The Shareholder Lawsuit Exception
Stinnett v. Paramount: The Shareholder Lawsuit Exception
Stinnett v. Paramount: Texas Supreme Court develops exception permitting the individual shareholder lawsuit for harm done to the corporation.
Damage to the Corporation
Stinnett v. Paramount-Famous Lasky Corp. of New York: Individual Shareholder Lawsuit for Damage to the Corporation
Stinnett v. Paramount-Famous Lasky Corp. of New York, involved a claim by shareholders of a corporation, not against the controlling shareholders or management, but against third parties arising from harm to the corporation. In 1923, the two plaintiffs, who held the lease to a movie theater in Dallas, Texas, formed a corporation for the purpose of engaging in the Class A theater business. The corporation secured a contract with the defendants for the distribution of films to show in the theater, but the plaintiffs were frustrated with their inability to obtain quality films, resulting ultimately in an altercation with one of the defendants, who threatened physical violence, declared that he would not renew the contract, and swore that he would see to it that the plaintiffs “did not get a decent picture to operate [the] theater.”
As a result, in late 1925, the plaintiffs quit the theater business and sold the lease and the corporation. The plaintiffs sued the defendants for the destruction of their business on breach of contract and antitrust theories and received a favorable jury verdict and a judgment in the amount of $318,770. The defendants appealed, and the Waco Court of Appeals reversed the case on based solely on the fact that the harm was to the corporation and not to the plaintiffs individually:
The cause of action for injury to or destruction of the property of a corporation or the impairment or destruction of its business is nevertheless vested in the corporation, as distinguished from its stockholders. In such cases the injury to the corporation is direct and the injury to the holders of its stock remote. A recovery by the corporation inures to their benefit in proportion to their respective holdings and affords them compensation for the indirect or consequential loss sustained by them.
The court of appeals remanded the case for new trial. The Texas Commission of Appeals affirmed the reversal and remand based on defective jury questions and evidentiary errors. However, the Court reject the defendants’ argument that “the undisputed evidence as a matter of law show that the sole cause of action against defendants belongs to the Capitol Amusement Company, a corporation, and that plaintiffs have no cause of action either in their individual capacities or as stockholders of the Capitol Amusement Company,” which had been the basis of the court of appeals’ decision.
Individual Shareholder Lawsuit Exception
The Court acknowledged the “general rule [that] an action to redress or prevent injuries to the corporation cannot be maintained by a stockholder or the body of stockholders in their own names , but the action must be brought by, and in the name of, the corporation itself. This is true, although the injury to the corporation may incidentally result in the destruction or depreciation of the value of the stock.  The stockholders cannot as individuals recover on a cause of action vested in the corporation, although all unite in the action.” However, the Court also stated the exception to the general rule, that individual stockholder may maintain a direct action in their individual capacity for “wrongful acts which are not only wrongs against the corporation but also violations of duties arising from contracts or otherwise and owing directly to the injured stockholders.” This is the first case in Texas to state this often-repeated exception to the general rule. The plaintiffs argued that they had been injured individually by “the ruthless and illegal acts of defendants that drove them out of the moving picture business, and that, by reason of such acts on the part of defendants, plaintiffs were not permitted to continue, either through a corporation or individually, in the moving picture business in which they had been successfully engaged for many years,” and, particularly because they held the lease to the theater building individually, “that they were injured in a way that the corporation, which owned no physical assets and had no interest in the lease, could not have suffered injury.”
The first opinion to state the exception that shareholder may sue individually for harm to the corporation when the wrongdoing also violates “a duty arising from contract, or otherwise, and owing directly by him to the stockholders” was the Sixth Circuit case of Ritchie v. McMullen, authored by Judge William Howard Taft,which was discussed at length in the Stinnett opinion. Ritchie v. McMullen involved a shareholder who had borrowed large sums of money and pledged his stock in several corporations as collateral—corporations over which his creditors had control. The shareholder appealed the refusal by the trial court to permit the amendment of his answer to add counterclaims against the creditors for damage to the value of his pledged shares resulting from alleged intentional mismanagement of the corporations. The trial court had held that the amendment was improper because “that the wrongs committed were injuries to the corporations only, and that Ritchie, as a stockholder, could have no redress directly against the wrongdoers, and must find a remedy, if at all, in the enhancement in value to his stock caused by a recovery of damages by the corporations.”
