“A plaintiff asserting a derivative claim seeks to recover for injury to the business entity. A plaintiff asserting a direct claim seeks redress for injury to him or herself individually. Sometimes whether the nature of the claim is direct or derivative is not readily apparent.”
The preceding quotation, from a signed opinion by Justice Karla Moskowitz (pictured) writing for a unanimous panel of the Appellate Division, First Department, in Yudell v. Gilbert, 2012 NY Slip Op 05896 (1st Dept Aug. 7, 2012), captures the essence of a thorny issue that can arise in lawsuits brought by shareholders, LLC members and partners asserting fiduciary breach and other claims against controlling persons of the business entities and sometimes against persons outside the entity.
There are, as Justice Moskowitz also observed, a number of standard scenarios — e.g., involving shareholders who suffer solely through depreciation in the value of their stock, or who allege mismanagement or diversion of corporate assets and opportunities — which clearly fall in the category of derivative claims. At the other end of the spectrum are claims clearly identifiable as direct claims seeking individual redress, such as discriminatory shareholder distributions. But in the middle is an endless supply of unique fact patterns where the line separating direct from derivative can get blurry.
Why does it matter? For one, derivative claims belong to the business entity, which is why there exist both statutory and common law rules requiring a plaintiff suing derivatively to allege in the complaint with particularity the plaintiff’s pre-suit efforts to secure initiation of the action by the controlling board or other governing body, or that doing so would have been futile. For another, there are situations where a plaintiff may have standing to litigate direct but not derivative claims, such as following a freeze-out merger. The recharacterization of a direct claim as derivative therefore may be fatal to a complaint that either does not allege at all, or does not allege adequately, pre-suit demand or demand futility.