McClain v. PDA

Fighting with Giants

It begins with the tragic tale of the birth of Jerry Jacob McClain in 1995 who, due to a lack of oxygen during his birth, was born with severe birth defects which have substantially impacted his life.

In 1997, Lori Rutledge, McClain’s mother, filed a medical malpractice claim against the delivering physician, Dr. Northern and his group, Rolla Medical Group, as well as against the nurses at Phelps County Memorial Hospital in Rolla. Northern and his group were insured by Physicians Defense Association (PDA) with $200,000 liability limits. PDA provided a defense to the malpractice action. While the case was being actively litigated, two years after the filing date, the court summarily dismissed the matter without prejudice because it had not been tried within two years. (McClain I).

The case was re-filed within two months. At that time, PDA chose to deny coverage. PDA claimed that because this was a claims-made policy, coverage did not apply because the refiling of the case in 1999 constituted a new claim which was not made during the policy term. PDA first defended under a reservation of rights and ultimately withdrew its defense of Northern and his group. In 2000, after a trial on damages, the court entered judgment in favor of McClain and his mother, Lori Rutledge, and against Northern and his group in the sum of $14,425,916.00. (McClain II).

A declaratory judgment action was filed by Northern against PDA. Rutledge joined in the action and added a count for equitable garnishment. In 2001, the court granted summary judgment in favor of Northern and Rutledge holding that the PDA policy provided coverage for the McClain action. PDA appealed the judgment. Summary judgment in favor of plaintiffs and against PDA was upheld in Northern v. Physicians Defense Association, 88 S.W.3d 130 (Mo.App.S.D. 2002). (McClain III).

While the McClain I action was pending, PDA lost one of its major members (Northern and his group) and decided to dissolve in 1997. Lloyd Downard and Charles James were appointed Trustees for the purposes of dissolving the Association. Downard and James as Trustees were to wind down the affairs of PDA, satisfy the debts and obligations of the association, distribute any remaining proceeds to the members of PDA, and dissolve the corporation. Although there was very little business to conduct, one of the first orders of business for Downard and James was to amend and accelerate their own employment contracts to the tune of $168,000 each. Throughout the wind-down process, Downard and James increased the payments to themselves when they deemed appropriate.

The Department of Insurance performed an audit of PDA during the dissolution process where the changes to the compensation agreements for Downard and James were brought into question. When Downard and James attempted to justify their accelerated compensation, the Director instructed Downard and James to ensure the Association maintain a solvent position, which includes “cancelling any additional compensation payments or seeking the return of compensation already paid on these compensation settlements.” In their response, Downard and James responded by telling the Director that “Compensation contracts between the Association and its officers/employees were amended to provide for limited annual compensation or payment upon dissolution whichever occurs first,” when in fact no changes were made to the compensation contracts to provide for limited compensation.

It was during this wind-down period of overcompensation to the Trustees that PDA, through Downard and James, chose to arbitrarily deny coverage for McClain II. Further, they failed to hold any funds in reserve when Downard and James knew that the Courts would likely determine that the PDA policy for Northern and his group would provide coverage for McClain II.

The meeting minutes during the wind-down process of Downard and James and corporate counsel were replete with references to the McClain judgment and the very real possibility that the court may find the PDA policy provided coverage for the McClain II judgment.

Nonetheless, Downard and James continued to deplete the assets of PDA with no regard for its insured, Northern and Rolla Medical Group, or their judgment creditors, McClain and Rutledge.

In 2001, while summary judgment motions were pending before the court, with full knowledge of the pendency of the claims of coverage contained in McClain III, PDA filed Articles of Termination and Articles of Dissolution with the Secretary of State of Missouri. The Articles of Termination were signed by its Trustees, Respondents James and Downard, stating, “All debts, obligations and liabilities of the corporation have been paid or discharged, or adequate provision has been made therefor.” Of course, this statement was false on its face because McClain III was still pending and there was no provision for satisfaction of this debt or liability. McClain and his mother filed objections to the dissolution. When summary judgment was granted against PDA holding that the PDA policy did in fact provide coverage for the McClain II judgment, Downard and James continued to disburse all funds of PDA, mostly to themselves, while they appealed the summary judgment. There was no effort to reserve any assets for the McClain judgments.

