The Tennessee Supreme Court recently adopted a new standard for determining whether a shareholder claim is direct or derivative.  Specifically, in Keller v. Estate of Edward Stephen McRedmond, the Court “set aside the approach for determining whether a shareholder claim is direct or derivative described…in Hadden v. City of Gatlinburg, 746 S.W.2d 687, 689 (Tenn. 1988), and adopt[ed]…the analytical framework enunciated by the Delaware Supreme Court in Tooley v.. Donaldson, Lufkin, & Jenrette, Inc., 845 A.2d 1031, 1039 (Del. 2004).”  No. M2013-02582-SC-Rll-CV, 2016 Tenn. LEXIS 506, *2-3 (Tenn. July 11, 2016).

Determining whether a shareholder claim is derivative or direct is often an important threshold matter in suits involving corporations and their shareholders.  A derivative action is a suit brought by one or more shareholders on behalf of a corporation to redress and injury sustained by, or to enforce a duty owed to, the corporation.  Id. at *37 (quoting House v. Estate of Edmondson, 245 S.W.3d 381-92 (Tenn. 2008).  In contrast, “the purpose of a direct shareholder suit is to compensate a shareholder for suffering a harm that the corporation itself has not suffered.” Id. at *39 (citations omitted).

In cases applying Tennessee law, prior to Keller and the adoption of Tooley, a shareholder could bring a direct action “for an injury done directly to them distinct from that incurred by the corporation and arising out of a special duty owed to the shareholders by the wrongdoer.” Id. at *48-49 (citing Hadden, 746 S.W.2d at 689).  As the Keller Court noted, application of this standard was difficult because the Hadden opinion “was not a model of clarity and…offered little insight into how the standard should be applied.”  Id. at *59.

By adopting Tooley, however, the issue of whether a shareholder’s claim is direct or derivative now turns on the following questions: “(1) who suffered the alleged harm (the corporation or the suing stockholders, individually); and (2) who would receive the benefit of any recovery or other remedy (the corporation or the suing stockholders, individually)?” Id. at *57 (citing Tooley, 845 A.2d at 1033).  Indeed, as the Keller Court noted, the “[a]doption of the Tooley standard…allows our lawyers and our courts to utilize the rich body of law in other jurisdictions for guidance…[which] in turn should facilitate consistent predictable outcomes in disputes involving shareholder claims.”  Id. at *59.

Ultimately, courts and litigants operating under Tennessee law should now look to Keller, Tooley and its offspring to determine whether a shareholder claim is direct or derivative.