If you ask me to name the most common skirmishes over the adequacy of pleadings at the outset of business divorce litigation, at or near the top of the list are motions to dismiss a dissident owner’s direct claims that should have been brought derivatively, or derivative claims that should have been brought directly, or claims pleaded as both direct and derivative.
The frequency of such motion practice contrasts with the simplicity of the two-factor test devised by the courts for determining whether a claim is direct or derivative. As stated by the Appellate Division, First Department in Yudell v Gilbert, borrowing from the Delaware Supreme Court’s Tooley formulation, the determination depends on “(1) who suffered the alleged harm (the corporation or the stockholders); and (2) who would receive the benefit of any recovery or other remedy (the corporation or the stockholders individually).”
The test sounds easy to apply, and in most cases it is, especially when the alleged wrongful conduct by a controller involves misuse or waste of company funds or other financial impropriety that affects the nonculpable owners indirectly and on a shared basis by devaluing their equity interests. While the nonculpable owners of a closely held business may be victimized in a very real sense by the controller’s alleged misconduct, the direct injury is to the company for which the company is entitled to any recovery. Stated differently, the claim is company property, the prosecution of which normally depends on the business judgment of those holding the company’s managerial reins, and therefore can only be asserted by the non-managerial owners as a derivative claim after making demand upon the company managers or establishing that demand would be futile.
Let’s look at some recent examples of derivative and direct claims that went astray. Continue Reading Singin’ the Derivative Plaintiff Blues