In Kollman v. Cell Tech International, Inc., decided last month by the Oregon Court of Appeals, one of the issues before the court was whether the plaintiff shareholder's claim against another shareholder for breach of fiduciary duty was derivative or direct. In a derivative action, a shareholder brings a lawsuit on behalf of the corporation and all of the shareholders benefit from any recovery. In a direct action, a shareholder sues on his own behalf and recovers individually. In Kollman, the Court of Appeals, applying Delaware law, held that, under some circumstances, a plaintiff shareholder may have a direct action against a fellow shareholder, even if the defendant's alleged breach of fiduciary duty caused a pro rata dilution of their respective shares of the corporation.
The plaintiff in Kollman alleged that the defendant shareholder, who was his former spouse and a corporate director, deceived him into giving up his positions as an officer and director of the corporation; that, once he was ousted, he was excluded from all meaningful participation in the management of the corporation; that his employment with the corporation was terminated; and that his former spouse increased her salary from $140,000 to $290,000. The plaintiff also alleged that his former spouse entered into a transaction with a third party that resulted in substantial dilution to his and his former spouse's ownership of the corporation. This transaction with the third party reduced their combined ownership in the corporation from approximately 80% to less than 10%.
Citing Delaware law, the Court of Appeals noted a two-prong test to determine whether a claim is derivative or direct: (1) who suffered the alleged harm--the corporation or the plaintiff shareholder; and (2) who would receive the benefit of the recovery or other remedy. In the typical direct action lawsuit, the plaintiff suffers some harm that the other shareholders do not suffer. However, in Gatz v. Ponsoldt, the Delaware Supreme Court held that plaintiff shareholders can have a direct claim for breach of fiduciary duty if the fiduciary expropriates economic value and voting power from the shareholders, even if the fiduciary does not retain the direct benefit of the expropriation.
In this case, the Court of Appeals agreed with the trial court that plaintiff's fiduciary duty claim is direct and not derivative. First, the Court held that the plaintiff suffered a unique harm because he was excluded from any meaningful participation in corporate affairs. Second, any recovery on behalf of the corporation in a derivative action would benefit the third party who already was the main beneficiary of the defendants' breach of fiduciary duty.
Controlling shareholders must be wary of how they structure transactions that have the effect of extracting value from their corporations, even if they suffer a pro rata decrease in voting power and ownership.