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Direct Action Versus Derivative Action: When Does an LLC Member Have Standing to Bring A Suit Against Another Member?
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Direct Action Versus Derivative Action: When Does an LLC Member Have Standing to Bring A Suit Against Another Member?

May 25, 2016 Professional Services Industry Legal Blog

Reading Time: 6 minutes

If an LLC sustains a loss that causes the company to lose value, its members are never pleased.  However, that loss is compounded when that member believes the loss was due to the tortious conduct of another LLC member.  This scenario presents an interesting, and increasingly frequent, issue of Florida law: when does a member of an LLC have individual standing to bring suit against fellow members— i.e. a direct action—as opposed to having to file a derivative claim on behalf of the LLC?

Determining whether an LLC member may directly bring an action, or whether it must be maintained as a derivative suit, can be a confusing inquiry. That is because it is axiomatic that a member of an LLC, who has a personal stake in the company, suffers a loss when the company loses value.  Thus, the determination of whether the loss is compensable via direct suit requires fine lines to be drawn.  Such distinctions are even more nuanced in the context of closely-held LLCs, which typically have fewer individuals possessing an ownership interest in the company, because claims of mismanagement or self-dealing become a zero-sum game in which one member profits from the company’s loss, while the other member is harmed due to the company’s reduced value.

Complicating this already complex issue is the lack of clarity in Florida’s case law dealing with what standard should be applied when determining whether an aggrieved member’s lawsuit against another member can be brought directly.  In general, jurisdictions throughout the country apply three distinct methods to determine whether an action may be brought directly or must instead take the form of a derivative action: (1) the “direct harm” test; (2) the “special injury” test; and (3) the “duty owed” test.  Strazzulla v. Riverside Banking Co., 175 So. 3d 879 (Fla. 4th DCA 2015).

  1. The Direct Harm Test

The direct harm test examines whether the harm from the alleged wrongdoing flows first to the company and only damages the LLC’s members in the form of loss of value of their respective ownership interest, or whether the harm flows “directly” to the member such that it is not secondary to the company’s loss. This analysis focuses solely on the questions of who suffered the alleged harm and who would receive the benefit of the relief awarded. Id.  Accordingly, the court compares the member’s injury to that suffered by the company itself. Utilizing this approach, a member will only have standing to bring his suit directly if the damages are unrelated to the damages sustained by the company and if the company would have no right to recover in its own action.  Id; Dinuro Investments, LLC v. Camacho, 141 So. 3d 731 (Fla 4th DCA 2014).  This test provides the greatest simplicity in application, as the analysis centers solely on whether the alleged wrongful conduct devalued the company as a whole or was directed specifically towards the member bringing suit.

  1. The Special Injury Test

Another test utilized to determine whether an action is direct or derivative is the special injury test. This analysis focuses on the individual plaintiff’s injury as compared to the injury suffered by the other members of the company, and then determines whether the plaintiff’s injury is “special”—i.e., separate and distinct from other members or shareholders. Strazulla at 883.  This test requires the aggrieved member to establish a loss substantially different from any loss suffered by other shareholders or members in order to maintain a direct action.  This approach allows for greater flexibility in bringing a direct suit in small or closely-held LLC’s, but at the same time can be much more difficult to apply.  Id.  The difficulty in application arises from the “special” nature of the injury, which can be a nebulous inquiry. Dinuro Investments at 737.

  1. The Duty Owed Test

The last test for determining whether the nature of an action is direct or derivative is the duty-owed test, which examines the statutory and contractual terms at issue to determine whether the duty at issue was owed to the member by a particular manager or member, or whether those duties were generally owed to the company.  This approach allows for the greatest freedom of contract, allowing the parties to determine whether and when to allow direct suits, and what conduct such suits can be based upon.  Id. 

  1. Florida’s Test

Presently, Florida law adopts none of these tests individually, but implements all three collectively to assess whether an action can be brought directly by the LLC member.  Id.   Florida’s Supreme Court has yet to address this issue, and to determine the current standard one must distill nearly fifty years of case law.

The first Florida case to issue a rule on this issue was Citizens National Bank of St. Petersburg v. Peters, 175 So.2d 54, 56 (Fla. 2d DCA 1965), where Florida’s Second District Court of Appeal held that a derivative suit is one in where a member seeks to enforce a right of action existing in the company. Conversely, the Court held, a direct action is a suit by a member to enforce a right of action existing in him.  The Court went on to explain that if the injury is primarily against the company, or the members generally, then the cause of action is in the company and the individual’s right to bring it is derived from the company.

This analysis seemingly requires both direct harm and special injury before a member will have standing to maintain a direct action, and that language has essentially become the standard; most subsequent cases dealing with the issue have quoted Peters or one of its progeny. See, e.g., Karten v. Woltin, 23 So.3d 839 (Fla. 4th DCA 2009); Alario v. Miller, 354 So.2d 925 (Fla. 2d DCA 1978); and Fried v. Easton, 293 So.2d 87 (Fla. 3d DCA 1974).  To add a further layer of complexity, Florida courts have also recognized an exception to the Peters test when an individual member or manager owes a specific duty to another member or manager apart from the duty owed to the company. See, e.g., Braun v. Buyers Choice Mortg. Corp. ex rel. McAloon, 851 So.2d 199 (Fla. 4th DCA 2003); Harrington v. Batchelor, 781 So.2d 1133 (Fla. 3d DCA 2001).

In summation, the state of Florida law with respect to determining whether an action must be brought directly or derivatively is unclear, and the test applied by the courts may vary from case to case depending on the specific facts.  Based on the foregoing, it seems that, under Florida law, a direct action may only be brought if there is a direct harm to the member such that the alleged injury does not flow subsequently from an initial harm to the company and if there is a special injury to the member that is separate and distinct from those sustained by the other members. See e.g., Peters at 56; Dinuro Investments at 741.  But, Florida law also provides for an exception to this rule. A member need not satisfy the two-prong test if the defendant owes the member/plaintiff a separate duty under contractual or statutory mandates.  Dinuro Investments at 741.

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