Nevada Supreme Court Rules Claim of “Gross Negligence” Doesn’t Plead Breach of the Fiduciary Duty of Care

Nevada Supreme Court
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Gross negligence-based allegations did not state an actionable claim against corporate directors or officers, the Nevada Supreme Court held recently. That is because, based on its plain text, Nev. Rev. Stat. § 78.138(7) applies to all claims of individual liability against directors and officers, which precludes the imposition of liability for grossly negligent breaches of fiduciary duties. The Supreme Court said that a claimant must establish that the director or officer had knowledge that the alleged conduct was wrongful in order to show a knowing violation of law or intentional misconduct pursuant to the exculpatory statute.

Justice Hardesty wrote the opinion for Chur v. Eighth Jud. Dist. Ct. for the unanimous Court en banc.

The case required the Court to consider whether a corporate director or officer may be held individually liable for breaching his or her fiduciary duty of care through gross negligence. Statutorily, a director or officer is not individually liable for harm resulting from official actions unless the director or officer engages in “intentional misconduct, fraud or a knowing violation of law, Hardesty wrote, quoting NRS § 78.138(7)(a)-(b).

In Shoen v. SAC Holding Corp., 122 Nev. 621, 640, 137 P.3d 1171, 1184 (2006), however, the Court stated that “[w]ith regard to the duty of care, the business judgment rule does not protect the gross negligence of uninformed directors and officers.” As a result, some courts, including the district court in this case, have permitted claims against individual directors and officers to proceed based only on allegations of gross negligence.

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The Court clarified that, based on the plain text of the statute, § 78.138(7) applies to all claims of individual liability against directors and officers, precluding the imposition of liability for grossly negligent breaches of fiduciary duties. The Court further concluded that the gross negligence-based allegations in the operative complaint below fail to state an actionable claim under § 78.138.

Petitioners (collectively, “the Directors”) formerly served as directors of Lewis & Clark LTC Risk Retention Group, Inc. The company was a Nevada risk retention group that insured long-term care facilities and home health providers across the country. In 2012, the Nevada Division of Insurance filed a receivership action related to Lewis & Clark, and the district court entered a liquidation order. In the order, the court appointed the Commissioner of Insurance as receiver. In addition, the liquidation order granted the receiver the power to “[p]rosecute any action which may exist on behalf of the policyholders, members, or shareholders of [Lewis & Clark] against any officer of [Lewis & Clark] or any other person.”

As receiver, the Commissioner filed a complaint against the Directors, amongst others, alleging claims of gross negligence and deepening insolvency. As to the gross negligence claim, the Commissioner claimed that the Directors “fail[ed] to properly inform [themselves] of [the] status of [Lewis & Clark]” and take appropriate corrective action. Regarding the deepening insolvency claim, the Commissioner alleged that the Directors’ “inaction severely prolonged the insurance actions of [Lewis & Clark] that led to its initial insolvency and that then also increased its insolvency.” The Directors sought to dismiss the claims pursuant to NRCP 12(b)(5), maintaining that the Commissioner failed to state a viable claim. The district court denied the Directors’ motion.

The Directors then filed an NRCP 12(c) motion for judgment on the pleadings. The Directors argued that, even accepting the Commissioner’s allegations as true, gross negligence cannot support a claim for personal liability against the Directors pursuant to § 78.138. The district court denied this Directors’ motion, relying on Shoen.

Following the district court’s denial of the Directors’ motion for judgment on the pleadings, the Directors filed a motion for reconsideration. They argued that the district court’s order improperly relied on Shoen and ignored the clear standard required to hold directors individually liable under NRS § 78.138(7). The district court denied the Directors’ motion and found that the Commissioner stated a claim for breach of the fiduciary duty of care pursuant to Shoen, as well as a claim for deepening insolvency. Thus, the district court used a bifurcated approach to evaluate allegations for claims seeking to hold directors and officers individually liable. This required a showing of at least gross negligence to state a duty-of-care claim or “intentional misconduct, fraud, or a knowing violation of the law to state a duty-of-loyalty claim.”

The Directors petitioned the Supreme Court for a writ of mandamus directing the district court to apply the plain text of § 78.138 and to grant the motion for judgment on the pleadings. The Court was concerned that its language in Shoen had misled lower courts about the law surrounding individual liability for directors and officers in Nevada, and that this confusion risks imposing inconsistent results for different litigants.

