Sub-standard corporate governance practices often lead to or exacerbate a dispute among business stakeholders.  A recent Iowa Court of Appeals case, North Skunk River Greenbelt Association, Inc. v. Allen, 2019 WL 6358298 (Nov. 27, 2019), illustrates that this can occur even in the non-profit context.  The court in this “classic case” found that such failures “led to distrust, dissention, and disorganization” and that if proper “corporate principles and practices” were followed, “likely no lawsuit would have been filed.”  Id. at *1.

In 2013, an arsonist badly damaged the historic Bunker Mill Bridge near Kalona, Iowa.  Washington County authorities announced their intention to demolish the bridge.  In response, a number of local residents -- including defendants Scott Allen and Doris Park -- formed Friends of Bunker Mill Bridge (FBMB) to save it.  An Iowa nonprofit called the North Skunk River Greenbelt Association, Inc. (NSRGA), dedicated to saving historic bridges, offered support and fiscal sponsorship to FBMB, which FBMB accepted. 

 With an ostensible rehabilitation plan in place, Washington County donated $80,000 to FBMB/NSRGA, which was earmarked for bridge demolition expenses.  In addition, FBMB received $46,000 in donations.  Most of the money was placed in an FBMB account, but NSRGA deposited the rest in its own account.  

At first, FBMB generally supported the NSRGA collaboration, but things began to unravel in late 2013.  At that time, FBMB asked NSRGA and its executive director, Julie Bowers, for an accounting of the money from the County.  Bowers refused.  This caused some FBMB members to resign.  To help deal with the PR kerfuffle, Bowers asked Allen and Park, who still supported her, to join the NSRGA board of directors.  Allen and Park were duly elected to the NSRGA board in January 2014. 

In early 2016, Bowers invited her daughter, Laran Bowers and her friend Anna Sutherland, to join the NSRGA board of directors.  These two additions to the board were not formally voted on or documented when they occurred.

In March 2016, the bridge was completed.  At this “tipping point,” as the Court put it, a serious dispute arose among NSRGA and Bowers, on the one hand, and FBMB members on the other, including Allen and Park.  Id. at *2.  The dispute centered on the propriety of constructing a fence on the south side of the Bunker Mill Bridge.  Bowers felt NSRGA was obligated to build the fence pursuant to an easement agreement.  The defendant FBMB members felt there was no such obligation, and believed the fence would destroy goodwill built around the bridge restoration and impede access to the bridge. 

The dispute took a turn for the dramatic when Allen shouted on a phone call that he was “going rogue” to prevent Bowers from constructing the fence.  Id. at *3.  Allen called the fencing company, indicating that the planned construction was illegal and, along with another FBMB member, parked his car where the construction was to go forward.  This prevented construction until sheriff’s deputies instructed Allen and his compatriot to remove their cars.  The fence construction was completed on May 9.

Thereafter, on September 8, NSRGA held its first board of directors meeting of the year to consider removing Allen and Park as directors.  Two directors voted for removal, as did Laran and Sutherland.  Allen and Park voted against removal.  Bowers abstained.  Three days later, NSRGA performed a “clean-up operation” recognizing Laran’s and Sutherland’s election to the board.  Id. at *3. 

Scorched earth litigation ensued between the NSRGA/Bowers camp and the FBMB camp led by Allen and Park.  Among other disputes, the parties contested whether Allen and Park were properly removed as directors of NSRGA.  The issue turned on whether Laran and Sutherland were elected to the board prior to the September 8 meeting.  If they were, the majority vote necessary for removal was achieved, 4-3.  If not, the vote was 3-2 against removal, In either case, Bowers’ abstention was treated as a “no” vote under Iowa law.  Id. at *6. 

Reversing the trial court, the appellate court held that Laran and Sutherland were not elected prior to the vote for removal of Allen and Park, so they were never removed.  This resulted from NSRGA’s “pattern of inattention to the important details” of corporate governance.  Id. at *5.  Pointing to two Facebook posts as evidence, NSRGA contended that Laran and Sutherland were elected to the board in January and April 2016, respectively.  The court rejected that contention.  The Facebook posts reflected no board of director votes.  And, even if they did, the NSRGA bylaws did not permit telephonic meetings, let alone Facebook meetings.  Thus, the default rule in Iowa controlled:  “the members of the board cannot agree separately, and outside of a meeting, and thereby bind the corporation.”  Id. at *6.  Thus, Allen had to be reinstated as a director.  Park, unfortunately, passed away during the litigation.

This reversal had considerable consequences for NSRGA.  The court found that Allen and Park were entitled to indemnification from NSRGA because they were successful in defending claims against them in their capacity as directors.  Id.  An Iowa nonprofit corporation must “indemnify a director who was wholly successful, on the merits or otherwise, in the defense of any proceeding to which the director was a party because the director is or was a director of the corporation.”  Id. (quoting Iowa Code § 504.853.)  A director is wholly successful, in turn, only “if the proceeding is disposed of on a basis which does not involve a finding of liability.”  North Skunk River, 2019 WL 6358298, at *6.  

The court held this standard was met with respect to claims against Allen and Park arising from their alleged breaches of duty as directors because they “avoided any finding of liability against them” at trial.  Id.  The court rejected the trial court’s basis for withholding indemnification -- that Allen and Park had not acted in good faith and that their conduct was not in NSRGA’s best interests.  The appellate court held that the only relevant consideration was whether Allen and Park were wholly successful, without consideration of “good faith” or the best interests of the corporation.  Id. at *7.

The reinstatement also gave Allen and Park standing to seek dissolution of NSRGA.  They argued that dissolution was warranted because of NSRGA’s lack of financial oversight and controls.  The court disagreed, finding that the evidence failed to warrant dissolution.  Allen and Park’s conversion claim against Bowers failed for many of the same reasons.  While the trial and appellate courts bemoaned NSRGA’s lack of financial controls, “abysmal” financial reporting and “nightmare” books and reporting, Allen and Park did not provide the court with a financial report showing what happened to the relevant funds.  Id. at *5 n.11, *7, *8.  Without that, despite the reporting and oversight problems, there was not enough evidence for Allen and Park to compel the dissolution of NSRGA.

There are two key lessons in this case.  The first is how important it is for corporate entities to follow financial best practices, such as proper financial oversight and consistent use of a general ledger.  Concerns about financial transparency led various board members to resign because “alarm bells were going off” based on the lack of accounting of funds.  Id. at *7.  If these practices had been in place, there may never have been dissention between NSRGA and FBMB in the first place.

The second is that all corporations, including non-profits, must follow corporate governance requirements set forth in their governing documents or statutes when adding or removing directors and otherwise.  Failing to do that can have dire retroactive consequences.  Here, Allen -- who had, rightly or wrongly, said he was “going rogue” -- is back on the NSRGA board of directors and entitled to indemnification for the defense of claims against him.  If NSRGA had executed best practices, there may never have been a dispute about who was on its board at what times.  

At Novack and Macey, we have extensive experience advising shareholders involved in closely held company disputes, as well as advising companies on how to avoid disputes in the first place. For more information about our services, please contact John Haarlow at 312.419.6900 or jhaarlow@novackmacey.com.