Understanding the Distinction between Direct and Derivative Shareholder Actions

Whether a shareholder or member of a company can bring a derivative action or direct action against another shareholder or member is a critical matter when corporate wrongdoing or misconduct has occurred. A derivative action involves claims asserted on behalf of the company itself against the bad actor – the company itself is the actual victim of the wrongdoing. 

 

When a company shareholder or member initiates a derivative action, the idea is that the person being sued committed a wrong against the company itself, and by extension, the shareholders or members collectively. Hence, the lawsuit may be initiated by an individual shareholder or member, but it “derives” from the company and the collective interests of all the owners. On the other hand, a direct action is a suit brought by an injured shareholder or member on their own behalf against the wrongdoer.  

 

Florida case law has been somewhat ambiguous on determining when precisely an individual shareholder or member has the ability to bring a direct action. A direct action can have important ramifications when it comes to the ability to recover for a particular loss or injury. In this post, we will examine how Florida has approached the issue of the ability of an individual to bring either a derivative or direct action.

 

Dinuro Investments, LLC & the Tests for Derivative v. Direct Actions

 

• The Direct Harm Test 

 

Historically, courts in Florida have used three different legal tests to determine whether a given individual has a right to bring a direct action as opposed to a derivative action. The first test is referred to as the “direct harm test.” This test basically examines the path of the harm caused by the wrongdoer and attempts to determine whether the wrongdoer’s actions caused a direct injury to the individual, or whether the individual was only harmed as a result of a harm to the company collectively.

 

Ultimately, the court will find that an individual has no right to a direct action if the company itself would otherwise have the ability to recovery with an action of its own. In other words, the individual can only bring a suit if the damage was specifically suffered by the individual. 

 

• The Special Injury Test

 

The next test is the so-called “special injury test.” With this test, the court inquiries as to the precise nature of the damages suffered by the individual and asks whether those damages were substantially different than those suffered by other shareholders or members. If the damages sustained by a given individual are substantially distinct from those of others – and therefore the individual suffered a “special injury” – then a direct action is appropriate.  

 

• The Duty Owed Test 

 

The third and final test is the “duty owed test.” This test requires the court to determine whether the wrongdoer’s conduct violated an obligation owed to a specific individual, or an obligation to the company as a whole. The individual should be able to sustain a direct action if the obligation was specifically owed to him or her.

 

In Dinuro Investments, LLC v. Camacho the Third District Court of Appeal provided a concise discussion of these three tests and established Florida’s position with respect to derivative actions and direct actions. The Dinuro court referenced a general rule developed in Florida in a 1965 case, Citizens National Bank of St. Petersburg v. Peters, and ultimately settled on a “two-prong” approach to the availability of direct actions: an individual shareholder or member must satisfy both the direct harm test and the special injury test to qualify for a direct action.

 

In other words, the damage must be suffered specifically by the individual, rather than the company, and the damage suffered by the individual must be “special” and separate from the damage suffered by other shareholders or members. 

 

The Dinuro court noted an important exception, however: these two tests needn’t be satisfied if the individual can prove that the third test, the duty owed test, has been satisfied. In other words, if the individual can show that a special contractual or statutory duty was owed, then the individual can initiate a suit without satisfying these other tests.

 

The Ferk Family Case & Additional Considerations for Direct Actions

 

In 2018, the Third District Court of Appeal decided another case which basically followed the general principle laid down in the Dinuro case. In Ferk Family, LP v. Frank, the court determined that an individual member had the ability to bring a direct action against other members for breach of an operating agreement.

 

The court concluded that the individual member had a contractual right to a direct action because of a provision within the operating agreement itself. Hence, the provision within the operating agreement fulfilled the “duty owed test” and provided a sufficient foundation to sustain a direct action.

 

Contact The Frazer Firm to Evaluate the Nature of Your Business Litigation Claims

 

We hope the information provided here has shed some light on this topic. The distinction between derivative actions and direct actions has additional nuances. Accordingly, it’s important to seek counsel from experienced business litigation attorneys to fully explore the nature of potential claims you may have relating to corporate wrongdoing.

 

To learn more, schedule a consultation with the business litigation attorneys at The Frazer Firm today by calling 561-295-1551.