Editorial: Fla. Sets Strict Standard For Direct Shareholder Claims

by Bilzin Sumberg

Florida recently clarified the limited circumstances in which a corporate shareholder or limited liability company member has standing to bring a direct claim for damages relating to the company. On July 9, in Dinuro Investments LLC v. Camacho, the Third District Court of Appeal affirmed the dismissal of an LLC member's direct claims against the other LLC members and managers. The opinion has far-reaching implications and clarifies an issue of standing that has become more and more unsettled since the seminal 1978 case, Alario v. Miller, 354 So. 2d 925 (Fla. 2d DCA 1978).

The Direct vs. Derivative Question

A key issue in almost any shareholder litigation is — who gets the money? This issue is presented as whether the claim can be maintained directly on behalf of the shareholder or whether the claim must be asserted derivatively on behalf of the corporation. In a direct claim, the shareholder receives any recovery. In a derivative action, the recovery goes to the company. Given the bottom-line nature of the distinction, it is not surprising that this is a hotly contested issue.

The difficulty in litigating the issue was exacerbated by the fact that the Florida Supreme Court has not weighed in on the issue. In turn, this led to what the Third DCA termed a "lack of clarity" on an already complicated point of law.

Florida Adopts Unusual Two-Prong Approach

Dinuro Inestments analyzed Florida's sparse case law on the issue and concluded that Florida law applies a two-prong approach. Under this two-prong approach, the plaintiff-shareholder must meet both the "direct harm test" and the "special injury test" before being able to proceed with a direct claim.

The direct harm test compares the plaintiff-shareholder's injury to the company's injury. Under the direct harm test as formulated in Dinuro Investments, a claim is direct if "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." This is a complicated way of saying that if there was an initial injury to the company that led to the shareholder's injury, then the claim is derivative.

The special injury test compares the plaintiff-shareholder's alleged injury with the other shareholders' injuries. Under the special injury test, the claim is direct if "there is a special injury to the shareholder or member that is separate and distinct from those sustained by the other shareholders or members." If the plaintiff's injury is no different than the injury suffered by the other shareholders, then the claim is derivative.

The Separate Duty Exception

There is an exception to the two-prong test where there is a separate contractual or statutory duty owed to the plaintiff-shareholder. In that case, the claim can be brought directly without analyzing either of the two prongs. But this exception may prove applicable only in limited circumstances.

Direct statutory duties are rare in the corporate context, and although statutory fiduciary duties apply by default to LLC managers, those duties can be limited by the LLC's operating agreement. Further, Dinuro Investments made it difficult for LLC members to use an LLC operating agreement as the contract on which to base this exception. Under Dinuro Investments, the exception will be satisfied by an LLC operating agreement only if that agreement explicitly states that the members are directly liable to each other for breaches of its provisions.

Applying the New Florida Test

Plaintiff-shareholders likely will have a difficult time bringing direct claims under the new two-prong test. Most shareholder complaints begin with an officer or director's alleged improper conduct with regard to corporate assets. The usual allegation is that the officer or director misappropriated or wasted corporate assets on improper or unwise business ventures. This type of allegation runs squarely into the direct harm test — a waste of corporate assets necessarily is a direct harm to the corporation.

The nature of the commonly alleged damages also will present a difficult hurdle for the plaintiff to overcome. Generally, the financial injury alleged is a reduction in stock value. But, if the plaintiff's stock value declines, it usually is because the price of all outstanding stock declines. The special injury test would preclude claims based on diminution in stock value. A simple rule of thumb is that the plaintiff will have to allege some financial injury other than stock price decline in order to have a chance to meet the two-prong standard.

The end result is that, in most circumstances, an aggrieved shareholder or LLC member will have to bring his or her claims derivatively on behalf of the company. This leads to the appropriate result: if the company is injured, it is the company and all of its shareholders that will be made whole.

Distinguishing Delaware

Florida courts often look to Delaware courts for guidance on corporate law issues. This is due to the number and detail of opinions issued by the Delaware Court of Chancery. While there may not be a Florida case with facts or issues similar to those in front of the Florida court, there most likely is a similar Delaware case to turn to as persuasive authority. But, practitioners must be careful when relying on Delaware case law on the direct/derivative issue, because Florida has adopted a test that Delaware explicitly rejected.

In 2003, Delaware explicitly rejected the "special injury test" that is now the second prong of the Florida two-prong approach. Tooley v. Donaldson Lufkin & Jenrette Inc., 845 A.2d 1031 (Del. 2003). Tooley termed the concept of "special injury" as confusing and not helpful to the proper analytical distinction. In its place, Delaware adopted a modified version of the direct harm test, holding that a claim is direct only if (1) the duty breached was owed to the stockholder, and (2) the stockholder can prevail without showing an injury to the company.

The result for Florida practitioners is that pre-2003 Delaware opinions may be useful for analyzing the "special injury" prong of the Dinuro Investments test. However, post-2003 Delaware opinions apply a test that is neither prong of Florida's two-prong approach. Therefore, those opinions should have little sway over a Florida court.

This article is reprinted with permission from Law360.

DISCLAIMER: Because of the generality of this update, the information provided herein may not be applicable in all situations and should not be acted upon without specific legal advice based on particular situations.

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