ANALYSIS OF THE FEN PEHN DECISION – DID THE COURT ERR ON THE STANDING ISSUE REGARDING THE SEIZURE OF $20 MILLION DOLLARS FROM A NON-PROFIT CORPORATION?

By Stan Billingsley                           Feb. 8, 2011

    The Kentucky Court of Appeals issued a decision in the Fen Phen case last week.   The majority of the decision concerned  the trial judges grant of a summary judgment.   That ruling appears to this author to be absolutely correct considering the reasoning of the Court of Appeals and the law regarding summary judgment standards.

    However, one issue raises some troubling questions in the Court of Appeals decision.  This deals with the seizure of the trust assets of the charitable trust Kentucky Fund for Healthy Living (KFHL).   Judge Wehr sized the assets of the trust, and Melbourne Mills sought in his appeal to raise the issue of this seizure.  Apparently it was Judge Wehr’s intention to have the $20 million dollars of KFHL paid to the Fen Phen plaintiffs.

 The Ct. of Appeals decision held that “genuine issues of material fact” remained in dispute and a summary judgment was improper. 

 The appellate court held that the following issues remained in dispute and should be determined by a jury.

 1. Whether the entire settlement, minus fees and expenses, was to be split between the 431 settling claimants;

 2. Whether the settling complainants were fairly and adequately compensated;

 3. Whether KFHL was funded with money that should have been distributed to the settling claimants or was funded with excess funds for which the plaintiff’s consent to its ultimate use was not required;

(Note:  This finding by the Ct. of Appeals appears to preserve the issue to the fact finder as to whether or not the funds were properly paid into the charitable trust.  But on the standing issue takes away the right for this issue to be heard.)

 4. Whether Gallion, Mills and Cunningham and Chesley were obligated to indemnify AHP (the manufacturer of the diet drug Fen Phen)  for additional claimants who might come forward after the settlement had been dispersed.

      Two remaining issues involved the issues that Boone County was not the proper venue for these claims, and that the appeal of the Fund for Healthy Living was improper.

 The venue ruling of Judge Wehr, the Senior Status judge who granted the original summary judgment, was upheld. 

    The last issue is very interesting from a legal standpoint.  KFHL (the charitable trust created with $20 million dollars of “excess” settlement funds i.e. cy pres funds) was a trust created under the cy pres doctrine recognized in Kentucky and in Federal courts.

     It is not uncommon for class actions to have “left over” funds after all plaintiffs claims have been evaluated and settled.  Such “left over” funds may be placed in a charitable trust, to theoretically benefits the members of the public who may have been damaged by the wrongdoers acts, but who did not join in the actual lawsuit.   It is said that 50,000 Kentuckians used the diet drug Fen Phen but only 431 joined in the lawsuit.   The purpose of KFHL was to was finance various “health” related issues in Kentucky which had the purpose and intent to compensate the “victims” of the diet drug who had not joined the class action.

     There are no allegations that there were any misdealing with these funds after they were paid into the KFHL. One report we have heard is that under the management of the trustees, the principal of the fund actually grew, even though they made several grants to Kentucky institutions.

    The bottom line on this issue is that the public has an interest in preserving the $20 million dollars in assets seized by Judge Wehr.  If these funds are restored to the KFHL, they will not go to the clients of Angela Ford and they will not go to Gallion, Cunningham or Mills.  They will be for the benefit of all Kentuckians.   The Court of Appeals decision did not provide a suggestion on who did have standing to represent the public on this issue.  They held that Mills did not have standing, but they didn’t say who, under the circumstances, would have standing to file an appeal for a charitable trust. 

    Judge Wehr issued an order that substantially affected the rights of KFHL to defend itself in the lawsuit filed by the plaintiffs in the Boone County suit against Gallion, Cunningham and Mills.   KFHL was joined as a defendant in the Boone County lawsuit, and was represented by Bob Sanders of Kenton County.  Sanders had no connection to the Fen Phen attorneys.