At the management meeting of PDA on December 13, 2002, following the Supreme Court’s denial of transfer of Northern v. Physicians Defense Association, the financial statements of PDA showed no assets and the bank statement balance was $0.00. At this point, Downard and James decided to shred the remaining unused PDA checks. Downard and James made absolutely no provisions for payment of the judgment against its insured, Northern and his group. Nor had it made any provisions for the payment of the judgment against PDA.

In an attempt to satisfy the judgment and hold Downard and James individually liable, plaintiffs filed McClain IV in 2003 against PDA, Downard, James and the members of PDA alleging various counts in equity for fraudulent transfer, equitable assessment and unjust enrichment. The suit also alleged various legal counts, for fraudulent misrepresentation, breach of fiduciary duty, negligent claims handling, bad faith and punitive damages.

The trial court entered summary judgment in favor of the defendants and against plaintiffs holding that the claims were barred by the statute of limitations. Plaintiffs appealed the judgment. The summary judgment was reversed and the court remanded the matter. McClain v. Carpio, 338 S.W.3d 361 (Mo.App.S.D. 2011).

The equitable matters were court-tried in July, 2012. The trial court found in favor of the defendants on all equitable claims. The court then granted summary judgment against plaintiffs on the legal claims in December, 2012.

Plaintiffs appealed all judgments entered against Plaintiffs. The court reversed summary judgment on the counts for Fraudulent Misrepresentation and for Punitive Damages. McClain v. James, 453 S.W.3d 255 (Mo.App.S.D. 2015). The issues with regard to fraudulent misrepresentation were 1) whether corporate officers can be liable for the fraud of the company; and 2) whether plaintiffs can sue for fraud when they were not the hearer of the fraudulent statements and did not rely upon the fraudulent statements. The Court held officers/directors can be held liable for fraud when they have actual or constructive knowledge of the actionable wrong and participated therein. McClain v. James, 453 S.W.3d at 266, citing Osterberger v. Hites, 599 S.W.2d 221, 229 (Mo.App.E.D. 1980).

Further, the court held that because Plaintiffs, as judgment creditors of PDA, were persons for whom R.S.Mo. Section 355 were designed to protect, they have standing to pursue a cause of action for fraud regardless of whether they actually heard the statements or relied upon them. McClain, 453 S.W.3d at 267, citing B.L. Jet Sales v. Alton Packaging, 724 S.W.2d 669 (Mo.App.E.D. 1987). The fraudulent statements at issue were: 1) the statement made to the Department of Insurance that the employment contracts were amended to limit compensation of its officers/employees, and 2) the statement to the Secretary of State that “all debts, obligations and liability of the corporation have been paid and discharged or adequate provisions had been made therefor.”

The court held that when statutes or regulations impose an obligation on a person in the course of their profession or employment, this creates a public duty to do so truthfully which extends to all “persons within the class of persons for whose benefit the duty is created.” McClain, 453 S.W.3d at 367. The court held that it is not necessary to be the direct hearer of the false statement to pursue a claim for fraud. Id. The court further held that when a person while under a public duty to give information gives false information, that person is “liable for the losses suffered by any of the class of persons for whose benefit the duty is created.” Id.

Finally, Downard and James could be held accountable for the actions they took in winding down PDA.

Upon remand, the matter was set for trial on the sole counts of fraud and punitive damages. The matter was settled shortly thereafter. Justice, with the help of a great deal of tenacity, though most certainly delayed, was not denied.

By Matthew Padberg, Teri Appelbaum & Anna Haber
This article first appeared in the Spring 2016 issue of The Missouri Trial Attorney