Direct Versus Derivative in Shareholder Litigation

By on December 21, 2018

Executive Summary of an article written by
Jon Polenberg, Becker & Poliakoff

When a shareholder brings a claim involving company officers and directors, the court must decide whether the shareholder is suing for harm suffered, and the claim is direct, or the alleged harm is suffered by the company and the claim is derivative. Distinguishing between direct and derivative claims, however, has become complicated. This article analyzes the difference, and as most courts follow similar reasoning, the analysis is instructive for all jurisdictions.

In 2004, the Delaware Supreme Court attempted to clarify the distinction between derivative and direct claims in Tooley v. Donaldson, Lufkin & Jenrette, Inc. The court examined three cases and deduced certain principles that were central to the 2017 decision reached in In re Straight Path Communications Inc. Consolidated Stockholder Litigation.

The Straight Path decision held that a shareholder’s post-merger claim was direct, despite the fact that the plaintiff would recover in proportion to ownership in the corporation’s stock — what would otherwise appear to be a derivative claim. The direct/derivative distinction for post-merger claims is significant. After a merger, shareholders lose standing to pursue derivative claims once they are no longer shareholders. If the claim is derivative, the lawsuit ends.

The evolving standard therefore may spiral into an ad hoc inquiry deciding whether the alleged facts insult the conscience rather than evaluating who suffered the harm and the effect of the remedy. The inquiry should be tied to deciding whether the harm and recovery affect a single shareholder (direct claim) rather than affecting all shareholders in proportion to their ownership (a derivative claim).

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