News & Noteworthy

The Test for a Direct or Derivative Claim Established in Frydman LLC Decision Five Years Later

Posted on October 11, 2017

This is the five year anniversary of the decision obtained by Frydman LLC in Yudell v. Gilbert, 99 A.D.3d 108, 949 N.Y.S.2d 380 (1st Dep’t 2012), where we successfully defended a joint venture partner and property manager of a shopping center on Long Island.  The plaintiff, a minority joint venturer, asserted breach of fiduciary duty and other claims based upon alleged improper management of the shopping center.  A core issue was whether the claims were direct (held by the partner) or derivative (where the partner was seeking to enforce a claim held by the joint venture and affecting all of the joint venturers).  If it was a derivative claim, the plaintiff would have to explain why he failed to simply demand that the joint venture bring the claim.  Derivative claims are a potent weapon for shareholders to redress mismanagement and self-dealing in corporations – from IBM to family owned companies.

Frydman LLC moved to dismiss the complaint on the basis, among others, that the claims were derivative, or owned by the joint venture, and plaintiff failed to properly plead that it would have been futile for plaintiff to demand that the joint venture bring the claims.  The trial court agreed, granted our motion and dismissed the case.  The appellate court affirmed.

While there were some other novel issues, in adopting our arguments the appellate court noted that “New York does not have a clearly articulated test” for determining whether a shareholder claim is direct or derivative (despite the prevalence and importance of such claims in corporate litigation).  The appellate court made a precedent setting holding by adopting the test used by Delaware courts set forth in Tooley v. Donaldson, Lufkin & Jenrette, Inc., 845 A.2d 1031 (Del. 2004) to determine whether a claim is direct or derivative:  (1) who suffered the harm? (e.g. the company or the shareholders) and (2) who would receive the benefit of recovery? (e.g. would the recovery go to the company or the shareholders).  The appellate court upheld the trial court’s holding that plaintiffs’ claims were derivative because (1) the joint venture suffered the alleged harm caused by the mismanagement and (2) any potential recovery would go to the joint venture because “It is only through loss to [the joint venture] that plaintiffs suffer a loss at all … all members suffer losses from the failure to collect rents and other obligations owed the joint venture.”

It is gratifying to see that the Yudell holding has provided much needed clarity in the area of derivative litigation in New York, home to very significant corporate litigation, and has been cited some 100 times by state and federal courts, taught in corporate law classes and discussed in many legal publications.

If you have questions about the direct/derivative claim distinction or the ability to bring suit concerning a business dispute, please do not hesitate to contact us.