Defining the boundaries of the adverse domination doctrine: is there any repose for corporate directors?

• Author: Baughman, Michael E.

INTRODUCTION

Following the massive failure of the savings and loan industry, the federal government sought to recover some of the enormous losses to the banking system and federal insurance coffers from those responsible for the management of these institutions. The authority was placed in the hands of the Resolution Trust Corporation (RTC), Congress's avenging angel. On behalf of failing corporations, the RTC brought hundreds of suits against former officers and directors.(1) The RTC, however, was inhibited by a serious obstacle - many of these claims were barred under applicable state statutes of limitations. The RTC needed a mechanism to resurrect these otherwise stale claims. It found such a device in the doctrine of adverse domination.

During the early decades of this century, some courts refused to allow a corporation's cause of action against its board of directors to accrue as long as the board remained in control of the corporation, thus precluding the running of the statute of limitations.(2) The rationale behind this early adverse domination doctrine was that control of a corporation by those alleged to have harmed it rendered the corporation incapable of bringing suit.(3) The doctrine was rarely used after 1940,(4) until the RTC discovered that it could use the doctrine to revive claims against former directors of financial institutions under the Financial Institutions Reform, Recovery, and Enforcement Act of 1989 (FIRREA).(5)

The present formulation of the adverse domination doctrine varies in application depending on the jurisdiction. Most courts that accept adverse domination, however, do so for the same underlying purpose: "[T]he corporation which can only act through the controlling wrongdoers cannot reasonably be expected to pursue a claim which it has against them until they are no longer in control."(6) Application of the doctrine tolls the running of the statute of limitations for a corporation's cause of action against its directors until those directors no longer control the corporation.

It is now generally accepted that state law governs the tolling of statutes of limitations under FIRREA.(7) The increase of litigation involving adverse domination under FIRREA has begun to mold state law on the issue(8) and has increased the likelihood that the doctrine will be used more frequently to toll the statutes of limitations in other lawsuits against directors of corporations.(9) Thus, the issue will be resolved in state courts, using the law as it develops under FIRREA to shape the development of adverse domination in these state courts.(10) It is especially important that the doctrine be clearly understood so that state courts confronted with allegations of adverse domination will understand its proper application.

This Comment has two basic purposes: to discern the true nature of the adverse domination doctrine and to determine whether the result is a desirable rule for courts to apply. First, some grounding in limitations law and the nature of adverse domination is necessary. Thus, Part I will discuss the historical origins of statutes of limitations, their underlying purposes, and the development of the law regarding the tolling of these statutes. Part II will analyze the specific application of the adverse domination doctrine, concentrating on the increased use of the doctrine in the federal courts by the RTC and the Federal Deposit Insurance Corporation (FDIC) under FIRREA. This Part will expose the four primary inconsistencies in the application of the doctrine: the degree of domination required by the board of directors, the required level of culpability to which directors' actions must rise, whether the doctrine is applicable to toll the statute of limitations against nondirectors, and the burden of proof. Part III will analyze adverse domination under corporate and agency law to determine the legal posture of the doctrine under limitations law. This analysis will reveal that the theoretical underpinnings of the doctrine are most analogous to the discovery rule, another common-law method of delaying the accrual of a cause of action.

With this essential structure established, Part IV will apply adverse domination as a variant of the discovery rule, resolving the inconsistent application that has plagued its history in the federal courts. Analyzing adverse domination under the discovery rule requires a board of directors in which all knowledgeable directors are wrongdoing directors. The directors need only be negligent for the rule to apply, and the doctrine may also be applied to toll a corporation's cause of action against a nondirector who was involved in the underlying transaction. Finally, the burden of proving domination should be placed on the plaintiffs.

Having satisfied the first goal of discerning a uniform rule that courts are likely to apply according to contemporary case law, this Comment then questions the desirability of such a rule. Part V will analyze the effects of adverse domination, determining that its application would almost entirely eliminate the important policy goal behind statutes of limitations - repose. It will be argued that courts have become extremely liberal in their application of the discovery rule because they believe that the limitations periods prescribed by legislatures are too short. As a response, this Comment will suggest that legislatures supplement their statutes of limitations with longer statutes of repose (limitation periods that cannot be tolled by courts), which would create an upper limit to the time in which a cause of action may be brought.

1. The History of Statutes of Limitations and the

   Origins of Tolling Provisions

   Statutes of limitations restrict the amount of time in which plaintiffs may bring their causes of action to court.(11) Statutes of limitations were originally strict statutes of repose that prevented plaintiffs from bringing suit after the prescribed time periods unless the statutes explicitly provided exceptions.(12) Eventually, however, statutes of limitations became subject to provisions that tolled the statutes under certain circumstances, thereby extending the time in which plaintiffs could bring suit.(13) This Part will explore the origins of limitations law, both at law and in equity, and the purposes served by statutes of limitations. This Part will then explore the development of tolling provisions from their origins in courts of equity under the doctrine of laches to their current expansive use in courts of law under the discovery rule.

   1. The Development of Statutes of Limitations

      The history of limitations of action extends back at least to Roman times, when limitations were placed on actions to recover real property.(14) Early English common-law courts placed no time limitations on causes of action, believing this to be "the responsibility or prerogative of the king or the Parliament, which acted infrequently and on an ad hoc basis."(15) The modern era of statutes of limitations did not begin until the Limitations Act of 1623 was enacted.(16) This statute, promulgated under the reign of James I, "provided specific lengths of time for numerous real property and personal actions."(17) Certain explicit disabilities suspended the running of the statute.(18) Because the English legal system was the basis of American law, American legislatures enacted general statutes of limitations early in their histories.(19)

      Statutes of limitations generally are perceived as having two purposes: a "substantive" purpose in granting repose to defendants and a "procedural" purpose in encouraging plaintiffs to bring suit in a timely manner.(20) The substantive purpose of repose for defendants is the primary, driving force behind these statutes:

      Statutes of limitation ... in their conclusive effects are designed to promote justice by preventing surprises through the revival of claims that have been allowed to slumber until evidence has been lost, memories have faded, and witnesses have disappeared. The theory is that even if one has a just claim it is unjust not to put the adversary on notice to defend within the period of limitation and that the right to be free of stale claims in time comes to prevail over the right to prosecute them.(21)

      This right of repose for defendants makes intuitive sense. For example, it would be unfair and unjust to hold a director of a corporation liable for simple negligence forty years after the alleged infraction.(22)

      Although repose to defendants is the primary purpose of statutes of limitations, encouraging timely action by plaintiffs to promote the efficient management of the court system is an important secondary goal.(23) By promoting prompt filing of suits, the courts, and presumably society, benefit by avoiding excessive backlogs of ancient causes of action.(24) A careful look at both purposes of statutes of limitations shows that they have one overriding goal: to encourage plaintiffs to bring timely suits, thereby protecting both defendants and the courts.(25)

   2. The Development of Doctrines Designed to Toll

      the Statute of Limitations

      Originally, statutes of limitations were interpreted as rigid legal rules with little room for maneuvering.(26) Such limitations periods, however, governed only actions at law. Equity was governed by the doctrine of laches. Laches is based on the same policies as statutes of limitations.(27) Unlike statutes of limitations, however, laches is left to the discretion of judges.(28) Thus, laches is a more flexible doctrine - a legal standard, as compared to the rigid legal rules of early statutes of limitations.(29)

      The flexibility associated with the doctrine of laches gave impetus to the concept of tolling limitation periods. The general rule of laches focused on plaintiffs' diligence in pursuit of their causes of action. If plaintiffs did not bring suit within a reasonable time period, their actions were barred.(30) In other words, laches was...