    We have not seen the court order issued by Judge Wehr, although we have made a search of the Boone Circuit Clerk’s office (the file was in Frankfort at the Court of Appeals) and any final decision is conditioned on our understanding of what that order said.  Nevertheless  it is reported to LawReader that Judge Wehr’s  order held that no funds in the possession of the KFHL could be used to pay attorney fees in their defense of the Boone Circuit Court action (or an appeal).  The trust did not place itself in this lawsuit, it was named as a party defendant..

    After the charitable trust was forbidden to pay their attorney, Sanders withdrew from the action and did not file an appeal in their behalf. Sanders withdrawal was proper.  No one could expect him to devote years of litigation with no chance he would ever be paid for his services.  This fact situation raises the issue that the KFHL was prevented from filing an appeal by Judge Wehr’s ruling.  We suggest that under Kentucky’s “case by case” standard for reviewing issues of standing, that this ruling by Judge Wehr which prohibited an appeal by KHFL should have been considered by the Court of Appeals and may present a question for the Supreme Court to consider.

    Defendant Melbourne Mills, attempted to file an appeal in behalf of KFHL. He claimed standing as a “member of the Board” of KFHL and as a “citizen”.  

    Another issue is unclear.  KRS Chapter 273 provides procedures for dissolution of non-profit corporations.  It is not known by this author if Judge Wehr properly followed the requirements of Chapter 273.

   Mills argued in his brief,

 ”Judge Wehr, without authority to do so, effectively “dissolved” KFHL by seizing all of its assets and imposing a constructive trust on those funds.”

   The Court of Appeals held,

  ” We agree that creation of a cy pres trust is a valid option under the appropriate circumstances. However, Mills has failed to grasp that he has no standing to appeal on behalf of a corporate entity. Without citation to authority, Mills argues “that as a member of the governing board of the trust and a citizen of the Commonwealth of Kentucky . . . he is in the best position to pursue this matter on behalf of the cy pres trust.” We disagree.”

     Kentucky law provides standing for the Attorney General to intervene in actions regarding charitable trusts.  Two different Attorney Generals served during the litigation regarding the KFHL, but neither of them entered this law suit or defended the KFHL.

    The result is that a properly created charitable trust was forcible brought into a lawsuit, was denied the right to expend funds to hire an attorney, and its officers were found to have no standing to assert their defense.  

   Something about this is just unsettling.  It would seem to this author that the order of Judge Wehr denying KFHL the right to hire an attorney to defend itself should be found to have tolled the appeal time and that a new appeal time should now be allowed since the Court has reversed all of the grounds Judge Wehr relied upon to justify the seizure of the fund’s assets and to deny it the right to hire an attorney to advance an appeal. And in particular, the Court of Appeals held that the fact finder should determine if the assets paid into the KFHL were improperly taken from the Fen Phen plaintiffs.

 KRS Chapter 273 clearly authorizes a circuit judge to allow attorney fees to a non-profit corporation in dissolution proceedings.  Judge Wehr did not exercise that discretion.

   Further, we find some merit in Mill’s claim that in his status as a citizen he had standing to defend the assets of the charitable trust on appeal.  The public is the beneficiary of the KFHL.  Should not a member of the public have standing?

  At the very least, this issue cries out for review by the Ky. Supreme Court.

  Angela Ford, the attorney for the Fen Phen plaintiffs, has already announced that she will file an appeal of the Court of Appeals ruling, so this issue, if it is appealed, would not  add to the delay of this case.

 Perhaps the denial of standing for KFHL to present a defense still has some life in it. 

 STANDING TO APPEAL.

 We suggest that the issue of standing to maintain an appeal is broadly interpreted in U.S. law.

 The Ky. Court of Appeals denied standing for Mills to assert his appeal as a member of the Board of KFHL and as a “citizen”.  The Court justified their denial of standing to Mills by saying, no one has submitted citations on this issue.

 We note that as a Board member, Mills loss of salary as a board member is an issue which appears in some decisions to provide a basis for him to assert standing as an aggrieved party.

 We would suggest that standing must be decided on a case by case basis, and there are numerous issues which the Court of Appeals did not consider.

