Hames v. Cravens

David Newbern, Justice, dissenting. Ben Robinson and Pat Hames, husband and wife, formed Partners In Rehab., Inc., with Marybeth Cravens. Mr. Robinson and Ms. Hames alleged that they agreed to invest in and work for the corporation in exchange for Ms. Cravens’s efforts to obtain contracts with the Riley Corporation and the Catlett Corporation. They further alleged that thereafter Ms. Cravens formed Rehab. Plus, Inc., and solicited the Riley Corporation and Catlett Corporation accounts for Rehab. Plus, Inc.

The complaint, filed in Pulaski Circuit Court, was dismissed solely on the ground that it stated a stockholder’s derivative claim, Ark. R. Civ. P. 23.1, and should have been filed in a chancery court. The Circuit Judge did not have before him a specific allegation of failure to state a claim for fraud, nor did he make any ruling in that respect. The real issue in this case is whether two of three shareholders must proceed against the other for breach of her fiduciary obligation to them only in the derivative format before a chancery court.

At common law, a shareholder had no means of redress against officers and majority shareholders whose actions injured their interests in corporations; thus, equity courts began to provide relief in the nature of the derivative suit early in the 19th century. That history is recited in Ross v. Bernhard, 396 U.S. 531 (1970), in which the Supreme Court recognized that the sole reason for equity jurisdiction in the so-called equitable stockholder’s derivative action was lack of standing such plaintiffs once had in law courts. The Supreme Court held that, after the standing matter was settled, the claim on behalf of the corporation could proceed at law with the right of a jury trial guaranteed. Id. That means, of course, that in a federal court the judge decides the standing issue and then, assuming the remedy to be pursued on behalf of the corporation is a legal remedy, a jury may decide the facts and reach a verdict on the claim.

In Arkansas, our archaic division of law and equity courts leaves us with cases like this one in which the fundamental claim may be one at law, but it is thrown into an equity court, regardless of the remedy sought, because two hundred years ago the law courts were not flexible enough to allow such a case to be heard where it belonged.

There is a means to end this artificial situation when the standing question has to do with a close corporation. Mr. Robinson and Ms. Hames have presented a number of cases in their brief, from a variety of jurisdictions, in which it has been held that shareholders in a close corporation may proceed directly against others who have caused injury to their interests in the corporation. The majority has chosen to discuss only one of those cases and has ignored the others, thus giving short shrift to a meritorious argument. Some of the examples of the cases cited in support of the argument follow.

In Thomas v. Dickson, 250 Ga. 772 , 301 S.E.2d 49 (1983), the Georgia Supreme Court dealt with the issue as one of first impression. Three men formed a corporation of which they became the officers and operators. One of them died. His widow, who inherited one third of the stock of the corporation, sued the other two incorporators claiming they had conspired to keep her share of the profits and dividends, had reneged on a promise to pay her a “death benefit,” and had reduced the value of her stock. In response to the argument that the plaintiff was limited to bringing a derivative suit, the Court stated:

The general rule is that a shareholder seeking to recover misappropriated corporate funds may only bring a derivative suit

Although Georgia follows the general rule, we believe that in exceptional situations this Court. . . should look at the “realistic objectives” of a given case to determine if a direct action is proper ....

In the instant case, the reasons requiring derivative suits do not exist. The reasons underlying the general rule are that 1) it prevents a multiplicity of lawsuits by shareholders; 2) it protects corporate creditors by putting the proceeds of the recovery back in the corporation; 3) it protects the interests of all shareholders by increasing the value of their shares, instead of allowing a recovery by one shareholder to prejudice the rights of others not a party to the suit; and 4) it adequately compensates the injured shareholder by increasing the value of his shares ....

We will now examine this case to see if these reasons are applicable. First, Mrs. Dickson is the only injured shareholder; consequently, there can be no multiplicity of lawsuits, and there is no concern that a recovery by her will prejudice the rights of other shareholders.

In addition, Mrs. Dickson would not be adequately compensated by a corporate recovery. For a shareholder, the potential benefit of a corporate recovery in such cases is the increase in the value of his or her shares .... There would be no such benefit to Mrs. Dickson, however, since, in a closely held corporation, there is no ready market for her shares.

The final consideration underlying the general rule, the protection of creditors, is also not present in this case .... [T]here was no outstanding or dissatisfied creditor. [Internal citations omitted.]

Thomas v. Dickson, 301 S.E.2d at 50-51 . All of the reasons recited by the Georgia Court apply in the case now before us.

