Direct Harm, Special Injury, or Duty Owed: Which Test Allows for the Most Shareholder Success in Direct Shareholder Litigation?

By Thompson, Elizabeth J. | Journal of Corporation Law, Fall 2009 | Go to article overview

Direct Harm, Special Injury, or Duty Owed: Which Test Allows for the Most Shareholder Success in Direct Shareholder Litigation?


Thompson, Elizabeth J., Journal of Corporation Law


I. INTRODUCTION

In corporate law, there are two avenues through which a shareholder may attempt to sue a corporation in which the shareholder has stock: a direct or a derivative cause of action.1 A direct action is a claim asserted by a shareholder to remedy a personal injury suffered by that shareholder.2 A derivative shareholder action is a claim brought by a shareholder on behalf of a corporation to remedy an injury suffered by the corporation when the corporation's directors or officers have failed to do so.3

Different tests exist to determine whether a shareholder may sue a corporation directly rather than derivatively, and state law determines which test is to apply.4 This Note analyzes the three most commonly used tests as applied in Delaware, Illinois, and Indiana. These states in particular are discussed because courts in Delaware, Illinois, and Indiana have decidedly chosen one test to apply and have sufficiently developed the case law to allow for an analysis of the three tests.

Part III.A of this Note investigates the direct harm test as applied in Delaware and the Delaware courts' inability to apply the direct harm test with clarity. Part III.B examines the special injury test used by courts in Illinois and highlights the lack of decisiveness within Illinois case law as to whether a special injury is one that is suffered by shareholders in general, or only by the specific shareholder who brings the suit. Part III.C explores the duty owed test as applied in Indiana and the exception the Indiana Supreme Court created for closely-held corporations, which allows for more successful direct shareholder claims.

Through this analysis, it appears that the duty owed and direct harm tests lead to the most shareholder success in direct shareholder litigation. However, the duty owed test is the least arbitrary, and most clearly defined and applied. Therefore, courts should apply the duty owed test to determine whether a shareholder claim states a direct cause of action.

II. BACKGROUND

A. Differences Between Derivative and Direct Shareholder Claims

In corporate law, shareholders have the power to sue the corporations in which they own stock through two different means: direct shareholder suits and derivative shareholder suits.5 In general, criteria vary for determining whether a shareholder has the authority to file a direct, rather than derivative, claim.6 However, the ability to bring a direct suit is important to a shareholder. This is because the remedies and procedural steps involved in direct actions are more beneficial to shareholders than the remedies and procedural steps in derivative actions.7

In a derivative lawsuit, shareholders bring an action on behalf of the corporation for a wrong to the entity itself.8 As a result, all damages received in a derivative suit belong to the corporation and not the individual shareholder bringing the suit.9 In a direct action, on the other hand, a shareholder brings an action against the corporation for an injury to the shareholder itself, and not the corporation as a whole.10 Therefore, in a direct shareholder action the court awards all damages directly to the shareholder or shareholders participating in the action.11 Although shareholders tend to have a preference for direct suits because of their ability to receive damages directly and to avoid procedural requirements such as demand,12 courts generally require that shareholders sue derivatively.13 This is intended to prevent multiplicity of lawsuits by shareholders, to protect corporate creditors by giving the money back to the corporation, to protect the interests of all shareholders by increasing the value of their shares, and to benefit the injured shareholders specifically by increasing the value of their shares.14

1. Derivative Shareholder Claims

Derivative shareholder claims allow shareholders to sue on behalf of the corporation in order to enforce a right of the corporation that the entity itself has failed to assert.

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