July 19, 2018
Two of the most common, albeit frequently abused, claims in business lawsuits are “fraud” and “conspiracy.” Despite their pejorative connotation, all too often both go down in flames at or before trial.
This is because, to prove fraud, one must present evidence the defendant actually intended to deceive. The defendant must also, among other things, be shown to have had a duty to speak and intentionally remained silent, or intentionally spoke falsely. These can all be difficult challenges to overcome, as few defendants admit, or are foolish enough to put in writing, they intended to deceive, intentionally concealed information or intentionally spoke falsely. Without such “smoking gun” evidence, those hoping to prove fraud must rely on circumstantial evidence. Absent convincing circumstantial proof of “subjective” (what is in someone else’s head) intent, all that is left is a watered-down claim for negligent misrepresentation … not nearly as evocative, remunerative or bankruptcy proof. This is why many experienced trial lawyers say fraud is one of the hardest claims to prove.
To win a civil conspiracy claim, one must similarly muster and present evidence of the formation and operation of actual agreement to cause harm and damage resulting from act(s) performed in furtherance of that agreement. To prove an agreement was formed, all of the co-conspirators must be shown to have intended to cause a particular harm by acting in a particular way, thus shared a “common plan or design.” The plaintiff must also prove each was legally capable of committing a particular civil wrong (“tort”), i.e., show she, he or it owed the particular duty the plaintiff claims was breached. Finally, each co-conspirator must have profited, or at least stood to profit, from the conspiracy. These factors can be as hard to prove as fraud. After all, to prove multiple parties formed an agreement, means proving each reached a “meeting of the minds” … or, again, subjectively intended to carry out the same plan to cause the same harm.
An even bigger challenge in the corporate or business law context lies in proving each co-conspirator shared the same duty. Here’s why:
Three out of five members of Company X’s board of directors vote against a deal they believe would make Company X and its shareholders a great deal of money. They secretly do so to enable Company Y, a business owned or controlled by one of their friends or cousins, to step in and pursue the same lucrative opportunity. “Smoking gun” emails have since come to light showing the board members and friend/cousin planned this in advance, and the friend/cousin even secretly promised to pay the board members a share of Company Y’s resulting profits. Company X lost the deal and Company Y made a substantial profit.
A respected law, accounting or insurance firm has worked for Company X for over a dozen years. The professional firm knows the “in’s and out’s” of Company X; that is, they know who owns what percentage of Company X’s stock (or LLC membership rights), who holds what internal job(s) and who controls major decisions. The professional firm therefore knows who within Company X owes whom fiduciary duties of care and loyalty. In the course of its work, the professional firm learns Company X’s CEO and a majority of its board have decided to have Company X issue additional stock primarily to benefit themselves, family and friends. It also learns important details about this stock issuance are being kept secret from certain of Company X’s other shareholders/members. The CEO, wanting to avoid a boardroom battle or special election to replace the board, promises to pay the professional firm a bonus to help keep this information confidential. The professional firm then prepares the financials, risk analyses and/or legal documents making this stock issuance possible.
Despite such egregious (but not at all uncommon) facts, the friend/cousin in hypothetical #1, and professional firm in hypothetical #2, cannot be sued for conspiracy. They were never Company X insiders, hence never owed any direct duty to Company X or its other shareholders/members (other than, in the case of the professional firm, to exercise “that reasonable degree of knowledge and skill which is ordinarily possessed and exercised by other members of the same profession in similar circumstances.”) In the eyes of the law, they were not therefore “legally capable” of breaching the CEO’s and board members’ fiduciary duties of care, full disclosure, undivided loyalty and avoidance of self-interest. The mere formation and performance of a secret agreement to cause harm was not enough. This is true even though Company Y and the friend/cousin walked away with most of the money and the professional firm received its bonus.
The solution? An alternative claim for aiding and abetting the board member’s breach of fiduciary duties—aka, a business lawsuit “mega weapon.”
Aiding and abetting, unlike fraud and conspiracy, does not require a plaintiff to prove the aider and abettor intended harm. Nor must all of the defendants owe the same duties. Likewise, there is no need to prove formation of an agreement, a common plan or design or acts performed in furtherance thereof. Finally, there is no need to show the aider and abettor actually benefitted or profited.
Rather, to hold one defendant liable for aiding and abetting another’s breach of fiduciary duties, one only needs to prove:
- the aider and abettor knew the other was a fiduciary;
- the aider and abettor knew the other was breaching her, his or its fiduciary duties;
- the aider and abettor’s knowing participation in those breach(es); and
- resulting damages.
Actual knowledge, as opposed to mere suspicion, of a breach of fiduciary duties is required, however, such knowledge may be “discerned from the surrounding circumstances.” Knowing participation means the aider and abettor affirmatively assists, helps conceal, or by virtue of failing to act when required to do so enables the wrongdoing to proceed. Some courts even go so far as to say giving advice, encouragement or moral support to commit wrongdoing makes an aider and abettor just as liable as if she, he or it would be if they physically participated or rendered direct assistance.
Notably, if these criteria are met, the professional firm described in hypothetical #2 could be held liable even if (1) its senior management never knew about the arrangement, (2) those rendering the professional services making the stock issuance possible never intended to cause harm, (3) they performed their requested professional services diligently and within the operative “standard of care” and (4) the firm never received a bonus or additional compensation.
In short, aiding and abetting, in many instances, is vastly easier to prove than fraud or conspiracy. Like conspiracy, it makes the aider and abettor equally (or “jointly and severally”) liable. In hypothetical #1, it would make the “deep pockets” of Company Y and friend/cousin, and in hypothetical #2 those of the professional firm, available to satisfy a judgment that otherwise would issue against potentially judgment proof individual fiduciaries.
Just as aiding and abetting is a potential mega weapon for business plaintiffs, it is equally a lethal “land mine” for unsuspecting businesses and business owners (particularly professional firms). This, again, is because intent to harm is not a factor. Businesses and business owners can be held vicariously liable for any reasonably foreseeable (indeed, in California, even criminal) act committed by their agents and employees amounting to “knowing participation” in another’s breach of fiduciary duties.
Author: David A. Robinson, Esq., Enterprise Counsel Group, ALC, President and Founding Partner