Monday, December 04, 2017

REIT controllers owed fiduciary duties to public stockholders

By Joanne Cursinella, J.D.

Claims that certain defendants in a convoluted REIT scheme violated their fiduciary duties to stockholders survived a motion to dismiss. The court found that the plaintiff sufficiently alleged that the defendants set up a structure whereby they profited at the expense of the stockholders, maximizing the profits at the first entity they created to the detriment of the non-controlling stockholders of another entity they created and took public (RCS Creditor Trust v. Schorsch, November 30, 2017, Glasscock, S.).

Ownership structure exploited. The essence of the plaintiff’s claim is that, pursuing a convoluted scheme, certain of the defendants created an entity, AR Capital LLC, to develop and manage REITs. They formed another entity, RCS Capital Corporation (RCAP), which, through subsidiaries, was responsible for marketing and distributing, and providing other services, in connection with AR Capital investment products. These defendants owned 100 percent of AR Capital, but took RCAP public, retaining only a minority interest in RCAP.

Through retention of a single share of super-voting common stock, however, they ensured that they retained control of RCAP. Thereafter, they structured operation of the entities in a way that maximized profits at AR Capital, and that assigned expenses to RCAP, to the detriment of the non-controlling stockholders of that entity. The plaintiff claimed that the defendants owed fiduciary duties to the non-controlling stockholders of RCAP, which they breached, aided and abetted by an entity they controlled and an officer of one of RCAP’s subsidiaries.

Present action. The complaint contains three counts. Count I was brought against some of the defendants alleging that they breached their duties of care and loyalty in connection with the conduct outlined above. The second count, against these same defendants alleged that they are at least liable for aiding and abetting breaches of fiduciary duty by other defendants. Count III was brought against other defendants, and it alleged that each of these defendants was unjustly enriched by the conduct described above, and that such conduct warrants the imposition of a constructive trust.

Core claim remains viable. This complaint focused primarily on a series of allegedly self-dealing transactions in which the certain defendants caused RCAP, which they collectively controlled but in which they held only a 25 percent economic stake, to serve as a cost center for AR Capital, in which they (along with a non-party) retained a 100 percent ownership interest. These allegations adequately stated a claim for breach of the duty of loyalty against those defendants the court said, since the plaintiff also adequately alleged that the defendants owed fiduciary duties to RCAP. Further, these duties were breached by the defendants by their actions and the core claim, the allegation that these defendants used their control over RCAP to cause it to enter into off-market arrangements with AR Capital, which they wholly owned, remained viable despite the defendants’ objections.

Other claims. A proxy claim against these defendants was dismissed because the allegations that they received an ancillary benefit not shared by all stockholders required pleading that the benefit received was sufficiently material to overcome fiduciary duties, and here it was not, the court said. The decisions made, therefore, receive the protection of the business judgment rule, so any fiduciary duty claim premised on them was dismissed. However, the court reserved decision on the arguments for dismissing unjust enrichment and aiding and abetting claims, pending supplemental briefing, given that the core fiduciary duty claim remains.

The case is No. 2017-0178-SG.