If you are a minority shareholder of a corporation or a minority member of a limited liability company and you are thinking about bringing a lawsuit against the majority shareholder(s)/member(s), it is important to determine whether the lawsuit would be: (1) a direct action; or (2) a derivative action. This determination is critical because the two types of claims have different elements of proof and different procedural prerequisites.
To maintain a direct action, the plaintiff must allege facts sufficient to establish that he/she has suffered a “special injury” resulting from the alleged misconduct. This “special injury” must be unique from any damages suffered by the other shareholders. In contrast, claims redressing harm to the company as a whole (and not just the individual shareholder/member) are derivative.
When a plaintiff brings a derivative lawsuit, the plaintiff must meet a heightened pleading standard. The reason for this requirement is the recognition that derivative lawsuits are an infringement on the right of a company to govern its own affairs. A derivative cause of action actually belongs to the company, but an individual is permitted to bring the action on the company’s behalf where the company has failed to take action for itself. Because derivative actions could be ripe for abuse, New Jersey law requires as a prerequisite for bringing a derivative action that a demand to redress the harm must first be made to the company’s board. As explained by the New Jersey Supreme Court:
The demand requirement serves at least two purposes. First, it provides corporate managers with the opportunity to address a shareholder’s claims. Along those lines, if the board determines that the allegations are meritorious it may choose to remedy the situation internally or embrace the litigation. Second, if managers disagree with the shareholder’s concerns, the demand requirement provides the board with an opportunity to reject the demand and, if necessary, seek early dismissal of the suit.
In re PSE&G S’holder Litig., 173 N.J. 258, 278 (2002) (internal quotations omitted).
Pursuant to New Jersey law, if the lawsuit you seek to file is a derivative action, you must file a verified complaint asserting with particularity: (1) that a demand was made on the board before instituting the action; or (2) that such a demand would have been futile (for example, the board is controlled by people who you believe were involved in the misconduct).
Spector & Ehrenworth, P.C. has extensive experience representing clients in minority shareholder and LLC member disputes. Attorneys at the firm would be happy to help you to determine whether your claims are direct or derivative and advise you regarding the steps that need to be taken before you file a lawsuit. To schedule an appointment to speak with a business attorney, call (973) 845-6525 or e-mail firstname.lastname@example.org