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November 11, 2013 Articles

The Changing Landscape of Aiding and Abetting Breach of Fiduciary Duty Claims

Practitioners should anticipate encountering the claim with increasing frequency in the corporate arena.

By Linda M. Glover

In years’ past, claims of aiding and abetting a breach of fiduciary duty were predominantly asserted against professionals, such as attorneys and accountants, who were alleged to have facilitated their clients’ wrongdoing. Recent opinions, however, highlight the flexibility of the claim and hint at its potential to become one of the more potent business torts available to the plaintiffs’ bar. Indeed, the claim is particularly alluring because although the perpetrator of a breach of fiduciary duty may be an individual, the aider and abettor is often a large organization with deep pockets.

Establishing an Aiding and Abetting Claim
Aiding and abetting breach of fiduciary duty claims are creatures of state law. To establish the claim in Delaware, a plaintiff must prove “(1) the existence of a fiduciary relationship, (2) a breach of the fiduciary’s duty, and (3) knowing participation in that breach.” Carsanaro v. Bloodhound Techs., Inc., 65 A.3d 618, 643 (Del. Ch. 2013).

A fiduciary relationship exists either when there is a formal commitment to act for the benefit of another or when there are special circumstances from which the law assumes an obligation to act for another’s benefit. The most widely known examples of formal fiduciary relationships are those existing between attorney and client, executor and heir, trustee and beneficiary, and doctor and patient.

In the corporate environment, the primary focus is on fiduciary relationships between corporate officers, directors, and employees and their respective organizations or shareholders. In cases involving allegations of aiding and abetting, these fiduciaries are generally purported to have breached their duty of loyalty by engaging in self-interested conduct or failing to resolve conflicts.

Courts frequently consider the third element of an aiding and abetting breach of fiduciary duty claim as having two separate prongs. First, a plaintiff must plead and prove that the aider and abettor had actual knowledge of the perpetrator’s breach of fiduciary duty. Having “actual knowledge” of the wrongdoing has been held to mean “[a]n awareness or understanding of a fact or circumstance; a state of mind in which a person has no substantial doubt about the existence of a fact.” In re Lee Memory Gardens, Inc., 333 B.R. 76, 81 (Bankr. M.D.N.C. 2005) (citing Black’s Law Dictionary 888 (8th ed. rev. 2004)). Allegations that a purported aider and abettor had constructive knowledge or “should have known” of the underlying misconduct, therefore, ordinarily fail to state a claim. On the other hand, courts generally do not require proof that the aider and abettor intended to harm the plaintiff.

Second, a plaintiff must plead and prove that the aider and abettor substantially assisted or encouraged the underlying breach of fiduciary duty. Aiding and abetting liability will not attach, therefore, unless a party affirmatively assists a fiduciary’s breach of duty, fails to prevent a breach of fiduciary duty when required to do so, or assists in concealing a breach.

There is one notable exception to the requirement that plaintiffs plead and prove knowing participation to establish aiding and abetting liability. When the fiduciary is the agent of the purported aider and abettor, knowledge of the fiduciary’s breach may be imputed to the principal unless the agent is found to have acted adversely to the principal in the transaction at issue.

Recent Aiding and Abetting Opinions

Carsanaro v. Bloodhound Technologies, Inc., 65 A.3d 618, 643 (Del. Ch. 2013).An example of how aiding and abetting liability may be imputed to a principal is evident in the Delaware Chancery Court’s recent opinion in Bloodhound, whichgranted in part and denied in part the defendants’ motion to dismiss. Although the opinion has garnered attention for recognizing stockholders’ rights to pursue direct claims against corporate directors breaching their fiduciary duties through self-interested dilutive transactions, it is equally noteworthy for imputing aiding and abetting liability.

The five plaintiffs in Bloodhound are the founding former officers and employees of Bloodhound Technologies, Inc., a software development company. The plaintiffs held common stock and brought suit after the corporation was sold for over $82 million and they collectively received less than $36,000 for their shares. The plaintiffs allege that after two successful rounds of financing, venture capitalists gained control of the corporation’s board of directors. The board then caused the corporation to enter into several additional series of financing based on terms that were unilaterally set by board members and that benefited only the venture capital funds and their board representatives, personally. The additional rounds of financing substantially diluted plaintiffs’ collective ownership percentages.

In a thorough opinion, the Delaware Chancery Court concluded that the business judgment rule did not apply to the sales transaction because members of Bloodhound’s board were neither independent nor disinterested. Applying the entire fairness standard, the court determined that the Bloodhound plaintiffs had standing to assert a direct claim for stock dilution because they had adequately alleged claims for breach of fiduciary duties against a majority of the corporation’s board.

