Glenn v. Hoteltron Systems Inc.
74 N.Y.2d 386, 547 N.Y.S.2d 816, 547 N.E.2d 71 (1989)
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Rule of Law:
In a shareholder's derivative action, any damages recovered are for the benefit of the injured corporation. This rule applies even in a closely held corporation where the wrongdoing shareholder will indirectly share in the recovery, as the interests of corporate creditors may be paramount.
Facts:
- Jacob Schachter and Herbert Kulik were each 50% shareholders and the only officers of Ketek Electric Corporation.
- Schachter formed another corporation, Hoteltron Systems, Inc., which he wholly owned.
- Schachter diverted assets, patent rights, trademark rights, and corporate opportunities from Ketek to Hoteltron.
- Hoteltron earned profits of $362,242.84 by using Ketek's assets and opportunities.
- Schachter withdrew the profits from Hoteltron for his personal use.
Procedural Posture:
- Herbert Kulik initiated three consolidated shareholder derivative actions against Jacob Schachter on behalf of Ketek Electric Corporation.
- The trial court (Supreme Court of New York) initially found no breach of duty by either party and dismissed the actions.
- On appeal, the intermediate appellate court (Appellate Division) reversed, finding Schachter liable for diverting corporate assets, and remanded for a trial on damages.
- Following the damages trial, the trial court ordered Schachter to pay damages, legal expenses, and attorneys' fees directly to Kulik.
- Schachter appealed the damages award to the Appellate Division.
- The Appellate Division modified the judgment, ruling that the damages should be awarded to Ketek Corporation and that Kulik's legal fees should be paid by Ketek out of that award.
- Both parties now cross-appeal to the New York Court of Appeals, the state's highest court.
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Issue:
In a shareholder's derivative suit involving a closely held corporation, must damages for a corporate injury be awarded to the corporation, even if the wrongdoing shareholder will indirectly benefit from the recovery?
Opinions:
Majority - Chief Judge Wachtler
Yes. In a shareholder's derivative action, recovery for a corporate injury must be awarded to the corporation itself, not directly to an innocent shareholder. The suit seeks to vindicate a wrong done to the corporation, so the recovery is a corporate asset. While it may seem inequitable for a wrongdoing shareholder to indirectly benefit from the award, creating an exception for this reason would nullify the general rule and could harm corporate creditors whose claims may be superior to those of the shareholders. The harm to the innocent shareholder is derivative of the harm to the corporation, not a direct personal injury. Therefore, the profits Schachter diverted must be returned to Ketek Electric Corporation.
Analysis:
This decision reaffirms the traditional legal distinction between the corporate entity and its shareholders, even in the context of a closely held corporation where that distinction can seem artificial. By prioritizing the corporation's recovery, the court protects the interests of third-party creditors whose claims might be jeopardized if damages were paid directly to shareholders. The ruling reinforces the principle that a shareholder's derivative suit is brought on behalf of the corporation to remedy a corporate injury, and any recovery properly belongs in the corporate treasury. While the court does not completely foreclose the possibility of a direct award to shareholders in other circumstances, it sets a high bar for deviating from the general rule.
