Breach of Fiduciary Duty in North Carolina
April 27, 2021 by Jeremy Sugg
No Harm, No Foul: Are actual damages required to punish a breach of fiduciary duty in North Carolina?
Claims for breach of fiduciary duty are common in business and commercial litigation. Such claims seek redress when officers, directors, managers and others who control business operations abuse their power or neglect their responsibilities.
It has typically been understood that a claim for breach of fiduciary duty required a plaintiff to prove some harm resulting from the breach. For example, the North Carolina Pattern Jury Instruction for a breach of fiduciary duty indicates a plaintiff must prove that “the defendant’s [acts or omissions] proximately caused damage to the plaintiff.”
In other words, if a defendant breached a fiduciary duty, but there was no harm resulting from his conduct, there was no claim. No harm, no foul.
Or so we thought.
The North Carolina Supreme Court and the North Carolina Business Court have recently indicated this is not a correct assessment.
In Chisum vs. Compagna, the plaintiff brought various claims against his business partners arising out of their alleged efforts to dilute his interest in various limited liability companies. This included two separate claims for breach of fiduciary duty: (1) one claim asserted “derivatively” on behalf of one of the companies, and (2) a separate claim asserted directly by the plaintiff on his own behalf. This individual claim was dismissed early on by the trial court, but don’t forget it because it will be important later.
As for the derivative claim, the jury decided the defendant did breach his fiduciary duty to the company, but the company had not been damaged by the breach. The jury then awarded the company $1.00 in “nominal damages.”
In essence, the jury said, ‘we don’t think the company was damaged by the defendant’s breach, but we’ll throw it a dollar in recognition of the fact the defendant did something wrong.’
However, the jury then went on to award the company $250,000 in punitive damages! Yikes.
What was the jury thinking?
You would be justified in questioning this odd result. How could a jury find there were no damages, but award $1 in nominal damages and $250,000 in punitive damages?
The defendant wondered the same thing and filed a post-trial motion asking the court to set aside the verdict. The defendant argued the award of punitive damages could not stand in light of the jury’s determination that the company had not suffered any actual damages. In short, the defendant argued that if there was no harm, there was no foul. Moreover, he could not be punished if there was no underlying claim to support such an award.
Well why didn’t you say that?
The trial court indicated it was “skeptical” that the defendant was correct, but ultimately held it did not have to decide this issue because the defendant had not properly preserved it at trial.
During the trial, the defendant argued a claim for breach of fiduciary duty required proof of some “injury” or “damages”. He did not specifically argue the claim required proof of “actual damages”. Because “nominal damages” are in fact “damages”, the defendant missed its chance to argue an award of nominal damages could not support a claim for breach of fiduciary duty.
The trial court then pointed to a long line of case law in which courts have held an award of nominal damages is sufficient to support an award of punitive damages.
The defendant appealed to the North Carolina Supreme Court. In an opinion issued on March 12, 2021, the Court noted “the issue of whether a plaintiff is required to prove actual damages in support of breach of fiduciary duty and constructive fraud claims” was one of first impression for the Court.
However, the Court further explained the Court of Appeals had addressed this issue “on a number of occasions.” The Court then went on to cite various opinions in which the Court of Appeals indicated nominal damages were sufficient to support a claim for breach of fiduciary duty.
The Courts opinion
Based on these opinions, the Supreme Court held “potential liability for nominal damages is sufficient to establish the validity of claims for breach of fiduciary duty and constructive fraud and can support an award of punitive damages.”
In further support of this holding, the Court explained: “Aside from the fact that nothing in the prior decisions of this Court indicates that proof of actual injury is necessary in order to support a claim for breach of fiduciary duty or constructive fraud, we see no basis for treating the incurrence of nominal damages as a second-class legal citizen in this context, particularly given that such damages do reflect the existence of a legal harm and the fact that the policy of North Carolina law is to discourage breaches of fiduciary duty and acts of constructive fraud.” Wow.
The plot thickens
Reading this portion of the opinion, you would be justified in believing that actual damages are not required to support a claim for breach of fiduciary duty in North Carolina. But wait, there’s more.
Remember how the trial court dismissed the plaintiff’s separate, individual claim for breach of fiduciary duty? Well, he appealed to the Supreme Court at the same time the defendant appealed the punitive damages award.
In addressing whether the trial court properly dismissed the plaintiff’s individual claim for breach of fiduciary duty, the Supreme Court made the following observation: “As we have already noted, in order to successfully assert a claim for breach of fiduciary duty, ‘a plaintiff must show that: (1) the defendant owed the plaintiff a fiduciary duty; (2) the defendant breached that fiduciary duty; and (3) the breach of fiduciary duty was a proximate cause of injury to the plaintiff.” The Court then held the plaintiff’s individual claim for breach of fiduciary duty was properly dismissed “because of his failure to demonstrate that he sustained a legally cognizable injury.”
That’s right. After holding there was nothing in the Court’s prior decisions to indicate “proof of actual injury is necessary in order to support a claim for breach of fiduciary duty”, the Court held the plaintiff failed to prove a claim for breach of fiduciary duty because he failed to prove an injury.
Is your head spinning yet?
The only way to make sense of this is to distinguish an “actual injury” from a “legally cognizable injury.” In an apparent attempt to clarify this distinction, the Court held the plaintiff did not prove a “legally cognizable injury” because the only breaches of fiduciary duty he identified in support of his individual claim merely described “the specific steps the [defendants] took to deprive [the plaintiff] of his ownership interests” in the companies; as opposed to an injury resulting from their efforts.
However, the examples offered by the Court are not all that helpful. The Court cited to the defendants’ alleged attempts to freeze the plaintiff out of the companies, conducting “sham” capital calls, and treating plaintiff as if he was no longer a member of the companies.
In comparison, the injuries cited by the trial court in support of its order upholding the jury’s verdict on the derivative claim included things like violating the company’s operating agreement, failing to send the plaintiff required reports and documents, and selling the company’s assets without informing the plaintiff.
A distinction without a difference?
Is there really a difference between treating a plaintiff as if he is no longer a member of a company and failing to send him required reports and documents?
Other case law offers a little further insight into the distinction between an “actual injury” and a “legally cognizable injury.” Essentially, a legally cognizable injury sufficient to support an award of nominal damages is any interference with a legal right. For example, trespass is such an interference whether it results in damages or not. An “actual injury” is one resulting in actual harm, pecuniary or otherwise. However, this does not explain the difference between treating a plaintiff like he is no longer a member of a company and failing to send him required reports and documents.
This is even more difficult to parse out in light of the Supreme Court’s holding that not only are nominal damages sufficient to support a claim for breach of fiduciary duty, but the mere “potential liability for nominal damages is sufficient”. So, does that mean the mere possibility of interference with a legal right is enough?
All of this will require further clarification in the years to come. However, for now, the law in North Carolina is that potential liability for nominal damages is sufficient to establish the validity of claims for breach of fiduciary duty and constructive fraud and can support an award of punitive damages. In fact, a recent Business Court opinion cited Chisum v. Campagna for the proposition that “the absence of evidence of actual damages does not defeat” a claim for breach of fiduciary duty.
So, where does that leave things for the time being?
It is hard to say, but it could mean an increased number of claims for breach of fiduciary duty. Damages are often difficult to prove in business litigation, but if actual damages are no longer required to obtain an award of punitive damages, plaintiffs may find it a lot easier to justify the costs of litigating a breach of fiduciary duty claim.
If you are an officer, director or manager of a company, it is now more important than ever to make sure you are not engaging in self-dealing or anything that might even appear that way. If you do, you might have to pay for it whether it results in harm to the company or not.