In Richards v. Bryan, 879 P.2d 638 (Kan.App. 1994), the Kansas Court of Appeals reached the same result with respect to allegations by minority shareholders in a close corporation of a “freeze out” by the majority. It recognized the general proposition that “[a] shareholder may only litigate as an individual if the wrong to the corporation inflicts a distinct and disproportionate injury on the shareholder, or if the action involves a contractual right of the shareholder which exists independently of any right of the corporation.” Id. at 646 . Then the Court considered the close-corporation exception, recognizing that “an increasing number of courts are abandoning the distinction between a derivative and a direct action because the only interested parties are the two sets of shareholders.” Id. at 647 . It recited the concern about the corporation, under the control of the alleged wrongdoers, being the beneficiary of a derivative action, citing 2 O’Neal and Thompson, O'Neal's Close Corporations, § 8.11, p. 122 (3d ed. 1992), and then the following:

In its Principles of Corporate Governance: Analysis and Recommendations § 7.01(d), p. 731 (Tentative Draft No. 11, 1991), the American Law Institute recommends allowing an independent cause of action for freeze-outs in the close corporate setting under certain circumstances:

If a corporation is closely held . . . , the court in its discretion may treat an action raising derivative claims as a direct action, exempt it from those restrictions and defenses applicable only to derivative actions, and order an individual recovery, if it finds that to do so will not (i) unfairly expose the corporation ... to a multiplicity of actions, (ii) materially prejudice the interests of creditors in the corporation, or (iii) interfere with a fair distribution of the recovery among all interested persons.

See, Schumacher v. Schumacher, 469 N.W.2d 793, 798-99 (N.D.1991).

879 P.2d at 647-48 .

The same result was reached by the Ohio Supreme Court in Crosby v. Beam, 548 N.E.2d 217 (1989), a case in which minority stockholders in a close corporation claimed the majority stockholders had breached the fiduciary duty owed to the minority stockholders by misappropriating corporate funds. It was pointed out that, if the minority shareholders in a close corporation were forced to sue on behalf of the corporation, then any recovery would go to the corporation that remained under the control of the majority.

Underlying these cases permitting close-corporation shareholders to sue directly, in the circumstances stated, is the fact that most such corporations are operated more like partnerships than corporations. See Johnson v. Gilbert, 127 Ariz. 410 , 621 P.2d 916 (1980); Crosby v. Beam, supra. In the case now before us, it would be wrong to require Mr. Robinson and Ms. Hames to sue on behalf the corporation (assuming the petition to dissolve it has not yet been granted) so that the shares owned by Ms. Cravens could benefit by a recovery from Ms. Cravens. See Atkinson v. Marquart, 112 Ariz. 304 , 541 P.2d 556 (1975). It makes sense to require the derivative format with respect to a corporation having many shareholders whose interests require protection against the wrong allegedly perpetrated against all, but not when the alleged wrongdoer is the only other shareholder and the rights of creditors and other (in this case nonexistent) shareholders are not prejudiced. Watson v. Button, 235 F.2d 235 (9th Cir. 1956).

The case of Schumacher v. Schumacher, cited above in the quotation from the Richards case, is especially interesting in the respect that it deals properly with the matter of precedence of legal and equitable issues resulting from one set of facts. The Supreme Court of North Dakota concluded that it was necessary to have a jury trial of legal issues arising from breach of a fiduciary relationship owed by one close-corporation shareholder to another prior to deciding the entitlement to equitable remedies. If the right to equitable relief were tried first, and the factual issues decided in that context by the court without a jury, then the plaintiff would, by the application of law of the case, be denied a jury trial.

Although it has been said that breach of a fiduciary duty is an equitable claim, Watson v. Buton, supra, that may well depend upon the remedy sought. We have no definitive ruling on whether breach of a fiduciary relationship must be pursued in equity, but we note that we have entertained appeals from both chancery and circuit courts where breach of a fiduciary relationship was the basis for a remedy, legal or equitable, being sought. See, e.g., Wilson v. Wilson, 327 Ark. 386 , 939 S.W.2d 287 (1997) (appeal from chancery where remedy sought was an estate accounting and setting aside a deed); Alexander v. Flake, 322 Ark. 239 , 910 S.W.2d 190 (1995) (appeal from circuit court where remedy sought was damages); Green v. Jones-Murphy Properties, Inc., 232 Ark. 320 , 335 S.W.2d 822 (1960) (appeal from circuit court where remedy awarded was damages).

The complaint in this case, as abstracted by the appellee, makes it clear that money damages is the remedy being sought, and that remedy belongs in a circuit court. Even if, however, the matter were one to be tried by a chancellor as a direct, rather than derivative, action, the proper procedure for the Trial Court would have been to transfer the case rather than dismiss it. See Linder v. Howard, 296 Ark. 414 , 757 S.W.2d 549 (1988).

I respectfully dissent.

Corbin and Brown, JJ., join in this dissent.