pa . L. Rev. 1065, 1093 (1995) . It has been
described as "merely a corollary of . . . [the] discovery rule, applied in the
corporate context." Resolution Trust Corp . v. Farmer , 865 F. Supp. 1143, 1154
n.l l (E.D .Pa. 1994) (citing In re Lloyd Securities, 153 B .R. 677, 685 (E.D.Pa.
1993)) .
It is the `inherently unknowable' character of the
injury that is the critical factor that governs the
applicability of the discovery rule . . . . A corporate
plaintiff does not have `knowledge' of an injury to itself
until those individuals who control it know of the
injury and are willing to act on that knowledge .
(Emphasis added .)
Id . at 1155. Moreover, "a corporate plaintiff cannot `discover' injuries to the
corporation caused by those who control the corporation." Clark v. Milam, 452
S.E .2d 714, 718 (W.Va . 1994) . Therefore, adverse domination provides that the
"cause of action will be tolled during the period that a plaintiff corporation is
controlled by wrongdoers," Resolution Trust Corp . v. Gardner, 798 F.Supp.
790, 795 (D .D .C . 1992) .
The doctrine of adverse domination has not heretofore been considered
by this Court, but has been widely applied by federal courts in cases involving
corporate causes of action against directors and officers . I See, e ., Farmers &
Merchants Nat. Bank v . Bryan, 902 F.2d 1520 (10th Cir. 1990) ; IIT, an Intern .
Inv . Trust v. Cornfeld , 619 F.2d 909 (2d Cir. 1980) ; International Railways of
Central America v . United Fruit Co. , 373 F.2d 408 (2d Cir. 1967), cert. denied,
387 U .S . 921 (1967) ; Resolution Trust Corp. v . Kerr, 804 F. Supp . 1091
(W .D.Ark . 1992) ; Resolution Trust Corp . v. Gallagher, 800 F.Supp. 595 (N .D.I11.
1992) ; Resolution Trust Corp. v. Gardner, 798 F.Supp. 790 (D .D.C. 1992);
Federal Deposit Ins. Corp. v . Howse, 736 F.Supp. 1437 (S .D.Tex. 1990) ;
Federal Deposit Ins . Corp. v. Greenwood , 739 F.Supp. 450 (C .D.I11. 1989) ;
Federal Deposit Ins . Corp . v. Carlson , 698 F.Supp. 178 (D .Minn. 1988) ; Federal
Say. and Loan Ins . Corp . v. Burdette , 696 F .Supp. 1196 (E.D .Tenn. 1988);
Federal Deposit Ins. Corp. v. Hudson , 673 F .Supp. 1039 (D .Kan . 1987) ; Federal
Say . and Loan Ins . Corp. v. Williams , 599 F.Supp. 1184 (D .Md . 1984) ; Federal
Deposit Ins . Corp. v. Bird, 516 F. Supp. 647 (D .P. R. 1981) ; Saylor v. Lindsley ,
302 F.Supp. 1174 (S .D.N.Y. 1969) .
The doctrine is rooted in the long-established principles of agency law.
Adverse domination is premised on the notion that knowledge is not imputed if
the agent is acting in a manner adverse to the interests of the principal. This
rule is consistent with Kentucky agency law. Owsley County Deposit Bank v.
Burns, 196 Ky. 359, 244 S.W. 755 (1922) . Thus, "[t]he knowledge of the agent
While the majority of cases dealing with adverse domination have come at the
federal level, many states have considered the issue as well . For an exhaustive list
of states that have considered and applied adverse domination, see Resolution
Trust Corp. v. Grant, 901 P .2d 807, 812 at n.16 (Okl . 1995) .
is the knowledge of the corporation he serves when the knowledge relates to
some matter over which the agent has control and with which his duties are
connected and when they relate to matters over which he has authority . . . ."
Warfield Natural Gas Co . v. Anderson, 249 Icy. 586, 61 S .W.2d 27, 28 (1933) .
In the corporate context, the corporation is the principal and the board of
directors as a whole is the agent. When the board of directors is accused of
breaching its duty to the corporation, it necessarily is accused of acting
adversely to the principal's interests. See Resolution Trust Corp. v. Farmer,
at
865 F. Supp.
1155-56 .
"Because, in most cases, defendants' control of the corporation will make
it impossible for the corporate plaintiff independently to acquire the knowledge
and resources necessary to bring suit," the adverse domination rule "presumes
that actual notice will not be available until the corporate plaintiff is no longer
under the control of the erring directors ." Hecht v. Resolution Trust Corp., 635
A.2d 394,
4615
(Md.
1994) .
"This prevents the culpable directors from
benefiting from their lack of action on behalf of the corporation ." Id . at 408.
