OPINION
delivered the opinion of the Court,
The primary issue presented in this appeal is whether an individual creditor of an insolvent corporation may bring a direct cause of action for breach of fiduciary duty against the corporate directors and officers. We hold that a creditor of an insolvent corporation may not bring a direct claim, only a derivative claim, against officers and directors for breach of the fiduciary duties they owe to the corporation. We adopt the reasoning of the Delaware Supreme Court in
North American Catholic Educational Programming Foundation, Inc. v. Gheewalla,
Factual and Procedural Background
In 1995, Michael Sanford and Bruce Prow formed a company called SecureOne, Inc. Mr. Sanford and Mr. Prow each owned a one-half interest in SecureOne, a company that sold and serviced residential and non-residential security systems. In December 2002, following a dispute over the management of the company, Mr. Sanford sold his 50% interest in SecureOne to
To obtain funds to buy Mr. Sanford’s interest in SecureOne, Mr. Prow consulted with Troy and Carol Waugh (Mrs. Prow’s parents and the defendants in this case). Before the SecureOne stock sale to the Prows, the Waughs bought 25% of Mr. Prow’s SecureOne stock for $100,000 and loaned the company an additional $900,000. On December 19, 2002, SecureOne executed two promissory notes: one to the Waughs in the amount of $425,000 and another to Waugh & Co. (Mr. Waugh’s consulting and marketing training business for accountants) in the amount of $475,000. SecureOne also executed a security agreement (the “Waugh agreement”) detailing the $900,000 loan and listing the Prows as guarantors secured by their 75% stock ownership interest. Mr. Sanford was not advised of these transactions.
After the sale, Mr. Waugh convened a meeting of SecureOne’s board of directors, at which the following officers were elected: Mr. Prow — president/CEO; Mrs. Prow — vice-president of finance/treasurer; Mr. Waugh — chairman of the board of directors; and Mrs. Waugh — secretary. The Waugh agreement anticipated and required these elections and officer appointments.
In 2003, SecureOne’s sales diminished significantly, and the size of its workforce and scope of operations decreased. The Waughs loaned SecureOne additional money, including $70,000 in August of 2003. In October of 2003, SecureOne defaulted on its obligations under the Waugh agreement, and the Waughs foreclosed on the Prows’ shares of SecureOne stock and obtained 100% ownership in SecureOne. In December of 2003, the Waughs loaned Sec-ureOne an additional $120,000 and took a security interest in SecureOne’s “house accounts” 1 to secure the debt.
From February through December of 2003, SecureOne made monthly payments to Mr. Sanford in the amount of $70,166.50. In early 2004, however, the Waughs advised Mr. Sanford that Secu-reOne could no longer afford to make its payments to him. To settle the remaining debt, the Waughs offered Mr. Sanford approximately $650,000, SecureOne’s house accounts, and the company’s vehicles. Mr. Sanford declined the offer.
At about the same time, in early 2004, the Waughs decided to wind down Secu-reOne and began closing its branch locations. SecureOne did not renew its franchise agreement with ADT Security Systems and, in January 2004, received $1,173,213 from ADT, an amount representing the lifetime equity built over the course of SecureOne’s agreement with ADT. The remaining operations of Sec-ureOne were moved to the Prows’ home, although the Waughs controlled the decisions pertinent to SecureOne’s winding down process.
On February 13, 2004, Mr. Sanford sued Mrs. Prow and SecureOne to enforce the Sanford note that was in default. Mr. Sanford did not sue Mr. Prow, as he had filed for bankruptcy. Mrs. Prow and SecureOne answered and counterclaimed, alleging, among other things, that Mr. Sanford intentionally and/or negligently misrepresented SecureOne’s financial condition at the time of the stock sale by stating that all of SecureOne’s debts were current and there were no liabilities other than those reflected on SecureOne’s balance sheet. Mrs. Prow and SecureOne alleged that SecureOne actually had past due liabilities in the amount of $434,981.55. This cause of action against SecureOne and the Prows concluded in April of 2006 when the trial court awarded Mr. Sanford a judgment in the amount of $1,560,000. Mrs. Prow filed for bankruptcy shortly thereafter. Mr. Sanford received approximately $170,000 from SecureOne in satisfaction of the judgment. Mr. Waugh testified that the $170,000 represented the proceeds from sales of the company’s vehicles in which Mr. Sanford held a security interest pursuant to the security agreement executed with the Sanford note.
