Commercial Division Blog

Posted: January 4, 2014 / Categories Commercial, Business Divorce, Derivative Actions, Corporations

Appropriate Vehicle to Address Grievances In Two-Shareholder Corporations is Derivative Action

On December 20, 2013, Justice Demarest of the Kings County Commercial Division issued a decision in Machaneinu, Inc. v. Luria, 2013 NY Slip Op. 52197(U), concluding that a 50 percent shareholder of a not-for-profit corporation lacked authority to initiate a direct action on behalf of the corporation against the other 50 percent shareholder for breach of fiduciary duty, and instead, the lawsuit had to be maintained as a shareholder derivative action.

In Machaneinu, the court concluded that the 50 percent shareholder who initiated the direct action had authority as president of the corporation to cause the corporation to bring the lawsuit. However, a month after the lawsuit was filed, the corporation's board of directors passed a valid resolution that the lawsuit should be withdrawn. The court, therefore, dismissed the action without prejudice to commencement of a shareholder's derivative action. In its conclusion the court remarked:

[W]here, as in the instant case, a corporate entity is equally owned by two members or shareholders, and the suit is brought by one against the other claiming breaches of fiduciary duty and diversion of corporate assets, that the appropriate vehicle to address such grievances is not a direct action by the corporation against one of the 50% owners, but is a shareholder's derivative action brought by one of the shareholders, and that a direct action by the corporation must be dismissed.

In the context of most closely-held corporations with two equal owners, the technical distinction between a direct claim by corporation and a shareholder derivative claim will be largely a formality, since demand futility should be a foregone conclusion where the two owners of the corporation are deadlocked. In the case of a not-for-profit or other entity with non-shareholder directors, however, the requirement to bring a derivative action may be dispositive.