Direct vs. Derivative, or What's a Lawsuit between Friends in an 'Incorporated Partnership?'
77 Pages Posted: 30 Nov 2005
In any context the distinction between direct and derivative claims carries significant consequences. The procedural requirements are different, as are the available remedies. In addition, the remedies benefit different parties. A successful derivative claim typically enriches the corporate treasury, while a successful direct claim typically puts money directly in the hands of the shareholder claimant. Moreover, derivative defendants can shelter behind several powerful bulwarks-including special litigation committees and the business judgment rule-that are unavailable to direct defendants.
Under the 'internal affairs' doctrine, Minnesota law governs the direct/derivative issue for all Minnesota corporations. Current Minnesota law provides inadequate guidance when the corporation is closely held. The inadequacy has two main sources. First, the Minnesota rule for distinguishing between direct and derivative claims in general contains a serious conceptual flaw which confuses analysis regardless of the number of shareholders. Second, Minnesota close corporation cases rarely address the direct/derivative issue, and those that do, do so in a cursory fashion. Minnesota law, therefore, lacks a comprehensive, coherent approach for making the direct/derivative distinction in a Minnesota close corporation.
This article seeks to improve matters by (1) examining and proposing a remedy for the fundamental conceptual flaw and (2) providing a conceptual framework for making the fine distinctions necessary in the close corporation context. As background, Part II describes direct and derivative claims in their pure forms. Part III describes the special problems faced by derivative plaintiffs as contrasted with direct plaintiffs and thereby shows why the direct/derivative distinction matters. Part IV explains why it is important to draw that distinction early in any litigation. Part V examines and critiques Minnesota's current approach to the direct/derivative analysis. Part VI proposes a special rule for making the distinction in the context of closely held corporations, and Part VII wraps up the analysis with some important details concerning procedure and remedies.
Keywords: Closely Held Corporations, Direct, Derivative, Minnesota
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