When a shareholder, LLC member or partner sues to recover for damages based on wrongs committed against the business entity, the claim is derivative and the recovery belongs to the business. Derivative claims have special procedural rules.
Courts have discretion to allow the owners of closely held businesses to sue individually on a derivative claim when the plaintiff can show “special injury” or when the direct action is not unfair to the business, its creditors or other equity holders. The right to bring derivative actions is available to corporate shareholders, LLC members and partners in general and limited partnerships.
A shareholder may bring a direct claim to enforce rights that are contractual in nature or which enforce some right as shareholder, such as the right to vote or elect the directors.
It is not always easy to determine whether the remedy for the injury suffered as a result of some wrong among the owners of a closely held business belongs to the entity – whether a corporation, limited liability company or partnership – or instead belongs to one or more of the owners.
The distinction is both procedural and substantive, and may be fatal to the plaintiff’s claim. Some claims can belong only to the company. In addition, there are specific procedures in place for bringing a derivative claim in which an owner seeks to assert a right owned by the company. These procedural and substantive requirements can be fatal to a plaintiff’s claim.
But the line is often blurred in the context of the closely held business, and courts can ignore the distinction in some circumstances. In this post, we look at some recent cases in New Jersey considering the distinction, one involving a limited liability company and the other involving a closely held corporation. Although most of the case law has developed in corporate derivative actions involving shareholders, derivative causes of action may also exist in claims brought by members of a limited liability company or partners in a partnership.