Wessin v. Archives Corp.
| Decision Date | 13 May 1999 |
| Docket Number | C3-98-30,Nos. C5-98-28,s. C5-98-28 |
| Citation | 592 N.W.2d 460 |
| Parties | George WESSIN, David Wessin, E.R. Salovich, M.D., and George O. Holm, Respondents, v. ARCHIVES CORPORATION, a Minnesota Corporation, John D. Jerome and Sandra Jerome, Petitioners, Appellants. |
| Court | Minnesota Supreme Court |
Syllabus by the Court
1. When a shareholder seeks to enforce a right of a corporation, the shareholder may pursue that claim only by following the procedural requirements of Minn. R. Civ. P. 23.06.
2. The derivative pleading requirements of Minn. R. Civ. P. 23.06 apply to closely held corporations.
3. When a shareholder asserts direct and derivative claims together in a single cause of action, the shareholder must follow the pleading requirements of Minn. R. Civ. P. 23.06 with respect to all derivative claims.
4. When a plaintiff fails to properly plead derivative claims, a trial court does not abuse its discretion by granting a dismissal without prejudice.
5. The trial court did not abuse its discretion in refusing to grant respondents leave to amend their complaint more than 2 years after the initiation of the action.
Kay Nord Hunt, Phillip A. Cole, Lommen, Nelson, Cole & Stageberg, P.A., Minneapolis, for appellant Archives Corp.
Vincent D. Louwagie, Fruth & Anthony, Minneapolis, for appellants John D. and Sandra Jerome.
David R. Marshall, Cynthia Jokela, Steven J. Quam, Fredrikson & Byron, P.A., Minneapolis, for respondents.
Heard, considered, and decided by the court en banc.
This case was brought as a direct action by some of the minority shareholders of a closely held corporation. The minority shareholders allege that the corporation's majority shareholder misappropriated and wasted corporate assets. The minority shareholders sought recovery on their own behalf, rather than on the behalf of the corporation pursuant to Minn. R. Civ. P. 23.06, which governs derivative actions. The trial court determined that all of the minority shareholders' claims were derivative. Because the minority shareholders had failed to follow the derivative pleading requirements of Minn. R. Civ. P. 23.06, the trial court entered judgment on the pleadings against them and dismissed the case without prejudice. The court of appeals reversed, concluding that each of the claims was a direct claim. Because we conclude that all the claims are derivative and the minority shareholders failed to follow the requirements of Minn. R. Civ. P. 23.06, we reverse the court of appeals and reinstate the trial court's order dismissing the case without prejudice.
Archives Corporation (Archives) is a closely held Minnesota corporation. John D. Jerome (Jerome) is its founder and owned approximately 52% of its stock at the time this action was initiated. Sandra Jerome (S.Jerome) is Jerome's wife and an officer of Archives. Archives, Jerome, and S. Jerome will collectively be referred to herein as appellants. The Wessins, E.R. Salovich, and George O. Holm are some of the minority shareholders of Archives. There is no indication in the record that the parties at any time entered into a shareholder agreement.
In 1995, Holm, Salovich, and the Wessins initiated this lawsuit. One count in the complaint was pled on behalf of Holm and Salovich, and alleged breach of certain loan agreements that had been entered into upon Holm and Salovich lending money to Archives. These loan agreements, on which Jerome was a personal guarantor, set compensation limits on Jerome's salary. This claim was settled and dismissed with prejudice. Under the terms of the settlement, Archives acquired all of Holm's and Salovich's shares in Archives.
The Wessins continued to pursue relief on the four remaining claims: (1) Jerome engaged in common law fraud and misrepresentation; (2) the appellants engaged in statutory fraud and misrepresentation in violation of Minn.Stat. § 302A.751, subd. 1(b)(2) (1998); (3) the appellants engaged in unfair prejudice to minority shareholders in violation of Minn.Stat. § 302A.751, subd 1(b)(3); and (4) the Jeromes engaged in common law breach of fiduciary duties owed to minority shareholders. These counts are summarized as follows.
In Count I, common law fraud and misrepresentation against Jerome, and Count II, statutory fraud and misrepresentation against the appellants, the Wessins assert that the appellants misrepresented:
(a) the nature and extent of compensation [Jerome] was actually receiving, both directly and indirectly from Archives, in direct violation of the Loan Agreement * * *; (b) the correct net income of Archives; (c) the payment of dividends to [Jerome], both directly from Archives and through the use of subsidiary corporations, which were not received by other shareholders; (d) the reimbursement of personal expenses by Archives to [the Jeromes] which were unrelated to [the] business of Archives; and (e) the financial status of Archives resulting from [Jerome's] misuse and misappropriation of funds from said corporation.
