Safe Bldg. Compliance & Tech. v. Bernholtz

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SAFE BUILDING COMPLIANCE &TECHNOLOGY, Plaintiff-Appellee, v. MICHELLE BERNHOLTZ, n/k/a MICHELLE NAUGHTON, Defendant-Appellant.

No. 22-1044

Court of Appeals of Iowa

April 26, 2023

Appeal from the Iowa District Court for Polk County, Lawrence P McLellan, Judge.

A former director of a nonprofit corporation challenges some provisions of the district court's ruling she is liable for misappropriated funds.

Theodore W. Craig, David M. Repp, and Rachel L. Soderstrum of Dickinson, Mackaman, Tyler, &Hagen, P.C., Des Moines, for appellant.

Billy J. Mallory and Trevor A. Jordison of Mallory Law, West Des Moines, for appellee.

Heard by Greer, P.J., and Chicchelly and Buller, JJ.

GREER PRESIDING JUDGE.

Safe Building Compliance &Technology (SBCT), a nonprofit corporation, sought to hold former director Michelle Naughton^[1] liable for misappropriated funds in the amount of $481,481. Naughton admitted liability for some corporate funds that were improperly used on personal expenses but challenged others as expenses that were approved by the board of directors or spent after she resigned her position as director. Following a trial to the bench, the district court ordered Naughton to reimburse SBCT a total of $269,290.94.

On appeal, Naughton challenges some of the court's ruling. She disputes her liability for $78,425.38 spent on disability- and life-insurance policies for herself and her husband, Denny Bernholtz; $19,900 for excessive lease payments to 421 Main, LLC, a limited liability company owned by Naughton and Bernholtz; and $144,077 for construction and renovation expenses for the property owned by 421 Main.^[2]

I. Background Facts and Proceedings.

Naughton and Bernholtz formed SBCT in 2011, organized under Iowa Code chapter 504, which is the Revised Iowa Nonprofit Corporation Act. Pursuant to SBCT's articles of incorporation, one of the nonprofit's purposes was "[t]o lessen the burdens of . . . governmental agencies by performing building inspection and evaluation services, lead and energy assessment services, zoning consulting services, and building code and other regulatory compliance services" that the "governmental agencies would otherwise be required to perform." The corporation was to be governed by its board of directors; Naughton and Bernholtz were the only directors at the corporation's inception but were soon joined by three additional directors-Cody Christensen, Mark Chidley, and T.J. Bangs. In 2015, Bangs left the board and was replaced by Beth Gibbins.

A conflict-of-interest policy was included in SBCT's bylaws. The policy defines certain terms, such as an "interested person," which is "[a]ny director, principal officer, or member of a committee with governing board delegated powers, who has a direct or indirect financial interest, as defined below." Under the policy:

A person has a financial interest if the person has, directly or indirectly, through business, investment, or family:

a. An ownership or investment interest in any entity with which the Organization has a transaction or arrangement,

b. A compensation arrangement with the Organization or with any entity or individual with which the Organization has a transaction or arrangement, or

c. A potential ownership or investment interest in, or compensation arrangement with, any entity or individual with which the Organization is negotiating a transaction or arrangement.

Compensation includes direct and indirect remuneration as well as gifts or favors that are not insubstantial.

A financial interest is not necessarily a conflict of interest. Under Article III, Section 2, a person who has a financial interest may have a conflict of interest only if the appropriate governing board or committee decides that a conflict of interest exists.

The person with the possible conflict had a duty to disclose it to the board, and then it would become the board's responsibility to determine whether a conflict of interest existed:

After disclosure of the financial interest and all material facts, and after any discussion with the interested person, he/she shall leave the governing board or committee meeting while the determination of a conflict of interest is discussed and voted upon. The remaining board or committee members shall decide if a conflict of interest exists.