While courts which have been confronted with the question have almost
uniformly embraced adverse domination,2 there still exists some variation in its
2
A minority of courts that have considered this issue have declined to recognize the
doctrine of adverse domination, concluding that the doctrine is inconsistent with
applicable state law tolling doctrines and policies of strictly construing statutes of
limitations . See, e.g., Resolution Trust Corp. v. Armbruster , 52 F.3d 748, 752 (8th
Cir. 1995) (concluding that Arkansas courts do not recognize the doctrine of
adverse domination) ; Resolution Trust Corp. v. Artley , 28 F.3d 1099, 1102 (11th
Cir . 1994) (finding the doctrine inapplicable under Georgia law) ; Federal Deposit
Ins . Corp. v. Cocke, 7 F.3d 396, 402-03 (4th Cir. 1993) (declining, under Virginia
law, to apply the doctrine to the case at issue, but noting that Virginia recognizes
the tolling doctrine of equitable estoppel in cases involving intentional
concealment) .
application. Notably, courts have differed on the degree of domination of the
board required in order for the corporation to claim protection of the doctrine,
as well as the degree of culpability that the plaintiff must allege against the
directors .
Each shall be discussed in turn.
A majority of jurisdictions follow the "disinterested majority test,"
whereby a plaintiff is required to show that a majority of the board members
were wrongdoers during the period the plaintiff seeks to toll the statute of
limitations. See , e .g . , Fed . Deposit Ins. Corp . v. Dawson , 4 F.3d 1303, 1310
(5th Cir. 1993) ; Fed . Deposit Ins . Corp . v. Howse , 736 F.Supp. 1437, 1441
(S .D.Tex. 1990) ; Fed . Say . and Loan Ins . Corp. v. Williams, 599 F.Supp. 1184,
1195 (D.Md. 1984) ; Fed . Deposit Ins . Corp. v. Bird , 516 F.Supp. 647, 651
(D . P. R. 1981) . This standard is premised on the notion that "the mere
existence of a culpable majority on the board is so likely to preclude the
corporation from filing suit against the wrongdoers that tolling is thereby
justified." Dawson , 4 F.3d at 1310 (internal citations omitted) . Courts have
given two rationales to justify this assumption . First, a culpable majority can
control the flow of information and thereby prevent disclosure of incriminating
information. See Williams , 599 F.Supp. at 1193-94 n .12. ; Dawson , 4 F.3d at
1313 . Second, it is unreasonable to expect the culpable directors to bring suit
against themselves and that as a practical matter, only when a majority of the
board no longer consists of wrongdoers can an action be initiated. See , e.g. ,
Howse , 736 F .Supp . at 1441 . Indeed, though it is in the realm of possibility
that a board of directors could bring suit against itself, the likelihood of such is
minute . Hecht, 635 A.2d at 407 . Thus, "it is only when the culpable directors
are replaced by a majority of nonculpable directors and are no longer in control
that the claim can be brought." Id. at 402 .
Other courts have adopted the more stringent "complete domination"
test, which requires the plaintiff to show "full, complete and exclusive control
in the directors or officers charged" with the wrongdoing . Farmers 8v
Merchants National Bank v. BKyan , 902 F.2d 1520, 1522 (10th Cir. 1990)
(quoting Int'1 Rys . of Cent. Am. v. United Fruit Co. , 373 F.2d at 414) . See also
Mosesian v. Peat, Marwick, Mitchell 8s Co . ; 727 F.2d 873, 879 (9th Cir. 1984),
cert. denied, 469 U.S. 932 ( 1984) ; and Resolution Trust Corp. v. Fleischer, 826
F.Supp . 1273, 1276 (D .Kan. 1993) . Thus, the plaintiff must negate the
possibility that an informed shareholder or director could have induced the
corporation to initiate suit . Farmers 8v Merchants Nat. Bank, 902 F.2d at
1522 ; Int'1 Rys. , 373 F.2d at 414 .
We believe the wiser approach to be the "disinterested majority" test, as it
comports with both common sense and human nature . See Federal Deposit
Ins . Corp. v . Smith , 980 P.2d 141, 148 (Or. 1999) . The policies enunciated in
the "disinterested majority" test also comply with equity and with how
limitation defenses generally operate .
It provides that it is appropriate for the directors to
bear the burden of rebutting a presumption of control,
because they have greater access to the relevant
information - it is the directors, those in control of the
corporate records, who will know whether anyone was
in a position to bring suit on the corporation's behalf.
Resolution Trust Corp . v . Grant, 901 P .2d 807, 818 (Okl. 1995) . To rebut a
presumption that accrual of the claims does not take place until a disinterested
majority has replaced the culpable directors, the defendants must show that
there was someone who had the knowledge, the ability and the motivation to
bring suit during the period of corporate control . Hecht, 635 A .2d at 406 .
