Lightner v. Lightner

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No. 104,000


IN THE COURT OF APPEALS OF THE STATE OF KANSAS

IRMA LIGHTNER,
Appellee/Cross-Appellant,
and
ROBERT LIGHTNER and LLOYD LIGHTNER,
Interveners/Appellees,

v.

GERALD LIGHTNER and KYLE LIGHTNER,
Appellants/Cross-Appellees.

SYLLABUS BY THE COURT


1.
Standing to sue is a component of subject matter jurisdiction, which may be raised
for the first time on appeal or on the appellate court's own motion. Whether standing
exists is a question of law subject to unlimited review. It is clear that if a party does not
have standing to challenge an action or to request a particular type of relief, then there is
no justiciable case or controversy and the suit must be dismissed.

2.
When a corporation has been injured by the actions of those in control thereof, the
well-established general rule is that the suit seeking redress for such a grievance belongs
to the corporation and must be brought as a derivative action, meaning one or more
shareholders may bring suit on behalf of the corporation for harm done to the
corporation.



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3.
A direct action by a shareholder against officers or directors of a corporation is
generally reserved for injuries affecting the individual legal rights of that shareholder.
Shareholders do not have standing to sue for harms to the corporation or even for the
derivative harm to themselves that might arise from a tort or other wrong to the
corporation.

4.
The proper analysis to determine whether a lawsuit by a shareholder of a
corporation is a derivative or direct action must be based solely on the following
questions: Who suffered the alleged harm—the corporation or the suing shareholder
individually—and who would receive the benefit of the recovery or other remedy? The
inquiry should be whether the stockholder has demonstrated that he or she has suffered an
injury that is not dependent on an injury to the corporation. Looking at the body of the
complaint and considering the nature of the wrong alleged and the relief requested, the
plaintiff must demonstrate that he or she can prevail without showing an injury to the
corporation.

5.
In Kansas, a lawsuit by a shareholder of a corporation is a derivative action if
injury is either to the corporation directly or to the shareholder but mediated through the
corporation. A shareholder may only litigate as an individual if the wrong to the
corporation inflicts a distinct and disproportionate injury on the shareholder or if the
action involves a contractual right of the shareholder which exists independently of any
right of the corporation. Whether a cause of action is direct or derivative must be
determined from the nature of the wrong alleged and the relief, if any, which could result
if the plaintiff were to prevail.


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6.
Kansas has acknowledged an exception to the general rule precluding a direct
action for corporate injury when a minority shareholder is frozen out of the management
of a close corporation through oppressive majority conduct. If a corporation is closely
held, a court, in its discretion, may treat an action raising derivative claims as a direct
action if it finds to do so will not: (1) unfairly expose the corporation to a multiplicity of
actions; (2) materially prejudice the interests of creditors in the corporation; or (3)
interfere with a fair distribution of the recovery among all interested persons.

7.
Kansas does not recognize common-law close corporations, and a shareholder of a
common-law close corporation generally cannot claim any special treatment accorded
close corporations because common-law close corporations do not fit within our statutory
framework.

8.
Kansas law embraces the general rule that a shareholder suit for injuries to a
corporation as a result of officer or director misconduct—including the allegations of
self-dealing or breach of fiduciary duty—must be brought as a derivative action and may
not be brought as a direct action unless the corporation is at least a closely held if not a
statutory close corporation under K.S.A. 17-7202 and the plaintiff can prove that the
action will not unfairly expose the corporation to a multiplicity of actions, materially
prejudice the interests of creditor of the corporation, or interfere with the fair distribution
of the recovery among all interested persons. Then and only then does the trial court have
the discretion to permit a direct action rather than a derivative suit.



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9.
When the judgment after a bench trial is challenged as contrary to the evidence,
we must examine the record to determine whether any presumption of an underlying
basis was supported by the evidence when considered in the light most favorable to the
prevailing party.

