Florida’s Fourth District Adopts Third District’s Two-Prong Test to Determine When Shareholders May Bring Direct Actions Instead of Derivative Lawsuits
In the recent decision of Strazzulla v. Riverside Banking Company (Fla. 4th DCA, Sept. 2, 2015), the Fourth District aligned itself with the Third District in adopting a bright-line test for when a shareholder may bring a direct action instead of a derivative lawsuit.
In Strazzulla, shareholders of a corporation alleged that two of the corporation’s directors orally represented to them that the corporation had not invested in risky asset-backed securities, such as Collateralized Debt Obligations that previously led to the collapse of Bear Stearns. The directors allegedly assured the shareholders that the corporation’s holdings consisted almost entirely of safe investments, such as municipal bonds, treasuries, and corporate bonds. As a result of this assurance, the shareholders allegedly chose not to participate in a then-existing share buy-back program, under which the corporation would have purchased their shares for approximately $6 million. Ultimately it was discovered that the corporation did, in fact, invest in high-risk assets, which subsequently lost nearly all value and rendered the shareholders’ shares worthless.
The shareholders filed suit against the directors for negligent misrepresentation and fraudulent misrepresentation, and against the corporation on a theory of vicarious liability for the directors’ actions. The corporation moved to dismiss and for summary judgment, arguing that the complaint had been improperly filed as a direct action instead of a derivative action. The trial court agreed, holding that shareholders’ injury “emanates from the gross mismanagement” of the investments, not fraud, making their injury common to all other shareholders. The trial court ruled that every shareholder suffered the same alleged injury from the same wrong, and that the shareholders’ losses are not distinct and cannot be separated from the injuries suffered by the corporation and all other shareholders. As a result, the trial court held that the shareholders lacked standing because the lawsuit should have been filed derivatively, and not as a direct action. The trial court granted summary judgment in favor of the corporation and dismissed the complaint with prejudice.
On appeal to the Fourth District, the sole issue was “whether the Shareholders can bring a direct action in their individual capacity for these claims or whether they are required to bring a derivative action in the name of the corporation.” The Fourth District referred to this as a “murky question under Florida law” and relied upon the Third District’s survey of the law in Dinuro Investments, LLC v. Camacho, 141 So. 3d 731 (Fla. 3d DCA 2014). The Fourth District agreed with the Third District’s approach in Dinuro Investments and adopted the following test:
In order for shareholders to bring a direct action in their individual capacity, the shareholders must allege both a direct harm and a special injury. The two-prong test is consistent with our prior decisions requiring both a direct harm and a special injury. See Fort Pierce Corp., 671 So. 2d at 207 (holding “stockholders may bring a suit in their own right to redress an injury sustained directly by them individually and which is separate and distinct from that sustained by other stockholders.”); see also Chemplex Fla. v. Norelli, 790 So. 2d 547 (Fla. 4th DCA 2001). A shareholder may bring an individual action as an exception to the two-prong test where there is a separate statutory or contractual duty owed by the wrongdoer to the individual shareholder. See Braun v. Buyers Choice Mortg. Corp., 851 So. 2d 199, 203 (Fla. 4th DCA 2003) (“Generally, a shareholder cannot sue in the shareholder’s name for injuries to a corporation unless there is a special duty between the wrongdoer and the shareholder, and the shareholder has suffered an injury separate and distinct from that suffered by other shareholders.”). This approach provides a consistent framework and also “comports with general standards of corporate and LLC law by protecting individuals from the obligations arising out of their relationship to the company, while also allowing the parties greater freedom to contractually set their respective obligations.” Dinuro, 141 So. 3d at 740.
Based upon this test, the Fourth District reversed the trial court’s ruling and remanded for further proceedings because: (1) the complaint alleged direct harm since the claims could not belong to the corporation and the corporation would have no right to recover in its own action against the directors; and (2) the complaint alleged special injury because the injuries were based upon the shareholders being fraudulently induced to not sell their stock, which is distinct from any injury suffered by other shareholders who did not receive the same representations from the directors.
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