Court Holds That Individual Shareholder Should Have Brought Lawsuit as a Derivative Action Rather Than as a Separate, Individual Claim

Daniel Nickell filed a lawsuit against the officers and directors of Engineer Support. He claimed it had improperly diverted financial benefits by backdating stock options, which decreased the value of the corporation for its shareholders. Nickell was a shareholder of Engineer Support Systems Inc. (ESSI). ESSI merged with DRS Technologies in January 2006.

In Nickell’s lawsuit, he alleged that the officers and directors made material misrepresentations to induce the merger at a reduced price for the company in exchange for DRS assuming responsibility for the backdating scheme.

The trial judge dismissed Nickell’s lawsuit on the grounds that his claims were pleaded as a shareholder derivative claim and that he did not have standing to sue the ESSI directors and officers for his individual claims. Nickell appealed to the Supreme Court of Missouri, which affirmed the dismissal of his case.

“A derivative action is a suit by the corporation conducted by the shareholders as the corporation’s representative. The shareholder is only a nominal plaintiff, and the corporation is the real party in interest” — Goldstein v. Studley, 452 S.W. 2d 75, 78 (Mo. 1970). Derivative actions are aimed at vindicating injuries “to the corporation-to the shareholders collectively-and not the shareholders individually.” Centerre Bank of Kansas City, Nat Ass’n v. Angle, 977 S.W. 2d 608, 613 (Mo. App. 1998).

Illinois courts agree that shareholders normally must bring a derivative suit to file against an officer or director of a corporation. A derivative lawsuit is required generally even as in the Nickell case, the plaintiff alleges that the directors or officers of a corporation breached their fiduciary duty, resulting in damages to shareholders. The lawsuit is derivative, rather than direct, because the fiduciary duty of a director or officer of a corporation is “generally held between the directors and the shareholders as a whole.” Centerre Bank, 976 S.W.2d at 613.

In plain language, the fiduciary duty of a corporate officer or director to act in the best interests of all of the shareholders is required. If the fiduciary duty is alleged to have been breached causing shareholder damages, a shareholder cannot bring his or her own action in his own name or for his own personal purpose and benefit against the corporation to recover corporate funds or property improperly diverted or taken by the corporation’s officers or directors.

Individual lawsuits are permitted by shareholders against the corporation in the event that the injury or damages to the shareholders themselves are direct and not to the company or corporation.

Principally, the difference between a direct action lawsuit against a corporation and a derivative action is that in a derivative lawsuit brought against officers or shareholders when the corporation has chosen not to bring suit for injuries to the corporation itself, the Illinois Business Corporation Act creates a statutory cause of action for such event. In Illinois, the officers and directors of the corporation have an enhanced fiduciary duty to shareholders of a closely-held corporation which is similar to that of partners in a partnership.

A common and recurring fact setting that would lead to a derivative lawsuit in the close-corporation context would be a “freeze-out” or an exclusion of minority shareholders from management of the corporation. Another example might be where there is disparate treatment of shareholders. In some instances, minority shareholders may have the ability to outmuscle the controlling shareholders in its litigation.

The court in Nickell made it plain as to what the differences are between a direct action by a shareholder and derivative lawsuit brought by a shareholder against a corporation.

Nickell v. Shanahan, No. SC 93719 (Mo. Banc 2014).

Kreisman Law Offices has been handling corporate and commercial disputes, business litigation, commercial litigation and trial practice for more than 38 years in and around Chicago, Cook County and its surrounding areas. . Robert Kreisman is also a member of the Missouri Bar and has been since 1976. Kreisman Law Offices represents clients throughout the Chicago area including Round Lake Beach, Prospect Heights, Tinley Park, Schiller Park, Skokie, South Barrington, South Chicago Heights, Park Ridge, Palos Park, Inverness, Lockport, Lansing, Chicago (Little Village, Lawndale, Humboldt Park, Lincoln Park, Logan Square, Englewood, Marquette Park, Roseland, Washington Heights, Riverdale), Alsip, Blue Island and Calumet Park, Ill.

Related blog posts:

U.S. Court of Appeals Finds that Claims of an Individual Shareholder are Derivative to the Corporation

Illinois Appellate Court Finds That a Non-Shareholder Can Be Held Liable for Corporate Debts

U.S. Court of Appeals Affirms Tortious Interference Judgment