On April 15, 2004, the Waughs and Waugh & Co. filed a separate action against Mr. Sanford, asserting allegations of fraudulent misrepresentation that essentially mirrored the allegations in Mrs. Prow and SecureOne’s countercomplaint. The Waughs voluntarily dismissed this action on March 11, 2005.
On April 13, 2005, Mr. Sanford filed his complaint in the action presently on appeal, asserting claims against the Waughs and Waugh & Co. for abuse of process, malicious prosecution, and breach of fiduciary duty. In September of 2006, Mr. Sanford amended his complaint against the Waughs to assert causes of action for fraudulent conveyance, conspiracy, and conversion, and sought compensatory and punitive damages. The Waughs moved for summary judgment on all claims. The trial court granted summary judgment and dismissed Mr. Sanford’s claims for abuse of process, conversion, and breach of fiduciary duty, and granted partial summary judgment to the Waughs on the fraudulent conveyance claim with respect to some of the alleged fraudulent transactions. The trial court denied summary judgment on the remaining claims of fraudulent conveyance with respect to consulting fees and interest payments made by SecureOne to the Waughs, conspiracy, and malicious prosecution.
During the discovery process, the Waughs propounded an interrogatory requesting that Mr. Sanford “[ijdentify with specificity the tort underlying the conspiracy claim alleged in ... the Amended Complaint.” ■ Mr. Sanford answered by stating, “Sanford has asserted claims against Defendants for breach of fiduciary duty, malicious prosecution, fraudulent conveyance and conversion, all of which resulted from the Waughs’ and the Prows’
The case was tried before a jury on August 20-24, 2007. At the close of Mr. Sanford’s proof, the Waughs moved for a directed verdict on the claims of fraudulent conveyance, malicious prosecution, and punitive damages. The trial court dismissed the claim for punitive damages and denied the motion for directed verdict on the remaining claims. The Waughs presented no additional proof.
The jury returned a verdict in favor of Mr. Sanford on the malicious prosecution claim, with Mr. Waugh, Mrs. Waugh, and Waugh <& Co. each liable in the amount of $17,000; in favor of Mr. Sanford on the fraudulent transfer of assets claim with Waugh & Co. liable for $109,733, Mrs. Waugh liable for $48,248, and Mr. Waugh liable for $18,249; and found that the defendants conspired together to commit the torts of malicious prosecution and fraudulent conveyance, resulting in the trial court entering a judgment of joint and several liability against the defendants in the amounts awarded by the jury.
Both parties appealed. The Court of Appeals held that the trial court erred by: (1)granting the Waughs summary judgment on Mr. Sanford’s claim for breach of fiduciary duty; (2) granting the Waughs’ motion in limine and refusing to allow Mr. Sanford to present evidence supporting a claim of conspiracy to commit interference with contract; and (3) granting a directed verdict and dismissing the punitive damages claim.
Sanford v. Waugh & Co.,
No. M2007-02528-COA-R3-CV,
Issues Presented
We address the following issues:
(1) whether an individual creditor of an insolvent corporation may assert a direct claim for breach of fiduciary duty against the corporation’s officers and directors;
(2) whether the trial court erred in granting the Waughs’ motion in limine and thereby refusing to allow Mr. Sanford to present evidence supporting a claim of conspiracy to commit the tort of interference with contract; and
(3) whether the trial court erred in granting the Waughs a directed verdict on the claim for punitive damages.
