Opinion ID: 3161633
Heading Depth: 2
Heading Rank: 3

Heading: Direct Action v. Derivative Action

Text: ¶36. Since the companies are closely held corporations, we turn to whether Jo Ann’s action is a derivative or direct action. “There is little case law in Mississippi which addresses the difference between derivative and direct actions, but the general rule is that derivative actions seek recovery for injuries to the corporation.” Mathis v. ERA Franchise Sys., Inc., 25 So. 3d 298, 303 (Miss. 2009) (citing Bruno v. Sw. Servs., Inc., 385 So. 2d 620, 622-23 (Miss. 1980)). Section 7.01 of the Principles of Corporate Governance states: (a) A derivative action may be brought in the name or right of a corporation by a holder . . . to redress an injury sustained by, or enforce a duty owed to, a corporation. An action in which the holder can prevail only by showing an injury or breach of duty to the corporation should be treated as a derivative action. (b) A direct action may be brought in the name and right of a holder to redress an injury sustained by, or enforce a duty owed to, the holder. An action in which the holder can prevail without showing an injury or breach of duty to the 16 corporation should be treated as a direct action that may be maintained by the holder in an individual capacity. Mathis, 25 So. 2d at 303 (quoting Principles of Corporate Governance § 7.01 at 17). ¶37. “The action is derivative if the gravamen of the complaint is injury to the corporation, or to the whole body of its stock or property without any severance or distribution among individual shareholders, or if it seeks to recover assets for the corporation or to prevent the dissipation of its assets.” Mathis, 25 So. 3d at 303 (quoting 12B William Meade Fletcher, Cyclopedia of the Law of Corporations § 5911 (Rev. Ed. 2009)). “Thus, in determining whether the action belongs to the corporation or the individual, the focus of the inquiry is whether the corporation or the individual suffered injury.” Mathis, 25 So. 3d at 303. ¶38. In the present case, Jo Ann sought an accounting, asking the chancellor to compel Gerald to produce all financial records and to appoint a special master to examine the records and issue a report. Jo Ann also requested that the chancellor judicially dissolve the corporations and compel a stockholders’ meeting to dissolve the corporations. She further asked that the chancellor partition and distribute real property owned by the corporations. “An action to inspect corporate books and records is a direct action.” Principles of Corporate Governance § 7.01 at 18 cmt. (c). “Actions to require the holding of a shareholders’ meeting and actions to compel dissolution, appoint a receiver, or obtain similar equitable relief are direct actions.” Id. Thus, we find no standing issue as to Jo Ann’s accounting and corporatedissolution claims, as they are direct actions. ¶39. Jo Ann also maintained in her complaint that, as a fifty-percent owner of the Campground corporation, Gerald owed a fiduciary duty to her to account for all profits and 17 expenses and to divide the proceeds, and that he failed and refused to do so. She stated she was entitled to fifty-percent of the profits of the Campground corporation and that the chancellor should enter a money judgment. ¶40. This proposition that a shareholder exercising control over a closely held business owes a fiduciary duty to the other shareholders comes from the seminal case Fought v. Morris, 543 So. 2d 167 (Miss. 1989). Fought also involved dissension among shareholders in a close corporation. Id. at 169. Fought, the vice-president; Morris, the president; and Strong and Peyton each had equal shares. Id. at 168. Morris bypassed the stock-redemption agreement when he purchased Peyton’s stock, and Fought filed suit. Id. at 169. ¶41. This Court held that “in a close corporation where a majority stockholder stands to benefit as a controlling stockholder, the majority’s action must be ‘intrinsically fair’ to the minority interest. Thus, stockholders in close corporations must bear toward each other the same relationship of trust and confidence which prevails in partnerships . . . .” Id. at 171. The Court found that the controlling shareholder had breached his fiduciary duty to the corporation and other shareholders by purchasing stock in violation of the terms of the stockredemption agreement. Id. at 172-73. Fought, however, does not provide any analysis on whether the claim for a breach of fiduciary duty is a direct action or a derivative action. ¶42. Gerald chiefly relies on two cases, Derouen v. Murray and Mathis v. ERA Franchise Systems, Inc., to argue that Jo Ann’s claims were derivative in nature. Derouen, 604 So.2d at 1088; Mathis, 25 So.3d at 301. A derivative claim, Gerald argues, would be for the $180,000 Jo Ann claims Gerald improperly utilized out of the proceeds of the corporations 18 to purchase the stock of the minority shareholders. The present case, however, is distinguishable from Derouen and Mathis. ¶43. Derouen v. Murray involved shareholders each with a