10.
Under the facts of this case, a direct action by a single shareholder against the
corporation and two officers and directors holding only 23.5% of the outstanding shares,
for claims conceded to be derivative in nature, was a mangled misalignment of parties,
demonstrating that the statutory safeguards of a derivative action may not be ignored.
Because the single shareholder had no standing to file and pursue these claims as a direct
action, the district court was without subject matter jurisdiction.

Appeal from Finney District Court; ROBERT J. FREDERICK and PHILIP C. VIEUX, judges. Opinion
filed September 23, 2011. Vacated and remanded with directions.

James D. Oliver and Toby Crouse, of Foulston Siefkin LLP, of Overland Park, John M. Lindner,
of Lindner & Marquez, of Garden City, and Daniel H. Diepenbrock, of Law Office of Daniel H.
Diepenbrock, P.A., of Liberal, for appellants/cross-appellees.

Charles D. Lee, Myndee M. Reed, and Arlyn Miller, of Martindell Swearer Shaffer Ridenour LLP,
of Hutchinson, for appellee/cross-appellant.

John Shirley, of Wallace, Brantley & Shirley, of Scott City, for interveners/appellees.

Before GREENE, C.J., MALONE and BRUNS, JJ.

GREENE, C.J.: Gerald and Kyle Lightner (the defendants) appeal the district court's
judgments against them and in favor of their sister and plaintiff, Irma Lightner, for
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$264,951 as well as their brothers and interveners, Robert and Lloyd Lightner for a
combined total of $895,786, as well as costs, after a bench trial of Irma's claims that
Gerald and Kyle engaged in a breach of fiduciary duty and self-dealing in their respective
capacities as officers and directors of D. Lightner Farms, Inc. (the Corporation). Gerald
and Kyle argue on appeal (a) that the action against them was barred in part by the statute
of repose and barred completely by the applicable statute of limitations; (b) that the
inequitable conduct of the plaintiff and interveners barred any recovery; and (c) that the
district court erroneously imposed the burden of proof on the defendants. Concerned that
lack of the plaintiff's standing to sue might prove to be a jurisdictional defect, we ordered
supplemental briefing on this question as well. Ultimately concluding that the plaintiff
and interveners indeed lacked standing as individual shareholders to bring what they
initially termed and have conceded were derivative claims against the corporation, we
vacate the judgments and remand with directions to dismiss the action.

FACTUAL AND PROCEDURAL OVERVIEW

In October 2003, Irma Lightner filed her petition against the defendants, as well as
the Corporation and "R.F. Let it Ride, L.L.C." (the LLC), alleging that the defendants
were "actively involved in the management and operations" of the Corporation as
"executives and directors" and that during the period since 1991 they "participated in the
acts of mismanagement and self-dealing" in a manner that resulted in the "dilution of the
shareholders' interests" in the Corporation. The only claim for relief was titled "breach of
fiduciary duty" and contained allegations (a) that the defendants "engaged in a series of
self-dealing lease transactions" and "have inappropriately benefitted themselves while
resulting in underpayment" to the Corporation "for equipment rental and cash rent for
land" and (b) that the defendants "arranged for and been paid compensation well in
excess of that which is reasonable." Although the petition categorized the same
misconduct as "fraud," there was no further allegation or specificity beyond the single
mention of fraud. Notably, the petition included an allegation that the claims, "though
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derivative in nature, will not (a) unfairly expose the corporation to a multiplicity of
claims; (b) materially prejudice the interests of creditors in the corporation; or (c)
interfere with a fair distribution of the recovery among all interested persons."

At the time of the petition's filing, ownership of outstanding corporate shares was
held by the eight children of Dale and Jessie Lightner, who were killed in a vehicle
accident in 1980. Ownership of the shares at all material times was as follows: Irma
(plaintiff) 10.25%; Gerald (defendant) 13.25%; Kyle (defendant) 10.25%; Lloyd
(intervener) 22.25%; Robert (intervener) 13.25%; Vivian (not a party) 10.25%; Phyllis
(not a party) 10.25%; and Edith (not a party)10.25%.

