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Posted: October 11, 2014

First Department Discusses Differences Between Direct and Derivative Claims

On September 30, 2014, the First Department issued a decision in Serino v. Lipper, 2014 NY Slip Op. 06551, explaining the differences between direct and derivative claims.

In Serino, a “complex, multi-party litigation, extending over a period of 12 years,” the cross-claim plaintiff sought “three categories of damages in connection with his cross claims”: “the lost value of his share of the Lipper entities, lost earnings that he attributes to his damaged reputation in the financial investment community and $6 million reflecting the gift tax payment he made on the inflated value of his holdings” The “central issue” facing the court was “whether all of [the cross-claim plaintiff’s] cross claims are barred, as a matter of law, because they are actually derivative claims, belonging only to the funds” of which he was a shareholder.

The court explained:

It is black letter law that a stockholder has no individual cause of action against a person or entity that has injured the corporation. This is true notwithstanding that the wrongful acts may have diminished the value of the shares of the corporation, or that the shareholder incurs personal liability in an effort to maintain the solvency of the corporation, or that the wrongdoer may ultimately share in the recovery in a derivative action if the wrongdoer owns shares in the corporation. An exception exists, however, where the wrongdoer has breached a duty owed directly to the shareholder which is independent of any duty owing to the corporation. This is a narrow exception, and [the cross-claim plaintiff’s] cross claim must be factually supportable by more than complaints that conflate his derivative and individual rights. In addition, [the cross-claim plaintiff] may not obtain a recovery that otherwise duplicates or belongs to the corporation.

. . . [T]his court [has] adopted the test developed by the Supreme Court of Delaware in Tooley v Donaldson, Lufkin & Jenrette, Inc. (845 A2d 1031, 1039 [Del 2004]) as a common sense approach to resolving such issues. We held that the Delaware test is consistent with existing New York State law. In order to distinguish a derivative claim from a direct one, the court considers (1) who suffered the alleged harm (the corporation or the suing stockholders, individually); and (2) who would receive the benefit of any recovery or other remedy (the corporation or the stockholders individually). If there is any harm caused to the individual, as opposed to the corporation, then the individual may proceed with a direct action. On the other hand, even where an individual harm is claimed, if it is confused with or embedded in the harm to the corporation, it cannot separately stand.

(Internal quotations and citations omitted) (emphasis added). The court went on to hold that the cross-claim plaintiff’s “claim for damages based on the lost value of his holdings is derivative” because “[t]he lost value of an investment in a corporation is quintessentially a derivative claim by a shareholder.” Similarly, the court held that the cross-claim plaintiff’s

claim for lost earning capacity is barred because it is inextricably embedded in the derivative claim. While certainly the funds would have no right to recover for injury to [the cross-claim plaintiff’s] reputation in the financial community, it is the scandal that befell the funds as a result of the overvaluation and perceived mismanagement that could have negatively impacted [the cross-claim plaintiff’s] reputation. [The cross-claim plaintiff’s] argument, that had PwC informed him about the overvaluation at an earlier time he could have stemmed the damage, demonstrates this point. [The cross-claim plaintiff’s] ability to have done damage control derives from his right to participate in management of the funds, not as a result of simply being an investor.

(Citations omitted). However, the court held that the cross-claim plaintiff’s “claim regarding the gift taxes he paid . . . is an independent claim deriving from an independent duty, which survives the Yudell test. Nor is this claim dismissible as an embedded claim.”

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