Partners Owe Fiduciary Duty to Each Other Even During Adversarial Litigation

After partners in a closely held corporation entered into years of adversarial litigation, a settlement agreement was reached. One of the partners later sued the other two, alleging that he was fraudulently induced into agreeing to the settlement when the defendant’s counsel misrepresented the financial position of the corporation at the time of the settlement. The circuit court dismissed the plaintiff’s complaint, finding that the defendants did not owe him a fiduciary duty during the litigation settlement discussions. The appellate court reversed, determining that because there was no document specifying that the parties’ relationship had been dissolved at the time of the settlement talks, the defendants still owed the plaintiff a fiduciary duty, and there was a question of material fact as to whether the resulting settlement agreement was valid. The appellate panel then reversed the decision of the circuit court.

Samuel Arndt, III, Nicholas Nardulli, and Diana Johnson were shareholders in Redhawk Financial Services, Inc. Arndt owned 49 percent of Redhawk’s shares; Nardulli was the controlling shareholder, a director, and the president of Redhawk; Johnson was a shareholder, a director, and the secretary of Redhawk. In December 2012, Redhawk filed a complaint against Arndt for breach of fiduciary duty. The complaint alleged that Arndt withdrew over $100,000 from Redhawk without an apparent business justification and also diverted Redhawk’s commissions into Arndt’s personal bank account. Arndt filed a counterclaim against Redhawk as well as a third-party complaint against Nardulli and Johnson, alleging breach of fiduciary duty and oppression of him as a minority shareholder.

Both sets of parties were represented by counsel in the 2012 litigation. In January 2015, Arndt’s counsel received a letter from the defendants’ counsel proposing a settlement. A settlement was agreed to in February 2015, which included an assignment of Arndt’s shares of Redhawk to Nardulli, a release by Arndt of his claims against the defendants, and a non-reliance clause.

Arndt had entered into the settlement agreement because Redhawk’s 2013 tax return indicated that the company was operating at a loss. One week after the parties executed the settlement agreement, however, Arndt received an IRS Schedule K-1 Form reporting his personal tax liability of $79,181 resulting from Redhawk’s 2014 profits. In June 2015, Arndt filed a demand requesting access to Redhawk’s books and accounts, and Redhawk and Nardulli refused to produce the requested records. Arndt then filed a petition for mandamus against Redhawk, while Redhawk argued in response that Arndt lacked standing to inspect the books because he was no longer a shareholder.

The circuit court granted the defendant’s motion while giving Arndt leave to file an amended complaint. In December 2015, Arndt filed an amended complaint against Redhawk and the other defendants, alleging that he was fraudulently induced into executing the settlement agreement. Arndt sought rescission. Arndt later amended his complaint a second time, asserting claims for fraud and breach of fiduciary duty against the defendants, and dropping the request for rescission. Arndt alleged that the defendant’s counsel falsely represented the financial position of Redhawk while the settlement was being negotiated and that the defendants owed him fiduciary duties while negotiating the settlement, which they breached by authorizing their attorney to make false statements about Redhawk’s financial condition. In November 2017, the circuit court dismissed Arndt’s second amended complaint, and Arndt appealed.

The appellate panel began by stating that, contrary to the defendant’s argument, Arndt was not required to prove justifiable reliance in order to establish a claim for breach of fiduciary duty or constructive fraud based on a breach of fiduciary duty. Citing Hamilton v. Williams, the panel stated that the law was clear that partners are fiduciaries to each other and are bound to exercise the utmost good faith and honesty in all dealings and transactions relating to the partnership. The panel then noted that an individual that controls a corporation owes a fiduciary duty to the corporation and its shareholders. The panel then determined that, based on the record, the parties maintained a fiduciary relationship at the time of the defendants’ attorney’s alleged misrepresentation. The panel stated that, though the parties’ relationship was in the process of dissolving at the time, the record did not reveal any mutual document demonstrating that the parties had agreed to dissolve their relationship until after the date of the defendants’ attorney’s letter.

Finally, the panel determined that the defendants had not shown by clear and convincing evidence that the agreement embodied in the release was just and equitable. The panel stated that, further, the defendants had not proved that they provided full and frank disclosure of all material facts, especially Redhawk’s accurate financial position. Accordingly, the panel reasoned, Arndt had raised genuine issues of material fact regarding the validity of the release, and dismissal of his complaint was inappropriate. The panel determined that the circuit court erred and it, therefore, reversed the decision of the circuit court.

You can read the court’s decision here.

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