Shareholder Litigation - June 21 Flashcards
What is a derivative suit? (Q)
In a derivative suit, a shareholder brings a civil suit on behalf of a corporation that has failed to assert a valid cause of action for its injuries. In a derivative suit, the shareholder is not suing in a personal capacity for the shareholder’s own injuries (e.g., unfair treatment of minority shareholders). Rather, the shareholder is suing in the corporation’s name to redress an injury to the corporation and shareholders at large (e.g., a breach of fiduciary duty to the corporation).
What is the difference between a direct action and a derivative action? (Q)
The difference between a direct action and a derivative action lies in whose interests the plaintiff is suing to vindicate. In a direct action, a corporate shareholder or member in an unincorporated association sues to vindicate her own interests—that is, sues for a personal injury to herself. In a derivative suit, by contrast, the shareholder or member sues to assert a claim on the entity’s behalf, for an injury to the entity at large, if the entity itself has failed to do so.
In general, may a member in an unincorporated association bring a derivative suit? (Q)
Yes. In general, a member in an unincorporated association, such as a limited liability company (LLC), may bring a derivative suit on the entity’s behalf. Typically, the same basic rules apply, whether the suit is by a corporate shareholder or a member in an unincorporated association.
What two elements must be present for a shareholder to have standing to bring a derivative suit on behalf of a corporation in many state courts? (Q)
In many state courts, a shareholder has standing to commence or maintain a derivative suit on behalf of a corporation if the shareholder both:
owned corporate stock at the time of the act or omission in question (or acquired stock by operation of law from one who owned stock at that time, as by court-ordered transfer) and
fairly and adequately represents the corporation’s interests in enforcing the right to bring the suit.
If a shareholder cannot establish either element, then the shareholder lacks standing and may not bring a derivative suit on the corporation’s behalf.
What does it mean to say that the plaintiff in a derivative suit fairly and adequately represents the corporation’s interests in bringing the derivative action? (Q)
To say that a derivative plaintiff fairly and adequately represents the corporation’s interests in bringing a derivative action is to say that the shareholder’s and the corporation’s interests and issues are aligned. The most important factor to this determination is whether there is a meaningful conflict of interest between the shareholder and the corporation, so that the plaintiff might not represent the corporation’s interests with due vigor. If there is, then the plaintiff does not fairly and adequately represent the corporation’s interests.
Must a shareholder always make a written demand on a corporation to take suitable action before seeking judicial authorization to pursue a derivative suit on the corporation’s behalf? (Q)
No. A shareholder need not always make a written demand on a corporation to take suitable action before seeking judicial authorization to pursue a derivative suit on the corporation’s behalf. Generally, a shareholder must demand that the corporation act for itself before the shareholder may act on the corporation’s behalf by filing a derivative suit. However, in some states, if the shareholder can show that a demand to the corporation to act on its own behalf would be futile, then the shareholder need not engage in the futile exercise. A demand to the corporation would be futile if the board of directors were unable to independently assess the demand.
In the context of derivative litigation, what does it mean to say that the board of directors cannot independently assess a demand to bring suit? (Q)
In the context of derivative litigation, to say that the board of directors cannot independently assess a demand to bring suit means that either:
there is a reasonable doubt that the directors are disinterested and independent (i.e., there is a meaningful conflict of interest), or
failure to bring suit is not a reasonable exercise of business judgment (i.e., it would violate the business-judgment rule).
In either of these circumstances, a derivative plaintiff’s failure to demand that the board of directors bring suit will generally be excused as futile.
After making a written demand on a corporation to take suitable action, must a shareholder always wait 90 days before seeking judicial authorization to pursue a derivative suit on the corporation’s behalf? (Q)
No. After making a written demand on a corporation to take suitable action, a shareholder need not always wait 90 days before seeking judicial authorization to pursue a derivative suit on the corporation’s behalf. Before seeking judicial authorization to pursue a derivative suit, a shareholder must make a written demand on the corporation to take suitable action unless a demand would be futile. Generally, once the demand is made, the shareholder must give the corporation 90 days to consider the demand and may not seek authorization to file a derivative suit until that 90-day period has expired. However, the shareholder may commence the derivative suit at an earlier date if either:
the corporation rejects the demand, or
the 90-day expiration period would cause irreparable injury to the corporation.
If a corporation makes a good-faith determination that a derivative suit is not in the corporation’s best interests and moves to dismiss the derivative suit, must a court grant the corporation’s motion to dismiss the derivative suit? (Q)
Yes. A court must grant a corporation’s motion to dismiss a derivative suit if the court finds that the corporation has made a good-faith determination that the proceeding is not in the corporation’s best interests. The good-faith determination must result from a reasonable inquiry conducted by:
a quorum of independent directors or
a committee consisting of two or more independent directors.
The court may also appoint a panel of one or more people to determine whether the derivative suit is in the corporation’s best interests. In some states, however, the court retains discretion to refuse to dismiss the suit even if these requirements are satisfied, if the court finds, in its own, independent business judgment, that the suit should continue.
For purposes of derivative litigation, who is an independent director? (Q)
For purposes of derivative litigation, an independent director is one who has no:
material interest in the proceeding’s outcome or
material relationship with anyone who has a material interest in the proceeding’s outcome.
Put differently, an independent director is one without a material stake in the litigation that could affect her impartial judgment, such as the prospect of being held liable for some breach of duty to the corporation.
