Minority shareholder barred from bringing a direct action because (i) she failed to allege a “special injury separate and distinct” to her and (ii) direct action may harm creditors of the corporation. Callicott v. Scott, 849 S.E.2d 547 (Ga. Ct. App. 2020).
Homeowners Mortgage of America, Inc. (“HOMA”) was a mortgage lending company that operated from 1998 through July 2014. In 2008, HOMA’s founding shareholder agreed to merge HOMA with Foundation Financial Group, LLC (“FFG”). After the transaction was consummated, the founding shareholder and two FFG shareholders each retained a one-third ownership interest in HOMA. Beginning in 2012, the majority shareholders created various companies to provide marketing, accounting, and other administrative services to HOMA, and in turn, HOMA was charged a fee for services rendered by these companies. The founding shareholder claimed that the majority shareholders caused HOMA to pay inflated fees to these companies, and that the majority shareholders operated these companies as part of a scheme to misappropriate funds from HOMA. As a minority shareholder in a close corporation, the founding shareholder brought a direct action against the remaining shareholders alleging that they breached their fiduciary duties to HOMA because they “misappropriated corporate assets and disguised these misappropriations on corporate documents to hide the nature of their activities.” Relevant to the case at hand was the defendant shareholders’ first motion for summary judgment in which they argued that the founding shareholder lacked standing to proceed individually to recover from HOMA because the founding shareholder’s claims were derivative in nature.
The defendant shareholders argued that the founding shareholder was required to file a derivative action on HOMA’s behalf, not a direct action. In a direct shareholder action, the shareholder “sues on her own behalf for injuries done to her in her individual capacity by corporate fiduciaries, and any damages recovered go to the shareholder rather than the corporation.” On the other hand, in a shareholder derivative action, the shareholder “sues on behalf of the corporation for the harm done to it, and any damages recovered by the shareholder are paid to the corporation.” Under Georgia law, a direct action, rather than a derivative action, is appropriate when the plaintiff shareholder “alleges a special injury separate and distinct from that suffered by other shareholders, or alleges a wrong involving a shareholder contractual right existing apart from any right of the corporation.” The Court of Appeals of Georgia noted that whether a claim is direct or derivative depends on what the plaintiff alleged.
The founding shareholder’s complaint alleged that the defendant shareholders misappropriated corporate assets, but in Georgia, the prevailing rule is that claims of misappropriation of corporate assets and breach of fiduciary duty can only be raised in a shareholder derivative suit since the injury is suffered by all shareholders and the corporation. Furthermore, one reason for requiring derivative suits is “to protect corporate creditors by ensuring that the recovery goes to the corporation.” Here, HOMA had an outstanding judgment creditor. The court highlighted the fact that the founding shareholder’s direct action could “circumvent” the judgment creditor’s rights as a creditor because any damages would go to the founding shareholder. If the founding shareholder would have brought a derivative action rather than a direct action, the judgment creditor would have been protected because any damages would have flowed to HOMA. Accordingly, the Court of Appeals of Georgia ruled that (i) the founding shareholder lacked standing to bring a direct action because she failed to allege a “special injury separate and distinct” to her and (ii) the founding shareholder was required to bring a derivative action to protect the outstanding judgment creditor of HOMA.
Courtesy of Jeff Dutson (King & Spalding LLP)