If the board determined a conflict existed, it was required to follow the procedure set forth in the policy:

a. An interested person may make a presentation at the governing board or committee meeting, but after the presentation, he/she shall leave the meeting during the discussion of, and the vote on, the transaction or arrangement involving the possible conflict of interest.

b. The chairperson of the governing board or committee shall, if appropriate, appoint a disinterested person or committee to investigate alternatives to the proposed transaction or arrangement.

c. After exercising due diligence, the governing board or committee shall determine whether the Organization can obtain with reasonable efforts a more advantageous transaction or arrangement from a person or entity that would not give rise to a conflict of interest.

d. If a more advantageous transaction or arrangement is not reasonably possible under circumstances not producing a conflict of interest, the governing board or committee shall determine by a majority vote of the disinterested directors whether the transaction or arrangement is in the Organization's best interest, for its own benefit, and whether it is fair and reasonable. In conformity with the above determination it shall make its decision as to whether to enter into the transaction or arrangement.

The process surrounding compensation for a voting member or director was less ambiguous. Directors who received compensation from SBCT were not allowed to vote "on matters pertaining to that member's compensation" and were also "prohibited from providing information to any committee regarding compensation."

Naughton and Bernholtz were not only directors for SBCT, they were also employees of the nonprofit. They were paid a salary by the corporation and received benefits and other perks, such as life insurance; disability insurance; gym memberships; and access to trainers, food, work vehicles (that they also drove during their personal time), and fuel.

In October 2013, 421 Main purchased a building in Slater, Iowa. Over the next couple of years, SBCT spent more than $100,000 renovating 421 Main's building. At the point the expenditures began, SBCT worked out of a property in Huxley, Iowa, and did not have a contractual relationship with 421 Main.

Beginning June 1, 2014, SBCT leased the main floor of 421 Main's building, paying the limited liability company $1000 per month. The building also had a second floor, where Naughton and Bernholtz's family lived. Per the lease SBCT entered into with 421 Main, SBCT paid all "utilities and services . . . used on the premises, including all electricity, gas, sewer, garbage/trash removal, janitor/cleaning and snow removal." Accordingly, Naughton and Bernholtz's family did not pay any utilities for their residence.

SBCT entered into a number of leases with the limited liability company for the premises in Slater; the term lengths were irregular, and the rent increased with each contract. SBCT paid 421 Main $1000 per month from June 1, 2014, through March 31, 2015; $1350 per month from April 1, 2015, through November 30, 2016; $1850 per month from December 1, 2016, through January 30, 2018; and $2000 per month from February 1, 2018, through September 30, 2018.

Eventually, Naughton and Bernholtz began having marital problems, and Naughton filed a dissolution petition in July 2017. A few months later, in October, she resigned as a director of SBCT and quit her employment. Gibbins and Chidley resigned from the board around the same time-leaving just Bernholtz and Christensen as directors.^[3]

Bernholtz died in May 2018.^[4] At that time, SBCT had four full-time and four part-time employees, and Christensen was left as the only director. So, following Bernholtz's death, his brother Chad took over as the president and treasurer for SBCT and sat on the board of directors.

After coming on board, Chad found a letter Bernholtz wrote to the IRS that purported to provide "[i]nformation about [SBCT] and [Naughton's] misuse of [SBCT] funds."^[5] This, along with concerns Bernholtz previously shared with Chad, led SBCT to seek a forensic analysis of the corporation's accounts. SBCT hired HDH Advisors (HDH) to conduct the forensic analysis.

In April 2019, HDH provided SBCT a report outlining:

the amount of excess benefits received by [Naughton] and [Bernholtz] in the form of excess compensation, payment of personal expenses using SBCT funds, the payment of above fair market value rent to a related-party entity solely owned by [Naughton] and [Bernholtz] and the excess payment of constructions expenses by SBCT for a building owned through the same related-party entity.

The report covered several areas of expenses and concluded that Naughton and Bernholtz "privately benefitted from their roles as directors and operators of SBCT" and that the pair received $481,481 "to the detriment of the non-profit."

Armed with the report, SBCT filed suit against Naughton, alleging she misappropriated SBCT funds and seeking reimbursement of the whole $481,481 from her. While not included in the original petition, SBCT would later clarify that it believed Naughton was liable for violating the standards for a director of a nonprofit as governed by Iowa Code section 504.832 (2020).

SBCT tried its case to the bench over three days in December 2021. It largely relied on the testimony of Duane Tolander, a certified public accountant and a partner and...