Transcript : Direct versus derivative claims and the difference between them.
Yaniv Adar | 00:00:00:12 – 00:00:05:26
Now is a good time to talk about Direct versus Derivative claims. Why don’t you tell us about the differences between the two.
Etan Mark | 00:00:05:26 – 00:00:34:12
Florida has drawn a strict line between what is considered a direct claim versus what is considered a derivative claim. Both are in the context of corporations or LLCs, where you’ve got shareholders or members that are suing either for damage that they sustained in their individual capacities or are standing in the shoes of a corporation or LLC and bringing damages that that entity has sustained.
Courts in Florida look very carefully to determine whether or not the damage that is alleged in the case is really unique to that individual, shareholder or member, or something that’s ultimately damage that the corporation or LLC suffered. Don, one of our partners, litigated one of the seminal cases in Florida on this direct versus derivative issue and was called the Ferk case that went up to the Third District Court of Appeal.
So Florida courts exercise fairly strict adherence to recognizing and maintaining a distinction. Is that something you see in courts across the country or is it unique to Florida?
Yaniv Adar | 00:01:30:19 – 00:02:00:27
When you’re looking to decide whether to bring a direct or derivative claim, you need to look at not only the choice of law that applies, but you also need to look at where the entity is incorporated or organized. So, for example, if you’re looking at a lawsuit against a company that is organized in the state of New York, but there is a choice of law provision in the state of Florida, then you’re going to be looking at both Florida law for determining what law applies to the causes of action. But you’ll also be looking at New York state law to see what are the rules that govern that particular LLC. So you can have an overlap depending on where you’re suing and what type of entity it is.
Etan Mark | 00:02:14:02 – 00:02:27:05
The most common jurisdiction for these kinds of cases, at least as far as the choice of law, is Delaware, because most many corporations and LLCs in the United States are Delaware based.
Yaniv Adar | 00:02:14:02 – 00:02:27:05
There are standards that apply for a lot of the entities that exist. For example, for LLC, there’s the revised Limited Liability Company Act and for partnerships they’ll be the Uniform Partnership Act. Templates have been created by legal scholars that create a framework, and then individual legislatures will decide whether or not they want to adopt in whole or in part, these uniform statutes.
What you’ll see in Florida, New York and Delaware is that the majority of the statutes have a lot of overlap. Many of the provisions are substantially similar. But obviously, when you’re looking to file a lawsuit, the devil is going to be in the details and there are differences in each particular state statute.
Etan Mark | 00:03:08:27 – 00:03:29:01
That said, to the extent that if you’re suing in Florida under the LLC act, our courts look to Delaware for guidance to the extent there is not Florida law directly on point, because it’s universally recognized that Delaware has the most well-developed rules. I think there is jurisprudence on that particular topic.
Yaniv Adar | 00:03:33:16 – 00:03:56:06
Right. There’s, for example, in 2015 when the revised Limited Liability Company Act came about, there was this new concept of judicial expulsion that only existed in the common law prior to the revised act being introduced to the states, but then was put into an actual statute. It exists in Florida, but there’s few, if any, cases that are out there. So when we, when my partner Josh and I, were litigating a disassociation case, we inevitably had to look to New York and Delaware to be able to find precedent on this novel legal concept.
Etan Mark | 00:03:33:16 – 00:03:56:06
Let’s go back to this distinction of the damages of direct versus derivative, because it’s it’s such a common pitfall for litigants in Florida to to screw that up, frankly. Can you give an example of what would be considered a direct damage versus what would be considered a derivative damage?
Yaniv Adar | 00:04:25:16 – 00:04:49:00
Sure. So there is a there are tests that exist in every jurisdiction, but the clearest example of a derivative claim would be plain corporate waste. For example, there is a member of a company that is stealing from the company, and he’s doing so in a way that is hurting the bottom line. In that instance, the entity that is being harmed is the company itself. And my harm as a member, the one that’s wanting to sue is a derivative plaintiff, is only derivative based on how the company has been harmed.
A classic direct claim, on the other hand, would be one such as fraud in the inducement. If there was a specific fraud by one member against another into the entry of the operating agreement, the creation of this limited liability company, that would be a direct claim that one has to the other.
Etan Mark | 00:05:15:11 – 00:05:36:07
And another example of a direct claim that I’ve seen is where the operating agreement specifically provides for a particular right or obligation of a particular member and if those rights are somehow infringed or otherwise trampled, then that individual member could have the right to bring that claim directly as opposed to in the derivative capacity.
Yaniv Adar | 00:05:36:15 – 00:05:56:29
Right. These limited liability companies and a lot of these entities that are created are just creatures of contract. So one of the topics they were touching on was the concept of duties that exist and duties generally arise out of one of three things. It’s going to be out of contract, statute or the common law. So when you’re looking to decide whether you can sue someone directly or derivative you’ll have to look at those three sources to decide how you can sue that person. Using Etan’s recent example to what he just mentioned. As an example, you can look at the operating agreement, which is a matter of contract, and it might specifically say that one member owes a duty to another and that he has the right to sue them for any breach of that duty. But absent such a clear and express statement, it’s unlikely there would be a direct claim.
Etan Mark | 00:06:21:28 – 00:07:05:26
Let’s let’s just spend a minute talking about attorney’s fees in the derivative capacity. So so when an individual is bringing a lawsuit standing in the shoes of the corporation or standing in the shoes of the LLC, ultimately they’re hiring an attorney, right? This individual is hiring an attorney to represent the themselves standing in the shoes of this LLC or other legal entity. That individual is trying to do right, arguably or theoretically, by this corporation, by this corporate entity, does that individual have to come out of pocket to pay legal fees, or is this something that the entity itself can pay those legal fees and how does that work?
Yaniv Adar | 00:07:06:12 – 00:07:27:10
So the answer to that question is going to be based on whatever the operating agreement or statute says. So anytime you’re dealing with any conflict involving a legal entity, such as a corporation or company, you’re going to want to look at the statute, the operating agreement and the common law to decide what are the rights of the parties in this instance that you just asked about, typically you are going to have to come out of pocket. You are going to have to initially pay the expenses and costs associated with bringing a derivative lawsuit. And in Florida, for example, if you ultimately prevail, then you are capable of receiving a reimbursement for your attorney’s fees and costs out of the pot that you’ve collected. So if you were to sue someone in a derivative capacity for $5,000, but spend $7 million litigating those claims, then you’re unlikely to be able to be reimbursed for the entire amount absent something extraordinary. But again, it would be governed by statute contract in the common law.
#law #litigation #LawRealigned #derivativeclaim #Directclaim #DirectversusDerivatives #feerecovery