Iowa Supreme Court Says Director and Employee of Family Farm Corporation Did Not Breach Duties

On April 19, 2024, the Iowa Supreme Court reversed a decision from the Iowa Court of Appeals and ruled that shareholders of a family farm corporation did not prove their breach of fiduciary duty claims against their father and brother. Hora v. Hora, No. 22-0259 (Iowa S. Ct. 2024) provides a good review of the duties and obligations of corporate directors in a family business. It also serves as a sober reminder of how easily family disputes can arise.

Background

The detailed facts of this case are set forth in our summary of the Court of Appeals decision issued last year. At the time the dispute arose, the family farming corporation was primarily owned and controlled by Keith, the son of the corporation’s founder. His two siblings owned minority interests, as did his six children. From 2001 to 2015, Kurt, one of Keith’s sons, worked as the operations manager of the corporation. He also had his own farming business. Keith acted as a director of the corporation and was also heavily involved in the farming operation. In 2015, Keith’s mother, who was serving as the only other director of the company, died. Keith appointed his son Gregg to replace her, and Gregg and Brian, another one of Keith’s sons, became concerned about the finances of the corporation. Although they were farmers, Gregg and Brian were not working with the corporation at this time.

After an eight-hour shareholder meeting in 2016, Gregg resigned as a director, and Darren, another one of Keith’s sons, took his place. As director, Darren helped Keith restructure the business and reduce debt. In 2017, Gregg and Brian, individually and on behalf of the corporation, filed claims against Keith and Kurt for breach of fiduciary duty and fraud. The lawsuit also asked the court to appoint an independent custodian to manage the corporation.

Lower Courts’ Rulings

The district court heard much witness testimony and ultimately issued a 37-page opinion finding that Gregg and Brian failed to meet their burden of proof on all claims. The court of appeals reversed a portion of the district court ruling, finding that Kurt misappropriated corn for his personal use (to feed his livestock) without reimbursement, thereby breaching his duty to the corporation. The court of appeals also found that Keith engaged in self-dealing when he used the corporation’s credit cards to pay his personal expenses and when he allowed Kurt to misappropriate the corn. As such, the court of appeals determined that the business judgment rule did not shield Keith from liability. The court of appeals agreed with the district court that Keith and Kurt had not committed fraud.

Supreme Court Decision

On appeal, the Supreme Court rejected the court of appeals’ decision and reinstated the district court’s order.

First, the Court ruled that because Kurt was not an officer or director of the corporation, he owed no fiduciary duty to the corporation. Such duties are reserved for individuals in a position of trust, like an agent. Kurt was not an agent of the corporation, but an employee. As such, he simply owed the common law duty of loyalty to the corporation. The question for the Court was then whether Brian and Gregg had proven that Kurt misappropriated corn owned by the corporation when he fed it to his livestock. Deferring to the detailed fact finding of the district court, the Supreme Court determined that the corporation had a long-standing practice of enhancing Kurt’s compensation by providing him with in-kind payments of corn. Any “missing corn,” the Court found, was a matter of poor recordkeeping, not intentional wrongdoing. Kurt’s employment contract, which had been written by Brian years earlier, stated that Kurt would be paid in part by corn. It did not identify quantity. The fact that the payments were not reported to the IRS did not mean that the corn was not part of Kurt’s compensation. In the end, the Court agreed with the district court that Brian and Gregg failed to prove that Kurt violated a duty of loyalty by misappropriating corn.

The Court also reviewed the duties of care and loyalty owed by Keith, as a director, to the corporation. Brian and Gregg alleged that Keith violated these duties by failing to properly provide oversight to Kurt and by failing to ensure that the corporation maintained a positive cash flow. The brothers also alleged that their father violated his fiduciary duties when he paid some personal expenses, including sports tickets, using the corporate credit card.

Again, the Supreme Court agreed with the findings of the district court, which had ruled that Keith’s actions were protected by the business judgment rule. This rule provides a presumption that a director’s actions are informed, made in good faith, and honestly believed by them to be in the best interests of the corporation. The court of appeals found that the business judgment rule did not apply because Keith’s actions were “conflicting interest transactions” since they were related to the management of his son. The Supreme Court rejected this reasoning, finding that this application would subject every family-owned business that employs family members to a heightened standard for its day-to-day operations. Although a heightened standard might apply to specific transactions like a decision to hire an employee, the Court found that the business judgment rule applied to Keith’s general oversight of Kurt as the operations manager of the corporation. The Court stated that the fact that there may be different or better ways to operate the farm and to account for its transactions did not mean Keith violated fiduciary duties owed to the corporation.  

The Court also agreed with the district court and found that no duties were violated with respect to Keith’s use of the corporate credit card. The district court had determined that Keith’s overall compensation from the company was reasonable, averaging just over $31,000 per year. This included $10,000 as an annual cash salary, and $21,000 of personal expenses paid by the corporation. In addition to the services he provided to the corporation, Keith personally guaranteed all of the corporation’s debt. The proper inquiry was not how Keith was paid, but whether the payment amount was reasonable. The Court agreed that this compensation was fair to the corporation.

Considerations

Many of the disputes that arose in this case might have been prevented with better record keeping and attention to detail. Solid business and financial processes are no less important to family businesses than non-family businesses. Well documented practices, coupled with solid communication, can help reduce conflict by equipping owners with information and warding off unfounded suspicion.