Analysis
Direct Cause of Action by Creditor of Insolvent Corporation for Breach of Fiduciary Duty
Mr. Sanford brought a direct claim for breach of fiduciary duty against the Waughs, as officers and directors of the insolvent corporation, SecureOne. The trial court dismissed the claim and the Court of Appeals reversed, holding that a creditor of an insolvent corporation could bring
We begin with a brief review of the role and responsibilities of corporate officers and directors. A corporation is governed by its directors and officers. Tennessee Code Annotated section 48-18-101 (2002) establishes the position and general role of a corporate director, stating as follows:
(a) Except as provided in subsection (c), each corporation must have a board of directors.
(b) All corporate powers shall be exercised by or under the authority of, and the business and affairs of the corporation managed under the direction of, its board of directors, subject to any limitation set forth in the charter.
(c) A corporation having fifty (50) or fewer shareholders may dispense with or limit the authority of a board of directors by describing in its charter who will perform some or all of the duties of a board of directors; provided, that any such person or persons shall be subject to the same standards of conduct that this chapter imposes on directors in the performance of their duties.
Similarly, Tennessee Code Annotated section 48-18^401 (2002) governs corporate officers by stating that “[a] corporation has the officers described in its bylaws or designated by its board of directors in accordance with the bylaws; provided, that every corporation shall have a president and a secretary.” The corporation’s officers are appointed or elected by the board of directors unless its charter or bylaws provide otherwise. Id.
In a solvent corporation, there is a clear distinction between the fiduciary duty the officers and directors owe to shareholders of the corporation and the duty the officers and directors owe to creditors. The directors and officers of a corporation owe a fiduciary duty to the corporation and to its shareholders.
Deadrick v. Bank of Commerce,
With respect to directors in a close corporation, “They are required to act in the utmost good faith, and ... they impliedly undertake to give to the enterprise the benefit of their care and best judgment and to exercise the powers conferred solely in the interest of the corporation ... and not for their own personal interests.” A fiduciary is not an insurer, but is bound to exercise good faith and due diligence.
Id. (internal citations omitted).
Tennessee Code Annotated section 48-18-301 (2002) (pertaining to directors) and section 48-18-403 (2002) (pertaining to officers) require that directors and officers discharge all duties under their discretionary authority: “(1) In good faith; (2)With the care an ordinarily prudent person in a like position would exercise under similar circumstances; and (3) In a manner the director [or officer] reasonably believes to be in the best interests 2 of the corporation.” Id. Although shareholders, as “owners” of the corporation, cannot exercise any control over the corporation’s ordinary business operations, they are properly protected by the fiduciary duty owed to them and the corporation by the directors and officers. “[A]lthough the shareholder bears the risk, it is the director and officer who, through their decisions, can directly affect the value of the firm. Thus directors must act as custodians entrusted with the management of the shareholders’ assets.” Cory Dean Kan-destin, Note, The Duty to Creditors in Near-Insolvent Firms: Eliminating the “Near-Insolvency” Distinction, 60 Vand. L.Rev. 1235, 1242 (2007) (internal quotation marks omitted).
Officers and directors, however, do not owe a fiduciary duty to creditors of a solvent corporation.
Deadrick,
The directors of a corporation or a majority of its shareholders, acting for the corporation, are the proper parties to bring a claim on behalf of a corporation.
House v. Estate of Edmondson,
In contrast, creditors may not directly sue officers and directors of a corporation because they allegedly failed to properly manage corporate affairs. In
Merriman,
the court observed the general rule that “to become directly liable to a creditor, a statutory duty must devolve upon the director or there must be some conduct which creates privity of contract between them or which results in tortious injury to the creditor for which an action
ex delicto
3
will lie.”