In December 2004, Robert and Lloyd filed their motion to intervene, alleging their
shareholder interests and attaching their petition containing nearly identical allegations
and seeking their share of damages.

In September 2005, the defendants sought summary judgment based upon (a)
failure to plead statutory prerequisites for a derivative action; (b) lack of standing to
maintain a direct shareholder action on a derivative claim; (c) no factual allegation or
support for fraud; (d) laches, acquiescence, and ratification; and (e) statutes of repose and
limitations. District Judge Robert Frederick heard arguments on the motion and then, in a
well-reasoned and thorough memorandum decision, denied it in all aspects except as to
those claims barred by the statute of repose.

With respect to the standing question, Judge Frederick relied on Mynatt v. Collis,
274 Kan. 850, 57 P.3d 513 (2002), and Richards v. Bryan, 19 Kan. App. 2d 950, 879
P.2d 638 (1994), holding that "other courts were beginning to recognize an exception to
the historical distinctions between derivative and direct individual shareholder actions in
the context of closely held corporations." He concluded that both Mynatt and Richards
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made it discretionary to allow a party to proceed with a direct suit in lieu of a derivative
action:

"'[I]f [the court] finds to do so will not (1) unfairly expose the corporation to a
multiplicity of actions; (2) materially prejudice the interests of creditors in the
corporation; or (3) interfere with a fair distribution of the recovery among all interested
persons.' "A fair distribution of the recovery" requires a court to consider the effect of
recovery on any nonparty shareholders.'" (Quoting Mynatt, 274 Kan. 851, Syl. ¶ 9).

Notably, however, Judge Frederick also specifically held that he was making no finding
that the three requirements set forth in both Mynatt and Richards were satisfied here.

"As important as this ruling may be to Plaintiff and Interveners, it does nothing to
suggest that Plaintiff and Interveners have satisfied the three (3) prong test of Richards or
that the Court, in its equitable power and discretion, could not deny Plaintiff and
Interveners the ability to proceed directly for reasons not yet raised or fully developed."

The matter proceeded to bench trial in the fall of 2008 before District Judge Phillip
C. Vieux. At the close of the plaintiff's case, the defendants moved for a directed verdict
on the standing issue. Their motion noted that the only approach to damages was an
estimate of the lost net worth to the Corporation, with an allocation to party shareholders
based on percentage interest. They also argued that the plaintiff had the burden to prove
the elements of the Richards test but had failed to do so. Finally, they argued that the
plaintiff and interveners were no longer in the minority, but they had become the
controlling block of the corporation. Judge Vieux took the issue under advisement.

In May 2009, Judge Vieux issued his Memorandum Decision and Order holding
that the defendants had breached their fiduciary duties to the Corporation and engaged in
self-dealing resulting in benefits to the defendants to the prejudice of the Corporation.
The total damages to the Corporation (without excluding those barred by the statute of
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repose) were established at $2,523,343, and the court then allocated a judgment award in
favor of the plaintiff and interveners based on their percentage shares of stock ownership
and against all defendants and each of them—including the Corporation.

In their motion to alter or amend the judgment, defendants argued that the plaintiff
and interveners had represented that their action would establish the elements of the
Richards test, but that the evidence demonstrated that their direct action had "exposed the
corporation to a multiplicity of actions" and "severely prejudiced the interests of creditors
and other stockholders." The district court denied this motion without further findings.

The defendants timely appeal. Prior to oral argument, we directed the parties to
submit supplemental briefing on issues of standing. All parties complied with our order
and were also prepared to discuss the issue at oral argument.

