On August 7, 2012, in Yudell v. Gilbert, [available here], the Appellate Division, First Department adopted a test first articulated by the Delaware Supreme Court in assessing whether a claim is direct or derivative in nature. The key distinctions hinge on who really suffers the harm of alleged wrongdoing and to whom the recovery will go. Prior to this decision, New York lacked a precise approach for determining the difference, rather focusing its analysis on a case-by-case basis depending on the nature of the allegations.
The Yudell case involved a dispute among the stakeholders of Baldwin Harbor Associates (“BHA”), a joint venture established to construct and manage a Long Island shopping center. At the time of the lawsuit, the Yudell Family Trust, the Psaty Family Trust, and the Weiser Family Trust each owned a third of BHA. In 2008, plaintiffs initiated this action alleging that Jerrold Gilbert, the managing agent for the shopping center and a trustee for the Psaty Family, had for years failed to collect rent timely and to properly maintain the shopping center, thereby breaching the joint venture agreement and the management agreement. Plaintiffs further alleged that the other members of the joint venture breached their fiduciary duty through “their de facto alliance with Gilbert in support of [Gilbert’s] exclusive management and control of virtually every BHA transaction during the past 17 years, and Gilbert’s opposition to the exercise of the partnership rights of the Yudell Trust.” The suit purported to bring claims both directly and derivatively.
In May 2010, on a motion to dismiss for failure to make a demand or plead futility with requisite particularity, the court held that all of the claims were derivative in nature and therefore granted defendants’ motion on all counts, including breach of fiduciary duty. On appeal, plaintiffs maintained that the motion court erred because the cause of action for breach of fiduciary duty by members of the joint venture was a direct claim not subject to a demand requirement.
The Appellate Division disagreed. In adopting a bright line test first articulated by the Delaware Supreme Court in Tooley v. Donaldson, Lufkin & Jenrette, Inc., 845 A.2d 1031 (Del. 2004) [available here], the New York court held that any claim of this nature must undergo the following “common sense” analysis: (1) whether a corporation or individual stockholder suffered the alleged harm; and (2) who would receive the benefit of a recovery. The court emphasized that “[a] plaintiff asserting a derivative claim seeks to recover for injury to the business entity, whereas, a plaintiff asserting a direct claim seeks redress for injury to him or herself individually.” Applying the Tooley framework to the claims at issue in this case, the court affirmed the lower court’s dismissal, finding that the allegations of mismanagement were harmful to the business entity rather than individually.
By adopting the Tooley framework, claims that previously may have been considered individual claims will now be subject to the procedures and defenses of derivative litigation, including a prior demand or demand futility requirement, the corporation’s ability to form a special committee to first investigate the allegations, and possibly a more stringent business judgment defense.