Burg v. Horn

United States Court of Appeals for the Second Circuit · 1967 · Corporations

CorporationsShareholder derivative suitsCounterclaimsderivative actioncounterclaimopposing partyclosely held corporationindividual relief

Facts

Plaintiff alleged that she was a shareholder, director, and secretary of Darand Realty Corp., and that Max and George Horn were the corporation's other shareholders, directors, and officers. She sued derivatively, claiming the Horns profited from a real estate opportunity Darand could have taken, retained part of Darand's rents, charged false or excessive expenses, and borrowed corporate money. Defendants responded with a counterclaim alleging that plaintiff was withholding stock dividends and a bond and mortgage belonging to Darand. Plaintiff argued that because she sued only derivatively, the corporation could not counterclaim against her individually.

Issue

May defendants assert a counterclaim against a shareholder plaintiff individually when she has brought the action in derivative form on behalf of the corporation? More specifically, does the usual bar on individual counterclaims in derivative suits apply where the case is effectively a dispute among the corporation's few shareholders and the relief may be molded directly among them?

Rule

The general rule is that a shareholder suing derivatively is not an "opposing party" for purposes of a counterclaim alleging her individual liability to the corporation, because she sues only to vindicate a corporate right and ordinarily has no personal interest in the recovery. But that rule is not absolute: where the derivative action is in substance a suit to determine the rights of the individual parties against one another, and the likely relief may bypass a formal payment to the corporation, an individual counterclaim may properly be entertained in the same action.

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One of 10 multiple-choice questions for this case. Pick an answer to see why.

In Portland, Maine, Lena Ortiz owns 25 shares of Harbor Row Properties, a closely held corporation whose only other shareholders are Nolan Pike and Erica Velez. Lena files a derivative suit alleging Nolan and Erica diverted rental income and overbilled the corporation for repairs; the defendants respond that Lena is personally holding a corporate promissory note and refuse to release it unless paid herself.

If Lena moves to dismiss the responsive pleading on the ground that she sued only derivatively, how should the court rule?

Explanation. The majority recognized a general rule that a shareholder suing derivatively is ordinarily not an opposing party for a claim alleging her individual liability to the corporation. But it also recognized a limited exception when the case is in substance a dispute among the individual shareholders of a closely held corporation and the likely relief may effectively bypass formal payment to the corporation. These facts fit that exception, so dismissal should be denied. (Derived from Burg v. Horn (1967).)