That directors are liable in an action at law to their principal, the corporation, for losses resulting to it from their malfeasance, misfeasance, or their failure or neglect to discharge the duties imposed by their office, and, in equity, to the stockholders for these losses, the corporation declining to bring suit, is clear.... Though the corporation is the legal entity, yet the stockholders are interested in the operations of the corporation while in a state of activity, and, upon its dissolution, in the distribution of its property, after all debts are paid; and so its officers or agents stand in a fiduciary relation to both. But it is otherwise as to creditors.... It is true that the creditors may extend credit upon the faith that the company has assets to pay its debts, and that these assets are prudently managed; yet they are strangers to the directors; they maintain no fiduciary relation with them; there is a lack of privity between the two.
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To enable the creditors to sue the defendants directly, they must have some independent right of action, either legal or equitable.
When a corporation becomes insolvent, additional protection is afforded to corporate creditors, including the power to initiate a derivative action on behalf of the corporation, because upon a corporation’s insolvency, “its creditors take the place of the shareholders as the residual beneficiaries of any increase in value.”
N. Am. Catholic Educ. Programming Found., Inc. v. Gheewalla,
Creditors are further protected by the application of the “trust fund” doctrine which allows creditors of an insolvent or dissolved corporation to collect payment of their debts before distributions to shareholders, as noted by this Court as follows:
Under this doctrine, as it has been applied in Tennessee, the creditors of an insolvent or dissolved corporation “are entitled in equity to payment of their debts before any distribution of corporate property is made among stockholders,” and these creditors also possess “a right to follow its assets or property into the hands of [anyone] who is not a holder in good faith in the ordinary course of business.” See Jennings, Neff & Co. v. Crystal Ice Co.,128 Tenn. 231 , 236,159 S.W. 1088 , 1089 (1913).
Kradel v. Piper Indus.,
Mr. Sanford is asking this Court to recognize a new
direct,
not derivative, cause of action by a single creditor against the corporate directors and/or officers of an insolvent corporation. The trial court dismissed Mr. Sanford’s direct claim for breach of fiduciary duty, finding the reasoning of the Delaware Supreme Court in the
Gheewalla
case to be persuasive. In
Gheewalla,
the Court addressed as a matter of first impression
It is well established that the directors owe their fiduciary obligations to the corporation and its shareholders. While shareholders rely on directors acting as fiduciaries to protect their interests, creditors are afforded protection through contractual agreeihents, fraud and fraudulent conveyance law, implied covenants of good faith and fair dealing, bankruptcy law, general commercial law and other sources of creditor rights.
Id.
at 99 (footnotes omitted). The Court, observing that the recognition of a new direct right to assert breach of fiduciary claims by creditors of corporations that are insolvent or in the zone of insolvency may involve ‘“using the law of fiduciary duty to fill gaps that do not exist,’ ”
id.
at 100 (quoting
Production Resources Group L.L. v. NCT Group, Inc.,
creditors’ existing protections — among which are the protections afforded by their negotiated agreements, their security instruments, the implied covenant of good faith and fair dealing, fraudulent conveyance law, and bankruptcy law— render the imposition of an additional, unique layer of protection through direct claims for breach of fiduciary duty unnecessary.
Gheewalla,
Secondly, the Gheewalla Court observed that allowing a direct breach of fiduciary duty claim would create problems with corporate governance, causing uncertainty and potential conflicts of interest for officers and directors:
Recognizing that directors of an insolvent corporation owe direct fiduciary duties to creditors, would create uncertainty for directors who have a fiduciary duty to exercise them business judgment in the best interest of the insolvent corporation. To recognize a new right for creditors to bring direct fiduciary claims against those directors would create a conflict between those directors’ duty to maximize the value of the insolvent corporation for the benefit of all those having an interest in it, and the newly recognized direct fiduciary duty to individual creditors. Directors of insolvent corporations must retain the freedom to engage in vigorous, good faith negotiations with individual creditors for the benefit of the corporation.
Id. at 103.
We agree with and adopt the Delaware Supreme Court’s reasoning and holding in
Gheewalla.
