Tuesday, August 18, 2015
The Direct-Derivative Distinction in Kentucky Corporate Law
The direct/derivative distinction relates to whether or not a shareholder may bring a particular claim for their own benefit or, rather, whether the claim must be brought on a derivative basis for the benefit of the corporation. Essentially, if it is the corporation that has been injured, including by a director’s breach of fiduciary duty, the claim is derivative. It has from time to time been argued that, however, in closely held corporations, this distinction should be eliminated, and shareholders should, for their personal benefit, be able to pursue redress. Kentucky courts have carefully followed the direct versus derivative distinction, sometimes utilizing a “real party in interest” analysis. In addition, the direct versus derivative distinction has of late been applied in the context of LLCs.
In opposition to the direct versus derivative distinction, plaintiffs have in numerous cases argued that Section 7.01 of the ALI’s Principles of Corporate Governance should be applied to the effect that, in a closely held corporation, shareholders should be able to bring a direct action for breach of fiduciary duty. There is no published Kentucky decision in which this argument has been accepted. There are, however, at least two trial courts that have rejected this suggestion.
First, in Snyder v. Baumgardner, No. 09-CI-04445 (Jefferson Circuit Court, Div. 4, Cunningham, J), in an Order dated April 15, 2010, that was rejected the suggestion that pursuant to Section 7.01(d) of the Principles of Corporate Governance the plaintiff should be permitted to proceed on an individual, rather than a derivative basis, Judge Cunningham writing that the Principles had not been adopted by Kentucky courts.
Second, in Fenley v. Fencroft Company, No. 10-CI-0998 (Jefferson Circuit Court, Div. 2, Shake, J.), in an Opinion and Order dated April 25, 2011, while discussing the ALI Principles of Corporate Governance § 7.01 and the suggestion that, based thereon, the individual shareholder should be allowed to proceed on an individual rather than derivative basis, it was written that:
“While the ALI materials are certainly reasonable and make interesting reading, they are not the law of Kentucky and there exists at this time no exception [from the derivative action rules] for closely held corporations.”