Third DCA Clarifies When Shareholders and Members May File Direct Actions for Damages
In closely held corporations and limited liability companies, the distinction between a direct and a derivative action is not always clear. When a company has three shareholders or members, and only one of the three owners is harmed by the majority’s malfeasance, is the injury a direct injury to the minority owner or an indirect injury that derives from the injury to the entity itself? The Third District Court of Appeal sought to bring clarity to this inquiry in its recent opinion in Dinuro Investments, LLC v. Camacho, 141 So. 3d 731 (Fla. 3d DCA 2014).
In general, Florida courts have required that the individual shareholder or member sustain an “injury” that is both direct and peculiar to the shareholder. For instance, in Karten v. Woltin, 23 So. 3d 839 (Fla. 4th DCA 2009), the Fourth District Court of Appeal held that “[s]hareholders may bring a direct suit only ‘in their own right to redress an injury sustained directly by them individually.'” Id. at 840 (citation omitted). In addition to being a “direct” injury, that injury must be “separate and distinct” from injuries suffered by fellow shareholders or members. Id.
Despite these general statements of the direct/derivative distinction, the Third District Court of Appeal concluded that the “current Florida doctrine explaining which actions should be maintained directly and which must be brought derivatively is incredibly opaque.” Dinuro, 141 So. 3d at 739. The court examined a series of cases from the various district courts and noted, however, that some courts looked only for a “direct harm,” while others sought evidence of a “special injury.” See id. at 739.
The court sought to reconcile these divergences by reformulating the direct injury test as follows:
In our view, the 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.
Id. at 739-40.
The sole exception recognized by the Third DCA is 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.” Id. at 740. For instance, when a shareholder is a party to a shareholder’s agreement, that shareholder may sue for breach of the agreement “even if he has not suffered an injury separate and distinct from that suffered by other shareholders.” Harrington v. Batchelor, 781 So. 2d 1133, 1135 (Fla. 3d DCA 2001) (citation omitted).
Notwithstanding the Third DCA’s recognition of its prior holding in Harrington that a party to a shareholder’s agreement may sue for this breach, the court in Dinuro found that the LLC member plaintiff in that case could not sue other members directly for breach of the operating agreement. Noting that the “precise terms of the agreement are critical,” the court reasoned that the agreement at issue lacked “any provision stating that the members shall be directly liable to each other for breaches of the terms of the operating agreement.” Dinuro, 141 So. 3d at 742. The court applied a presumption that “individual members are not liable for obligations or decisions of the company, as limited liability is one of the paramount reasons for forming an LLC.” Id. In other words, unless the agreement expressly creates a duty between members, the member must bring a derivative action.
The usefulness of the direct and derivative distinction in closely held entities has been questioned for years. See Allan B. Cooper et al., Too Close for Comfort: Application of Shareholder’s Derivative Actions to Disputes Involving Closely Held Corporations, 9 U.C. Davis Bus. L.J. 171, 182-86 (discussing the majority and minority views in the U.S. regarding the distinction for closely-held entities). Nevertheless, Florida retains, for the most part, the majority position that all business entities should be treated the same for the purpose of shareholder or member disputes. In fact, the Revised LLC Act, enacted in 2013, sets forth a similar test to the one mandated by the Third DCA Dinuro. In order to file a direct action, the member must show a duty arising out of the operating agreement or arising “independently of the membership relationship,” and the member must “plead and prove an actual or threatened injury that is not solely the result of an injury suffered . . . by the limited liability company.” § 605.0801(1)-(2), Fla. Stat.
As such, it appears the Dinuro test will be guiding the direct/derivative analysis for the foreseeable future. When representing a client with a dispute over a closely-held entity, counsel should be mindful of the duties and injuries involved in the dispute, in order to select the proper type of action.