Florida Appeals Court Clarifies Law On Derivative And Direct Shareholder Lawsuits
July 22nd, 2014
On July 9, 2014, Florida’s Third District Court of Appeal issued a landmark opinion in the case of Dinuro Investments, LLC vs. Felisberto Figueira Camacho, et al., 3D13-1242 & 3D13-1246, (July 9, 2014). In Dinuro, the Court analyzed whether a member of a limited liability company (“LLC”) had standing to commence a lawsuit directly against fellow LLC members. In reaching its conclusion, the Court synthesized nearly fifty years of inconsistent Florida case law bringing clarity to which actions must be maintained directly and which actions must be brought derivatively.
Direct Claim vs. Derivative Claim
But first, it’s important to understand the basic distinctions between direct and derivative claims. Generally, a derivative action is “an action in which a stockholder seeks to sustain in his own name a right of action existing in the corporation. The corporation is the real party in interest, the stockholder being only a nominal plaintiff.” James Talcott, Inc., v. McDowell, 148 So. 2d 36, 37 (Fla. 3d DCA 1962). A derivative action “must allege two distinct wrongs: the act whereby the corporation was caused to suffer damage, and a wrongful refusal by the corporation to seek redress for such act.” Id. at 38. See also Kaplus v. First Cont’l Corp., 711 So. 2d 108, 110 (Fla. 3d DCA 1998) (“In a derivative action, a stockholder seeks to sustain in his or her name, a right of action belonging to the corporation.”). Both the Florida Business Corporation Act and Florida Revised Limited Liability Company Act contain provisions for derivative actions. See Fla. Stat. §607.07401 (shareholder derivative actions) and Fla. Stat. §605.0801-605.0806 (member derivative actions).See also Florida Limited Liability Company Act, specifically, Fla. Stat. §608.60, for derivative actions in LLCs formed before January 1, 2014. However, effective January 1, 2015 all LLCs will be governed by the Revised Limited Liability Company Act. Comparatively, a direct action (a/k/a an “individual action”) is a suit by a shareholder/member to enforce a right of action existing in him, separate and distinct from that sustained by other shareholders/members. Citizens National Bank of St. Petersburg v. Peters, 175 So. 2d 54, 56 (Fla. 2d DCA 1965).
A significant distinction between a derivative and a direct lawsuit is one that ultimately impacts the bottom line. In a derivative action, all recoveries belong to the corporate entity. In a direct action, all recoveries belong to the individual shareholder/member plaintiff(s). That said, aggrieved shareholders/members typically prefer to initiate direct actions and pocket the recovery. However, as clarified by Dinuro, the bar to initiate a direct lawsuit has now been raised.
The Dinuro Facts
In Dinuro, three equal members of San Remo Homes, LLC (“San Remo”) obtained financing to purchase pieces of real estate through subsidiary entities. Due to a decline in the housing market San Remo was forced to negotiate a loan modification with its lender. A term of the revised loan agreement required the three members to make additional contributions to San Remo. Two members made the contributions, while one member, Dinuro, did not. Further, the two compliant members refused to front Dinuro’s member contribution. Consequently, the loan went into default.
The two compliant members formed a new corporation, SR Acquisitions, LLC, and successfully negotiated a purchase of San Remo’s defaulted loan from the lender. Thereafter, SR Acquisitions, LLC initiated foreclosure proceedings against San Remo, acquired the San Remo properties, and left San Remo with no viable assets. Dinuro initiated a direct member lawsuit against the two other members and the lender alleging a breach of operating agreements, tortious interference, and conspiracy to cause the damage outlined in previous counts.
The Defendants moved to dismiss on several grounds, including Dinuro’s lack of standing. The trial court granted the motion to dismiss “finding that Dinuro lacked individual standing to bring a direct claim against the other members for this type of harm, and that its claims should have been brought derivatively on behalf of San Remo.”
The Third District Court of Appeal agreed with the trial court and provided a detailed opinion to “provide clarity on a complicated point of law.”
Florida’s New Two-Prong Approach
Pulling from “scholarly literature and case law from around the country,” including Florida, the Dinuro Court stated as follows:
[t]he only way to reconcile nearly fifty years of apparently divergent case law on this point is by holding that an action may be brought directly only if (1) there is a direct harm to the shareholder or member such that the alleged injury does not flow subsequently from an initial harm to the company and(2) there is a special injury to the shareholder or member that is separate and distinct from those sustained by the other shareholders or members.
The Court also identified an exception to the rule stating that a “shareholder or member need not satisfy this two-prong test when there is a separate duty owed by the defendant(s) to the individual plaintiff under contractual or statutory mandates.”
Succinctly, if a plaintiff cannot satisfy the two-prong test (direct harm and special injury) or demonstrate a contractual or statutory exception, the plaintiff will have to bring his or her claims derivatively on behalf of the corporation or company. Relying on this new approach, the Dinuro Court reached the same conclusion as the trial court, that is, Dinuro’s claims could only be maintained derivatively because it was the entity that was initially injured, not the individual.
The attorneys at Fuerst Ittleman David & Joseph, PL will monitor subsequent application of Dinuro. Our attorneys have extensive experience in the areas of complex corporate litigation, business litigation, tax, tax litigation, administrative law, regulatory compliance, and white collar criminal defense. If you have any questions, an attorney can be reached by emailing us at email@example.com or by calling 305.350.5690.