Court split over whether shareholder siblings can pursue direct action against brother

A divided Indiana Court of Appeals has affirmed a grant of summary judgment that prohibited three siblings from pursuing a direct action against their brother, finding the rule prohibiting shareholders from bringing direct actions to redress an injury to their family corporation barred their action.

The case centers around Westville-based TP Orthodontics Inc., a closely held, family-owned business run by the Kesling family. Andrew Kesling serves as president and owns 51 percent of voting stock, while his siblings, Christopher, Adam and Emily, own 11 percent.

In January 2010, the sibling minority shareholders filed a complaint individually and derivatively on behalf of TPO against Andrew Kesling, alleging wrongdoing causing a significant decrease in shareholder value. TPO was then granted permission to intervene and formed a special litigation committee, which recommended that TPO pursue only four of its derivative claims: breach of fiduciary duty to TPO based on royalty and patent payments, using TPO funds for personal expenses and failing in corporate governance

TPO moved to dismiss the other claims and for summary judgment as to the sibling shareholders’ rights on the remaining claims, which it said were derivative claims. Based on the rule that individual shareholders cannot maintain actions at law in their own names to redress injuries to the corporation, TPO said the siblings should not be permitted to pursue the remaining claims in a direct action against Andrew Kesling.

The minority shareholders then filed a response to TPO’s motions, claiming the special litigation committee was not disinterested and designating evidence that SLC failed to conduct a good-faith investigation of their claims. The siblings argued they should be allowed to bring a direct action against their brother pursuant to the exception in Barth v. Barth, 659 N.E.2d 559, 560 (Ind. 1995), to the general rule regarding derivate claims.

The LaPorte Superior Court granted TPO’s motion to dismiss and/or for summary judgment, finding the siblings did not show the SLC was not disinterested or did not conduct a good-faith investigation. The trial court also found the remaining claims were derivative and that the Barth exception did not apply, but that TPO as a board could pursue the derivative claims.

The siblings then appealed, arguing that under Barth, which provides an exception for closely held corporations, they should be allowed to pursue a direct action. But in a Thursday opinion, Indiana Court of Appeals Judge Terry Crone wrote the siblings had the burden to prove the Barth exception does apply and failed to meet that burden.

Crone, writing for the majority of a divided appellate panel, said the siblings “failed to present sufficient facts to show that permitting a direct action will not unfairly expose TPO or Andrew to a multiplicity of actions,” as there are six other shareholders in the corporation. Further, there is no evidence to show that a direct action would not materially prejudice the interests of TPO’s creditors, Crone wrote, or to show a direct action wouldn’t interfere with a fair distribution of recovery.

Finally, Crone wrote that the siblings failed to cite to authority to support their argument that the TPO board is not the proper party to prosecute the claims. He pointed to Indiana Code 23-1-32-4, which governs the SLC, and said nothing in the statute prohibits a corporate board from controlling litigation after an SLC has determined that pursuit of the litigation is in the corporation’s best interests.

But in a dissenting opinion, Judge Michael Barnes wrote he believes the Barth exception should apply, noting that the danger of a multiplicity of suits seems non-existent since none of the other shareholders have participated in the lawsuit or expressed a desire to file their own. He also does not think TPO’s creditors would be materially prejudiced because the corporation is solvent, and there is no indication that a direct action would interfere with fair distribution of recovery.

Finally, Barnes wrote he does not believe the board is disinterested, as it has been “stonewalling” the litigation along with Andrew Kesling. Thus, he would reverse summary judgment and remand for direct action. The case is Christopher K. Kesling, DDS, MS, Adam Kesling and Emily Kesling, individually and derivatively on behalf of TP Orthodontics, Inc. v. Andrew C. Kesling, individually and as Trustee of the Andrew C. Kesling Trust dated March 28, 2001, and the Andrew C. Kesling Trust dated March 28, 2001 and TP Orthodontics, Inc., 46A03-1701-MI-64.