In addressing the plaintiffs’ claims against the venture capital funds for aiding and abetting breach of fiduciary duty, the court commented that there are some finely nuanced differences between aiding and abetting a breach of fiduciary duty and conspiracy to commit a breach of fiduciary duty, but the court found the claims to be functionally equivalent based on the facts alleged.

Conspiracy is certainly similar to aiding and abetting in that both require proof of concerted wrongful action. Conspiracy claims, however, generally require proof of an agreement between co-conspirators and an overt act in furtherance of the conspiracy. There is no requirement that an aider and abettor reach agreement with the fiduciary or any other party. Rather, aiding and abetting merely requires assistance to or encouragement of the underlying misconduct. For that reason, aiding and abetting is often easier to prove than conspiracy.

Another difference between aiding and abetting and conspiracy is that members of a conspiracy are responsible for the entire injury suffered by a plaintiff and are jointly and severally liable for the torts of any of its members. By contrast, an aider and abettor’s liability is separate from the fiduciary’s liability for the underlying tort.

In Bloodhound, the court found the distinction between aiding and abetting and conspiracy immaterial because under Delaware law, the knowledge of an agent acquired while acting within the scope of his or her authority is imputed to the principal. Whether an agreement existed between the venture capital funds and their board representatives or whether the funds encouraged their representatives’ misconduct was therefore irrelevant.

Although the Bloodhound opinion merely addresses a motion to dismiss and is therefore not dispositive, it nonetheless may serve as a beacon to the plaintiffs’ bar. It is not uncommon for venture capital funds to place their own representatives on the boards of companies in which the funds invest or for the subsequently formed boards to engage in alphabet rounds of financing that dilute the stock of the companies’ entrepreneurial founders. Venture capital funds should therefore take heed that Bloodhound may require them to cede control to disinterested and independent boards of directors, special committees to negotiate mergers and sales, or common stockholders themselves to avoid potential aiding and abetting liability.

The Nielsen Co. (U.S.) v. Success Systems, Inc., No. 11CV 2939 LAP FM, 2013 WL 1197857 (S.D.N.Y. Mar. 19, 2013) (slip op). Although imputing liability for aiding and abetting occurs on occasion, it is more common that plaintiffs are required to demonstrate that the alleged aider and abettor provided substantial assistance to or encouragement of the perpetrator’s breach of fiduciary duty. A recent opinion from the Southern District of New York demonstrates how easily that bar is met when the underlying breach of fiduciary duty is unambiguous. 

The Nielsen Company (U.S.) is in the business of collecting sales data, which it then analyzes to produce market research reports for retailers. In 2010, Nielsen sought bids from vendors to recruit stores for conversion to automated reporting. Nielsen awarded the contract to Success Systems, Inc., based on representations that it had fully functioning software applications for use in implementation and hundreds of retailers within its network that could be added to Nielsen’s existing base of clients. According to the court’s opinion, the first of these representations proved to be inaccurate.

Almost immediately after execution of the agreement, Success allegedly advised Nielsen that it could not meet the contractually established deadline but that it had obtained contracts from hundreds of retailers that were willing to provide automated sales data to Nielsen. Nielsen agreed to extend the time for Success’s performance.

Shortly thereafter, Nielsen began receiving emails from a disgruntled Success employee, Scott Sottile, who alleged that Success had been defrauding Nielsen since the inception of the parties’ agreement. Sottile asked Nielsen to cover his lost salary and any legal fees that might result from his disclosure of Success’s purported fraud. Nielsen declined Sottile’s request for indemnity but responded that it would like to find a way to obtain the information without identifying either Sottile or Nielsen to Success. Thereafter, Nielsen and Sottile engaged in frequent communications in which Sottile allegedly transmitted confidential Success information to Nielsen. Nielsen is purported to have hidden these communications from Success.

In March 2011, each party sent a letter through its respective counsel claiming that the other party had breached their agreement, and the agreement was subsequently terminated. At that time, Success allegedly had converted only 88 retail stores of the 1,222 it had agreed to convert under the parties’ agreement.

Nielsen brought suit against Success. In a motion to dismiss Success’s counterclaim for aiding and abetting, Nielsen contended that it did not have actual knowledge of Sottile’s fiduciary duty to Success because Sottile had never informed Nielsen that he owed such a duty. Spurning the contention, the court noted that, as a matter of law, an employee owes a fiduciary duty to his or her employer and is therefore required at all times to exercise the utmost loyalty in performing his or her duties. The court pointed to communications in which Sottile wrote that he could be fired or sued by Success for providing confidential information to Nielsen, and held that there was sufficient evidence from which it could be inferred that Nielsen had actual knowledge of Sottile’s breach of fiduciary duty.

