The Institute in the Courts: CT Supreme Court Relies on Principles of Corporate Governance

Recently, in Saunders v. Briner, 221 A.3d 1 (Conn. 2019), the Supreme Court of Connecticut relied on the approach set forth in Principles of the Law, Corporate Governance: Analysis and Recommendations § 7.01(d) in holding that, under certain circumstances, a member of a single-member limited-liability company could bring derivative claims in a direct action for injuries suffered by the company.

In that case, the plaintiff, who was the sole member and owner of a limited-liability company, brought an action against, among others, the co-owner of a lending business that had sought financing from the plaintiff, alleging, inter alia, claims for breach of fiduciary duty and breach of the implied covenant of good faith and fair dealing for failure to repay the remainder owed on a bridge loan that the plaintiff’s limited-liability company had made to the lending business. Following a bench trial, the trial court entered judgment in part for the plaintiff, awarding him a payment for his direct claims for the failure to repay the loan. On appeal, the defendants argued that the plaintiff lacked standing to bring direct claims, and the Supreme Court of Connecticut addressed the question of “whether to exempt single-member limited liability companies from the direct and separate injury requirements necessary to bring a direct action.”

Affirming in part, the Supreme Court of Connecticut determined that the plaintiff had standing to bring his direct claims regarding the bridge loan, holding that, “when the unique circumstance arises in which the sole member of a limited liability company [sought] to remedy a harm suffered by it, a trial court [could] permit such a member to bring his claims in a direct action, as long as doing so [did] not implicate the policy justifications that underlie the distinct and separate injury requirement.” Citing Principles of Corporate Governance § 7.01(d) and § 7.01, Comment d, the court explained that there were policy reasons for the general rule prohibiting shareholders from bringing a direct action for an injury to the company that a derivative action could avoid. However, § 7.01(d) provided trial courts discretion to treat a derivative action as a direct action if to do so would not “(i) unfairly expose the corporation or the defendants to a multiplicity of actions, (ii) materially prejudice the interests of creditors of the corporation, or (iii) interfere with a fair distribution of the recovery among all interested persons,” quoting
§ 7.01(d)(i)-(iii). As discussed in § 7.01, Comment e, § 7.01(d) followed the position taken by the Ninth Circuit in Watson v. Button, 235 F.2d 235 (9th Cir. 1956), which “recognized that, in some circumstances, the policy reasons for requiring shareholders to bring an action on behalf of the corporation [might] not be present even though the action allege[d] in substance a corporate injury,” observing that the policy concerns were not always applicable to a closely held corporation.

Persuaded by § 7.01(d) and numerous other jurisdictions that had followed § 7.01(d)’s rationale, the court concluded that “a narrowly tailored exception [could] provide a more flexible mechanism for addressing member standing,” such as here, when “both the parties and the court system expended time and resources to litigate these matters and the ‘concept of a corporate injury that [was] distinct from any injury to [its sole member] approache[d] the fictional,”’ quoting § 7.01, Comment e. The court determined that the trial court’s exercise of jurisdiction over the plaintiff’s direct claims “implicitly relie[d] on and [was] supported by the three factors set forth by the American Law Institute,” reasoning that allowing the plaintiff to recover directly would not lead to a multiplicity of actions, prejudice the interests of other creditors, or interfere with the fair distribution of recovery, because the trial court found, and neither party disputed, that the plaintiff was the sole member of the limited-liability company and had funded the loan with his personal funds, and neither party claimed that any creditors of the limited-liability company existed.

The dissent disagreed with the majority’s decision to follow § 7.01(d) and adopt the “single-member limited-liability company” exception to the rule prohibiting shareholders from bringing direct claims for injuries suffered by the company, arguing, among other things, that the exception “invade[d] our legislature’s primary role in the formulation of public policy—in an arena that [was] purely statutory” and “[could] open the door to gamesmanship with the LLC corporate form.”