STANDARDS OF REVIEW APPLICABLE TO ISSUES OF STANDING

Standing to sue is a component of subject matter jurisdiction, which may be raised
for the first time on appeal or on the appellate court's own motion. State v. Ernesti, 291
Kan. 54, 60, 239 P.3d 40 (2010). Whether standing exists is a question of law subject to
unlimited review. State v. Gilbert, 292 Kan. 428, 431-32, 254 P.3d 1271 (2011); Mid-
Continent Specialists, Inc. v. Capital Homes, 279 Kan. 178, 185, 106 P.3d 483 (2005). It
is clear that if a party does not have standing to challenge an action or to request a
particular type of relief, then there is no justiciable case or controversy and the suit must
be dismissed. See Kansas Bar Ass'n v. Judges of the Third Judicial Dist., 270 Kan. 489,
490, 14 P.3d 1154 (2000).

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DID PLAINTIFF AND INTERVENERS HAVE STANDING TO BRING DERIVATIVE CLAIMS IN A
DIRECT ACTION AGAINST ALLEGED MALFEASANT OFFICERS AND DIRECTORS OF THE
CORPORATION AND THE CORPORATION ITSELF?

At the outset, this court raised the issue of standing on its own motion due to a
host of "red flags" that became apparent upon a review of the initial appellate briefs. We
noted: (1) The initial petition and the plaintiff's brief on appeal characterized the claims
herein as derivative in nature; (2) the Corporation itself was named as a party defendant
in the initial petition, and judgment was entered against the Corporation by the district
court; (3) the defendants together never owned more than a total of 23.5% of the
outstanding stock of the Corporation; (4) the damages were premised upon injury to the
Corporation, and the resulting judgments were based on a simple allocation of that
corporate injury only to shareholders who were parties based on percentage of
outstanding shares owned; (5) three shareholders representing 31.5% of outstanding
shares were not parties to the suit; (6) in 2005, the plaintiff became president of the
Corporation and, with the interveners and another shareholder, became a majority voting
block but continued their action against the Corporation; and (7) at least one additional
lawsuit has been filed among these same parties, which the trial court observed "could be
considered overlapping or undercutting this action."

In the defendants' supplemental brief, they essentially argue that the plaintiff and
interveners failed to satisfy the Richards three-prong test for a direct action and that the
Richards exception to the rule against direct actions does not apply here because the
Corporation was not a statutory close corporation, citing Hunt v. Data Mgmt. Resources,
Inc., 26 Kan. App. 2d 405, 985 P.2d 730 (1999). In contrast, the appellees argue that the
district court had discretion to permit a direct action here, that they satisfied the three-
prong test of Richards, and that the Hunt case did not limit direct actions to statutory
close corporations. These competing arguments require that we analyze the law
governing shareholder suits against corporations.

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Overview of the Law Distinguishing Direct Actions from Derivative Actions Against
Corporations


When a corporation has been injured by the actions of those in control thereof, the
well-established general rule is that the suit seeking redress for such a grievance belongs
to the corporation and must be brought as a derivative action, meaning one or more
shareholders may bring suit on behalf of the corporation for harm done to the
corporation. Kramer v. Western Pacific Industries, 546 A.2d 348, 351 (Del. 1988)
(quoting Clark, Corporate Law 639-40 [1986]). Direct actions by a shareholder against
officers or directors of a corporation are generally reserved for injuries affecting the
individual legal rights of that shareholder. Tooley v. Donaldson, Lufkin & Jenrette, 845
A.2d 1031, 1036 (Del. 2004). Shareholders do not have standing to sue for harms to the
corporation or even for the derivative harm to themselves that might arise from a tort or
other wrong to the corporation. Hammes v. AAMCO Transmissions, Inc., 33 F.3d 774,
777 (7th Cir. 1994); see In re First Interstate Bancorp Litigation, 729 A.2d 851 (Del.
1998).