fifty-percent ownership of a closely held corporation. Derouen, 604 So. 2d at 1088. One shareholder, Derouen, challenged the propriety of the other shareholder/president’s actions after sale of the corporation’s operations. The other shareholder/president later had formed a new corporation which acquired the first corporation’s assets. Id. Derouen, named the president, Murray, as the sole defendant in his complaint. Id. at 1089. From the outset the chancellor saw Derouen’s action as an individual action against Murray. Id. at 1090. ¶44. Upon review, this Court stated “Derouen has never called his action a ‘shareholder's derivative action,’ but looking to its nature, the proof he made and the relief he sought, that is exactly what it is.” Id. “When, as here, Derouen charges Murray’s breach of his fiduciary duty of fair dealing to the corporation, he charges a violation of Murray’s duties to the corporation and only derivatively owed him.” Id. at 1091. ¶45. Although the Court found the action in Derouen was derivative in nature, “the opinion stated in a footnote that it could have been brought as a direct action.” Mathis, 25 So. 3d at 301 (citing Derouen, 604 So. 2d at 1091). According to the Derouen doctrine: (d) In the case of a closely held corporation . . . , the [chancery] court in its discretion may treat an action raising derivative claims as a direct action, exempt it from those restrictions and defenses applicable only to derivative actions, and order an individual recovery, if it finds that to do so will not (i) unfairly expose the corporation or the defendants to a multiplicity of actions, (ii) materially prejudice the interests of creditors of the corporation, or (iii) interfere with a fair distribution of the recovery among all interested persons. 19 Derouen, 604 So. 2d at 1091 n.2. (emphasis added). ¶46. However, because the chancellor did not consider the issue of whether or not the plaintiff’s claim was a direct or derivative action, this Court did not address it. Derouen, 604 So. 2d at 1091 n.2. ¶47. Gerald also cites Mathis v. ERA Franchise Systems to support his argument that Jo Ann could not bring the derivative action as a direct action. Mathis, 25 So. 3d at 301. Mathis is distinguishable as well. In Mathis, the shareholder of a closely held corporation known as Real Estate Professionals, LLC (“REP”), attempted to bring a derivative claim as a direct action, but the chancellor dismissed for lack of standing. Id. at 299. This Court affirmed the chancellor. Id. at 299. The Court did not extend the Derouen doctrine7 in Mathis. ¶48. “Keeping in mind that [applying the Derouen doctrine] is a question left to the discretion of the trial judge,” this Court found “that the complexity of this case militates against application of the doctrine. A review of cases from other jurisdictions reveals that the doctrine is almost always employed in purely intracorporate disputes.” Mathis, 25 So. 3d at 302. This Court continued to explain why the Derouen doctrine could not be applied in that case: Although Mathis has filed suit against his current and former business partners, there are four defendants who are not and have never been owners or members of REP. Given the number of parties involved and the existence of several counterclaims and cross-claims, it is likely that a direct recovery would interfere with a fair distribution of the recovery or expose the corporation to 7 We also have referred to the Derouen doctrine as the “Murray exceptions.” Phillips Brothers v. Winstead, 129 So. 3d 906, 921-22 (Miss. 2014). 20 a multiplicity of actions. Moreover, ERA has asserted that it is owed $300,000 from REP, making it a potential creditor that would be prejudiced if Mathis were to receive an individual recovery. Id. ¶49. We acknowledge that the chancellor, rather than this Court, was required to make a Derouen finding. The chancellor apparently based his decision to treat the closely held corporations as partnerships under the authority of Fought, but he made no on-the-record finding as required by Derouen. We find, however, that this error was harmless. If the chancellor had made an on-the-record Derouen finding, the result would have been the same. ¶50. Unlike in Mathis, neither Jo Ann nor Gerald presented any evidence that there were any potential creditors that could be prejudiced.8 Further, there is no danger of a multiplicity of suits, since Jo Ann and Gerald were the only two shareholders. There also is no indication that a direct action would interfere with a fair distribution of the recovery among all interested persons, because the only persons interested are Gerald and Jo Ann. ¶51. Jo Ann’s claims for an accounting and to compel a shareholders meeting to dissolve the corporations are direct actions, and thus not subject to the written-demand requirement for derivative actions. Jo Ann’s claim for a breach of fiduciary duty, while held to be derivative in other cases, can be treated as a direct action for the reasons discussed. Thus, we find that Jo Ann had standing to bring this action and was excused from the written-demand requirement. 