Newman v. Newman:  Fiduciary Duties in Small, Closely-Held Family Corporations

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This blog previously has discussed fiduciary duty claims in the shareholder-derivative context.  Courts in derivative suits frequently address fiduciary duty questions, especially where the dispute involves a small, closely-held family corporation.   

Yet another recent decision of the Appellate Division, First Department, deals with fiduciary duties in a derivative action:  Newman v. Newman, 202 A.D.3d 442 (1st Dep’t 2022).  This case is helpful to understand how shareholder-derivative plaintiffs can avoid dismissal of claims they bring in their own, individual capacities, in contrast to derivative claims brought on behalf of the corporation itself.

The plaintiff in this dispute, Charles Newman (“Charles”), sued his father, Harvey Newman (“Harvey”), both derivatively on behalf of a corporation that they owned together, Port Parties, Ltd. (“Port Parties”), as well as in his own individual capacity.  Port Parties never had a Board of Directors, but instead operated under Harvey’s exclusive and total control.  Harvey was also the President of Port Parties.  According to the complaint, Harvey breached his fiduciary duties to Port Parties by engaging in a scheme where he illegally diverted millions of dollars from the company.  In connection with this scheme, Harvey allegedly failed to declare these diverted funds as income on his tax returns, apparently in an attempt to cover up his misconduct.  As a result, Harvey allegedly exposed Port Parties to millions of dollars in tax liabilities. 

Charles also brought a breach of fiduciary duty claim against Harvey in Charles’s individual capacity as a shareholder of Port Parties.  By that claim, Charles alleged that Harvey’s misconduct had exposed him to personal civil and criminal liability for failing to pay company taxes.

The defendants in the case moved to dismiss Charles’s claims pled in his individual capacity, but the lower court denied their motion.  The Appellate Division affirmed, and upheld Charles’s individual claim on two separate grounds. 

First, the Appellate Division held that Charles’s individual claim was not duplicative of his derivative claim on behalf of Port Parties, because Charles sufficiently alleged that he was exposed to personal liability as a result of Harvey’s misconduct: 

The motion court correctly determined that plaintiff’s individual claim[ ] for breach of fiduciary duty . . . w[as] not duplicative of the derivative claims asserted on behalf of nominal defendant Port Parties Ltd. and therefore, that plaintiff’s individual claims could proceed based on the allegations that he, individually, was exposed to personal criminal and civil liability as a result of defendants’ conduct.

Newman, 202 A.D.3d at 443. 

This is a key element of successful individual claims brought in a shareholder-derivative action:  such claims must clearly plead that the plaintiff, in his or her individual capacity, sustained some sort of harm separate and distinct from the harm to the corporation.  As the Newman court explained:  “The alleged harm to plaintiff – namely, potential personal civil and criminal liability as a result of defendants’ alleged misappropriations from the corporation – is an individual harm sufficiently ‘separate and distinct’ from the harm suffered by the corporation on account of defendants’ failure to pay certain state and federal taxes.”  Id.

Second, the court held that Charles’s claim sufficiently pled an independent breach of fiduciary duty owed to him in his individual capacity, as opposed to a duty owed by Harvey to Port Parties itself.  The father-son relationship of the parties was important here:  “Given the allegations that the nominal defendant corporation was a closely-held family business co-owned by plaintiff and his father, who is also a defendant, a separate fiduciary duty arises from their status as family members.”  Id.  As a result of this independent fiduciary duty to Charles, he was differently situated than a typical “arm’s length” shareholder “whose stock value would be affected by the individual defendants’ conduct.”  Id. at 444.  In other words, Charles suffered harm—personal liability exposure—separate and distinct from the mere decline in stock value that a typical shareholder might sustain.  As a result, Charles could pursue his individual claim.