 “Standing is established by the facts on a case by case basis. Appellants must have a judicially recognizable interest that is neither remote nor speculative.” City of Louisville v. Stock Yards Bank and Trust Co., Ky., 843 S.W.2d 327, 328-329 (1992)

 The Court of Appeals had neglected to consider the special standing granted to Melbourne Mills by KRS 273.357:

 (KRS  273.390 Title of law.

KRS 273.161 to 273.390 shall be known and may be cited as the “Kentucky Nonprofit Corporation Acts.”)

  KRS 273.357 Survival of remedy after dissolution.

The dissolution of a corporation either (1) by the filing of articles of dissolution with the Secretary of State, or (2) by a decree of court when the court has not liquidated the assets and affairs of the corporation as provided in KRS 273.161 to 273.390 shall not take away or impair any remedy available to or against the corporation, its directors, OFFICERS, OR MEMBERS, for any right or claim existing, or any liability incurred, prior to the dissolution if action or other proceeding thereon is commenced within two (2) years after the date of such dissolution. Any such action or proceeding by or against the corporation may be prosecuted or defended by the corporation in its corporate name. The members, directors, and officers may take corporate OR OTHER ACTION appropriate to protect the remedy, right, or claim.

Effective: July 15, 1998

History: Amended 1998 Ky. Acts ch. 341, sec. 17, effective July 15, 1998. — Amended 1988 Ky. Acts ch. 23, sec. 209, effective January 1, 1989. — Created 1968 Ky. Acts ch. 165, sec. 61.

 Another statute may apply to the procedure for seizing the assets of KFHL by Judge Wehr.  Until his order is available this question is not resolved.

 KRS  273.333 Procedure in liquidation of corporation by court.

(1) In proceedings to liquidate the assets and affairs of a corporation the court shall have the power to issue injunctions, to appoint a receiver or receivers pendente lite, with such powers and duties as the court, from time to time, may direct, and to take such other proceedings as may be requisite to preserve the corporate assets wherever situated, and to carry on the affairs of the corporation until a full hearing can be had.

(2) After a hearing had upon such notice as the court may direct to be given to all parties to the proceedings and to any other parties in interest designated by the court, the court may appoint a liquidating receiver or receivers with authority to collect the assets of the corporation. Such liquidating receiver or receivers shall have authority, subject to the order of the court, to sell, convey and dispose of all or any part of the assets of the corporation wherever situated, either at public or private sale. The order appointing such liquidating receiver or receivers shall state their powers and duties. Such powers and duties may be increased or diminished at any time during the proceedings.

(3) The assets of the corporation or the proceeds resulting from a sale, conveyance, or other disposition thereof shall be applied and distributed as follows:

(a) All costs and expenses of the court proceedings and all liabilities and obligations of the corporation shall be paid, satisfied and discharged, or adequate provisions shall be made therefor;  

  (Note:  This would appear to say that the non-profit has the right to incur expenses which may include costs of its legal defense against dissolution.)

 (b) Assets held by the corporation upon condition requiring return, transfer or conveyance, which condition occurs by reason of the dissolution or liquidation, shall be returned, transferred or conveyed in accordance with such requirements;

(c) Assets received and held by the corporation subject to limitations permitting their use only for charitable, religious, eleemosynary, benevolent, educational or similar purposes, but not held upon a condition requiring return, transfer or conveyance by reason of the dissolution or liquidation, shall be transferred or conveyed to one (1) or more domestic or foreign corporations, societies or organizations engaged in activities substantially similar to those of the dissolving or liquidating corporation as the court may direct;

 (Note: This appears to prohibit distribution of the charitable trust funds to the Fen Phen plaintiffs.)

 (d) Other assets, if any, shall be distributed in accordance with the provisions of the articles of incorporation or by the bylaws to the extent that the articles of incorporation or bylaws determine the distributive right of members, or any class or classes of members, or provide for distribution to others;

(e) Any remaining assets may be distributed to such persons, societies, organizations or domestic or foreign corporations, whether for profit or not for profit, specified in the plan of distribution adopted as provided in KRS 273.161 to 273.390, or where no plan of distribution has been adopted, as the court may direct.