8 The People’s Bank had been dismissed. No other creditors were joined as parties, nor were any outstanding debts identified during the trial. 21 II. Whether the chancellor erred by granting relief beyond the scope of the pleadings asserted by Jo Ann. and III. Whether the chancellor committed error by granting relief as to the divestment, division, and distribution of the assets of the corporate parties, outside the process of the corporate dissolution statutes. ¶52. Gerald argues that the chancellor erred in granting relief beyond the scope of the claims asserted by Jo Ann. He claims that, under Mississippi Rule of Civil Procedure 8(a), Jo Ann was required to set forth direct or inferential factual allegations respecting each material element necessary to entitle her to recovery under an actionable legal theory. Gerald argues the claims on which the chancellor premised a substantial portion of the Amended Final Judgment were not pleaded or asserted by Jo Ann. Such claims are: (1) seeking to treat the corporations as a “family partnership”; (2) the divestiture of Gerald’s stock interest in the Trailer Park; (3) damages as a derivative claim brought by Jo Ann; (4) the assessment of attorney’s fees and/or court costs on a basis other than what was set out in Mississippi Code Section 11-21-31; (5) the direct dissolution of the Trailer Park and the Restaurant; (6) the partition of property solely held in the name of the corporations; (7) piercing the corporate veil and setting aside the corporations; and/or (8) breach of a fiduciary duty by Gerald toward Jo Ann outside of an accounting. Gerald further contends that none of these claims was tried by implied consent. 22 A. Jo Ann’s Corporate-Dissolution Claim ¶53. Mississippi is a “notice pleadings” state. Upchurch Plumbing Inc. v. Greenwood Utils. Comm’n, 964 So. 2d 1100, 1117 (Miss. 2007). A claim for relief shall contain “a short and plain statement of the claim showing that the pleader is entitled to relief, and, a demand for judgment for the relief to which he deems himself entitled. Relief in the alternative . . . may be demanded.” M.R.C.P. 8(a). “Each averment of a pleading shall be simple, concise, and direct. No technical forms of pleadings or motions are required.” M.R.C.P. 8(e)(1). “All pleadings shall be so construed as to do substantial justice.” M.R.C.P. 8(f). “Every final judgment shall grant the relief to which the party in whose favor it is rendered is entitled by the proof and which is within the jurisdiction of the court to grant, even if the party has not demanded such relief in his pleadings.” M.R.C.P. 54(c) (emphasis added). ¶54. In her complaint, Jo Ann asked the chancellor to dissolve the Restaurant corporation under Mississippi Code Section 79-4-14.30(2)(i-iv), to judicially dissolve the Trailer Park corporation, and to compel a shareholders’ meeting to authorize the dissolution of the corporations. Toward the end of trial, Jo Ann expressed that she was not going forward with her dissolution claim, though it is unclear from the record whether the parties were referring to statutory dissolution, judicial dissolution, or both. The chancellor acknowledged this and stated he would re-open the record to allow Gerald to address the claims for dissolution if Jo Ann later decided to pursue that claim. The issue was never again addressed during trial. ¶55. Gerald argues that, although there was never a formal dismissal of Jo Ann’s claim, the chancellor was without authority under Sections 79-4-14.30, 14.33, and 14.34 of the 23 Mississippi Code to dissolve, divest, divide, and/or distribute the assets contained in the corporations. So, Gerald argues, the particular relief granted by the chancellor was not available. Gerald further argues the pleadings should not be considered amended under Rule 15(b) of the Mississippi Rules of Civil Procedure, because Gerald would suffer prejudice from such amendment. Par Indus., Inc. v. Target Container Co., 708 So. 2d 44 (Miss. 1998). ¶56. We find that the rules governing amendments under Rule 15(b) are not applicable here. Amending the pleadings to conform with the evidence concerns “issues not raised by the pleadings [that] are tried by expressed or implied consent.” M.R.C.P. 15(b). Jo Ann initially sought to dissolve the corporations. Nothing was formally adjudicated after she expressed her desire not to pursue dissolution. The chancellor stated, “[I]t was my understanding that . . . the issue of dissolution would remain in the complaint, with the understanding it would not be urged but could be brought up if tax issues were somehow resolved or worked into the total issue of this lawsuit.” The chancellor left the dissolution claim in the complaint “to accommodate either a resolution or some agreement if in the event they elected to proceed.” Notwithstanding whether the issue of dissolution was still before the chancellor, we find the relief granted was adequately pleaded and the chancellor was cloaked with sufficient authority to grant the relief ordered in this case.9 9 Although it is not binding authority, we note a case from Illinois that held that a court’s oral statement that a counterclaim might be withdrawn did not affect the withdrawal, because no order permitting withdrawal was entered on the record. Galter v. Galter, 323 Ill. App. 297, 55 N.E. 2d 405 (1944). 