The Supreme Court agreed with the Directors that NRS § 78.138 provides the sole mechanism to hold directors and officers individually liable for damages in Nevada. The statute’s subsection (7) requires a two-step analysis to impose individual liability on a director or officer. First, the presumptions of the business judgment rule must be rebutted. Second, the “director’s or officer’s act or failure to act” must constitute “a breach of his or her fiduciary duties,” and that breach must further involve “intentional misconduct, fraud or a knowing violation of law.

The Court explained that in Nevada, that directors and officers owe the fiduciary duties of care and loyalty to the corporation. As is clear from the plain language of § 78.138, “the statute provides for the sole circumstance under which a director or officer may be held individually liable for damages stemming from the director’s or officer’s conduct in an official capacity.”

The district court here found that a “director’s misconduct must rise at least to the level of gross negligence to state a breach-of-the-fiduciary-duty-of-due-care claim, or involve `intentional misconduct, fraud, or a knowing violation of the law,’ to state a duty-of-loyalty claim.” Pursuant to this standard, the district court reasoned that the Commissioner stated a cause of action for a breach of the fiduciary duty of care. However, the Supreme Court found that this characterization of Shoen, however, conflicts with the plain language of NRS § 78.138.

The Court rejected the district court’s determination that Shoen provides a separate breach-of-the-duty-of-care claim apart from the strictures of § 78.138. Thus, the Court disavowed Shoen to the extent it implied a bifurcated approach to duty-of-care and duty-of-loyalty claims, and gave effect to the plain meaning of § 78.138. Thus, the Court held § 78.138(7) provides the sole avenue to hold directors and officers  individually liable for damages arising from official conduct.

As a result, the Commissioner failed to plead a cause of action pursuant to § 78.138 because allegations of gross negligence do not state a breach of the fiduciary duty of care involving a “knowing violation of law.” The Commissioner argued that the allegations of gross negligence both rebut the business judgment rule and constitute a breach of the fiduciary duty of care involving a knowing violation of law. The Directors respond that the Commissioner’s interpretation of NRS § 78.138(7) ignores the plain language of the statute and collapses the requirements of the exculpatory provision into a single step. Specifically, the Directors maintain that “[k]nowledge necessarily requires a level of scienter appreciably higher than that of gross negligence.” To support this, the Directors cited to Black’s Law Dictionary to contrast the legal definitions of “gross negligence”—”reckless disregard of a legal duty”—and “knowledge”—”[a]n awareness or understanding.”

The Supreme Court acknowledged that it had not yet defined the meaning of “a knowing violation of law” in the context of Nevada’s exculpatory provision for corporate directors and officers. However, the Court noted that the Tenth Circuit opined on the meaning of a “knowing violation of law” and “intentional misconduct” under NRS § 78.138(7)(b), holding that the shareholders of a Nevada corporation must assert allegations in their complaint that “establish whether, in light of the Nevada exculpatory statute, the [d]irector [d]efendants faced a substantial risk of liability in [a] derivative action.”

To answer this question, the Tenth Circuit considered what § 78.138(7)(b)’s terms “knowing violation” and “intentional misconduct” specifically require. The court noted that in certain contexts “knowingly” requires only “factual knowledge as distinguished from knowledge of the law,” quoting the U.S. Supreme Court. However, the Tenth Circuit also considered that courts have “interpreted knowingly and intentionally more expansively, to require knowledge of wrongfulness,” referencing cases from the U.S. Supreme Court, Eleventh Circuit, Ninth Circuit, Idaho, Indiana, and Massachusetts. The Tenth Circuit ultimately concluded that an expansive definition of “intentional” and “knowing” makes the most sense in the context of an exculpatory statute limiting the liability of corporate directors and officers.

The Court agreed with and adopted the Tenth Circuit’s definition of “intentional” and “knowing,” as enunciated in In re ZAGG Inc. S’holder Derivative Action, 826 F.3d 1222, 1232 (10th Cir. 2016) for determining whether a “director’s or officer’s act or failure to act constituted a breach of his or her fiduciary duties . . . involv[ing] intentional misconduct, fraud or a knowing violation of law.” As a result, the Court held that the claimant must establish that the director or officer had knowledge that the alleged conduct was wrongful in order to show a “knowing violation of law” or “intentional misconduct” pursuant to NRS § 78.138(7)(b).

Chur v. Eighth Judicial Dist. Court of Nev., 136 Nev. Adv. Rep. 7, 458 P.3d 336 (Nev. February 27, 2020).

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