Legal Briefs: A Periodic Summary Of Judicial Decisions Affecting Accounting And Financial Services Professionals

Shareholders in Close Corporations May Bring Both Derivative and Individual Claims If All Shareholders are Parties to the Action

Aggrieved corporate shareholders may pursue individual or derivative claims to redress wrongs against themselves and the corporation but, traditionally, a shareholder could not join both types of claims in the same action. In the recent decision of Tuscano, et al. v. Tuscano, et al., Ch. Div. Mercer Cty. June 8, 2011, the Chancery Court, declined to follow the traditional rule in a case involving a close corporation and relied on a minority rule espoused by the American Law Institute to permit both individual and derivative claims to proceed in the same action.

The parties in Tuscano were brothers who each owned 50 percent of four corporations engaged in the business of operating collection bins designed to receive products, including used clothing, for recycling to benefit charitable organizations. Richard and Ronald Tuscano had operated the businesses for about 25 years, and were the only shareholders and members of the corporations' Boards of Directors, with Ronald serving as President and Richard as Vice President.

Richard filed the New Jersey action in May 2010, and alleged several state-law claims including minority oppression, and breaches of fiduciary duty and the duty of loyalty; requested a court-ordered buyout of his ownership interests in the four corporations; and included a derivative action on behalf of the corporations for breach of fiduciary duties. Richard alleged that Ronald surreptitiously founded a competing business in April 2008, and that Ronald was wasting corporate assets by paying excessive fees to a shipping company owned by Ronald's son.

This was not a new dispute; in fact, in April 2005 Richard had filed a complaint in a New York federal court asserting similar state-law claims as well as federal RICO claims. The New York action was dismissed without prejudice because Richard failed to join a necessary party for the RICO claims, and therefore the federal court lacked jurisdiction. Subsequently, the New York action was dismissed with prejudice and a judgment was entered in favor of Ronald.

The New York action became an issue in the New Jersey action in January 2011, when, about eight months after the complaint was filed, Ronald filed a motion to amend his answer to include four additional affirmative defenses and, simultaneously, to dismiss the case based upon those defenses. Ronald claimed that the New Jersey action was barred under res judicata, collateral estoppel and entire controversy doctrines because of the dismissal of the prior New York action. Ronald further argued that the New Jersey complaint must be dismissed on the merits for failing to join the corporations as defendants and for joining individual and derivative claims simultaneously.

While the court determined that the res judicata, collateral estoppel and entire controversy doctrines would not bar the New Jersey lawsuit, we focus here only on the two pleading issues: (1) whether the corporations were necessary parties and (2) the appropriateness of bringing both individual and derivative claims in the same action.

With respect to the alleged failure to join the corporations as a party, the court observed that, although the corporations were not listed in the caption, or specifically identified as defendants, they were all listed as "parties" in the body of the complaint. In light of New Jersey's liberal notice pleading rules, which also provide that defects in the caption and format of pleadings may be corrected by amendment, the court permitted Richard to amend his pleadings to name the corporations as defendants for the purposes of the derivative claims.

The issue of whether Richard could maintain both individual and derivative claims was more difficult to resolve. The Chancery Court first narrowly defined the issue as "whether derivative and direct claims can be joined in a case involving a closely held corporation where there are only two shareholders." The traditional rule is that aggrieved shareholders may only sue for individual injury when they sustain a unique harm not suffered by other shareholders, and that all other claims are derivative in nature. The New Jersey Supreme Court follows that rule, but has not addressed the corollary rule that an inherent conflict exists when a party asserts both individual and derivative claims in the same action. Accordingly, the Chancery Court looked to an Appellate Division case, Brown v. Brown, 323 N.J. Super. 30 (App. Div., 1999). That case relied on Section 7.01 of the "American Law Institute's Principles of Corporate Governance" (2005) (ALI Section 7.01) and "held that under certain circumstances where the corporation in question is closely held, a court, in its discretion, may treat an action raising derivative claims as a direct action and exempt...