I recently covered whether parties can be liable for a claim of aiding and abetting breach of fiduciary duty in Pennsylvania.
In that post, I explained the two different frameworks for these claims that have been established by Pennsylvania courts. Both contain a knowledge requirement. One framework requires “knowledge of the breach by the aider and abettor.” The other requires that the alleged aider and abettor “knows that the other’s conduct constitutes a breach of duty and gives substantial assistance or encouragement to the other so to conduct himself.”
With knowledge of a breach of fiduciary duty such an important factor in aiding and abetting claims, when under Pennsylvania law will an alleged aider and abettor be deemed to know that the underlying breach was occurring?
When that party has actual knowledge of the breach.
Actual knowledge > Circumstantial evidence
When I discussed aiding and abetting breach of fiduciary duty claims in Pennsylvania, I noted that the first time an aiding and abetting claim in this context was recognized in Pennsylvania was by the Pennsylvania Superior Court in Potok v. Rebh, 2017 WL 1372754 (Pa. Super. Ct. Apr. 13, 2017). In that case, a minority shareholder claimed that the majority owners breached their fiduciary obligations to him by, among other things, improperly allocating the proceeds of the sale of the company’s assets. Specifically, the plaintiff alleged that those in control of the company sold the company’s assets to a third party and improperly allocated a significant portion of the purchase price as compensation to the majority shareholders for their non-competes.
In addition to initiating litigation against the majority owners, the minority shareholder sued the third-party purchaser of the company’s assets under the theory that the purchaser aided and abetted the majority’s breach of fiduciary duty. While the court recognized this cause of action, it upheld the trial court’s finding that the plaintiff failed to prove the claim.
One of the reasons the claim failed was because the plaintiff did not sufficiently show that the purchaser had actual knowledge of the breach. The plaintiff argued that circumstantial evidence, including the structure of the transaction which the plaintiff believed indicated self-dealing, supported “a compelling inference” that the third party knew the majority owners were breaching their fiduciary duty.
The Superior Court wasn’t buying it. It distinguished an “evidence-based inference” from “speculation and conjecture,” noting that the minority shareholder could not point to any evidence beyond his own speculation that the third-party purchaser actually knew of the breach. Given that the case at that point was past the discovery phase, simply claiming that the purchaser knew about the breach was not going to be enough. In order for his aiding and abetting claim to be successful, the minority shareholder had to come to the table with actual evidence obtained before or during discovery that showed the purchaser knew about the breach. In other words, as the kids say today, the plaintiff had to show receipts.
He could not. So his aiding and abetting claim failed.
Is Pennsylvania more demanding than Delaware about knowledge of a breach?
A Delaware Chancery Court decision from just last month suggests that the Pennsylvania Superior Court’s “actual knowledge” requirement is the standard approach courts take, especially when a third party is alleged to have aided and abetted a breach. But the Delaware decision also suggests Pennsylvania requires a higher showing of knowledge than Delaware does.
In Jacobs v. Meghji, 2020 WL 5951410 (Del. Ch. Oct. 8, 2020), a minority stockholder challenged a recapitalization that saw another minority shareholder partner with a company’s controlling stockholder on the capital infusion. The company, IEA, a publicly held infrastructure construction company, was facing a severe liquidity crisis and retained an investment bank to find additional investors.
Ultimately, IEA’s board selected an investor, Ares. Oaktree, IEA’s majority shareholder, made a corresponding investment as part of IEA’s deal with Ares.
The plaintiff, on behalf of himself and other IEA shareholders, sued a number of IEA board members and Oaktree over the transaction, alleging that the Ares/Oaktree investment was inferior to competing offers in part because that investment diluted IEA’s outstanding shares. The plaintiff and shareholders also sued Ares, claiming that it aided and abetted the IEA board members’ breach of fiduciary duty.
In a decision granting Ares’ motion to dismiss the claims against it, the Chancery Court held that the plaintiffs did not establish that Ares had actual knowledge of the board members’ alleged breaches. According to the court, under Delaware law, a plaintiff alleging a claim of aiding and abetting a breach of fiduciary duty must show that the aider and abettor had actual or constructive knowledge that their conduct was unlawful.
The Chancery Court looked for “specific facts” from which it could “reasonably infer” that Ares had knowledge of the board members’ alleged breach. It found none. No specific facts about Ares’ awareness of, or involvement in, decision making by IEA’s board or the investment bank. And no specific facts regarding Ares’ knowledge of flaws in, or control or influence over the IEA board’s Special Committee handling negotiations over the transaction.
As a backdoor approach to attempting to hold Ares liable for aiding and abetting the IEA board members’ alleged breach of fiduciary duty, the plaintiffs alleged that Ares had constructive knowledge of the breach because Ares had actual or constructive knowledge of Oaktree’s wrongdoing. The court was not persuaded. Neither the fact that the IEA board member negotiating with Ares had a connection to an Ares principal, nor the fact that Ares was involved in a transaction with Oaktree which Ares knew to be the controlling shareholder of IEA, nor the fact that the transaction included terms that were not “commercially typical,” supported an inference that Ares constructively knew that IEA board members were allegedly breaching their fiduciary duties. As with their actual knowledge argument, the plaintiffs’ constructive knowledge argument was a loser.
It is important to note here that the Chancery Court’s acceptance of either actual or constructive knowledge as satisfying the “knowledge” element of an aiding and abetting claim is a different approach than that taken by Pennsylvania courts. According to the Pennsylvania Superior Court’s decision in Potok, constructive knowledge is not enough to show knowledge of a breach. Potok only spoke of actual knowledge. In fact, the word “constructive” does not appear once in the Potok decision. For this reason, it appears parties in Delaware will have an easier time alleging or proving knowledge because Delaware allows for constructive knowledge.
(In case you are at a loss for what “constructive” means, a well-known legal dictionary defines it in this context as “legally imputed; existing by virtue of legal fiction though not existing in fact.”)
A little (actual) knowledge goes a long way
When shareholders of a Pennsylvania corporation claim a third party has aided and abetted a breach of fiduciary duty, those shareholders must prove that the third party had actual knowledge of the breach. Circumstantial evidence will not cut it.
While this requirement is not unusual, it appears that for the time being in Pennsylvania actual knowledge is the only knowledge a court will accept. Unlike in Delaware where constructive knowledge is acceptable, Pennsylvania courts will deem an alleged aider and abettor to have the requisite knowledge of a breach only when plaintiffs allege (early in a case) or prove (later in a case) that the alleged aider and abettor actually knew that a breach of fiduciary duty was occurring.