Judge Taft, who would later become President of the United States and then Chief Justice of the United States Supreme Court,pointed out the paradox of the general rule: “As the very object of the conspiracy and wrongs done was to cause Ritchie to cease to be a stockholder, it might be difficult to point out how such an indirect remedy could benefit him after the wrong had been completed and he had parted with his ownership of the stock.” The court noted that generally shareholders have no claim for harm to the corporation that results in the depreciation of the value of their shares, but held: “But we are of opinion that this principle has no application where the wrongful acts are not only wrongs against the corporation, but are also violations by the wrongdoer of a duty arising from contract, or otherwise, and owing directly by him to the stockholders.” The court reasoned that the basis of the general rule was the absence of privity between individual shareholders and the officers and directors of the corporation, who owe their duties to the corporation, but here the shareholder was in privity with the officers and directors because of the pledge of stock, which carried with it a duty on the pledgee of reasonable care as to the value of the pledge: “A fortiori it is the bailor’s duty not to do any act with the intention of depreciating the value of the pledge. Hence, if Payne, Burke, and Cornell combined together, and wrongfully reduced the value of the stocks pledged, with the intention of buying them in at less than their value, they have done Ritchie an injury, for which he is entitled to compensation.” The court held that the directors would not be liable for negligent or ill-advised decisions that incidentally damaged the value of the pledged shares, “[b]ut, if such pledgee use his position as director and his vote as stockholder intentionally to depreciate the stock of his pledgor held in pledge with the dishonest purpose of acquiring ownership of the stock at forced sale, this is a direct injury done by him to his pledgor, and he cannot avoid direct liability to his pledgor for it, by pleading that the means by which he accomplished this wrong, and violated his duty as pledgee, involved an injury to the corporation, for which it may also recover damages.” Nor would the creditors be liable for voting their own shares in a manner that resulted in damage to the pledged shares, “unless the vote is shown to be malicious; i.e. with intent to injure the person complaining. But it is well settled that, ‘if any number of persons combine with intent to injure and defraud another, they cannot defend themselves against an action by showing that they did the act in the character of corporators under any charter whatever.”
The Stinnett Court accepted the Sixth Circuit’s reasoning and held: “In applying these principles, we think it equally well settled that, if it appears from the pleadings and the proof that the wrongful acts are not only wrongs committed against the corporation, but also violations of duties arising from contracts or otherwise and owing directly to the injured stockholders, the stockholder should be permitted to file and maintain a suit for injuries sustained as a stockholder and as an individual.” Therefore, because the plaintiffs had alleged violation of the antitrust laws that arguably established a legal duty to themselves, they would be permitted to pursue an individual claim that involved actions that harmed the company. “We are in entire accord with the proposition that the well-recognized rules of law and equity should not be so strictly construed as to produce an irremediable situation or a total failure of justice, but, under proper pleadings and proof, those rules should, if necessary, be relaxed to promote the ends of justice and to furnish the litigant a forum in which to redress his alleged wrongs.”
The Court did express skepticism as to whether the plaintiffs had actually established antitrust violations as to themselves, but because the case was to be remanded for new trial in any event, the Court merely noted the suggestion that, “in our opinion, plaintiffs have not, in the development of this phase of the case, sufficiently complied with the exceptions to the general rule herein stated.”
A corporate stockholder may, however, have an action for personal damages for wrongs done to him as an individual stockholder “where the wrongdoer violates a duty arising from contract or otherwise, and owing directly by him to the stockholder.” This principle, often mischaracterized an exception to the general rule that stockholders may not sue for personal injury resulting from a violation of the corporation’s rights, simply recognizes that a stockholder may sue for violation of his own individual rights regardless of whether the corporation also has a cause of action. It is not personal injury which gives rise to a personal cause of action by the stockholder, for an injurious wrong to the corporation perforce injures its stockholders. Rather, it is the nature of the wrong, whether directed against the corporation only or against the stockholder personally, which determines who may sue.