The distinction between direct and derivative claims pervades business divorce litigation. Whether a dissident owner’s claim against his or her co-owners is a direct claim (one that the owner can assert in their individual capacity) or a derivative one (one that seeks to redress injury to, and therefore must be asserted on behalf of the business) factors into almost every claim we litigate, and it is one of the most common grounds for a pre-answer motion to dismiss, as this post demonstrates.
Given the choice, most owners would prefer to assert their claims directly. Derivative claims beget a host of prerequisites and considerations: has the pre-suit demand requirement been complied with? Can the corporation take the litigation out of a shareholder’s hands by appointing a special litigation committee? If successful on the claims, what assurances does the shareholder have that the corporation’s recovery will be passed on to the shareholders?
For that reason, we sometimes see shareholders or LLC members utilize artful pleading strategies to cast their claims as direct ones. But the Tooley test—the standard, under both Delaware and New York law to determine whether a claim is direct or derivative—is a good one. By considering (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), Courts and attorneys usually can spot the differences between a direct claim and a derivative one.
A recent decision from the Southern District of New York, Miller v Brightstar Asia, 20-CV-4849 (SDNY Sept 11, 2023) considers a shareholder’s reliance on the implied covenant of good faith and fair dealing inherent in the corporation’s shareholders agreement in an attempt to plead what otherwise would be derivative claims as direct ones.Continue Reading Derivative into Direct and Waived into Preserved: The Transformative Power of the Implied Covenant of Good Faith and Fair Dealing