Usually when a shareholder sues a corporation, the shareholder does so by means of a “derivative” action. Derivative means “coming from another.” A derivative action is a lawsuit that a shareholder files on behalf of the corporation against a third party – usually an officer, director or manager of the corporation – because of a loss or malfeasance by that third party that harmed the corporation. However, when a corporation is small and closely held, sometimes the nature of the dispute between a shareholder and the corporation is such that a derivative action is inappropriate, and the shareholder should sue the corporation directly as an individual. If a shareholder makes a mistake with regard to whether to sue derivatively or directly, the shareholder’s lawsuit may be dismissed. Peter Mavrick is a Fort Lauderdale business litigation lawyer, and also represents clients in business litigation in Miami, Boca Raton, and Palm Beach. The Mavrick Law Firm represents clients in breach of contract litigation, non-compete agreement litigation, trade secret litigation, trademark infringement litigation, and other legal disputes in federal and state courts and in arbitration.
Florida courts have recognized that “as the community of interests between shareholders and their closely held corporation becomes more tightly interwoven, the basis upon which one differentiates derivative from individual actions becomes more critical and, as a consequence, the cases become less self-evident.” Dinuro Investments, LLC v. Camacho, 141 So. 3d 731 (Fla. 3d DCA 2014). The Florida legislature recently addressed the issue of when a shareholder can sue directly as an individual with the passage of Florida Statute section 607.0750. It became law as of January 1, 2020.
Prior to enactment of the statute, Florida courts employed different tests to determine if a shareholder should sue derivatively or directly, but the law was not uniform. As the Third District Court of Appeal noted, “the current Florida doctrine explaining which actions should be maintained directly and which must be brought derivatively is incredibly opaque…” Id.
One test used was the “direct harm test.” Under the direct harm test, the court determined if (a) the harm from the corporate wrongdoing flowed first to the company and then to the shareholder in the form of a loss of share value, or (b) the harm from the corporate wrongdoing flowed directly to the shareholder and was not secondary to the corporation’s loss. Strazzulla v. Riverside Banking Co., 175 So. 3d 879 (Fla. 4th DCA 2015). If the harm from the wrongdoing went to the company first and then to the shareholder in the form of a share value loss, the shareholder should bring a derivative action. If the harm flowed directly to the shareholder, then the shareholder should bring a direct action.
A second test used was the “special injury test.” In this test, the court compared the injury sustained by the shareholder who filed suit against the injury suffered by other shareholders. For a direct action to succeed, the shareholder who filed suit must “demonstrate that he has sustained a loss that is substantially different from those losses sustained by other shareholders…” Dinuro Investments, supra. That could be a difficult to determine, however.
A third test the courts used was the “duty owed test.” In this test, the court looked to the “the statutory and contractual terms to determine whether the duty at issue was owed to the individual member or shareholder” or “whether those duties were owed to the company generally.” Id. If the corporation breached a duty that was owed to the shareholder individually, then the shareholder should bring a direct action against the corporation. If the corporation breached a duty owed to the corporation generally, then the shareholder should bring a derivative action. This also could be difficult to determine, particularly where there were overlapping duties that the corporation owed itself and its shareholders.
Florida’s Third District Court of Appeal held in Dinuro that for a shareholder to bring an action directly, the shareholder must allege either direct harm and special injury, or duty owed. Dinuro Investments, LLC v. Camacho, 141 So. 3d 731 (Fla. 3d DCA 2014). Florida’s Fourth District Court of Appeal agreed and adopted the same position. Strazzulla v. Riverside Banking Co., 175 So. 3d 879 (Fla. 4th DCA 2015).
The new statute, Florida Statute section 607.0750, provides that a shareholder can sue directly if the shareholder pleads and proves, “either: (a) An actual or threatened injury that is not solely the result of an injury suffered or threatened to be suffered by the corporation; or (b) An actual or threatened injury resulting from a violation of a separate statutory or contractual duty owed by the alleged wrongdoer to the shareholder, even if the injury is in whole or in part the same as the injury suffered or threatened to be suffered by the corporation.” Fla. Stat. §607.0750 (2020).
The language in subsection (b) of the statute is clearly a codification of Strazzulla and Dinuro and allows a direct action under the duty owed test. Subsection (a) of the statute is not so clear, but it appears to be the direct harm test. If the statute only requires that a shareholder show direct harm and not also special injury, then it would depart from the current law of the Third and Fourth District Court of Appeals. This may become the subject of litigation in cases where shareholders seek to sue a corporation directly.
The bottom line is that when a shareholder believes that they have been wronged by a corporation in which they hold shares, the shareholder needs to be careful in deciding how to sue and not just whether to sue, and needs to consider the evolving legal landscape of derivative versus direct actions.
Peter Mavrick is a Fort Lauderdale business litigation attorney who also practices business litigation in Miami, Boca Raton, and Palm Beach. This article does not serve as a substitute for legal advice tailored to a particular situation.