Direct verses derivative claims are often confusing, even for seasoned attorneys, and the wrong claim can get an entire case dismissed. How to decide if the plaintiff in a claim for fiduciary duty or conversion should be the company itself, or an owner/shareholder. The recent Eastern District case entitled Minia Meisels, v. Henry Meisels, 2024 WL 3889007 (E.D.N.Y. Aug. 20, 2024) provides an excellent example, with a well-explained rationale, on an instance where claims are properly brought directly, even where multiple layers of corporate ownership might appear to muddy the waters. Both wise attorneys and business owners should keep this example in mind when preparing for litigation.
In Meisels v. Meisels, in a scenario worthy of a television drama, the plaintiff brought an action against her son and grandson concerning five properties. These properties, as is common now in property ownership, are owned by five separate limited liability companies. Each LLC, in turn, has one member (which member is one of five distinct New York corporations). Plaintiff claims to hold the majority interest in these five corporate owners of the five LLCs that own the five properties.
The Plaintiff brought her claims (which include breach of fiduciary duty and conversion, as direct claims in her individual capacity. The Plaintiff alleges that her son (who acted as the manager and, eventually, president, of the corporations, and also managed the properties) wrested her ownership from her by simply declaring that he now owns all the companies. Plaintiff also alleged that the son also caused the cessation of payments from the revenue of the properties that the Plaintiff had been receiving for years.
Defendants moved for a judgment on the pleadings, arguing that the claims presented should have been brought as derivative claims on behalf of the LLCs. Further, if the LLCs had been parties, diversity jurisdiction would be destroyed, as the parties would no longer be located in different states.
The Meisels Court applied the “Tooley Test,” which originated in Delaware but has been adopted in New York, to determine if the Plaintiff’s claims were properly pled. The Tooley Test instructs courts to consider (1) who suffered the alleged harm (the corporation or the suing stockholder, individually); and (2) who would receive the benefit of any recovery or other remedy (the corporation or the stockholder, individually). If the answer is the corporation, the claim is derivative, and if the answer is the individual shareholder, then the claim is direct.
Under these circumstances, there is no injury to the corporations and LLCs – indeed nothing changed at that level. Instead, the Plaintiff was damaged by the loss of control of her companies and the loss of money due her directly. Citing precedent, the Meisels Court stated “when a shareholder in a close corporation is denied the right to participate in distributions, that denial constitutes a breach of the fiduciary duty owed to that shareholder, and such a claim is direct because the harm and benefit of recovery accrue to the shareholder directly.”
Further, the Meisels Court found that Plaintiff had stated a direct claim here for a breach of fiduciary duty, as the son, as manager, owed a fiduciary duty to Plaintiff personally as a shareholder of the companies, which is independent of any fiduciary duty owed to the companies. Citing precedent, the Meisels Court stated, “New York law recognizes a fiduciary or trust relation which directors and officers sustain to stockholders, which imposes upon directors and officers as fiduciaries the duty not to use their position for their own personal advantage or for that of their confederates or to the detriment of stockholders.”
The Meisels Court noted that adding layers of corporate ownership, including holding companies does not undo this result. In sum, this was a strong-arm move to wrest control from the Plaintiff personally and deprive her personally of funds, and thus properly brought as a direct claim.
For the same reasons, the Meisels Court also found that the Plaintiff had sufficiently alleged conversion in asserting that Defendants claimed dominion over her “possessory interests in the cash, assets and LLC interest held by each corporation,” to her detriment by “asserting their own ownership,” denying the Plaintiff access to her own apartment, and transferring Plaintiff’s money to themselves. Again, it was the Plaintiff, not the companies, who was injured.
In rejecting the Defendants’ argument that the conversion claim rightly belongs to the LLCs, the Meisels Court noted that conversion claims are generally derivative where property is stolen from the company, but not where there is interference with distributions. Further, here there is alleged a wrongful takeover of the entire enterprise. It is equivalent to robbing Plaintiff of her own stock.
Thus, this case should undoubtedly serve as an excellent example for future litigants who want to argue similar direct claims, and further should remind all litigants of the critical importance of the Tooley Test in crafting claims or seeking to dismiss them.