(4) The court shall have power to allow, from time to time, as expenses of the liquidation, compensation to the receiver or receivers and to attorneys in the proceeding, and to direct the payment thereof out of the assets of the corporation or the proceeds of any sale or disposition of such assets.  

  (Note: Judge Wehr did not allow payment of the KFHL attorneys fees.)

 (5) A receiver of a corporation appointed under the provisions of this section shall have authority to sue and defend in all courts in his own name as receiver of such corporation. The court appointing such receiver shall have exclusive jurisdiction of the corporation and its property, wherever situated.

History: Created 1968 Ky. Acts ch. 165, sec.

 We respectfully  provide  citations on the issue of standing found by a  LawReader search.

 Bell Atlantic Corp. v. Bolger, 2 F.3d 1304 (C.A.3 (Pa.), 1993)

        Generally, “only parties to a lawsuit, or those that properly become parties, may appeal an adverse judgment.” Marino v. Ortiz, 484 U.S. 301, 304, 108 S.Ct. 586, 587, 98 L.Ed.2d 629 (1988) (per curiam); Fed.R.App.P. 3(c) (“The notice of appeal shall specify the party or parties taking the appeal”). But it is not settled whether an objecting member of the class or derivative litigation who is not a named party may appeal the court’s approval of the compromise. According to two leading treatises, “[a] member of the class who appears in response to the court’s notice, given pursuant to the Rule [23.1], and objects to the dismissal or compromise has a right to appeal from an adverse final judgment although he did not become a formal party of record.” 3B James W. Moore, Moore’s Federal Practice, p 23.1.24 (objector’s right to appeal derivative suit settlement); p 23.80 (objector’s right to appeal class action settlement) (1993); 7C Charles A. Wright, et al., Federal Practice & Procedure, Sec. 1839, at 182 (1986) (“[a]n objector to the settlement may appeal the court’s approval of the compromise”); see also Webcor Elecs. v. Whiting, 101 F.R.D. 461, 465 n. 11 (D.Del.1984) (“The law is now settled that objectors may appeal a court’s decision approving a settlement”).

…        The Ninth and Seventh Circuits follow a different approach. Without much elaboration, they have consistently allowed unnamed, non-intervening class members standing to appeal approval of settlement agreements. For example, in Armstrong v. Board of School Directors, 616 F.2d 305, 327-28 (7th Cir.1980), the court permitted an objecting unnamed class member to appeal from a class action judgment. Accord Patterson v. Stovall, 528 F.2d 108, 109 n. 1 (7th Cir.1976). The Ninth Circuit in Marshall v. Holiday Magic, Inc., 550 F.2d 1173, 1176 (9th Cir.1977), stated that unnamed class members appealing from the district court’s approval of a class action settlement had legal rights affected by the settlement and thus had standing to sue. Accord In re Cement Antitrust Litig., 688 F.2d 1297, 1309 (9th Cir.1982), aff’d, 459 U.S. 1191, 103 S.Ct. 1173, 75 L.Ed.2d 425 (1983); Dosier v. Miami Valley Broadcasting Corp., 656 F.2d 1295, 1299 (9th Cir.1981) (dissatisfied class member could have challenged settlement by direct appeal). See also Cohen v. Young, 127 F.2d 721, 724 (6th Cir.1942) (although settlement objector did not appeal order denying motion to intervene, objector was entitled to appeal order approving settlement because “[a]ppellant appeared in court in answer to the court’s notice to show cause why the settlement should not be approved”).

…        Given the agency, collective action, and information problems inherent in settlements of derivative litigation, and the broad view of objector standing embodied in Ace, we conclude Lazar had standing to appeal the district court order approving the settlement. Assuring fair and adequate settlements outweighs concerns that non-intervening objectors will render the representative litigation “unwieldy.” It is sufficient that Lazar attended the settlement hearing and voiced before the district court the same objections he now raises before us on appeal.

