Potential Restraints on Counterclaims Interposed in a Derivative Suit

Shareholders who sue derivatively on behalf of a corporation are often faced with counterclaims against them as individuals. The issue of whether such counterclaims are properly interposed against a shareholder in their individual capacity is not typically a heavily contested issue in New York. However, this may soon change as a result of a recent decision in the case of Jean-Pascal Simon v. Francinvest, S.A., et. al., 2023 N.Y. Slip. Op. 32422[U] (Sup. Ct. N.Y. Co. July 7, 2023), where the court was confronted with arguments about the feasibility of such countersuits and reaffirmed, at least in part, an earlier rule that counterclaims cannot be interposed against a shareholder individually in a derivative action. 

Simon involved claims of fraud brought by a shareholder directly and derivatively on behalf  of a corporation, alleging that a family member, another controlling member and a defendant in the case, engaged in a complex scheme to defraud the business. The family member interposed counterclaims against the shareholder plaintiff individually, claiming abuse of process, malicious prosecution, defamation, and intentional infliction of emotional distress. The shareholder moved to strike the counterclaims, arguing that – based on a decades-old  case – stockholders suing derivatively are generally not subject to counterclaims as individuals. Significantly, the court did not dispute (and thus seemingly agreed) that, as a general rule, shareholders in a derivative action cannot be subject to counterclaims against them individually. However, perhaps recognizing the rigidity of such rule and the practical realities, the court did not go as far as to find that the counterclaims should be dismissed on that basis. Rather, in resolving this particular issue, the court ultimately relied on a limited exception articulated by the Third Department in the case of Conant v. Schnall, 33 A.D.2d 326, 328 (3d Dep’t 1970), to find that it could not “determine as a matter of law that it was improper for [] [the defendant] to counterclaim against [] [the shareholder] individually, particularly because [] [the company] is a closely held corporation and its interests are tied closely with [] [the shareholder’s] own interests” and thus the two capacities had merged.

It is significant that, while the court in Simon did not expressly conclude that dismissal of counterclaims against a shareholder individually in a pure derivative suit was proper, it did re-open the door to these arguments for plaintiffs seeking to dismiss such claims going forward. For instance, where the business at issue is not a closely held corporation, the plaintiff is not the sole shareholder, and the claims were only brought derivatively on behalf of the corporation, Simon may support dismissal of a counterclaim brought against the shareholder in his individual capacity. No court has affirmed the reasoning of Simon yet but we may soon see an influx of disputes concerning the general viability of these direct counterclaims, which will likely come as a surprise to many defendants and their attorneys, who have historically interposed many such similar claims.