Authored By: Kenneth F. Neuman and Stephen McKenney
Michigan law has long distinguished between actions that may be properly brought by a shareholder on a direct, rather than derivative, basis. The established dividing line has traditionally focused on whether an action is brought “to enforce corporate rights or to redress or prevent injury to the corporation.” Mich Nat’l Bank v Mudgett, 178 Mich App 677, 679 (1989). In this scenario, the shareholder’s injury is derivative of those of the corporation and must be brought in accordance with the standing and notice requirements for commencing and maintaining a derivative action. (For example, MCL 450.1492a; MCL 450.1493a). The noted exception to this rule has been where “there is a breach of duty that is owed to the individual personally” resulting in a “special injury.” Belle Isle Grill Corp v City of Detroit, 256 Mich App 463, 474 (2003). Earlier this year, the Michigan Supreme Court refined the direct-versus-derivative divide in a unanimous opinion authored by Justice Zahra in Murphy v Inman, 2022 Mich. LEXIS 733 (Apr. 5, 2022).
Murphy concerned a direct action brought by a shareholder of Covisint Corporation in the midst of a cash-out merger with OpenText Corporation. Before the merger was consummated, the shareholder plaintiff brought suit in his individual capacity against the eight directors of Covisint alleging they had breached their fiduciary duties in connection with the merger. After a majority of Covisint shareholders approved the merger, the then former-shareholder plaintiff amended his complaint by alleging the directors had breached their fiduciary duties by failing “to maximize shareholder value when they sold Covisint,” by “engag[ing] in a flawed sales process,” by “act[ing] in their self-interest and received personal financial benefits as a result of the merger,” and by “issu[ing] a materially incomplete and misleading proxy statement….” Defendants moved to dismiss, arguing that plaintiff lacked standing as the claim was derivative in nature. Plaintiff responded that the directors owed statutory (MCL 450.1541a) and common law fiduciary duties directly to him, thus permitting a direct action by him. The circuit court sided with defendants and granted summary disposition, holding that “because plaintiff could not demonstrate an injury to himself without showing injury to the corporation, nor could he show harm separate and distinct from that of other Covisint shareholders, plaintiff’s action was derivative.” The Michigan Court of Appeals later affirmed in a per curiam unpublished opinion.
The Michigan Supreme Court reversed. It first held “that corporate directors owe common-law fiduciary duties directly to the shareholders of the corporation.” The Court rejected Defendants’ argument that the enactment of MCL 450.1541a eliminated directors’ common law fiduciary duties owing to shareholders, leaving only duties to the corporation. It reasoned “under this state’s common law, directors owe fiduciary duties first and foremost to the shareholders of the corporation; their roles within, and obligations to, the corporation cannot be properly understood without first recognizing this fundamental tenet of corporate law in Michigan.” Relying on the Delaware Supreme Court’s holding in Revlon, Incorporated v MacAndrews & Forbes Holdings, Incorporated, the Court held “in the context of a cash-out merger transaction, directors of the target corporation must disclose all material facts regarding the merger and must discharge their fiduciary duties to maximize shareholder value by securing the highest value share price reasonably available.”
Turning to the question of whether the shareholder action was direct or derivative, the Michigan Supreme Court adopted the Delaware Supreme Court’s test set forth in Tooley v Donaldson, Lufkin & Jenrette, Inc, 845 A2d 1031 (Del, 2004):
This framework is similar to the “exception” to the general rule recognized by the Court of Appeals in Belle Isle Grill and Mudgett; however, rather than focusing strictly on the duty allegedly breached and asking to whom that duty is owed, the Tooley framework streamlines the inquiry by asking (1) who suffered the harm, and (2) who will receive the benefit of any remedy. In answering the first question, the relevant inquiry is: “Looking at the body of the complaint and considering the nature of the wrong alleged and the relief requested, has the plaintiff demonstrated that he or she can prevail without showing an injury to the corporation?” The second question, whether the benefit of any recovery will go to the corporation or the shareholders individually, logically follows from the first.
Applying the Tooley rule in the context of the Covisint cash-out merger, the Court held that the plaintiff’s claims for breach of fiduciary duty were direct, not derivative. The harm resulting from the alleged breaches were personal to the shareholders, because “[a] higher or lower price received by shareholders for their shares in the cash-out merger in no way implicate[s] [the corporation’s] interests and causes no harm to the corporation.” Furthermore, “any remedy for defendants’ breach of their fiduciary duties would flow directly to plaintiff,” because “[]in a cash-out merger transaction, the target corporation itself does not receive any of the cash that constitutes the merger consideration.”
For litigators prosecuting or defending shareholder actions, Murphy v Inman should be required reading. Its holding provides a different lens through which direct or derivative actions should be gauged, albeit similar to the long-established rules recognized in Belle Isle Grill and Mudgett. And while in most instances the answer will be the same, Murphy underscores that this will not always be the case.