Requiring the directors to carry the burden of production is consistent with the
general rule that the party raising the statute of limitations bears the burden of
presenting evidence to establish the time bar . Slack v. Bryan , 299 Ky. 132,
184 S .W.2d 873, 876 (1945) . The plaintiff, however, still has the initial burden
to plead and prove facts that the board was composed of a majority of culpable
directors . See Southeastern Kentucky Baptist Hosp., Inc . v. Gaylor, 756
S.W.2d 467, 469 (Ky. 1988) ("Once the statute of limitations is raised, the
burden falls on the complainant to prove such facts as would toll the statute
Furthermore, it is reasonable to assume that a culpable majority would
act in its own interest, and, in so doing, would conceal information and prevail
on whether to pursue claims.
While [the culpable majority] retain[s] control they can
dominate the non-culpable directors and control the
most likely sources of information and funding
necessary to pursue the rights of the association. As a
result, it may be extremely difficult, if not impossible,
for the corporation to discover and pursue its rights
while the wrongdoers retain control.
Williams, 599 F. Supp. a t 1193-94 n .12 . We, therefore, adopt the
"disinterested majority" version of the adverse domination doctrine . The party
most likely to be in possession of the information carries the burden to rebut a
presumption that accrual of the claim does not occur until a disinterested
majority has replaced the controlling culpable directors.
The second area of disagreement among courts concerns the required
level of culpability that the plaintiff must allege against the directors. Three
theories have emerged . One theory holds that negligent conduct, without
more, is sufficient to toll the statute of limitations . See Federal Deposit Ins.
Corp v. Carlson , 698 F. Supp. 178, 180 (D .Minn. 1988) . More recently, courts
have held that negligent conduct is not enough to warrant the application of
adverse domination . See Dawson , 4 F.3d at 1313; Resolution Trust Corp. v.
Acton, 49 F.3d 1086 (5th Cir. 1995); Farmer, 865 F. Supp. at 1157. These
courts, however, have not defined exactly what level of culpability is required .
Lastly, at least one court has held that the degree of culpability was irrelevant ;
because the reason for tolling the statute of limitations is that the plaintiffs
cannot discover the cause of action. Clark, 452 S .E.2d at 719 .
It is true that the discovery rule arose from medical malpractice claims,
and because adverse domination is a corollary of the rule, the logical result
would be to follow the Carlson theory whereby negligent conduct would be
sufficient. However, as other courts who have dealt with this issue have noted,
we fear that a negligent conduct standard would make the doctrine become too
widespread. As the Dawson court aptly stated :
To [allow a negligence standard] would effectively
eliminate the statute of limitations in all cases
involving a corporation's claims against its own
directors . . . . [I]t could almost always be said that
when one or two directors actively injure the
corporation, or profit at the corporation's expense, the
remaining directors are at least negligent for failing to
exercise "every precaution or investigation." (Internal
citation omitted.) If adverse domination theory is not
to overthrow the statute of limitations completely in
the corporate context, it must be limited to those cases
in which the culpable directors have been active
participants in wrongdoing or fraud, rather than
simply negligent.
Id . , 4 F .3d at 1312 .
We believe that the Dawson standard best reflects the fundamental
concerns that adverse domination was designed to address. The doctrine is
founded on the presumption that those who engage in fraudulent activity likely
will make it difficult for others to discover their misconduct . "[T]he danger of
fraudulent concealment by a culpable majority of a corporation's board seems
small indeed when the culpable directors' behavior consists only of
. . . ."
negligence
Id. at 1312-13 (emphasis added) . Accordingly, a corporate plaintiff
cannot toll the statute of limitations under adverse domination unless it shows
that a majority of its directors was more than negligent for the desired tolling
period . We hold that intentional wrongdoing of some kind, which would
include fraud, is required.
The doctrine of adverse domination recognizes the reality of situations
involving wrongdoing by controlling directors and officers of a corporation and
the corporation's inability to institute suit to protect it. It is applied to toll
statutes of limitations or to delay accrual of causes of action in situations when
those in power control the information necessary to institute suit on behalf of
an injured corporation. These parties cannot be expected to sue themselves or
to initiate an action contrary to their own interests. Today, we hold that the
doctrine of adverse domination may operate to toll the statute of limitations
under KRS §§ 271B .8-330(3) and 2718 .6-400 while directors, who are guilty of
alleged misconduct, exercise control over a corporation.
The law is hereby certified to the United States Bankruptcy Court for the
Western District of Kentucky .
All sitting. All concur.
COUNSEL FOR APPELLANT:
John Rollin Wilson
Ruck, Wilson, Helline 8v Brockman, PLLC
6008 Brownsboro Park Blvd., Suite A
Louisville, KY 40207-1295
COUNSEL FOR APPELLEE, DAVID B . PAINE:
John H. Dwyer, Jr.
Pedley, Zielke, Gordinier 8s Pence, PLLC
2000 Meidinger Tower
462 S . 4th Avenue
Louisville, KY 40202-2555
COUNSEL FOR APPELLEE, JOHN NEWTON :
Jan Charles Morris
125 S . 6th St., Suite 300
Louisville, KY 40202
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