Capital Bluecross v. Pa Ins. Dept., 937 A.2d 552 (Pa. Commw. Ct., 2007)

 3. Substantial, Direct and Immediate Interest

        Based on the averments in Dr. Sklaroff’s petition to intervene, Commissioner Koken determined Dr. Sklaroff purchases Blue Shield coverage for himself, his family and his employees. Commissioner Koken noted the allegation that the Highmark approval would allow Highmark “to dictate prices, hurt competition, decrease quality of care, terminate physician contracts, dictate unfavorable contract terms, lessen physician governance and destroy the social mission of [Blue Shield].” C.R. Ex. 73 (January 1999 Koken Decision) at 31; Cap. R. at 305.

        Commissioner Koken also noted Dr. Sklaroff was an elected corporate member of Blue Shield. Dr. Sklaroff alleged the Highmark consolidation would divest him of his elected position and deprive him and other physician members of their ability to participate in Blue Shield/Highmark governance. Id. Commissioner Koken further observed Dr. Sklaroff, a Blue Shield provider, also asserts he participated in Blue Shield’s social mission to provide medical care to low income persons at affordable rates. He also had a provider contract with one of the subsidiaries. Id.

        Highmark does not contest Dr. Sklaroff’s status as a Blue Shield subscriber/consumer, provider and former corporate member. Dr. Sklaroff alleges a number of harms to his interests resulting from the Highmark formation. In view of Dr. Sklaroff’s status, we conclude Dr. Sklaroff established a substantial, direct and immediate interest in the 2006 Koken Order. S. Whitehall Twp. Police Serv.; Wm. Penn Parking Garage, Inc. As a result, Dr. Sklaroff adequately established he was aggrieved by the 2006 Koken Order and thus has standing under 2 Pa. C.S. § 702 to appeal that decision to this Court. Id.

        Accordingly, Highmark’s application to quash is denied.

 Fourroux v. City of Shepherdsville, KY, No. 2003-CA-001016-MR (Ky.App. 10/15/2004)

To sustain a cause of action a party must have standing As stated in City of Ashland v. Ashland F.O.P. No. 3, Inc., Ky., 888 S.W.2d 667, 668 (1994):

[23]    In order to have  standing in a lawsuit “a party must have a judicially recognizable interest in the subject matter of the suit.” The interest of a plaintiff must be a present or substantial interest as distinguished from a mere expectancy. The issue of standing must be decided on the facts of each case. Simply because a plaintiff may be a citizen and a taxpayer is not in and of itself sufficient basis to assert standing.

Standing is established by the facts on a case by case basis. Appellants must have a judicially recognizable interest that is neither remote nor speculative. City of Louisville v. Stock Yards Bank and Trust Co., Ky., 843 S.W.2d 327, 328-329 (1992)

 Charitable Trust Doctrine

An Article on the Charitable Trust Doctrine raises a question overlooked by the Ky. Court of Appeals:

Argument:  Once the KFHL was incorporated as a charitable trust, the Boone Circuit court had no jurisdiction to seize the money for distribution to the Fen Phen plaintiffs.

  Under the Charitable Trust Doctrine,  “once a charitable dollar, always a charitable dollar.”  South Dakota Supreme Court – Banner Health System v. Lawrence E. Long, 663 N.W.2d 242 (2003) (PDF).

Until a court has ruled that the assets placed in KFHL were improperly diverted from the Fen Phen plaintiffs, the Charitable Trust Doctrine prevents expenditure of these funds for any purpose other than a charitable purpose. 

What is the Charitable Trust Doctrine?

Despite its name, the charitable trust doctrine applies to certain nonprofit corporations as well as trusts. Under the doctrine, all the assets of a nonprofit corporation exist within a charitable trust and these assets must be used only for the charitable purposes articulated in the nonprofit’s articles of incorporation. The charitable trust doctrine requires that a corporation’s assets, including donations, gifts, and all revenues generated by the organization, be used to fulfill its charitable activities. These restrictions continue even if the corporation later changes its purposes, dissolves and distributes its assets, or transfers its assets to another organization.

The charitable assets must continue to be devoted to the original charitable purposes. A nonprofit corporation can change its purposes, but the change does not extinguish the charitable obligations. A simple, shorthand way to understand the concept is: “once a charitable dollar, always a charitable dollar.”

