Yudell v. Gilbert: Distinguishing Direct and Derivative Claims

In Yudell v. Gilbert, 2012 N.Y. Slip Op. 05896, 2012 WL 3166788 (N.Y. App. Aug. 7, 2012) the Appellate Division of the New York Supreme Court affirmed the dismissal of an action brought by a joint venture, holding that the breach of fiduciary duty claim was derivative, not direct, and the plaintiffs, a few members of a joint venture, failed to plead demand futility with requisite particularity.

In 1965, Baldwin Harbor Associates (BHA) was formed as a joint venture for the purpose of constructing and managing a shopping center. BHA hired Jerrold Gilbert (“Gilbert”) as the managing agent for the shopping center, responsible for billing and collecting rents and maintaining and repairing the premises. Gilbert later became a trustee of one trust set up as the successor venture partner to a deceased partner of BHA.

In 2008, the plaintiffs filed suit against Gilbert as an individual, the other members of BHA, and BHA as a nominal defendant, alleging both direct and derivative claims. On appeal were five causes of action pled by the plaintiffs stemming from Gilbert’s alleged failure to timely and regularly collect additional rents and charges including tax obligations and common area maintenance as required by the leases, and his decision to enter into third-party contracts on behalf of BHA. The specific claims against Gilbert were for his failure to properly account to the joint venture partnership, breach of the management agreement, negligence, breach of the joint venture agreement, and breach of the fiduciary duty he owed to BHA and each of the joint venture partners.

To bring derivative claims, a plaintiff must first make demand on the board of directors. The demand requirement may be waived if it would be futile. Futility will occur where the board is not independent or the decision is not protected by the business judgment rule. The plaintiffs alleged demand futility, but did not plead futility with the required degree of particularity. The plaintiffs argued that the pleading requirement was unnecessary because the fiduciary duty claim was direct rather than derivative.

The court adopted the Delaware framework to determine whether a claim was direct or derivative. This required the court to

look to the nature of the wrong and to whom the relief should go. The stockholder’s claimed direct injury must be independent of any alleged injury to the corporation. The stockholder must demonstrate that the duty breached was owed to the stockholder and that he or she can prevail without showing an injury to the corporation.

A court should, therefore, look to “(1) who suffered the alleged harm (the corporation or the stockholders); and (2) who would receive the benefit of any recovery or other remedy (the corporation or the stockholders individually).”

Accordingly, the court held that the plaintiffs’ claim of breach of fiduciary duty was derivative because any loss suffered by the plaintiffs derived from a loss to BHA. Additionally, any recovery on the claims would equal the value of lost rent and charges that would be to the benefit of BHA; the plaintiffs would receive their proportionate share of the recovery after BHA received its recovery and divided it among the members of the entity.

Because the plaintiffs’ failed to sufficiently plead demand futility, the claims were properly dismissed. As the lower court dismissed the claims without prejudice, the plaintiffs would be afforded the opportunity to amend the complaint and refile.

The primary materials for this case may be found on the DU Corporate Governance website.

Kirstin Dvorchak