Pennsylvania Superior Court Decision Required Claims to be filed “Derivatively” As Opposed to Individually on Behalf of a Shareholder

Posted in Shareholder Oppression

On February 5, 2014, a Superior Court of Pennsylvania issued an interesting and important decision explaining when claims must be brought derivatively as opposed to individually in the name of a shareholder. Hill v. Ofalt, 85 A.3d 540 (Pa. Super. Ct. 2014).

A “derivative” claim is a lawsuit brought by a shareholder on behalf of the corporation against a third-party. The central issue in Hill v. Ofalt, was whether or not Thomas Hill (“Hill”) a 50% shareholder of a closely held Pennsylvania corporation called Millstone Restaurant Company, Inc. (“Millstone”) could assert direct claims alleging breach of contract, breach of fiduciary duty, unjust enrichment, and conversion and seeking declaratory relief all against the other 50% shareholder, Defendant Ronald Ofalt (“Ofalt”). After considering the nature of those claims, the Superior Court of Pennsylvania held that Hill could not assert those claims directly. In other words, the Pennsylvania Appellate Court agreed with the Trial Court that those claims belonged to the corporation and therefore had to be asserted derivatively. Nevertheless, the Hill Court reversed the Trial Court’s denial of Hill’s motion to amend the complaint, so as to assert derivative claims.

The decision is important and interesting because it provides a good explanation as to when claims must be brought derivatively as opposed to individually in Pennsylvania. In summary, the analysis hinges on who suffered the complained damages as alleged in the complaint. In this case, the Plaintiff alleged that Ofalt was stealing from the corporation. Moreover, Hill alleged that Ofalt stole trustee taxes from the company. Furthermore, Hill alleged as a result of Ofalt’s unlawful activities the corporation eventually went out of business exposing Hill to personal financial peril because he personally guaranteed the corporation’s mortgage.

The Superior Court of Pennsylvania analyzed each of the claims raised in the complaint. The Hill Court held, “under established Pennsylvania law, a shareholder does not have standing to institute a direct suit for "a harm [that is] peculiar to the corporation and that is only indirectly injurious to the shareholder." Hill v. Ofalt, 85 A.3d at 548 (quoting, Reifsnyder v. Pgh. Outdoor Adver. Co., 405 Pa. 142, 173 A.2d 319, 321 (Pa. 1961)).” Rather, such a claim belongs to, and is an asset of, the corporation. Id. “To have standing to sue individually, the shareholder must allege a direct, personal injury – that is independent of any injury to the corporation – and the shareholder must be entitled to receive the benefit of any recovery.” Hill v. Ofalt, 85 A.3d at 549. Because the Court concluded the primary injuries suffered as a result of the alleged unlawful activities were borne by the corporation the Court held the claims must be brought derivatively.

The decision in dicta (a part of the opinion which went beyond the facts of the case) discussed whether or not a Pennsylvania shareholder could individually assert minority oppression claims under Pennsylvania law. Id. at 550. The Court relied upon previously decided cases and said that an oppressed minority shareholder could assert direct claims against the majority shareholder. Id. (considering, Feber v. Am. Lamp. Corp., 469 A.2d 1046, 1050 (Pa. 1983); Viener v. Jacobs, 834 A.2d 546, 556 (Pa. Super. 2003). Because Hill did not assert oppression claim against Ofalt, the Court did not reverse.

One of the unique things about litigating in Pennsylvania is “preliminary objections.” Pennsylvania requires litigants to plead with specificity (as opposed to most states which are merely notice pleading states). If the case is not plead with specificity it is subject to dismissal by way of preliminary objections. Hence, when asserting minority oppression claims in a Pennsylvania action it is extremely important to set forth specific ways the minority shareholder was injured (as opposed to the corporation).

Finally, when drafting or responding to a complaint filed in Pennsylvania state court, it is imperative that the claim be properly asserted derivatively or individually. The Hill decision provides guidance on this issue.