Supreme court keeps Beloit Liquidating intact with split decision in fiduciary duty case  

By Joe Forward, Legal Writer, State Bar of Wisconsin

March 2, 2011 – The Wisconsin Supreme Court’s recent 3-3 split in a lawsuit against corporate officers means a $6.5 million jury verdict against them will not stand and a corporation’s creditors still have limited power to sue officers and directors who breach fiduciary duties.

The supreme court also split 3-3 in July 2009 when the case came up on certification from the District IV Court of Appeals, which hoped the supreme court would modify its holding in Beloit Liquidating Trust v. Grade, 2004 WI 39, 270 Wis.2d 356, 677 N.W.2d 298.

Instead, the case went back to the appeals court, which adhered to the supreme court’s rule in Beloit Liquidating that corporate officers and directors do not owe fiduciary duties to the corporation’s creditors until the corporation is both insolvent and no longer a going concern.

The corporation and a court-appointed receiver appealed that decision to the supreme court, which recently announced another 3-3 split, effectively affirming Polsky v. Virnich, 779 N.W. 2d 712, 2010 WI App 20 (Wis. App., 2010).

Facts and circumstances 

Daniel Virnich and Jack Moores were corporate officers of Communications Products Corporation (CPC), which they fully owned as sole shareholders. In 2003, CPC defaulted on a loan with its largest creditor, American Trust and Savings Bank (Bank).

The Bank alleged the corporation was insolvent and the circuit court appointed a receiver, who brought claims against Moores and Virnich (corporate officers) on behalf of CPC.

The receiver argued the corporate officers breached their fiduciary duty to CPC by taking excessive compensation and engaging in self-dealing at the corporation’s expense. The corporate officers argued the receiver’s claims were barred under Beloit Liquidating.

However, the receiver argued that Beloit Liquidating bars claims by creditors suing the officers or directors for breach of fiduciary duty on their own behalf, not claims on behalf the corporation. Here, the receiver asserted, the claims were brought on behalf of the corporation.

The Grant County Circuit Court agreed with the receiver, and a jury awarded the receiver $6.5 million – $3.8 million for breaching fiduciary duties and $2.7 million on a conspiracy claim.

Beloit Liquidating controls 

After the supreme court split 3-3 on certification, the appeals court ruled in Polsky v. Virnich, 779 N.W. 2d 712, 2010 WI App 20 (Wis. App., 2010) that the supreme court’s holding in Beloit Liquidating controlled to bar the receiver’s claims, reversed the $6.5 million judgment against the corporate officers, and ordered the circuit court to dismiss the receiver’s claims.

“Here, we find no clear indication in the record as to when Communications Products became insolvent, that is, when its debts exceeded its assets,” wrote District IV Court of Appeals Judge Paul Lundsten. “But there is no dispute that, at the time of Virnich and Moores’ alleged misconduct, Communications Products remained a going concern.”

The appeals court also relied on Beloit Liquidating to rule that the receiver’s claims were essentially the claims of creditors – not claims on behalf of the corporation – triggering the Beloit Liquidating rule that limits a creditors ability to sue directors and officers unless the corporation is insolvent and not a going concern. The court based its decision on the harm involved.

In other words, the only identified harm caused by the corporate officers’ breach of fiduciary duty was a diminished ability to pay creditors. If the impaired ability to pay creditors resulted in no injury to the corporation, Judge Lundsten explained, “we discern no reason why it is an actionable injury to the corporation in this case.”

Despite its ruling, the appeals court expressed concern that Beloit Liquidating seemingly allows corporate officers and directors to run the business as a going concern after it becomes insolvent, thereby allowing them to “strip many of the remaining assets of the ‘sinking ship’ without fear of running afoul of a duty to creditors.”

The court also voiced concern about Beloit Liquidating's impact on a corporation’s ability to obtain financing from banks. Judge Lundsten noted the Wisconsin Bankers Association’s view that Beloit Liquidating creates diminished creditor protection that will make it more difficult and expensive for corporations to borrow money in the future.

“[I]t appears to us that that corporations as a whole would benefit if our supreme court modified the Beloit Liquidating holding to bring it into line with the majority of other jurisdictions,” Judge Lundsten wrote. “Lacking the authority to do that, we apply Beloit Liquidating and affirm.”

Notes 

Justice David Prosser, Justice Patience Roggensack, and Justice Michael Gableman would have affirmed the appeals court ruling in favor of the corporate officers. Chief Justice Shirley Abrahamson and Justice Ann Walsh Bradley would have reversed in favor of the receiver. Justice Annette Ziegler did not participate, leading to the 3-3 supreme court split on appeal.

Both the Wisconsin Bankers Association and Sheet Metal Workers Local #565 filed amicus briefs on appeal to the supreme court.

Attorneys

Robert Kasieta and Andrew Parrish of the Kasieta Legal Group LLC, Madison, represented the receiver and Communications Products Corporation.

Donald Schott, Valerie Bailey-Rihn, James Richgels, Freya Bowen, and Elyce Wos of Quarles & Brady LLP, Madison, and Jeffrey Davis of Quarles & Brady LLP, Milwaukee, represented Daniel Virnich and Jack Moores.