Murphy v Inman – New Standard for Direct vs. Derivative Shareholder Claims

In the recent decision in Murphy v Inman, No. 161454, Mich ; NW2d (April 5, 2022), the Michigan Supreme Court clarified the standard for determining whether an aggrieved shareholder may bring a direct claim (in his individual capacity) or a derivative claim (on behalf of the corporation) against corporate directors and officers (and likely, by analogy, managers of limited liability companies). This decision is an important development in Michigan business law because aggrieved shareholders and members often face this question when deciding whether and how to bring a lawsuit against the individuals in control of the business.

Corporate directors owe common-law fiduciary duties directly to the shareholders of the corporation under Michigan common law, and these common law duties are independent of those prescribed in the Business Corporation Act (the BCA), MCL 450.1101 et seq. The Michigan Supreme Court has continued to recognize that directors owe fiduciary duties to their shareholders since the enactment of the BCA, and the statutory history of the BCA and its predecessor, the General Corporation Act, 1931 PA 327, supports a conclusion that the Legislature did not abrogate these common-law duties.

While corporate directors and officers owe fiduciary duties to the shareholders, a suit to enforce corporate rights or to redress or prevent injury to the corporation must be brought in the name of the corporation and not that of a stockholder, officer, or employee. Michigan courts have recognized two exceptions to this general rule: (1) where the individual has sustained a loss separate and distinct from that of other stockholders generally, and (2) where the individual shows a violation of a duty owed directly to the individual that is independent of the corporation.

A suit to enforce corporate rights or to redress injury to the corporation is a derivative action; although it may be brought by the shareholder, the action itself belongs to the corporation. If a claim is derivative, a shareholder has no standing to sue except on behalf of the corporation, and the shareholder must comply with numerous statutory requirements before bringing that action. A direct action, on the other hand, belongs to the shareholder; it seeks redress for harm done to the shareholder or to enforce a personal right belonging to the shareholder independently from the corporation. In other words, when the shareholder suffers the harm or seeks to enforce a personal right, the general rule formerly applied and articulated by the Court of Appeals in this case that an action is derivative does not apply.

In order to distinguish between direct and derivative actions brought by shareholders of a corporation in Michigan, courts must ask (1) who suffered the alleged harm and (2) who would receive the benefit of any remedy recovered. If the answer to both questions is the corporation, the action is derivative. If the shareholder suffers the harm separate from the corporation and receives the remedy instead of the corporation, the action is direct. Under that framework, a shareholder must establish that those in charge of the corporation breached their fiduciary duties owed to the shareholder and that the claim can be sustained without relying on an injury suffered by the corporation. If these conditions are satisfied, a shareholder has standing to bring a direct shareholder action against the officer or director.

The Court’s decision in Murphy v Inman is an important development in Michigan business law for two key reasons. First, it confirms that directors owe common law fiduciary duties to shareholders. Secondly, it enables individual shareholders to sue those directors if they breach their fiduciary duties without having to comply with the statutory prerequisites and procedure of bringing a derivative claim on behalf of the entity as a whole.

Corporate directors and shareholders now have additional clarity regarding the distinction between direct and derivative actions and the scope of the fiduciary duties owed to shareholders. The Supreme Court’s recent decision should help business lawyers counsel corporate clients on the risks and benefits of taking certain decisions. And while Murphy v Inman answers this question in the context of corporate affairs under the BCA, it is likely that the import of the Court’s decision will be relevant for other business entity types in Michigan, such as LLCs.

If you would like to learn more about the implications of this new development and its impact on your business, please contact any of the seasoned business law attorneys at Kuhn Rogers.