Direct vs. Derivative Claims Among Shareholders of a Close Corporation

Tully v. Mirz, 457 N.J. Super. 11 (App. Div. 2018).  This opinion by Judge Geiger today addresses the question of what claims, between two owners of a closely-held corporation, are properly considered derivative claims and what claims are correctly treated as direct claims.  After a one-day bench trial, the trial court dismissed the complaint for lack of standing, asserting that all claims presented were derivative claims that could not be brought directly.  Applying de novo review of the purely legal issue of standing, the Appellate Division affirmed in part and reversed in part, ordering a new trial on certain claims.

Judge Geiger noted that New Jersey “courts have traditionally taken a generous view of standing in most contexts.”  A direct claim, he said, “is one in which liability is based upon an injury or violation of a duty owed to a particular shareholder,” while a derivative claim provides shareholders, or a representative shareholder, “with a means to protect the interests of the corporation from the misfeasance and malfeasance of ‘faithless directors and managers.'”

In the context of a close corporation, courts have discretion to construe a derivative cause of action as a direct claim if doing so “will not (i) unfairly expose the corporation or the defendants to a multiplicity of actions, (ii) materially prejudice the interests of creditors of the corporation, or (iii) interfere with a fair distribution of the recovery among all interested persons.”  Those principles come from the American Law Institute’s Principles of Corporate Governance, which were derived from a Ninth Circuit case.

Applying those concepts, Judge Geiger concluded that plaintiff’s claims that defendant failed to contribute his proper share to the debts and liabilities of the entity, in breach of an alleged agreement between the parties and in alleged violation of the duty of good faith and fair dealing, were direct claims.  Plaintiff (unlike the corporation) was a party to the alleged agreement and thus had standing.

But claims of mismanagement, conversion, and fraud were derivative claims.  They “concern [the corporation’s] assets and operations rather than plaintiff as an individual.”  Those claims were captured by plaintiff’s claim for breach of fiduciary duty, which Judge Geiger observed has been considered to be a derivative claim “unless the injury to shares is distinct.”

The panel was unable to determine whether treating the derivative claims as direct claims would create prejudice to creditors of the corporation.  Accordingly, the court affirmed dismissal of the claims determined to be derivative, but remanded for further proceedings on the claims found to be direct.

Finally, Judge Geiger rejected plaintiff’s argument that decisions in his favor on threshold motions to dismiss were the law of the case and could not be revisited.  He stated that those decisions were interlocutory, and decided only that plaintiff’s allegations were sufficient to be allowed to proceed further.  The evidence offered at trial was not available at the pleading stage, and law of the case does not control a subsequent proceeding where there is “substantially different evidence.”

This is a murky region of the law.  But Judge Geiger’s opinion should help everyone find their way through this area more easily.