Direct and Derivative Shareholder Actions

Interesting Legal Issues

A “derivative” action is a claim asserted by one or more minority shareholders of a corporation asserting a right or claim on behalf of the corporation. See Ala.R. Civ. P. 23.1 (describing a derivative action as an “action brought by one or more shareholders or members to enforce a right of a corporation or of an unincorporated association,” and setting forth the procedure involved in a derivative action). A direct shareholder claim is one in which the shareholder sues on his own behalf for damages alleged to have harmed the shareholder individually, and not simply harmed the shareholder because he owns a portion of the company. A derivative action is particularly appropriate when the wrongful conduct is alleged to be directly harmful to the corporation, and thus only indirectly and pro rata harmful to shareholders. In other words, the individual (or multiple) shareholders only suffered harm because they were part of the class of shareholders – not because of their individual position(s).

As early as 1978, in Burt v. Burt Boilerworks Inc., 360 So. 2d327 (Ala. 1978), the Alabama Supreme Court foreshadowed its willingness to permit a direct shareholder claim. In Burt, the Supreme Court acknowledged that majority stockholders owe a duty to act fairly to the minority interests, and that the majority cannot avoid that duty merely because the action taken by the majority might be legally authorized. But, during the 1980s, the Alabama Supreme Court issued a series of cases holding that a shareholder derivative action is the exclusive remedy for wrongful conduct by directors, officers, or shareholders. This line of cases has never been expressly overruled by the Court despite later rulings (beginning in 1990) in which the Supreme Court recognized a direct shareholder claim. In order to fully understand the evolution of the direct claim, a familiarity with the Court’s earlier decisions relating to derivative shareholder claims is helpful.  

           In Green v. Bradley Construction, Inc., 431 So. 2d 1226 (Ala. 1983), the Alabama Supreme Court held:

Green’s complaint alleges fraudulent conversions of corporate assets, which, if the allegations are true, would by law have to be returned to the corporation, as the assets are not solely Green’s but belong to the corporation. As noted in 19 Am.Jur.2d, Corporations § 534 (1970):

“An action brought by a stockholder to recover assets for the corporation or to prevent a dissipation of corporate assets is derivative in nature. Stockholders as such may not maintain actions to recover possession of corporate property. Thus, a stockholder may not bring an action in his own name for an alleged fraudulent transfer of corporate property to another stockholder; such a suit must be by or in behalf of the corporation.”(Emphasis added.)

It is only when a stockholder alleges that certain wrongs have been committed by the corporation as a direct fraud upon him, and such wrongs do not affect other stockholders, that one can maintain a direct action in his individual name. It is clear from Green’s complaint that the acts complained of would affect all stockholders.

Green, 431 So. 2d 1226, 1229 (emphasis added).

           In Galbreath v. Scott, 433 So. 2d 454 (Ala. 1983), the Court reversed a direct recovery of money damages by a minority shareholder. The minority shareholder sued the majority shareholder and the corporation. The theory presented to the jury was that the majority shareholder improperly wasted or diverted corporate funds, thereby depriving the minority shareholder of his share of corporate profits. In reversing the jury’s award of money damages, the Court held as follows:

The verdict in favor of Scott cannot, however, be allowed to stand. The waste of corporate assets by majority stockholders is primarily an injury to the corporation itself. The injury to minority stockholders is secondary. See 13 Fletcher, Cyclopedia Corporations § 5924 (1980). If the corporation refused to assert its cause of action, an action may be maintained by stockholders on behalf of the corporation. In such an action the corporation is the real party in interest and would be the one in whose favor a judgment would be rendered.

Galbreath, 433 So. 2d at 457 (emphasis added) (citations omitted).

           In Galbreath, the Court discussed the reality that a corporate form was being adopted by persons who actually intended to conduct their business as a partnership. Galbreath, 433 So. 2d at 457. This results in the creation of numerous opportunities for majority shareholders in closely held corporations to “squeeze-out” or “oppress” the minority.  

           In Robinson v. Hank Roberts, Inc., 514 So. 2d 958 (Ala. 1987), the Court again affirmed the dismissal of a minority shareholder’s direct action:

The trial court found that Robinson had failed to state a claim upon which relief could be granted concerning conversion of Fleck’s [the corporation] assets because Robinson brought an action for personal recovery for conversion rather than a derivative action on behalf of the corporation as provided by Rule 23.1,A.R.Civ.P.

Robinson,514 So. 2d 958, 959 (emphasis added).

           As to a corporation’s dividend policy, the Court in Boykin v. First Alabama Bank, 384 So. 2d 10 (Ala. 1980) preferred a derivative action and held as follows:

Initially,this court has stated that it will not interfere with a corporation’s dividend policy, a management function of the directors, unless there has been fraud,abuse of discretion, or misappropriation of corporate funds, none of which was established here. Kohn v.Birmingham Realty Company, 352 So. 2d 834 (Ala. 1977). The proper way to have challenged the dividend policy was through a shareholder’s derivative suit pursuant to ARCP 23.1.

Boykin,384 So. 2d at 12.      

           Significantly,in 1989, the Court held in McDonald v. U.S. Die Casting, 541 So. 2d 1064 (Ala. 1989), as follows:

Ordinarily,a stockholder may not bring an action in his own name for an alleged fraudulent transfer of corporate property to another stockholder; such a suit must be by or in behalf of the corporation. Green v. Bradley Const., Inc.,431 So. 2d 1226, 1229 (Ala. 1983); quoting 19 Am.Jur.2d Corporations §534 (1979). However, if the stockholder alleges that wrongs have been committed by the corporation as a direct fraud upon him, and that such wrongs do not affect other stockholders, that one stockholder may maintain a direct action in his individual name. Green v. Bradley Const., Inc.,supra, at 1229.

McDonald v. U.S. Die Casting, 541 So. 2d at 1068-69 (emphasis added).

           Then,in 1990 in Ex parte Brown, 562 So. 2d 485 (Ala. 1990), the Alabama Supreme Court for the first time recognized a minority shareholder’s right to bring a direct claim against individual offices, directors, or shareholders for violating their fiduciary duty owed to minority shareholders.

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