The Difference Between Shareholder Derivative Lawsuits and Direct Shareholder Lawsuits in Massachusetts

The Parker Scheer business lawyers have handled a large number of Massachusetts shareholder lawsuits, both for plaintiff shareholder groups and for defendant controlling groups and corporations. We have found that our clients are often times confused over the difference between direct shareholder lawsuits and shareholder derivative lawsuits in Massachusetts. An understanding of the difference is important, as it deals directly with the issue of whether the shareholder is compensated or the corporation is compensated.

As a starting point, Massachusetts law requires that shareholders in a closely held (also called a "close" or non-public) corporation, have a duty to one another of the utmost good faith and fair dealing. In other words, a shareholder cannot use his or her position to his wrongful or unfair advantage and to the detriment of another (usually minority) shareholder. When that happens, it usually gives the minority shareholder the right to bring a lawsuit directly against the majority shareholder.    

Sometimes however, the wrongful conduct is not against the individual shareholder, but against the corporation. For instance, if Mr. Smith as a shareholder and president of XYZ Corporation is presented with a business opportunity for the corporation, but instead, diverts the business to another company with which he is involved, it is not a single shareholder who is being harmed, but the corporation. The right to that business belonged to the XYZ Corporation. In that instance it would be appropriate for one or more shareholders to bring a shareholders derivative lawsuit on behalf of the corporation.

Contrast that situation to a situation often seen in the Massachusetts courts where several persons form a corporation, and invest money with the expectation that they will all work in the corporation and have the benefit of an income. After two years, the majority shareholder fires the minority shareholders and refuses to declare dividends or other payments. The minority shareholders are, in effect, "frozen out".   Because stock in closely held corporations typically has no ready market and the shares cannot be sold.   The claim is a personal claim by the minority shareholders against the majority shareholder, and if the minority shareholders succeed they will be awarded relief individually, giving rise to a direct shareholder lawsuit.

Occasionally, the distinction even causes the courts trouble. For instance, in one case the majority shareholders in a close corporation authorized outsized salaries for themselves as corporate officers and for other family members. A judge of the Massachusetts Superior Court ordered payments back to the minority shareholders but the Massachusetts Appeals Court reversed, holding that the salaries were taken from the corporation and therefore it was the corporation which had the remedy and not the shareholders, even if the salaries were part of a freeze-out scheme.

It is important to know whether your claims against a majority shareholder or controlling group are personal or belong to the corporation. Usually, a consultation with an experienced Massachusetts business litigation lawyer will provide you with the knowledge necessary to move forward. If you are in the Boston metropolitan area, a member of the Parker Scheer business litigation group will be happy to assist you. Contact Barry Scheer or Garrett Lee to set up an appointment.

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For more information on shareholder lawsuits or if you are seeking a Boston business lawyer for any other needs, please contact Barry Scheer. If you prefer, you can also telephone our offices in Boston seven days a week at toll free 866-414-0400.

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