Dead on Arrival The Perils of Litigating an Aggrieved Shareholder’s Breach of Fiduciary Duty Claim, 0320 COBJ, SC Lawyer, March 2020, #38

AuthorBy Cory Manning, Adam Hegler and Axton Crolley
PositionVol. 31 Issue 5 Pg. 38

Dead on Arrival The Perils of Litigating an Aggrieved Shareholder’s Breach of Fiduciary Duty Claim

Vol. 31 Issue 5 Pg. 38

South Carolina BAR Journal

March, 2020

By Cory Manning, Adam Hegler and Axton Crolley

While it’s black letter law that the officers and directors of a corporation owe fiduciary duties to the corporation and its shareholders, applying this principle to the facts of a new case quickly poses complex questions. For example: What duties do officers and directors have to prospective shareholders? What duties do they face regarding injuries to all shareholders collectively? What about injuries to individual shareholders that are separate and distinct from those to other shareholders?

As even these few questions demonstrate, both suing and representing officers and directors in shareholder disputes can be challenging. To make matters worse, litigants commonly lump as many grounds for relief as possible into a single case—regardless of their applicability to the facts at hand. Failure to carefully identify and separate appropriate claims early on, however, can result in costly and protracted arguments over unnecessary and unsuitable theories of recovery. Accordingly, both parties (and the courts) should work to ensure that the initial legal framework actually fits the facts of the case. The following survey provides a simple road map to ensure that you, your client, and the court are proceeding with a full and accurate understanding of corporate fiduciary law in South Carolina.

Corporate fiduciary law in South Carolina: Basic principles

The basic principles of corporate fiduciary law are well established in South Carolina. The South Carolina Code, building upon and incorporating common law fiduciary principles, imposes on directors, officers and majority shareholders the fiduciary duties of loyalty and care.1 Specifically, the Code requires a director, officer or majority shareholder to act “(1) in good faith; (2) with the care an ordinarily prudent person in a like position would exercise under similar circumstances; and (3) in a manner he reasonably believes to be in the best interests o f the corporation and its share-holders.”2

These fiduciary duties form the basis of corporate law, and they provide the broad outlines for how directors, officers and majority shareholders must conduct themselves.[3] Such fiduciaries cannot take actions that benefit themselves at the expense of the corporation.4 For example, they cannot engage in transactions that divert proceeds to themselves or otherwise reward themselves with self-dealing bonuses.5 Nor can they take actions that harm share-holders—for example, reducing a shareholder’s equity percentage.6 While a breach of these duties may be easy to identify, seeking relief for the breach is frequently more complicated. Indeed, litigating your case requires that you educate your client, your opposing counsel, and the court on the correct framework for the facts before you.

Direct versus derivative claims

Shareholders commonly seek redress for what they believe are breaches of the statutory fiduciary duties described above. Of paramount importance when initiating a lawsuit on behalf of an aggrieved shareholder—or when defending a corporate fiduciary from such a suit—is determining whether the claims are direct or derivative in nature.[7]

A direct suit is an action by a shareholder for a harm suffered by that shareholder uniquely—that is, an injury “separate and distinct” from injuries to other shareholders or to the corporation itself.[8] A derivative suit, by contrast, is an action brought by a shareholder on behalf of the corporation for a wrong suffered by the corporation; it is the default manner of recovery.9

This direct-derivative distinction is not merely academic. Indeed, “an individual stockholder has no right to bring an action in his own name and in his own behalf for a wrong committed solely against the corporation.”10 Thus, a direct claim is dead on arrival without allegations of individualized harm. What’s more, the procedural requirements of direct and derivative claims also meaningfully differ: complaints for derivative actions must comply with the heightened pleading and demand requirements of Rule 23(b)(1) of the South Carolina Rules of Civil Procedure.11

Thus, in order to understand the procedural, pleading, and evidentiary requirements for bringing (or defending) a suit, attorneys must determine initially whether the suit is direct, derivative, or contains claims of both types.12 Attorneys must also make this distinction before assessing potential damages; while damages for direct actions accrue only to the harmed individual, damages for derivative actions accrue to the corporate entity and “should be divided among all the stockholders in the corporation.”13

The South Carolina Supreme Court recently articulated a two-prong test for distinguishing direct and derivative cases.14 “[T]o distinguish a derivative claim from a direct one, the court considers: (1) who suffered the alleged harm, the corporation or the suing stockholders, individually, and (2) who would receive the benefit of any recovery or other remedy, the corporation or the stockholders individually.”15

Derivative claims

Rivers v. Wachovia Corporation offers an example of a “classic” derivative action.16 The plaintiff shareholder sued Wachovia’s former officers to recover for the “precipitous decline in value” of his shares during the 2008 “financial crisis.”17 His primary allegation was that the officers’ misrepresentations regarding “the financial health of Wachovia” prompted his misguided retention of those shares.18 The Fourth Circuit Court of Appeals found that the plaintiff “had no leg to stand on,” as his theory of personal recovery ran “directly afoul” of the direct-derivative distinction in claiming individual harm from a shareholder-wide injury.19 It thus deemed dismissal of his action proper.20

Direct claims

In contrast to Rivers, Hite v. Thomas & Howard Company offers an example of a shareholder’s distinct injury providing grounds for a direct claim.21 In Hite, the individual shareholder of a corporation sued its majority shareholder, alleging that the majority shareholder engaged in a scheme to reduce and devalue the percentage of his minority ownership.22 As a result of a stock exchange agreement between the corporation and its majority shareholder, the individual’s ownership interest was reduced from 33.3 percent to 11.5 percent.[23...

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