Determining whether an action is derivative or direct is sometimes difficult and
has many legal consequences. See, e.g., Abelow v. Symonds, 156 A.2d 416, 420 (Del. Ch.
1959). In Tooley, the Supreme Court of Delaware has provided the quintessential test for
the distinction:

"The analysis must be based solely on the following questions: Who suffered the
alleged harm—the corporation or the suing stockholder individually—and who would
receive the benefit of the recovery or other remedy? This simple analysis is well
imbedded in our jurisprudence . . . .
". . . [T]he inquiry should be whether the stockholder has demonstrated that he or
she has suffered an injury that is not dependent on an injury to the corporation. . . .
'Looking at the body of the complaint and considering the nature of the wrong alleged
and the relief requested, has the plaintiff demonstrated that he or she can prevail without
showing an injury to the corporation?'" Tooley, 845 A.2d at 1035-36.
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Although the plaintiff and interveners argue on appeal that this general rule is
"archaic," we disagree. The general rule as articulated by the Delaware court in Tooley
has been cited and applied in a host of jurisdictions; Tooley has been characterized as a
"landmark" decision and applied in Delaware as recently as 2011. Hartsel v. Vanguard
Group, Inc., C.A. No. 5394-VCP, 2011 WL 2421003, at *16 (Del. Ch. 2011)
(unpublished opinion); see Feldman v. Cutaia, 951 A.2d 727, 729 (Del. 2008); see also
12B Fletcher, Cylopedia of the Law of Corporations §§ 5908 (2009) et seq. (recognizing
the general rule but acknowledging jurisdictions allow direct actions in some
circumstances, citing Richards); Annot., Action in Own Name by Shareholder of Closely
Held Corporation, 10 A.L.R.6th 293 ("It has been a fundamental principle of corporate
law that when a third party causes harm to a corporation, if the corporation does not bring
an action for compensation, a shareholder may not proceed by way of a direct action to
seek such recovery"). Although these authorities acknowledge that many jurisdictions
have now recognized exceptions to the general rule—as noted by our court in Richards—
the general rule is alive and well in the absence of the specific circumstances where an
exception may be recognized in the unique jurisprudence of a given state. See 12B
Fletcher, Cyclopedia of the Law of Corporations § 5911, p. 517 (state law determines
whether a shareholder may maintain a direct, nonderivative action).

Overview of Kansas Law Applying These Concepts


Kansas courts have a long history of looking to the decisions of the Delaware
courts involving corporation law, as the Kansas Corporation Code was modeled after the
Delaware Code. Welch v. Via Christi Health Partners, Inc., 281 Kan. 732, 765, 133 P.3d
122 (2006). Thus, we must give significant precedential value to those cases cited above
from Delaware.

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At the outset, we note that since 1969, Kansas has recognized derivative actions
within our Code of Civil Procedure. At the time the Lightner action was filed, K.S.A. 60-
223a provided:

"In a derivative action brought by one or more shareholders or members to
enforce a right of a corporation or of an unincorporated association, the corporation or
association having failed to enforce a right which may properly be asserted by it, the
petition shall be verified and shall allege . . . . The derivative action may be maintained
only if the court is satisfied that the plaintiff will adequately represent the interest of the
corporation or association."

This pre-2010 version of the statute, which is applicable here, provided a degree of
protection against unreasonable or unfair results. The statute required a verified petition
with specific allegations that the plaintiff was a shareholder at the time of the subject
transaction and that the action was not a collusive one to confer jurisdiction on a Kansas
court. The petition was also required to allege with particularity the efforts made by the
plaintiff to obtain the action desired from the directors or others in control and the
reasons for failure of those efforts or failure to exhaust those efforts. Finally, the statute
placed a responsibility on the court to assure that the plaintiff would adequately represent
the interest of the corporation. In 2010, the legislature amended the statute to state with
more clarity these protective measures and to supplement them with other protections
including those regarding settlement or compromise of such an action. See K.S.A. 2010
Supp. 60-223a; L. 2010, ch. 135, sec. 91, effective July 1, 2010.