24 B. Whether the chancellor erred in denying Gerald’s election to purchase shares. ¶57. Section 79-4-14.30(a)(2)(i-iv) of the Mississippi Code provides the grounds for dissolution in a proceeding by a shareholder and also states that “shareholders may elect to purchase all shares owned by the petitioning shareholder at the fair value of the shares.” Miss. Code Ann. § 79-4-14.34 (a)(Rev. 2013). This election is “irrevocable unless the court determines that it is equitable to set aside or modify the election.” Id. (emphasis added). Gerald elected to purchase all the shares owned by Jo Ann at fair value, but the chancellor determined it was equitable to set Gerald’s election aside. ¶58. Gerald argues that, since the chancellor set aside the election to purchase Jo Ann’s shares of the Trailer Park and the Restaurant, the chancellor was no longer clothed with broad authority under Sections 79-4-14.30, 14.33, and 14.34 of the Mississippi Code to dissolve, divest, divide, and/or distribute assets contained in the corporations. Outside the scope of a dissolution action, Gerald argues, the chancellor is not authorized to utilize these equitable powers because such powers are to be relied upon when an election to purchase has been asserted. Gerald cites In the Matter of Will and Testament of Hardin, 158 So. 3d 341 (Miss. Ct. App. 2014), to support this argument. ¶59. We find In re Hardin does not support Gerald’s assertion that a chancellor is cloaked with broad equitable relief only if he grants the election to purchase the petitioning shareholder’s shares. In In re Hardin, a shareholder filed an action under the Mississippi Business Corporation Act to judicially dissolve an incorporated family farm, which was owned by four shareholder siblings. In re Hardin, 158 So.3d at 343. The corporation moved 25 to elect to purchase the petitioning shareholder’s shares, which the chancellor granted. Id. at 344. The chancellor ordered the corporation to convey to the shareholder a portion of real property instead of a cash buyout. Id. The Court of Appeals held that “the chancellor was still within his right to reserve an in-kind division of land in lieu of a cash payment. Section 79–4–14.34(i) specifically allows for the ‘inherent equity powers of the court to fashion alternative remedies to judicial dissolution.’” Id. at 346. We find that nothing in this case or the dissolution statutes suggests that a chancellor must grant the election to purchase the petitioners’ shares before continuing to exercise his broad equity powers in granting relief under Section 79-4-14.34 (i) of the Mississippi Code. C. Alternative Remedies to Dissolution ¶60. We now turn to the relief granted by the chancellor. In an action to judicially dissolve a corporation, a chancellor does not have to order a dissolution, even if grounds such as oppression or deadlock are met. This is because the general view in Mississippi is that “[d]issolution is an extraordinary remedy to be sparingly administered in exceptional cases only.” Capitol Toyota, Inc. v. Gervin, 381 So. 2d 1038, 1039 (Miss. 1980). However, “if the strife among the participants has been so long and bitter that the former relationships of congeniality and trust cannot be re-established [like Jo Ann and Gerald’s case], there is little left that an unhappy shareholder can do except . . . bring about the dissolution of the business.” F.H. O’Neal & R. Thompson, O’Neal’s Close Corporations § 9.04 (3d ed. 1971). “But the more common relief in modern cases . . . is to provide relief alternative to dissolution.” Id. at § 9.25. Mississippi’s corporate dissolution statute states that “[n]othing 26 contained in this section shall diminish the inherent equity powers of the court to fashion alternative remedies to judicial dissolution.” Miss. Code Ann. § 79-4-14.34 (i) (emphasis added). ¶61. Contrary to Gerald’s assertion, the chancellor did not dissolve the corporations. Instead, he fashioned an alternative remedy to this problem. The chancellor found that the source of funds for the $180,000 Gerald used to purchase the minority shareholders’ interest in the Trailer Park and the Restaurant corporations came from the corporations themselves. Those shares were purchased with funds equitably owned by both Jo Ann and Gerald. So Gerald’s purchase was for the benefit of both parties. The chancellor then disregarded the shares purchased by Gerald and considered Jo Ann and Gerald to be equal shareholders in the Restaurant and the Trailer Park. After equalizing their interests in the corporations, the chancellor ordered that the property lines be modified by survey to reflect that Jo Ann and Gerald owned fifty-percent of the land upon which the Trailer Park and the Campground were