On August 7, 2012, the First Department “adopt[ed] the test the Supreme Court of Delaware developed in” Tooley v. Donaldson, Lufin & Jerette, Inc., 845 A.2d 1031, 1039 (Del 2004) (Veasey, J.) for differentiating between direct and derivative claims. Yudell v. Gilbert, 2012 WL 3166788, at *1 (N.Y. App. Div. 1st Dept. Aug. 7, 2012) (Moskowitz, J.). The First Department found that “[t]he Tooley test is consistent with New York law and has the added advantage of providing a clear and simple framework to determine whether a claim is direct or derivative.” Id.
Trustees of one member of a joint venture brought suit against “(1) the managing agent of the joint venture’s sole asset, a shopping center on Long Island, (2) the other members of the joint venture and (3) the joint venture as a nominal defendant.” Id. “The complaint purported to bring both derivative and direct claims and pleaded demand futility[.]” Id.
“The first cause of action alleged that [the managing agent] had ‘squandered, mismanaged and wasted joint venture partnership funds and property’” and had “‘failed properly to account to the joint venture partners.’” Id. at *2. “The second cause of action alleged that [the managing agent] had breached the management agreement.” Id. at *3. The third cause of action alleged that the managing agent and certain other members of the joint venture had breached fiduciary duties owed to the joint venture and each of the joint venture partners. “The fourth cause of action was against [the managing agent] for negligence[,]” and “[t]he sixth cause of action alleged that [the managing agent had] breached the joint venture agreement.” Id.
On May 3, 2010, the motion court found that these causes of action “were derivative in nature and granted [the] defendants’ motion to dismiss … for failure to plead demand futility with the requisite particularity.” Id. at *3, 5. “On appeal, [the] plaintiffs contend[ed] [that] this was error because … not every aspect of [these] causes of action … was derivative in nature.” Id. Specifically, the plaintiffs argued that “the third cause of action for breach of fiduciary duty was a direct claim.” Id.
The First Department Rejects New York’s Case-by-Case Approach for Differentiating Between Direct and Derivative Claims in Favor of the Delaware Supreme Court’s Test in Tooley
“A plaintiff asserting a derivative claim seeks to recover for injury to the business entity” while “[a] plaintiff asserting a direct claim seeks redress for injury to him or herself individually.” Id. “Sometimes whether the nature of a claim is direct or derivative is not readily apparent.” Id.
The First Department explained that “New York does not have a clearly articulated test” for differentiating between direct and derivative claims, but instead “approaches the issue on a case by case basis depending on the nature of the allegations.” Id. “For instance, where shareholders suffer solely through depreciation in the value of their stock,” New York courts have found that “the claim is derivative, even if the diminution in value derives from a breach of fiduciary duty.” Id. (internal citations omitted). New York courts have also found that “[a]llegations of mismanagement or diversion of corporate assets also plead a wrong to the corporation[.]” Id. The First Department observed that these “case by case analyses … are sometimes difficult to apply to new fact patterns.” Id. at *1.
Recognizing the need for “a clear approach for determining [the] difference” between direct and derivative claims, id., the First Department adopted the Delaware Supreme Court’s test in Tooley. Id. Tooley provides that:
A court should look to the nature of the wrong and to whom the relief should go. The stockholder’s claimed direct injury must be independent of any alleged injury to the corporation. The stockholder must demonstrate that the duty breached was owed to the stockholder and that he or she can prevail without showing an injury to the corporation.
Tooley, 845 A.2d at 1039. Under the “common sense approach” set forth in Tooley, “a court should consider ‘(1) who suffered the alleged harm (the corporation or the stockholders); and (2) who would receive the benefit of any recovery or other remedy (the corporation or the stockholders individually)’[.]” Yudell, 2012 WL 3166788, at *4 (quoting Tooley, 845 A.2d at 1035).
The First Department Finds That the Plaintiffs’ Claims Were Derivative in Nature
Applying the Tooley test, the First Department found that the “plaintiffs’ claim for breach of fiduciary duty [was] derivative, because any pecuniary loss [the] plaintiffs suffered derive[d] from a breach of duty and harm to the [joint venture].” Id. The “[p]laintiffs’ allegations of breach of fiduciary duty involve[d] failure to collect rent, back taxes and common charges that tenants would have owed to [the joint venture].” Id. Thus, “[i]t [was] only through loss to [the joint venture] that [the] plaintiffs suffer[ed] a loss at all.” Id.
“Although [the] plaintiffs may own a minority interest in the joint venture, all members suffer[ed] losses from the failure to collect rents and other obligations owed the joint venture.” Id.
The First Department further noted that under Tooley, it should consider “who would receive the benefit of any recovery or other remedy, the joint venture or the members individually.” Id. “[H]ere, any recovery would represent the value of lost rent, CAM charges and the like that inure to the benefit of the joint venture.” Id. “Only if and when the joint venture receives this compensation would plaintiffs then be entitled to receive their proportionate share.” Id. Therefore, the First Department held that the “plaintiffs’ claims [were] derivative.” Id.
“To the extent, if any, that [the] plaintiffs have asserted direct claims,” the First Department determined that those claims were “embedded in an otherwise derivative claim for partnership waste and mismanagement.” Id. The First Department held that “the motion court [had] correctly determined that [the] plaintiffs’ causes of action [were] derivative because … none of the grounds for excusing demand appear[ed] in the complaint.” Id.