Jeffery J. Sattler
May, 2016

Absence of Adverse Domination Statutes is Leaving an Exploitable Void in Corporate Law

            Can controlling directors and managing members get away with breaching their fiduciary duties to their companies and hanging onto control long enough for the statute of limitations for bringing a lawsuit on their breach to expire?  The answer is “yes” in states, such as Michigan, Ohio, and Indiana, where legislatures have declined to codify the adverse domination doctrine.[1]

            Adverse domination is an equitable doctrine that tolls the statute of limitations for claims by a company against its directors, managing members, officers, lawyers, and accountants as long as the company is controlled by those acting against its interests.[2]  “Under this doctrine, the statute of limitation is tolled because controlling wrongdoers are unlikely to initiate actions or investigations for fear that such actions will reveal their own wrongdoing and because, in such circumstances, outsiders do not generally have access to facts from which they could discover the wrongdoing.”[3]

            Codification of the adverse domination doctrine exists in states such as Kansas.  Kansas Statute § 60-513(d) provides, “All other causes of action by a corporation or association against an officer or director of the corporation or association shall not be deemed to have accrued until . . . there exists a disinterested majority of nonculpable directors of the corporation or association[.]”[4]

            In states like Michigan, there is an absence of such statutes, which is effectively handcuffing the respective judiciaries.  For example, in Devillers v. Auto Club Insurance Association,[5] the Michigan Supreme Court reversed an earlier ruling permitting equitable tolling.[6]  The state’s high court viewed the prior decision as demonstrating “an act of judicial defiance in which this Court substituted its own judgment concerning ‘fairness’ for the plainly expressed will of the Legislature.  Such an act of judicial usurpation of the legislative function should not be permitted to stand.”[7]  The court kept emphasizing that a statute of limitations “must be enforced by the courts of this state as our Legislature has written it, not as the judiciary would have had it written.”[8]

            The injustice that can result from this handcuffing is evident in a recent Sixth Circuit Court of Appeals’ ruling just rendered on March 24th.  In Antioch Company Litigation Trust v. Morgan (In re The Antioch Company),[9] two principals allegedly breached their fiduciary duties as directors and officers by approving a highly leveraged buy-out of their company’s non-ESOP (Employee Stock Ownership Plan) shareholders and conversion to 100% ESOP ownership.  The supposedly overpriced transaction lined the principals’ pockets as non-ESOP shareholders, and left the ESOP owned company without the financial wherewithal to survive long-term.[10]  In the process, the principals purportedly declined independent evaluation of the buy-out, and misrepresented the buy-out’s prudence and fairness to the company.[11]

            While the principals relinquished their shares, they clung onto their positions as directors until the company finally succumbed and filed bankruptcy over four years later.[12]  During that time, the principals and other conflicted directors obviously never sued themselves for executing their self-serving transaction to the detriment of the company.  By the time the litigation trust had authority to stand in the shoes of the company and to sue them, it was too late.  Ohio Rev. Code § 2305.09(D) requires the bringing of such actions “within four years after the cause thereof accrued,” which, in this case, accrued when the transaction closed more than four years before the bankruptcy.[13]

            The Antioch court rejected the litigation trust’s argument that the doctrine of adverse domination should apply and toll the four-year statute of limitations.[14]  The trust argued that application of the doctrine would take into account the reality that the principals and other conflicted directors’ control of the corporation made “it impossible for the corporate plaintiff to independently acquire the knowledge and resources necessary to bring suit.”[15]  The trust’s argument fell on deaf ears, as the Antioch court’s analysis began and ended with the words of the Ohio statute and those omitted therefrom.[16]  The court ruled that “the legislature’s express inclusion of a discovery rule for certain torts arising under § 2305.09, including fraud and conversion, implies the exclusion of other torts arising under the statute.  Consistent with this reasoning, the . . . discovery rule does not toll the statute of limitations for claims for breach of fiduciary duty[.]”[17]  Hence, their running of the statute of limitations past expiration served the principals well.

            Dilemmas like the one experienced by the trust in Antioch are unnecessary.  Legislatures can easily preempt them by joining Kansas and other states in simply codifying the adverse domination doctrine.  While some can argue that codification theoretically burdens controlling principals and their professionals with uncertainty and deters business in respective jurisdictions, the exploitable void in corporate law that results from the absence of codification has a far worse and real-life effect, and leaves innocent parties without the means to redress significant injuries.

[1] See Gold v. Deloitte & Touche, LLP (In re NM Holdings Co., LLC), 405 B.R. 830, 850 (Bankr. E.D. Mich. 2008) (doctrine not available in Michigan); Antioch Co. Litig. Trust v. Morgan (In re Antioch Co.), 2016 U.S. App. LEXIS 5667, at *8 (6th Cir. 2016) (doctrine not available in Ohio); Stonemore Operating, LLC v. Bush, 2015 U.S. Dist. LEXIS 123358, at *18 (W.D. Mich. 2015) (“absence of . . . authority indicating adverse domination doctrine is recognized under Indiana law”).

[2] Antioch Co. Litig. Trust v. Morgan (In re Antioch Co.), 456 B.R. 791, 855 (Bankr. S.D. Ohio 2011) (citation omitted). 

[3] Id. (citations and quotations omitted).

[4] See also Rajala v. Gardner, 2011 U.S. Dist. LEXIS 10984, at *26 (D. Kan. 2011) (indicating that § 60-513(d) is a codification of the adverse domination doctrine).

[5] While Devillers pertained only to a statute of limitations for recovery of insurance benefits, its logic extended to further reaching cases like Trentadue v. Gorton, 738 N.W.2d 664, 680 (Mich. 2007) (“As we opined in Devillers, if courts are free to cast aside a plain statute in the name of equity, even in such a tragic case as this, then immeasurable damage will be caused to the separation of powers mandated by the Constitution”), and Gold, 405 B.R. at 850 (“The ‘doctrine of adverse domination’ is a form of ‘equitable tolling’ . . . .  But this common law tolling doctrine is no longer available under Michigan law, after the Michigan Supreme Court’s decision in Trentadue . . . .”).

[6] 702 N.W.2d 539, 554, 558 (Mich. 2005) (reversing Lewis v. Detroit Auto. Inter-Insurance Exch., 393 N.W.2d 167 (Mich. 1986)). 

[7] Id. at 553.

[8] Id. at 554.

[9] 2016 U.S. App. LEXIS 5667, at *3.

[10] Id.

[11] Id.

[12] Id. at *4.

[13] Id. at *4-5.

[14] Id. at *7-8. 

[15] Id. at *6.

[16] Id. at *7.

[17] Id. (citations, quotations, and internal punctuation omitted).