4
Mr. Sanford’s
Exclusion of Evidence of Conspiracy to Interfere With Contract
Shortly before trial, the Waughs filed a motion in limine requesting that the trial court refuse to allow Mr. Sanford to put on evidence of conspiracy to commit any underlying torts or bad acts other than fraudulent conveyance and malicious prosecution, because the court had previously granted summary judgment on the rest of Mr. Sanford’s claims. Mr. Sanford responded by alleging for the first time, less than two weeks before the trial was scheduled to begin, that the Waughs conspired with the Prows to commit the tort of interference with contract. Mr. Sanford did not plead interference with contract in his complaint or his amended complaint, The trial court granted the Waughs’ motion in limine on the grounds that “the plaintiff did not plead the tort of interference with contract and no discovery was exchanged on this cause of action.” The Court of Appeals reversed, and the Waughs argue on appeal that it erred in doing so.
In our review of the trial court’s decision to admit or exclude evidence, we apply a deferential abuse of discretion standard.
Biscan v. Brown,
Tennessee Rules of Civil Procedure 8.01 and 8.05 require parties to plead their claims in short, plain, simple, concise, and direct language. As the Court of Appeals correctly noted in this case, “[o]ne purpose of pleadings is ‘to give notice of the issues to be tried so that the opposing party can adequately prepare for trial.’ ”
Sanford,
Punitive Damages Claim
At the conclusion of Mr. Sanford’s proof, the trial court granted the Waughs’ motion for directed verdict on the punitive damages claim, finding that “the plaintiff has not met the clear and convincing burden that is required with [punitive] damages.” The final issue on appeal is the correctness of this ruling.
In reviewing a trial court’s disposition of a motion for directed verdict, the appellate court must “take the strongest legitimate view of the evidence in favor of the non-moving party, construing all evidence in that party’s favor and disregarding all countervailing evidence.”
Johnson v. Tenn. Farmers Mut. Ins. Co.,
Our review of the trial court’s directed verdict is limited to the question of whether the evidence supporting Mr. Sanford’s malicious prosecution was sufficiently egregious to justify punitive damages, because as the Court of Appeals observed, “[t]he trial court previously ruled that punitive damages were not recoverable on Sanford’s fraudulent conveyance claim and Sanford did not appeal this issue.”
Sanford,
There is no evidence that clearly and convincingly demonstrates that the
In summary, the proof offered by Mr. Sanford fails to clearly and convincingly demonstrate that the Waughs’ conduct in maliciously prosecuting their claim of misrepresentation was motivated by such ill will, hatred, or spite as to render it among “the most egregious of wrongs” justifying an award of punitive damages. The decision of the Court of Appeals on this issue is reversed; the trial court’s directed verdict is affirmed and reinstated.
Conclusion
As a result of our holding that individual creditors of an insolvent corporation have no right to assert direct claims for breach of fiduciary duty against corporate officers and/or directors, the judgment of the Court of Appeals reversing the trial court’s summary judgment on Mr. Sanford’s direct claim for breach of fiduciary duty is reversed. The judgment of the Court of Appeals reversing the trial court’s ruling on the Waughs’ motion in limine and granting a directed verdict on the punitive damages claim is also reversed. Costs on appeal are assessed to the appellee, Michael Sanford, and his surety, for which execution may issue if necessary.
Notes
. SecureOne sold and installed security systems to residential and non-residential customers. If the customer met ADT’s credit requirements, SecureOne sold the service contracts to ADT Security Systems, Inc. If a customer did not meet ADT’s credit requirements, SecureOne retained and serviced the account directly for a monthly fee of $30. These accounts were SecureOne's "house accounts.” In 2003, SecureOne’s house accounts generated a monthly revenue of about $30,000.
. The quoted language is identical in the two cited statutory sections, except that section 48-18-301 uses the word "interests” and section 48-18-403 uses the singular "interest.”
. "Ex delicto” is defined as "[a]rising from a crime or tort." Black's Law Dictionary 649 (9th ed.2009).
. Courts in several other jurisdictions presented with the same issue have similarly adopted Gheewalla's rationale and ruling.
See Master-Halco, Inc. v. Scillia, Dowling & Natarelli, LLC,