Member-Initiated Florida LLC Litigation: Direct Actions Versus Derivative Actions

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Member-Initiated Florida LLC Litigation: Direct Actions Versus Derivative Actions

June 7, 2017

Florida LLC Litigation: Theft or Other Misconduct by a Managing Member of an LLC

In the context of Fort Lauderdale business litigation, some members of Florida limited liability companies, also known as “LLCs,” learn that the managers or other members of the LLC have wrongfully taken funds from the company, or have otherwise harmed the company by breaching their fiduciary duties to the company.  When this happens, the members’ ownership interests in the company—which entitles them to distributions of the company’s profit—are usually dramatically reduced or completely eliminated.  Understandably, these members may wish to sue the managers and members whose conduct caused their losses.

A Threshold Decision: Whether to Bring a Direct Action or a Derivative Action

Aggrieved members of a LLC (or shareholders of a closely-held corporation) too often waste their time and resources filing suit in the wrong capacity, only to have their lawsuit dismissed, thereby exposing themselves to liability for the payment of the opposing party’s attorney’s fees.  There are two capacities in which a member of an LLC may bring a lawsuit for losses caused by a LLC manager’s or member’s misconduct.  The first is in his or her individual capacity for losses to the member directly caused by the manager’s or member’s misconduct—a so-called “direct action.”  The second is on behalf of the company itself for direct losses to the company—a so-called “derivative action.”  For example, if funds are wrongfully taken out of the company’s account (thereby diminishing a member’s proportionate share of the company’s profit), the loss is generally viewed as being direct as to the company but indirect as to the member, even when the number of members is fewer than three.  The distinction is important because, in a direct action, any damages awarded are payable directly to the member.  In a derivative action, on the other hand, the damages are payable to the company, with any proceeds from the proceeding to be divided among the members in accordance with their proportionate membership interests in the company (after the payment of just debts).  Thus, it is generally more advantageous for a member to bring a direct action, rather than a derivative action.

The Dinuro Investments Decision: A Guide for Florida business lawyers

In 2014, the Florida Third District Court of Appeal issued a seminal decision regarding when a member of an LLC is required to bring a direct action against a manager or member, rather than a derivative action.  Dinuro Investments, LLC v. Camacho, 141 So. 3d 731 (Fla. 3d DCA 2014), involved three investors who were members a real estate development company.  The company owned several parcels of real estate but, due to the declining housing market, was experiencing some financial difficulties.  Accordingly, two of the three investors used a separate corporation to purchase certain promissory notes outstanding on the development company’s properties from the company’s lender.  The two investors, through their separately-formed corporation, initiated and completed foreclosure proceedings against the company’s properties, leaving the company with no assets and the third investor with no valuable interest in the company.  The third investor filed suit against the individuals and the corporation that initiated the foreclosure action.  The Florida trial court entered an Order dismissing the case for lack of standing, and the plaintiff appealed.

The Third District affirmed the trial court’s decision, determining that individual members of LLCs may not maintain causes of action in their individual capacities without first meeting certain criteria.  In so doing, the Court established a two-prong test for determining when a direct action (rather than a derivative action) is appropriate, as follows:

[A]n action [by a shareholder or a member of a limited liability company] may be brought directly only if (1) there is a direct harm to the shareholder or member such that the alleged injury does not 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.

We also find that there is an exception to this rule under Florida law. 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.  Thus, if the plaintiff has not satisfied the two-prong test (direct harm and special injury) or demonstrated a contractual or statutory exception, the action must be maintained derivatively on behalf of the corporation or company.

Dinuro Investments, supra, 141 So. 3d at 739-40 (emphasis in original) (citations omitted). When applying this test to the facts, the Court determined that the plaintiff failed to allege a direct harm, and that the facts did not support the exception to the rule.

Conclusion

After the Dinuro case, it’s clear that an action between members of an LLC must be brought derivatively, unless: (a) there is direct harm to the member such that the harm does not flow from an initial harm to the company, and (b) there is a special injury to the member that is separate and distinct from those sustained by other shareholders or members.

If you’re involved in commercial litigation in Fort Lauderdale or elsewhere in Florida, please call a Fort Lauderdale business lawyer at (9544400901 to schedule a consultation.  The Carlin Law Firm, PLLC regularly provides legal advice to all kinds of business entities and regularly assists clients with litigating business disputes in Florida state and federal courts.

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