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Shareholder Suits after Cash-Out Mergers: Direct, Derivative, or Dead on Arrival?

The Michigan Supreme Court recently clarified the rights of shareholders bringing claims after a cash-out merger. In Murphy v. Inman, a shareholder brought suit against the directors of the Covisint Corporation, alleging that the company’s directors had breached their fiduciary duty by failing to maximize shareholder value during a cash-out merger. Among other complaints, the plaintiff also alleged that the corporate directors failed to procure the best price for Covisint, failed to pursue higher offers, and failed to disclose materially important information.

The Court first considered whether the action was properly brought as a derivative action, in which a shareholder attempts to sue on behalf of the corporation to enforce obligations owed to the corporation, as opposed to a direct shareholder action, in which a shareholder sues in its own name to enforce obligations owed to the shareholder. This distinction is key, because it implicates the complaining plaintiff’s duties to complete pre-suit statutory requirements in the case of a derivative action, and can therefore affect whether a suit is permitted to proceed or is dismissed as procedurally improper. Additionally, damages recovered in a derivative suit belong to the corporation, while damages in a direct action belong to the shareholder personally.

The Court’s opinion simplified the existing test for whether a claim should be derivative or direct. Applying reasoning from Delaware courts, the Court condensed this distinction into two key questions: (1) whether the corporation or the individual suffered the alleged harm, and (2) whether the corporation or the individual would receive the benefit of any remedy awarded by a court. Here, the Court found that plaintiff’s lawsuit, even if ultimately successful, would not benefit Covisint because the company had been wholly acquired and subsumed into the purchaser corporation. Moreover, a higher merger price (which the plaintiff contended should have been obtained), does not implicate or harm the corporation’s rights, and only affected the amount each shareholder would have received as a result of the transaction. As a result, the Court held that the plaintiff’s action should have been filed as a direct shareholder action, rather than as a derivative action.

Finally, the Court clarified that boards of directors do owe fiduciary duties directly to shareholders during a cash-out merger. Corporate boards must be vigilant and disclose all material facts and fully attempt to maximize the highest price that is reasonably available to meet these duties. The defendant had asserted that the Michigan statute governing board fiduciary duties to the corporation was exclusive, meaning that shareholders were not individually owed fiduciary duties, but the Court rejected this position.

Debate on the merits and demerits of shareholder litigation procedures, such as the divide between direct and derivative actions, has been robust. Legal scholars have argued that stronger shareholder protections, along with easier access to derivative lawsuits, can lead to greater corporate social responsibility and greater worker safety, and can also affect a firm’s investment decisions and performance. Although derivative actions are relatively rare, the Murphy v. Inman decision issued by the Michigan Supreme Court helps illustrate a much clearer view of fiduciary duties, and the potential litigation, arising from cash-out merger scenarios and similar corporate transactions.

You can read the full Michigan Supreme Court opinion at: https://www.courts.michigan.gov/4973da/siteassets/case-documents/uploads/opinions/final/sct/161454_73_01.pdf

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