NC Business Court Dismisses Breach of Fiduciary Duty Claim, But Allows Derivative Claims to Proceed
A recent decision from the North Carolina Business Court highlights the distinction between an individual claim for breach of fiduciary duty and a derivative claim for breach of fiduciary duty.
Most people have a general idea of what a fiduciary duty is. It’s a duty owed by one person to act in the best interests of another. North Carolina law very specific, stating that a fiduciary duty includes the following: (1) a duty of good faith and fair dealing, (2) a duty of loyalty, (3) a duty of impartiality, (4) a duty to delegate, (5) a duty to inform, and (6) a duty to keep adequate records.
So, in the business context, what is the distinction between an individual fiduciary duty and a derivative fiduciary duty? In short, it is the difference between whether the duty is owed to a shareholder, or to the company itself.
The case of Potts v. Kel, LLC is instructive. The plaintiff was the founder and director of a corporation. He owned half the company’s shares. The defendant was the company’s CPA, who offered to purchase the company from the plaintiff and his partner (who owned the other half of the shares). Though the parties negotiated extensively, their discussions fell apart. The partner then sold his half-interest in the company to the CPA.
The CPA, on behalf of the company, hired another company he owned to manage the first company. A dispute arose when the plaintiff claimed there had been no right to enter into such management agreements without his consent. The plaintiff also alleged that the CPA used corporate funds when purchasing the half interest in the company. The CPA claimed that these funds were not corporate funds, but rather were a salary and tax distributions paid to him by the company.
The plaintiff filed suit, and the defendant filed a motion to dismiss. Among the various issues raised were claims for breach of fiduciary duty – both an individual claim, and a derivative claim. The court dismissed the plaintiff’s individual fiduciary-duty claim because, under North Carolina business law, unless one shareholder owns a majority of shares, shareholders owe no duty to each other.
The court allowed the derivative fiduciary duty to proceed, though. The derivative fiduciary-duty claim was the alleged breach by a manager of the company (here, the CPA), to the company itself (as opposed to one of the company’s shareholders). The court held that if the plaintiff’s allegations were true – the allegations being that the CPA had a conflict of interest, withdrew a salary from the company without permission, and entered into a contract on behalf of the company without permission – the CPA would lose the case.
The lesson of the case is that a shareholder is entitled to file a “derivative” claim against a corporate manager on behalf of the company itself. The filing of the lawsuit on the company’s behalf, rather than on the shareholder’s individual behalf, is what makes it a derivative claim.
A manager, director, or other office of a company must “discharge [his or her] duties in good faith, with due care, and in a manner [he or she] believe[d] to be in the corporation’s best interests.” If the manger fails to act in the company’s best interest, then a shareholder, on behalf of the company, may file a derivative lawsuit.
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