Unfortunately, sometimes an aggrieved shareholder of a corporation has to sue to either prevent or remedy a wrong either on behalf the corporation or to protect that shareholder’s ownership of shares. Depending on the shareholder’s injury, a shareholder must decide if he or she is to bring a derivative lawsuit or a direct lawsuit.
What are Derivative and Direct Lawsuits and What is the Difference?
A derivative lawsuit initiated by a shareholder on behalf of the corporation because those in control of the corporation failed to assert a claim. It essentially allows shareholders to force the corporation to sue those that are liable to the corporation.
A direct suit is when a shareholder brings forth a claim based the shareholder’s ownership of shares. Some examples of direct suits involve contract rights related to shares, rights related to the recovery of dividends, and rights to review the records of the corporation.
How Do You Decide Whether a Claim is Derivative or Direct?
When a Minnesota court is determining if a claim is either direct or derivative, the main focus is on whether the injury asserted was either to the shareholder directly or the corporation. The Minnesota Supreme Court has highlighted that if any funds sought to be recovered belong to the corporation, the action must be considered derivative,
[t]he remedy for defendant’s alleged diversion of corporate funds is not an individual action against him for the consequential damages. The wrongs complained of are wrongs against the corporation. The funds diverted should be restored to the corporation. The right of action is in them. * * * A minority stockholder may sue because the corporations are under the control of the alleged wrongdoers, but he must sue in a representative capacity for the benefit of the corporation, and not for damages to him individually. * * * The wrong is done when the funds are improperly expended. Such funds do not belong to the stockholders, but to the corporation.
Seitz v. Michel, 148 Minn. 80, 87, 181 N.W. 102, 105 (1921). In contrast, if the shareholder’s injury is unique and distinct from any harm done to the corporation, then the claim is direct.
Why Does the Distinction Matter?
If a shareholder is planning on asserting a derivative lawsuit that shareholder is subject to Minnesota Rule of Civil Procedure 23.09, which imposes stricter pleading requirements. For instance, the complaint must state with particularity the efforts by the shareholder or members to obtain the desired action from the directors and the reasons for the shareholder’s failure to obtain the action or for not making an effort. In other words, prior to bringing the derivative action, the shareholder must demand the corporation take action to protect its right. The complaint must also maintain that the plaintiff shareholder fairly and adequately represents the interests of the shareholders similarly situated. A failure to abide by Rule 23.09 could result in dismissal of the complaint.