A friend and fellow corporate law professor (one of those wise folks that use Klein, Ramseyer & Bainbridge) sent along this question:
On the issue of direct versus derivative claims, there is some language on pp. 360-61 of the casebook (and in the accompanying slides) that may be confusing. We start with a general proposition that "a claim for breach of fiduciary duty can only be brought as a derivative suit" ( https://tremblylaw.com/difference-shareholder-derivative-suit-vs-direct-claim/ ) because fiduciary duties are generally understood run to the corporation, and thus any harm to the shareholders from breach thereof is derivative. However, we are told on the bottom of p. 361 that "the Tooley test [for direct claims] has been limited to claims asserting breach of fiduciary duty." If fiduciary claims are always derivative claims, why would we need a test for whether they can be brought as direct claims?
Put another way, there seems to be an apparent conflict between a general rule that says fiduciary claims are always derivative and a test that at least implies some fiduciary claims can be brought as direct claims.
My answer starts with rejecting the premise of the question; i.e., I don't agree that "a claim for breach of fiduciary duty can only be brought as a derivative suit.” To be sure, you can find opinions claiming that “cases are legion that a shareholder may not sue directly for breaches of duties by officers and directors of a company because those injuries are actually suffered by the corporation.”[1] It’s not clear when or where this belief took hold, but the weight of authority is to the contrary.
As the Delaware Supreme Court has explained:
Tooley and its progeny … deal with a different subject: determining the line between direct actions for breach of fiduciary duty suits by stockholders and derivative actions for breach of fiduciary duty suits subject to the demand excusal rules set forth in § 327 of the Delaware General Corporation Law, Court of Chancery Rule 23.1, and related case law.[2]
Obviously, it would be necessary to draw such a line only if there are two distinct categories that need to separated.[3]
Consider the classic business judgment rule case, Smith v. Van Gorkom, which was brought as “a class action”—not a derivative suit.[4] Likewise, in Omnicare, Inc. v. NCS Healthcare, the shareholders brought “a class action brought by NCS stockholders seeking to invalidate the merger primarily on the ground that the directors of NCS violated their fiduciary duty of care in failing to establish an effective process designed to achieve the transaction that would produce the highest value for the NCS stockholders.”[5]
In fact, most litigated cases fall into the direct category. Professors Black, Cheffins, and Klausner conducted a study of litigation involving outside directors, which found “136 hits for derivative suits and 235 hits for direct suits” in Westlaw’s MBUS-CS directory. They specifically identify “twelve post-1980 direct suit trials … involving fiduciary duty claims against outside directors of public companies, compared to “five post-1980 derivative suits … where there was a trial involving a claim for damages against outside directors of a public company.”[6]
Many scholars have read the law similarly. O’Neal and Thompson’s treatise, for example, opines that “A challenge to action taken by controlling shareholders or directors based on breach of fiduciary duty traditionally was brought as a derivative suit, but now is more likely to be brought as a direct suit.”[7]Deborah Demott asserts that “cases permit individual shareholders to sue directly when the directors misuse their powers,” resulting in a breach of fiduciary duty.[8] Nadelle Grossman states that “Stockholders can enforce directors' fiduciary duties through either a direct suit on behalf of that stockholder, where there is damage personal to that stockholder, or through a derivative suit to enforce the directors' duties on behalf of the corporation.”[9]
[1] 7547 Corp. v. Parker & Parsley Dev. Partners, L.P., 38 F.3d 211, 221 (5th Cir. 1994).
[2] NAF Holdings, LLC v. Li & Fung (Trading) Ltd., 118 A.3d 175, 179 (Del. 2015). The “different subject” to which the court referred in NAF Holdings was a claim arising out of a commercial contract under which the suing shareholder had personal rights. The NAFHoldings court held that, under those circumstances, the “the Tooley analysis was not needed to determine whether the commercial-contract claim was direct or derivative. As we explained there, when a plaintiff asserts a claim based upon the plaintiff's own right, such as a claim for breach of a commercial contract, Tooley does not apply.” El Paso Pipeline GP Co., L.L.C. v. Brinckerhoff, 152 A.3d 1248, 1259 (Del. 2016). In El Paso, however, the Court further clarified that “NAF Holdings does not support the proposition that any claim sounding in contract is direct by default, irrespective of Tooley.” Accordingly, it held that where a “sounds in breach of a contractual duty owed to the Partnership, we employ the two-pronged Tooley analysis to determine whether the claim ‘to enforce the [Partnership's] own rights must be asserted derivatively’ or is dual in nature such that it can proceed directly.”). As one commentator summarizes the result:
Following El Paso, Tooley applies to any claim to enforce rights that belong, at least in part, to a company. In a corporate case, a fiduciary duty suit against the board of directors invokes Tooley because directors owe fiduciary duties to both the corporation and its stockholders. In an alternative entity case, a claim for breach of the entity’s constitutive contract invokes Tooley if it involves contractual duties owed, at least in part, to the entity itself. The fact that a plaintiff is a party to that constitutive contract does not give the plaintiff standing to assert all claims for breach of that contract directly.
Michael Sirkin, Direct, Derivative, or Both? Delaware Supreme Court Answers Questions of Claim Ownership, 21 No. 3 M & A Law. NL 1 (Mar. 2017).
[3] See also Citigroup Inc. v. AHW Inv. Partn., 140 A.3d 1125, 1139 (Del. 2016) (holding that “there must be some way of determining whether stockholders can bring a claim for breach of fiduciary duty directly, or whether a particular fiduciary duty claim must be brought derivatively on the corporation's behalf. We established Tooley's two-pronged test as a means of determining whether such claims are direct or derivative.”).
[4] Smith v. Van Gorkom, 488 A.2d 858, 863 (Del. 1985).
[5] Omnicare, Inc. v. NCS Healthcare, Inc., 822 A.2d 397 (Del. 2002).
[6] Bernard Black et. al., Outside Director Liability, 58 Stan. L. Rev. 1055, 1155 (2006).
[7] 2 O'Neal and Thompson's Oppression of Minority Shareholders and LLC Members § 7:7.
[8] Deborah A. DeMott, Beyond Metaphor: An Analysis of Fiduciary Obligation, 1988 DUKE L.J. 879, 920.
[9] Nadelle Grossman, Director Compliance with Elusive Fiduciary Duties in a Climate of Corporate Governance Reform, 12 Fordham J. Corp. & Fin. L. 393, 400 (2007).