situated. ¶62. The Amended Final Judgment from which Gerald appeals states “that the Court divides, partites, and equitably separates the parties by granting each full ownership of separate companies . . . .” He then granted Jo Ann full ownership of the Trailer Park, and Gerald full ownership of the Campground. The chancellor ordered “that each of the parties is to execute the necessary documents, including deeds, bills of sale and stock certificates to accomplish the directions of the court.” Nowhere in the Amended Final Judgment does the chancellor mention “dissolution.” The chancellor did quite the opposite when he fashioned 27 an alternative remedy to dissolution, which he had full authority to do under Section 79-4- 14.34 (i) of the Mississippi Code. ¶63. Since the chancellor did not order a direct dissolution of the corporations, Gerald’s argument that this “equitable distribution” method violates the method provided by the Mississippi Legislature in Section 79-4-14.05 to dissolve a corporation and distribute its assets among its shareholders according to their interests is without merit. ¶64. We cannot locate any precedent in which a chancellor has granted this exact, or even similar, relief. However, we note that “[i]t is not necessary that some exact precedent be found for extending relief in a given situation.” Griffith’s Mississippi Chancery Practice § 35 (2000 ed.) (citing Miller v. Doxey, 1 Miss. 329, 333 (1829)). If a certain form of “relief is clearly requisite and a practical remedy may be applied, such remedy is not to be denied because that remedy has never been applied in just that manner to that exact state of case.” Id. The question for this Court to decide, then, is whether the relief granted here is an appropriate remedy under Mississippi Code Section 79-4-14.34(i), which states “[n]othing contained in this section shall diminish the inherent equity powers of the court to fashion alternative remedies to judicial dissolution.” Although little caselaw addresses Mississippi’s alternative-remedy provision, substantial precedent supports the chancellor’s broad powers to provide an equitable solution in cases such as this. See, e.g., In re Hardin, 158 So. 3d at 346. ¶65. Other jurisdictions offer guidance as to appropriate remedies to resolve disputes among dissenting shareholders in a close corporation. Some courts have resorted to remedies 28 listed by statute, while others have fashioned remedies not specifically mentioned in a statute. O’Neal’s Close Corporations at § 9.35. The corporate statutes in California and North Dakota, for example, authorize a court to “grant any equitable relief.” Id. at § 9.35; see Cal. Corp. Code § 1804, and ND Cent. Code § 10-19.1-115. ¶66. “In many states the statute authorizes courts to provide relief other than dissolution, and then sets out a nonexclusive list of what that relief may be.” O’Neal’s Close Corporations § 9.35; see e.g., Me. Rev. Stat. Ann. tit. 13A, § 1123; SC Code Ann. § 33-14310. “In the absence of statute, courts [show] a willingness to fashion a remedy that is best suited in the particular factual circumstances to resolve the problem presented to the court.” O’Neal’s Close Corporations at § 9.35. In Baker v. Commercial Body Builders, Inc., the Supreme Court of Oregon listed several remedies available for oppressive conduct as an alternative to dissolution. Baker v. Commercial Body Builders, Inc., 507 P.2d 387, 395-96 (1973). Subsequently, courts across the country have applied one or more of the remedies listed in Baker, and other courts have fashioned remedies in addition to those in Baker. A sample of such remedies includes: (1) Ordering issued stock to be cancelled or redeemed [to] achieve a 50/50 balance or some other ownership structure fair to the shareholders. (2) Permitting the minority to purchase additional shares . . . . (3) Treating a group of related corporations as a single entity for the purpose of determining appropriate relief. (4) Awarding damages to the minority shareholder as compensation for injuries suffered by oppressive conduct, sometimes including the awarding of punitive damages. O’Neal’s Close Corporations at § 9.35. 29 ¶67. After reviewing these alternative remedies, and in light of all the particular factual circumstances of this case, we find that granting full ownership in the respective separate corporations operated individually by Gerald and Jo Ann was a practical, fair, and just remedy to resolve the dispute. A chancellor’s remedial powers have long been “marked by plasticity.” Griffith’s Mississippi Chancery Practice § 35 (citing Hall v. Wood, 443 So. 2d 834, 843 (Miss. 1983)). “Equity jurisdiction permits innovation that justice may be done.” Id. If ever a case needed the innovation allowed by equity jurisdiction, it is this one. Considering that nothing “shall diminish the inherent equity powers of the court to fashion alternative remedies to judicial dissolution,” Miss. Code Ann. § 79-4-14.34 (i), we find that the chancellor did not abuse his discretion in fashioning this alternative remedy.