In almost every state, the charitable trust doctrine is well established by either statute (law passed by the legislature) or common law (law developed by courts). Some states have specific statutes governing charitable trusts.

 KENTUCKY LAW REQUIRES ASSETS OF CHARITABLE CORPORATION TO BE DISTRIBUTED FOR CHARITABLE PURPOSE

 KRS 273.303 Distribution of assets.

The assets of a corporation in the process of dissolution shall be applied and distributed as follows:

(1) All liabilities and obligations of the corporation shall be paid and discharged, or adequate provisions shall be made therefor;

(2) Assets held by the corporation upon condition requiring return, transfer or conveyance, which condition occurs by reason of the dissolution, shall be returned, transferred or conveyed in accordance with such requirements;

(3) Assets received and held by the corporation subject to limitations permitting their use only for charitable, religious, eleemosynary, benevolent, educational or similar purposes, but not held upon a condition requiring return, transfer or conveyance by reason of the dissolution, shall be transferred or conveyed to one or more domestic or foreign nonprofit corporations, societies, or organizations engaged in activities substantially similar to those of the dissolving corporation, pursuant to a plan of distribution adopted as provided in KRS 273.161 to 273.390;

(4) Other assets, if any, shall be distributed in accordance with the provisions of the articles of incorporation or the bylaws to the extent that the articles of incorporation or bylaws determine the distributive rights of members, or any class or classes of members, or provide for distribution to others;

(5) Any remaining assets may be distributed to such nonprofit societies, organizations or domestic or foreign corporations, as may be specified in a plan of distribution adopted as provided in KRS 273.161 to 273.390.

History: Amended 1974 Ky. Acts ch. 156, sec. 1. — Created 1968 Ky. Acts ch. 165, sec. 45

 Quote from the Court of Appeals Fen Phen ruling of Feb. 4, 2011.

 “Mills’s Standing to Defend KFHL

 Mills additionally engages in a discussion regarding the appropriateness of the creation of KFHL as a cy pres trust utilizing the “excess funds” from the original settlement amount. He argues KFHL was properly created as a legitimate act of the discretion of the Boone Circuit Court in Guard.

 Thus, he contends Judge Wehr, without authority to do so, effectively “dissolved” KFHL by seizing all of its assets and imposing a constructive trust on those funds.

 We agree that creation of a cy pres trust is a valid option under the appropriate circumstances. However, Mills has failed to grasp that he has no standing to appeal on behalf of a corporate entity. Without citation to authority, Mills argues “that as a member of the governing board of the trust and a citizen of the Commonwealth of Kentucky . . . he is in the best position to pursue this matter on behalf of the cy pres trust.” We disagree.

 KFHL is a separate corporate entity which was a party to the Abbott

action. KFHL participated in the instant litigation and had the ability to appeal from an adverse ruling, but it did not do so. A notice of appeal must be filed within thirty days of the notice of service of the adverse judgment. CR 73.02(1)(a). Under CR 73.02(2), the time for filing a notice of appeal is

considered mandatory and subject to strict compliance. Fox v. House, 912 S.W.2d 450, 451 (Ky. App. 1995). The failure to timely file a notice of appeal deprives appellate courts of jurisdiction. Burchell v. Burchell, 684 S.W.2d 296, 299 (Ky.App. 1984).

 Such a defect is fatal and cannot be cured. Fox, 912 S.W.2d at 451. Because KFHL did not appeal from the adverse ruling seizing its

assets and placing same in a constructive trust, it is not a party to this appeal and we are without jurisdiction to consider the argument Mills attempts to present on its behalf. Mills is properly a party to this appeal, but he cannot “bootstrap” an argument in support of KFHL onto his appeal as he has no standing to prosecute an appeal on behalf of this corporate entity. Mills cites us to no authority supportive of his contention to the contrary and we are convinced none exists.

 Thus, no further discussion of the issue is warranted, and that portion of the order of March 8, 2006, seizing all KFHL assets and imposing a  constructive trust thereon shall stand.”

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