Caselaw construing and applying these concepts in Kansas has not been prolific.
In Richards, our court explained the fundamental rules as follows:

"A claim is said to be derivative if injury is either to the corporation directly or to
the shareholder but mediated through the corporation. Bagdon v. Bridgestone/Firestone,
Inc., 916 F.2d 379, 383 (7th Cir. 1990), cert. denied 500 U.S. 952 (1991); McDaniel v.
Painter, 418 F.2d 545, 547 (10th Cir. 1969). A shareholder may only litigate as an
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individual if the wrong to the corporation inflicts a distinct and disproportionate injury on
the shareholder, or if the action involves a contractual right of the shareholder which
exists independently of any right of the corporation. Bagdon, 916 F.2d at 383; Moran v.
Household Intern., Inc., 490 A.2d 1059, 1070 (Del. Ch. 1985). 'Whether a cause of action
is individual or derivative must be determined from the "nature of the wrong alleged" and
the relief, if any, which could result if plaintiff were to prevail.' Kramer v. Western
Pacific Industries, 546 A.2d 348, 352 (Del. 1988)." 19 Kan. App. 2d at 961-62.

The Richards' panel determined that the majority of Richards' claims were to the
corporation, and that Richards should have filed a derivative action under K.S.A. 60-
223a, not an individual suit. 19 Kan. App. 2d at 962. The panel recognized that an
exception exists when a minority shareholder is frozen out of the management of a close
corporation through oppressive majority conduct. 19 Kan. App. 2d at 964. According to
Richards, if a corporation is closely held, a court, in its discretion, may treat an action
raising derivative claims as a direct action if it finds to do so will not: "(1) unfairly expose
the corporation to a multiplicity of actions; (2) materially prejudice the interests of
creditors in the corporation; or (3) interfere with a fair distribution of the recovery among
all interested persons." 19 Kan. App. 2d at 965.

After Richards, our court had occasion to address whether Kansas recognized
common-law close corporations or only close corporations organized under K.S.A. 17-
7202. See Hunt, 26 Kan. App. 2d at 407-08. In Hunt, our court rejected an Illinois rule
that extended such an exception to closely held corporations and embraced instead the
Delaware rule from Nixon v. Blackwell, 626 A.2d 1366 (Del. 1993). Hunt, 26 Kan. App.
at 407. The Delaware court resisted any extension of the exception to closely held
corporations not organized under the statute because "the legislature had preempted the
field by statute and any effort to construct a special rule outside the statutory framework
would amount to inappropriate judicial legislation." 26 Kan. App. 2d at 407. The Hunt
court recognized that if the statutory definition is not met, "simply put, appellants cannot
claim any special treatment accorded close corporations because [the corporation] did not
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fit within the statutory framework." 26 Kan. App. 2d at 408; 18 Am. Jur. 2d,
Corporations § 39, p. 686 (2004) (citing Hunt for the proposition that "some states do not
recognize a close corporation under common law").

Reading Richards and Hunt together, Kansas does not recognize common-law
close corporations and, therefore, the exception to the requirement for derivative claims
to be brought in a derivative action may not apply unless the corporation is a close
corporation under K.S.A. 17-7202. We are not prepared to hold, however, that the
exception must be strictly limited to statutory close corporations because both our court
in Richards and our Supreme Court in Mynatt use the terms "close corporation" and
"closely held corporation" interchangeably and did not restrict the exception to close
corporations formed under K.S.A. 17-7202.

In a later articulation of the law in Kansas, Judge Knudson addressed the close
corporation exception of Richards in Sparks v. CBIZ Accounting, Tax & Advisory of
Kansas City, Inc., 36 Kan. App. 2d 660, 142 P.3d 749 (2006).