If a derivative suit is successful, does the shareholder who brought the action usually receive the damage award? (Q)
No. If a derivative suit is successful, the shareholder who brought the action does not usually receive the damage award. Rather, the proceeds of a successful derivative suit are typically awarded to the corporation. However, the court may order the corporation to pay the shareholder’s reasonable expenses if the derivative suit has resulted in a substantial benefit to the corporation.
A corporation agreed to rent space in a building owned by the corporation’s former chief executive officer (CEO). After several months, some shareholders discovered that the former CEO had failed to comply with some provisions in the lease agreement. The shareholders wanted the corporation to sue the former CEO for breach of the lease, but the board of directors was reluctant to sue a former corporate officer. Further, the damage was already done and not ongoing. The shareholders sent a written demand to the board requesting that the board sue the former CEO for breach of the lease. After a week, the board had not yet responded to the demand. Frustrated, the shareholders filed a derivative lawsuit against the CEO on behalf of the corporation.
Did the shareholders follow all the required pre-suit procedures for filing a derivative suit? (Q)
No. The shareholders did not follow all the required pre-suit procedures for filing a derivative suit. In a derivative suit, a shareholder sues on behalf of a corporation that has not pursued a valid action on its own. Generally, before filing a derivative suit, a shareholder must make a written demand on the corporation to take action and then wait 90 days to see whether the corporation complies with the demand. The shareholder may file the derivative suit earlier if:
the corporation rejects the demand or
waiting 90 days would cause irreparable injury to the corporation.
Here, only one week had passed since the written demand, not 90 days. Further, the corporation had not rejected the demand. Finally, because the damage was already over, waiting 90 more days would not cause an irreparable injury. Thus, the shareholders’ attempt to file the derivative suit was premature and invalid.
A corporation entered into a contract to sells its scrap metal to a scrap-metal processor. The contract contained a repurchase provision. This provision provided that the corporation would refund the processor if the processor bought any structurally deficient metal from the corporation. There was some ambiguity in the repurchase provision, and the corporation considered suing the processor for a potentially fraudulent repurchase demand. One of the corporation’s current shareholders had owned shares of the corporation for many years. This shareholder owned a company that competed directly with the scrap-metal processor. To try to hurt her competitor, the shareholder demanded that the corporation sue the scrap-metal processor. The board rejected the demand.
Does the shareholder have standing to bring a derivative suit against the scrap-metal processor on behalf of the corporation? (Q)
No. The shareholder does not have standing to bring a derivative suit. In a derivative suit, a shareholder sues on behalf of a corporation that has not asserted a valid cause of action for its injuries. A shareholder has standing to commence or maintain a derivative suit if the shareholder:
owned corporate stock at the time of the act or omission in question and
fairly and adequately represents the corporation’s interests in enforcing the right to bring the suit.
Here, the shareholder had owned corporate shares for many years, meaning she owned shares at the time of the questionable repurchase claim. However, the shareholder wants to sue to help her own, competing company’s interests. This means the shareholder is not enforcing the corporation’s right to sue to fairly and adequately represent the corporation’s interests and, thus, does not have standing to pursue a derivative proceeding.
A group of shareholders was pursuing a derivative lawsuit against a corporation’s board of directors for failing to bring a claim against a former director. The corporation moved to dismiss the derivative lawsuit. As part of its motion, the corporation presented evidence that three of the corporation’s four officers had conducted a reasonable inquiry and made a good-faith determination that the derivative proceeding was not in the corporation’s best interests.
Must the court now grant the corporation’s motion to dismiss the derivative suit? (Q)
No. The court is not required to grant the motion to dismiss the derivative suit. A court must grant a corporation’s motion to dismiss a derivative suit if the court finds that one of the following two groups conducted a reasonable inquiry that led to a good-faith determination that the proceeding is not in the corporation’s best interests:
a quorum of independent directors or
a committee consisting of two or more independent directors.
The court may also appoint a panel to determine whether the derivative suit is in the corporation’s best interests.
Here, a reasonable inquiry led to a good-faith determination that the derivative suit was not in the corporation’s best interests. However, the determination was made by a majority of the corporation’s officers—which is not one of the sources that mandates dismissal. Thus, the court is not required to grant the motion to dismiss.
Shareholders brought a derivative lawsuit alleging that two of the corporation’s directors had improperly embezzled money from the corporation. During the discovery phase of the litigation, various emails detailing the embezzlement were discovered. Over $1,000,000 was eventually recovered.
May the shareholders who initiated the derivative lawsuit receive any portion of the recovered funds? (Q)
Yes. A portion of the recovered funds may be used to reimburse the shareholders’ reasonable expenses in bringing the suit. In a derivative suit, a shareholder sues on behalf of a corporation that has not asserted a valid claim on its own. If a derivative suit is successful, the proceeds are typically awarded to the corporation, rather than the shareholder who brought the action. However, the court may order the corporation to pay the shareholder’s reasonable expenses if the derivative suit has resulted in a substantial benefit to the corporation.
Here, the majority of the recovered funds will be awarded to the corporation. However, the suit recovered over $1,000,000 in embezzled funds, providing a substantial benefit to the corporation. Thus, the proceeds may also be used to reimburse the shareholders for their fees and expenses related to the derivative suit.
