Court Finds Evidence That Board And Head Of School Breached Fiduciary Duties, Subjecting Them To Potentially Millions In Damages

Science, Language, and Arts International School (SLA) was founded in 2013 by Jennifer Wilkin. SLA was an independent elementary school offering French and Mandarin language immersion education.

On January 13, 2022, SLA filed for Chapter 7 bankruptcy. Soon thereafter, Richard McCord was appointed as the Chapter 7 Trustee. In that role, Mr. McCord investigated and pursued claims and causes of actions on behalf of SLA’s bankruptcy estate.

On August 31, 2022, the Chapter 7 Trustee filed a complaint against several board members of SLA, including Wilkin (as SLA’s executive director and board chair) for breach of fiduciary duty, gross negligence and/or reckless conduct, breach of duty of care, breach of duty of loyalty and obedience, and corporate waste.

In the complaint, the Chapter 7 Trustee alleged the following pattern of conduct by the Board Defendants and Wilkin, which he believed violates the fiduciary duties each member owed to SLA:

• Wilkin breached her fiduciary duty as an officer, executive director, and board chair of SLA by borrowing $200,000 from SLA in the form of an interest-free loan to purchase a summer camp in her name. Wilkin signed the joint written consent for the loan as both the executive director and board chair, in violation of New York non-profit law and Internal Revenue (IRS) regulations. Wilkin did not fully repay the loan and did not pay rent to SLA.
• Wilkin let the SLA lease expire by not paying rent, while committing SLA to new lease obligations beyond its ability to pay. The result was SLA was sued by its landlord for approximately $24.6 million plus interest. In that case, the Court granted the landlord summary judgment for $6.1 million plus 10 percent interest.
• Despite SLA’s landlord having already terminated the lease, Wilkin advised parents that SLA would reopen for the next year and that rumors to the contrary were false. In the process, Wilkin collected almost $900,000 in tuition fees. Deposits were not returned to parents when the School went out of business in August 2021.
• The Board Defendants failed to ensure that SLA was making payroll withholding taxes and unemployment taxes to the IRS on behalf of SLA, resulting in a claim from the IRS against SLA for more than $700,000 and by the New York State Department of Taxation and Finance against SLA for more than $100,000.
• The Board Defendants made financial decisions or allowed Wilkin to make financial decisions, knowing that neither Wilkin nor the Board had accurate data, was relying on faulty financial projections, and which omitted obligations such as repayment of a loan, tax obligations, and never had audits performed on an annual basis. Board Defendants and Wilkin did not comply with SLA’s bylaws, by failing to hold annual elections, failing to file required annual reports, and failing to fill certain required officer positions.
• The Board Defendants and Wilkin did not manage SLA in a prudent manner, breaching their duty of obedience to the School’s mission of maintaining an independent elementary school, and instead permitted the School to be run into the ground by exercising no oversight or due diligence with respect to the reckless and grossly negligent conduct of Wilkin.

The Chapter 7 Trustee asserted claims for relief against the Board Defendants and Wilkin, seeking $27 million in damages arising from their alleged breach of fiduciary duties and gross negligent and/or reckless conduct.

The Board Defendants and Wilkin moved to dismiss the complaints against them.

Among their arguments, the Board Defendants and Wilkin contended that they were protected by the business judgment rule. The business judgment rule protects good faith conduct in the honest exercise of business judgment by members of a board of directors, absent claims of fraud, self-dealing, unconscionability, or other misconduct.

Here, the Board Defendants and Wilkin argued that they exerted poor judgment in trusting professionals hired to manage the School’s finances, but that this was nothing worse than ordinary negligence. In response, the Chapter 7 Trustee argued that the business judgment rule requires that a plaintiff show that an officer or director acted fraudulently or in bad faith, lacked disinterested independence, or at least closed their eyes to the corporation’s affairs and completely failed to act. Here, the Chapter 7 Trustee argued, the Board and Wilkin, at the very least, closed their eyes to SLA’s problems and failed to act.

The Court agreed with the Chapter 7 Trustee and found that there was enough evidence alleged by the Chapter 7 Trustee to conclude that the Board Defendants and Wilkin did not act in good faith when discharging their duties. The Court considered four factors in coming to this conclusion: (1) disinterestedness, (2) due care, (3) good faith, and (4) no abuse of discretion or waste of corporate assets.

The Court found that there was enough evidence to support that the Board and Wilkin were not disinterested. As one example, a board member’s law firm represented Wilkin in purchasing the summer camp. The Board and Wilkin also did not exert due care—for example, there was no treasurer or vice president on the Board and SLA did not timely file taxes or keep accurate financial data entries. The Board and Wilkin also did not act in good faith—for example, improperly borrowing $200,000 from SLA for purchasing the summer camp; agreeing to a non-interest loan in violation of New York law and IRS regulations; the lack of policies to ensure that financial obligations were paid; and wildly inaccurate budget projections. Finally, the Court found that there was enough evidence to suggest Wilkin’s and the Board’s actions amounted to an abuse of discretion. For example, Wilkin and the Board failed to ensure that SLA was paying payroll withholding taxes and failed to ensure that IRS Form 990s were filed, causing SLA to lose its tax-exempt status.

In light of these findings, the Court denied the Board’s and Wilkin’s motions to dismiss.

Note:  This case is an important reminder of the importance of following corporate formalities and for directors and executives of nonprofit organizations that their failure to uphold their fiduciary duties can result in personal liability. 

McCord v. Margaret (In re Sci., Language, & Arts Int’l Sch.) (Bankr. E.D.N.Y. May 7, 2024) 2024 Bankr. LEXIS 1074.