"Sparks admits his claim of professional negligence against CBIZ is derivative; that is,
his injury, if any, is mediated through [the corporation]; therefore, Sparks is precluded
from bringing an individual damage claim for the defendants' breach of duty owed to the
corporation. [Citation omitted.] . . . Unfortunately for Sparks, the close corporation
exception only applies when an oppressed minority shareholder brings suit against
majority directors, officers, or directors for breach of a fiduciary duty. [Citation omitted.]
It is a mischievous suggestion that the exception should be extended to permit litigation
by a minority shareholder against a third party not owing a contractual duty to the
shareholder. Such an exception would disregard the distinct nature of a corporation as a
legal entity and allow an individual shareholder damages that rightfully belong to the
corporation." (Emphasis added.) 36 Kan. App. 2d at 661.

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In the only case reflecting our Supreme Court's foray into these concepts, the court
was asked to overrule Richards in Mynatt, 274 Kan. 850. Instead, our Supreme Court
embraced the Richards' analysis and its three-prong test, particularly the test requiring
that any direct action not interfere with a fair distribution of the recovery among all
interested persons. The court noted that this prong of the Richards test "requires a court
to consider the effect of recovery on any nonparty shareholders." Mynatt, 274 Kan. at
873. In an effort to further restrict the exception, however, the court went so far as to hold
that a court had the discretion to deny a direct action even if all three prongs of the
Richards test were met. 274 Kan. at 873.

Contrary to the arguments of the plaintiff and interveners, however, at no time did
the Supreme Court suggest that a court had discretion to allow a direct action without
application and satisfaction of the Richards three-prong test; that is, unless the plaintiff
has alleged and thereafter proven that the direct action will not have any of the three
adverse consequences designated by Richards, the court has no discretion to allow the
action to proceed as a direct action. To suggest that the court has broad discretion to
allow a direct action prior to application and satisfaction of the Richards three-prong test
is a distorted construct of the Mynatt holding and is contrary to the clear direction of our
Supreme Court in its discussion and application of Richards.

Finally, and most recently, our court addressed these concepts in Miller v. Staab,
No. 91,931, unpublished opinion filed June 17, 2005, rev. denied 280 Kan. 983 (2005).
There, our court once again cited and applied Richards in holding that the plaintiff's
direct action petition raised derivative, not individual, claims. On this basis and because
the pleading requirements of K.S.A. 60-223a were not satisfied, the court held that the
petition failed to state a claim upon which relief could be granted. Miller, slip op. at 5-13.

In summary, Kansas law embraces the general rule that a shareholder suit for
injuries to a corporation as a result of officer or director misconduct—including self-
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dealing or breach of fiduciary duty—must be brought as a derivative action and may not
be brought as a direct action unless the corporation is at least a closely held if not a
statutory close corporation under K.S.A. 17-7202 and the plaintiffs can prove that the
action will not unfairly expose the corporation to a multiplicity of actions, materially
prejudice the interests of creditor of the corporation, or interfere with the fair distribution
of the recovery among all interested persons. Then and only then does the trial court have
the discretion to permit a direct action rather than a derivative action.

Did the Evidence Here Establish Satisfaction of the Richard' Three-prong Test?

At the outset of our analysis, we note that the parties concede that the Corporation
was not formed as a close corporation under K.S.A. 17-7202. Additionally we note that
this was clearly not a situation where a minority shareholder or group was being
oppressed by a majority shareholder or group; the defendants collectively owned only a
23.5% share and, presumably, could have been removed as officers at any time by a
majority of shareholders. Finally, we note that the ultimate result of a judgment against
the Corporation is antithetical to the analytical framework for a derivative claim. These
conclusions alone could arguably conclude our analysis, but we move on to the Richards
three-prong test to demonstrate that the court had no discretion to permit a direct action
under these circumstances.

We also note that the district court made no findings on the satisfaction of the
Richards test, despite the clear admonition in Judge Frederick's summary judgment
memorandum, the defendants' motion for directed verdict, and the defendants' posttrial
motion to alter or amend the judgment. We must examine the record to determine
whether any presumption that the test was satisfied by the evidence, when considered in
the light most favorable to the prevailing party, supports the judgment. See City of
Mission Hills v. Sexton, 284 Kan. 414, 422, 160 P.3d 812 (2007).