The Wessins assert that these misrepresentations were made with the intent to induce the Wessins "to not seek dividend compensation or otherwise seek further information relating to the misuse and misappropriation of funds from the company, and did, in fact, induce such actions and inaction." The Wessins sought money damages under Count I and equitable relief pursuant to Minn.Stat. § 302A.751, subd. 1(b)(2) under Count II.
In Count III, titled unfair prejudice, the Wessins reallege the prior allegations of the complaint, and assert that the appellants unfairly prejudiced the Wessins in violation of Minn.Stat. § 302A.751, subd. 1(b)(3). Under this count, the Wessins requested equitable relief pursuant to Minn.Stat. § 302A.751, subd. 1(b)(3).
Count IV alleges breach of fiduciary duties owed to the minority shareholders by the Jeromes. The Wessins allege that the Jeromes:
breached their fiduciary duties by committing fraud, mismanagement and waste of the corporate assets, and furthering their interests at the sacrifice of the best interests of the shareholders, by actions which include * * *: (a) requiring the corporation to pay personal debts; (b) diverting corporate assets to personal use * * *; and (c) paying themselves concealed and unearned compensation, both directly and through the use of subsidiary corporations.
Defendant J. Jerome's breach of his fiduciary duties included, but was not limited to: (a) breach of his duty to avoid conflict of interests and to deal fairly and in a good faith with the shareholders, including Plaintiffs; (b) self dealing; and (c) acting as a creditor to the corporation and shareholder, officer, and director.
The Wessins sought money damages under Count IV.
It is undisputed that the Wessins did not follow the requirements of Minn. R. Civ. P. 23.06, which governs derivative actions. The complaint did not contain any allegations of the efforts made by the Wessins to obtain the desired action from Archives' directors or shareholders, or the reasons for the Wessins' failure to make such an effort.
In 1997, the appellants moved the trial court for dismissal or, alternatively, judgment on the pleadings, based on failure to state a claim. The appellants argued that all of the Wessins' claims were derivative and should be dismissed because they were pled directly and not on behalf of the corporation pursuant to Minn. R. Civ. P. 23.06. The Wessins requested permission to amend their complaint a second time if the court concluded that the Wessins' claims should have been asserted derivatively. The Wessins did not serve a proposed amended complaint with this request.
After excluding an affidavit submitted by the appellants in support of the motion as being outside of the pleadings, the trial court granted appellants' motion for judgment on the pleadings. The trial court determined that each of the Wessins' claims asserted a harm to the corporation, rather than direct harm to the Wessins, and that the Wessins could prove no set of facts consistent with the complaint that would entitle them to direct relief. In arriving at this decision, the trial court concluded that Minnesota does not recognize an exception to the derivative action pleading requirements for closely held corporations. The trial court specifically dismissed each claim without prejudice.
The trial court did not rule on the Wessins' motion to amend their complaint. The Wessins moved the trial court to vacate the judgment and for leave to amend their complaint, and the trial court denied that motion. The Wessins appealed.
The court of appeals reversed the trial court, concluding that each of the Wessins' claims was a direct claim. Wessin v. Archives Corp., 581 N.W.2d 380, 385-86 (Minn.App.1998). The court of appeals determined that the fraud and misrepresentation claims of Counts I and II were direct claims given "Archives' size and character and the alleged wrongdoer's pivotal role in the corporation." Id. at 385.
As to the breach of fiduciary duty claim, the court of appeals concluded that because the appellants owed a fiduciary duty directly to the Wessins, as minority shareholders, the Wessins could assert a direct claim. Id. at 386. Finally, as to the claim of unfair prejudice, the court of appeals held that such a claim "is by its nature ordinarily a direct claim." Id.
The court of appeals next discussed the legislative history of Minn.Stat. § 302A.751 and the distinctions between closely held corporations and larger publicly held corporations. Id. at 387-91. The court of appeals also noted that Minn. R. Civ. P. 23.06 applies only to "derivative actions," and stated that "[a]n action that involves both direct claims and derivative claims would, strictly speaking, not be a derivative action." Id. at 390. Accordingly, the court of appeals held that the derivative pleading requirements of Minn. R. Civ. P. 23.06 "should not apply to actions that combine direct and derivative claims" under Minn.Stat....
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