Frivolous Counterclaim Against Minority Owners Leads to Attorney Fee Award Against Majority Owners
Lawsuits among closely held shareholders are notoriously acrimonious, and many litigation strategies have been tried to increase the leverage of one side over the other. A trial court has recently rejected one strategy, holding that majority owners generally cannot defend against a minority investor’s lawsuit with a counterclaim alleging that the minority’s lawsuit constitutes a breach of the minority’s fiduciary duty or a waste of corporate assets. A New Jersey trial court judge has deemed such a counterclaim frivolous and has sanctioned the majority owners by ordering them to pay the minority’s attorneys’ fees.
In Baratta v. Deer Haven, LLC, L-3682-09 (N.J. Super. Ct. Law Div. July 12, 2013), the plaintiffs, three limited partners in a Pennsylvania real estate venture, sued the general partners to recoup their entire $1,900,000 investment and alleged that the general partners had usurped partnership opportunities. The general partners filed a counterclaim seeking $1,000,000, asserting that the plaintiffs’ lawsuit constituted corporate waste, a breach of their fiduciary duties, and a breach of the covenant of good faith and fair dealing. After discovery and on cross motions for summary judgment, the court dismissed the entire counterclaim. The plaintiffs then moved for sanctions under New Jersey’s Frivolous Litigation statute (N.J.S.A. 2A:15-59.1) and Rule 1:4-8. Both the statute and court rule provide that a prevailing party may recover reasonable attorneys’ fees and costs from a party who has filed a frivolous pleading or a pleading solely for the purpose of harassment, delay or other improper purpose. The court granted the plaintiffs’ motion and awarded sanctions and attorneys’ fees.
After discovery revealed no support for defendants’ counterclaim, the court found the counterclaim to be nothing more than "an attempt to gain litigation leverage – to force the plaintiffs to expend more money, while also serving as a potential trade-off on settlement talks[.]" According to the trial court, the plaintiffs were simply passive minority investors who owed no fiduciary duty to the defendants, who were the managing partners. The court emphasized that, among owners in closely held businesses, "the fiduciary duty rests on the majority owners." However, had the plaintiffs been directors, officers, or attorneys of the business, they would have owed fiduciary duties to the defendants. The court identified only a few instances in which a counterclaim against a minority investor’s lawsuit could be viable:
Where the operative ownership agreements forbid litigation, relegating the investor to an arbitral or other forum;
Where the defendants offer the investors a stand-still agreement, pursuant to which the statute of limitations does not run on any cause of action (and all possible remedies of the investor remain viable);
Where the minority owner is an attorney for the business and/or a director or officer of the enterprise; and
Where the trial court concludes that all claims of the minority investors are without merit.
None of those situations applied to the Baratta case. Thus, the defendants’ attempt to intimidate the plaintiffs with their aggressive litigation strategy ultimately backfired when the counterclaim itself was deemed frivolous and the defendants had to pay the plaintiffs’ attorneys’ fees as a sanction.