Tuesday, November 1, 2011
Diminution in Value is a Corporate, and Not an Individual, Claim
Diminution in Value is a Corporate, and Not an Individual, Claim – Kepley v. Lanz
In a recent decision of the United States District Court, Western Division, by Judge Simpson, the distinction between direct and derivative claims was again addressed. Kepley v. Lanz, 2011 WL 4578362 (W.D. Ky. Sept. 30, 2011).
Bruce and Les Kepley were each shareholders in A Technological Advantage, Inc. (“ATA”), a Kentucky business corporation. The Kepleys initiated suit against Gerald Lanz, a former shareholder of ATA who, it was alleged, had breached an Investors Rights Agreement by selling his ATA stock to one of its competitors. The Kepleys asserted that Lanz’s sale reduced the value of their ATA stock. Ultimately, the Kepleys sold their ATA stock in order to minimize their losses.
Reciting the general rule that a litigant “must normally assert their own rights, rather than those of third parties,” the Court discussed the rule that a shareholder may not, in their own name, bring an action to redress an injury to the corporation. Quoting Candem Pharmaceutical Ltd. v. Elder Pharmaceuticals, Inc., 862 F.2d 597, 603 (6th Cir. 1988), the Court noted that this rule applies:
Even though in an economic sense real harm may well be sustained as the impact of such wrongful acts [brings] about reduced earnings, lower salaries, injury to general business reputation or diminution in the value of ownership. (emphasis in original).
The Court held that Lanz’s alleged breach of the Investors Rights Agreement actually harmed ATA, the corporation. Consequently, the claim had to be brought on a derivative, not a direct basis. The Court noted the possibility of a derivative action, but there is no explanation as to why the action was not brought in that form.
The Court specifically addressed and rejected a notion that the Kepley’s claim was somehow separate and distinct from the injury suffered by the corporation, thereby enabling a direct action:
The only injury the Kepleys allege is that the value of their ownership shares declined. Such an injury would necessarily have been shared by the corporation because the shares of the corporation derived their value from the value of the corporation as a whole.
It is worth noting that, apparently, the dismissal of this action for lack of standing was raised sua sponte by the Court and was not initially raised as a defense by Lanz. No reference was made to the statutory provision for the payment of the corporation’s legal fees where the proceeding was brought without reasonable cause. KRS § 271B.7-400(4).
A 2010 decision of the Kentucky Court of Appeals likewise held that diminution of share value is a derivative, and not a direct, claim. Sahni v. Hock, No. 2007-CA-001785-MR (Ky. App. 2010), slip op. at 13-15.
No word on whether an appeal is planned.