Closely held corporations that are named as defendants in a shareholder’s derivative lawsuit may pursue counterclaims against that shareholder, the North Carolina Business Court has ruled in a case of first impression.
Bill Gao, Johannes Heckmann, and Ellen Liu were the three co-owners of Sinova US, a seller of chemical products. In 2013 the trio negotiated the separation of their business interests, but agreed that Sinova would continue funding some specified projects that were deemed common projects. The agreement stated that any other projects must be pursued outside of Sinova’s common office facilities.
In 2016 Gao sued Heckmann and Liu, who collectively controlled most of Sinova’s shares, both on his own behalf and derivatively on behalf of Sinova, and sought to have the company dissolved. Sinova was nominally named as a defendant in the suit, and it filed counterclaims against Gao, alleging that he used common facilities to develop products for his own benefit, and concealed that fact from the company.
Gao moved to have Sinova’s counterclaims dismissed, arguing it that lacked standing to bring them because it was merely a nominal defendant to Gao’s derivative claims. As such, Gao contended, Sinova could not defend itself against his claims, and thus could not assert counterclaims against him.
On July 16, Judge Michael Robinson disagreed, and ruled that Sinova could proceed with its counterclaims.
Derivative actions are lawsuits brought by shareholders, on behalf of a corporation, against a third party—in this case, against Sinova’s other two co-owners. In general, corporations may not defend themselves against derivative actions on the merits because such actions seek to enforce the rights of the corporation, and any recovery goes to the corporation rather than the shareholder. So a corporation in a derivative suit, although technically a defendant, is generally aligned with the plaintiff.
But Robinson said this didn’t resolve the issue of whether a corporation in a derivative suit may assert counterclaims against the shareholder-plaintiff. He wrote that the question appeared to be an issue of first impression in North Carolina, and one that has not often been addressed in other jurisdictions.
The general rule in federal courts is that shareholders suing derivatively can’t be countersued by the corporation, but multiple courts have held that this rule doesn’t apply in cases involving closely-held corporations, where the substance of the action was to determine the rights of a small number of shareholders against one another. Applying such a technical rule to what is essentially a squabble between a few co-owners would be an exercise in valuing form over substance, the courts reasoned.
“The Court finds persuasive the reasoning of the federal courts that have confronted this issue and, in the absence of contrary case law from our appellate courts, concludes that Sinova US may assert counterclaims against Gao,” Robinson ruled. “As Gao has conceded, Sinova US could initiate a separate lawsuit against Gao, and the Court sees no reason why Sinova US should be prohibited from asserting its claims against Gao in this action, whether they be styled as counterclaims or crossclaims, as opposed to requiring Sinova US to file a separate action against Gao.”
In a separate decision handed down the same day considering the claims on their merits, Robinson dismissed some of the counterclaims against Gao, while allowing Sinova to move forward with others. Heckmann and Liu are also pursuing counterclaims against Liu on their own behalves.
Joe Moss of Erwin, Bishop, Capitano & Moss in Charlotte represented Sinova. Moss declined to comment on the ruling, citing the ongoing nature of the underlying dispute.
Jeff Oleynik, Jessica Thaller-Moran, and Ryan Fairchild of Brooks Pierce served as local counsel for Gao, who was also represented by attorneys from Greenberg Traurig in Chicago. Attorneys for Brooks Pierce did not respond to requests for comments on the ruling.
The 23-page decision finding that the company had standing is Gao v. Sinova Specialties, Inc. (Lawyers Weekly No. 020-049-18). The 37-page opinion dealing with the merits of the claims is Gao v. Sinova Specialties, Inc. (Lawyers Weekly No. 020-048-18). The full text of both opinions is available online at nclawyersweekly.com.
Follow David Donovan on Twitter @NCLWDonovan