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Exposure to a Multiplicity of Claims

Not only do we find that a secondary lawsuit has been filed that, according to the
district court "could be considered overlapping or undercutting this action," but there is
additional potential for litigation. Because three of the shareholders representing more
than 30% of the outstanding shares were not parties here, each could—subject to the
statutes of repose and limitations—bring their own action on grounds identical or similar
to those raised here. Other lawsuits could result from the financial stress on the
defendants, who have guaranteed substantial corporate debt; it is easy to envision defaults
on corporate debt that will result in a multitude of creditor actions against the
Corporation.

Prejudice to the Interests of the Corporate Creditors

The claim for relief framed by the plaintiff and interveners sought judgment
against the Corporation. Accordingly, the Corporation's assets were then theoretically
exposed to the suit, and—in turn—the Corporation's relationship with all its creditors
may have been imperiled. Not only was this a potential result from the initial pleadings,
we note that the judgment entered by the district court was entered against "Defendants,
and each of them" and therefore included a judgment against the Corporation. This is
simply turning the derivative claims on their head; instead of the shareholders bringing
suit on behalf of the Corporation, these shareholders sought and received judgment
against their own Corporation! It would be difficult to imagine any more prejudicial
outcome for the Corporation's creditors.

Fair Distribution of Recovery


Because the action here sought and achieved significant judgments on behalf of
some shareholders and excluded others, and also achieved a judgment against the
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Corporation, it cannot be said that it led to a fair distribution of recovery. The "double
whammy" to the nonparty shareholders of both being excluded from any recovery and
then seeing the same judgment imperil the Corporation's financial condition was entirely
unfair to the nonparty shareholders. Granted, they could have intervened, but this option
is not a sufficient prophylactic for our measurement purposes. Our task is to determine
whether the direct action, as filed, would ensure a fair distribution of recovery for all
interested persons. See Tooley, 845 A.2d at 1036 (inquiry is based on the body of the
complaint); Richards, 19 Kan. App. 2d at 961-62 (test for direct or derivative claims must
be determined from nature of the wrong alleged and the relief that could result). Here,
examining the allegations of the petition alone would lead one to conclude that this action
was not designed to ensure a fair distribution of recovery for all interested persons.

The plaintiff and interveners argue that "successful prosecution of a derivative
action, with consequent repatriation of damages to the Corporation, would end with the
[defendants] indirectly receiving a large portion of the recovery—surely a perverse
result." Granted, the defendants would presumably be entitled to their share of damages
awarded to the Corporation in a derivative suit, but they would be entitled to this share
because they were shareholders. This would not be a perverse result. It would simply be
associated with their percentage interest (here 23.5%) of any damages they may be
required to pay to the Corporation. That is, their entitlement to a share of recovery based
on percentage share ownership is wholly unrelated to the alleged misconduct that gave
rise to any damages. Moreover, the court could simply modify or reduce the judgment
against them by their percentage of ownership to avoid this result.

Summary and Conclusion

Examining each of the elements of the Richards test, combing the record for
evidence pertinent to each, and viewing that evidence in the light most favorable to the
19

plaintiff and interveners, we must conclude that the judgment is not supported because
the plaintiff and interveners—ultimate judgment creditors—had no standing to proceed.

We need not comment on the propriety of the defendants' mismanagement here.
We need only to conclude that this direct action by a single shareholder among several
against the Corporation and two officers and directors holding only 23.5% of the
outstanding shares, for claims conceded to be derivative in nature, was a mangled
misalignment of parties, demonstrating that the statutory safeguards of a derivative action
may not be ignored. We note there was no apparent obstacle to a derivative action here;
but the single shareholder had no standing to file and pursue these claims as a direct
action. Because the plaintiff had no standing to sue, the district court was without subject
matter jurisdiction. Accordingly, we must vacate the judgments and remand with
directions to dismiss the action.

Vacated and remanded with directions.