Nielsen next contended that Success’s pleadings were devoid of any allegations demonstrating Nielsen’s active participation in Sottile’s breach of fiduciary duty. Although Success’s pleadings described the communications between Nielsen and Sottile in substantial detail, Nielsen argued that it had merely passively received information that Sottile wanted to disclose. In response, the court observed that Nielsen had informed Sottile that it would not reveal his identity to Success, sought to alleviate Sottile’s concerns regarding his disclosure, and declined to disclose Sottile’s communications to Success. The court found that these facts, taken as a whole, would permit the finder of fact to conclude that Nielsen had affirmatively assisted Sottile in breaching his duties to Success and in concealing Sottile’s breach from Success.

Like Bloodhound, the Nielsen opinion was written in response to a motion to dismiss, and the ultimate resolution of the case remains to be seen. Nonetheless,it demonstrates how adaptable an aiding and abetting breach of fiduciary duty claim can be. In Nielsen, the claim is cleverly asserted by a defendant to mitigate its own purported misconduct. The claim, however, has a myriad of other applications in the employment context, including in cases involving allegations of theft of trade secrets. 

Freed v. J.P. Morgan Chase Bank, No. 12 C 1477, 2012 WL 6193964 (N.D. Ill. Dec. 12, 2012). Freed arises from a dispute between two attorneys, Freed and Weiss, who were members of a limited liability company (LLC) specializing in bringing class action lawsuits. Freed alleges that Weiss conspired to exclude him from control of the LLC and to convert its assets to his own use, and that J.P. Morgan Chase assisted Weiss in the wrongdoing.

In particular, Freed alleges that without his knowledge or authorization, Weiss opened bank accounts with Chase, falsely representing to Chase that Weiss was the LLC’s sole member and manager with full authority over the deposited funds. Upon learning that LLC funds had been transferred to Chase, Freed delivered to Chase a written demand that it immediately freeze the accounts opened by Weiss. Attached to the demand was a copy of the parties’ partnership agreement, which governed the LLC’s financial affairs. Instead of complying with Freed’s demand, one of Chase’s employees allegedly contacted Weiss, advised him that the accounts would be frozen, encouraged him to move the accounts, and assisted Weiss in obtaining a cashier’s check so that the money could be deposited in another bank.

In an opinion recounting the above allegations, the District Court of the Northern District of Illinois denied Chase’s motion to dismiss the aiding and abetting breach of fiduciary duty claim asserted against it. The court somewhat harshly concluded that Chase “easily could have made an independent investigation into the truth of Weiss’s assertions, but it did not; had it done so, it would have found that Weiss’s claims to sole authority over the funds were false.” Id. at *3. The court also found that at the time Chase took the above-described actions, “it was aware of the Partnership Agreement’s terms and of Weiss’s plot to take control of the LLC’s funds . . . .” Id.

In a futile attempt to avoid aiding and abetting liability, Chase argued that Freed could not bring the claim in his individual capacity because it belonged to the LLC. The court quickly dispatched Chase’s argument by pointing to the Illinois Limited Liability Company Act, which provides that a member-manger of an LLC, such as Weiss, owes fiduciary duties not only to the LLC but also to the LLC’s other members. The court determined that under the act, Weiss owed fiduciary duties directly to Freed and that if Weiss breached those duties, Freed’s interests were harmed directly.

Freed is interesting in that Chase’s alleged misconduct is attributable to a single employee who arguably acted adversely to Chase’s interests by assisting Weiss in moving money out of the bank. Under Illinois law, although the knowledge and conduct of agents are generally imputed to their principals, Metropolitan Condominium Ass’n v. Crescent Heights, 368 Ill. App. 3d 995, 998 (2006), an exception exists when the agent’s interests are adverse to the principal. Lease Resolution Corp. v. Larney, 308 Ill. App. 3d 80, 86 (1999). In Freed, it appears that Chase did not raise, or perhaps the court did not consider, the adverse interest exception, which arguably might have protected Chase from potential aiding and abetting liability.

Although aiding and abetting breach of fiduciary duty claims were once asserted primarily against professionals, they now dot the corporate legal landscape. The claim is extraordinarily adaptable; and because breaching a fiduciary duty seldom occurs in a vacuum, practitioners should anticipate encountering the claim with increasing frequency in the corporate arena.

Keywords: litigation, business torts, unfair competition, aiding, abetting, breach of fiduciary duty, conspiracy, adverse interest exception

Linda M. Glover – November 11, 2013