Glenn v. Hoteltron Systems, Inc., 74 N.Y.2d 32 (1989)

In a shareholder derivative suit, damages for corporate injury are typically awarded to the corporation, even if the wrongdoer is a shareholder, unless equitable considerations and the rights of creditors necessitate a different approach.

Summary

This case addresses the proper allocation of damages, legal expenses, and attorney’s fees in shareholder derivative suits, especially when the injured corporation is closely held and the wrongdoer is also a significant shareholder. The court held that damages should be awarded to the corporation, even if the wrongdoer indirectly benefits. The court also affirmed that legal expenses and attorney’s fees for the plaintiff shareholder should be paid out of the award to the corporation. This decision emphasizes the importance of protecting corporate assets for creditors and adhering to the established rules for derivative actions.

Facts

Jacob Schachter and Herbert Kulik were 50% shareholders and officers of Ketek Electric Corporation. Schachter diverted Ketek’s assets and opportunities to Hoteltron Systems, Inc., a corporation wholly owned by him. Kulik initiated a shareholder derivative suit against Schachter for breach of fiduciary duty. The lower court initially found neither party liable, but the Appellate Division found Schachter liable for diverting Ketek’s assets to Hoteltron.

Procedural History

The Supreme Court initially ruled neither party liable. The Appellate Division reversed, finding Schachter liable. Following a trial on damages, the Supreme Court awarded damages to Kulik personally, including profits from Hoteltron and Kulik’s legal expenses. The Appellate Division modified this, awarding profits to Ketek and directing Ketek to pay Kulik’s legal expenses. The New York Court of Appeals granted leave to appeal.

Issue(s)

1. Whether damages in a shareholder derivative suit involving a closely held corporation should be awarded directly to the innocent shareholder or to the corporation itself when the wrongdoer is also a shareholder.

2. Whether legal expenses and attorneys’ fees should be paid by the wrongdoer or by the corporation out of the damage award.

Holding

1. No, because the diversion of corporate assets resulted in a corporate injury, and awarding damages to the corporation protects the rights of creditors and adheres to the general rule for derivative actions.

2. The legal expenses should be paid by the corporation from the award, because this aligns with the principle of reimbursing the plaintiff for expenses incurred on the corporation’s behalf.

Court’s Reasoning

The Court of Appeals affirmed the Appellate Division’s decision, emphasizing the general rule that recovery in a shareholder derivative suit benefits the corporation. The court acknowledged the anomaly that Schachter, as a 50% shareholder, would indirectly benefit from the award to Ketek but reasoned that making an exception for closely held corporations would undermine the general rule. The court stated: “An exception based on that fact alone would effectively nullify the general rule that damages for a corporate injury should be awarded to the corporation.”

The Court emphasized that awarding damages directly to the innocent shareholder could impair the rights of creditors. “The fruits of a diverted corporate opportunity are properly a corporate asset. Awarding that asset directly to a shareholder could impair the rights of creditors whose claims may be superior to that of the innocent shareholder.”

Regarding attorneys’ fees, the court cited Matter of A. G. Ship Maintenance Corp. v Lezak, 69 NY2d 1, 5, affirming that attorneys’ fees are incidents of litigation not collectable from the loser unless authorized by agreement, statute or court rule. The court reasoned that the basis for awarding attorneys’ fees in derivative suits is to reimburse the plaintiff for expenses incurred on the corporation’s behalf, and these costs should be borne by the corporation itself.