Shareholder suits

Question 1

What are the two types of shareholder suits?

Answer 1

1) Direct suits

2) Derivative suits

Question 2

What is a direct suit?

Answer 2

An action brought by someone (shareholder) that was directly harmed by a corporations action.

Question 3

What is the typical procedure for a direct suit?

Answer 3

Class action

Question 4

Where do damages go in a direct suit?

Answer 4

Directly to the shareholder

Question 5

What are some examples of direct suits? (3)

Answer 5

1) An action to inspect the books
2) An action to require an entity to recognize an investors right to vote
3) An action to challenge a merger for failure to make disclosures

Question 6

What is a derivative suit?

Answer 6

They are claims of the corporation, which a shareholder brings on behalf of the corporation

Question 7

What is the two-for-one claim structure of derivative suits?

Answer 7

A suit demanding that the directors sue on behalf of the corporation

2) A suit for the claims themselves, brought on behalf of the corporation

Question 8

Are there special procedural hurdles for a derivative suit?

Answer 8

Yes. We will discuss more later

Question 9

Where do the damages do in a derivative suit?

Answer 9

To the corporation.

Question 10

What is an example of a derivative suit?

Answer 10

A claim that a director engaged in corporate waste.

Question 11

Is the line between a direct and derivative suit always clear?

Answer 11

Nope.

Question 12

The board of directors of Acme Forge Inc., defeated a coalition of insurgents at the annual shareholders’ meeting by issuing a 15% block of common stock to the Friendship Investment Company before the meeting. The CEO of Friendship assured the CEO of Acme that if he got a 10% discount from the market price of Acme’s stock, he would vote for the incumbent board for at least two election cycles. The newly issued stock was decisive and was issued at 10% below market.

What is the argument in favor of bringing a derivative suit?

Answer 12

1) The boards violation of its duty of loyalty cost the company money. (The shares were sold under the market rate.)

Question 13

The board of directors of Acme Forge Inc., defeated a coalition of insurgents at the annual shareholders’ meeting by issuing a 15% block of common stock to the Friendship Investment Company before the meeting. The CEO of Friendship assured the CEO of Acme that if he got a 10% discount from the market price of Acme’s stock, he would vote for the incumbent board for at least two election cycles. The newly issued stock was decisive and was issued at 10% below market.

What is the argument in favor of bringing a direct suit?

Answer 13

The shareholder’s voting rights were injured because there are new shareholders that got the right to vote for less money.

The shareholder’s voting rights are personal.

Question 14

What are the elements to distinguish between a direct and derivative suit according to Tooley?

Answer 14

1) who suffered the alleged harm? The corporation or the shareholders? and
2) Who would receive the benefit of any recovery? Shareholders or corporation

Question 15

What is an incentive of bringing a shareholder suit given the collective actions problems?

Answer 15

Attorneys fees are awarded in 90% of cases and can be around 25% of the recovery. This is a unique structure.

Question 16

What is a benefit of shareholder suits?

Answer 16

Attorney’s fees are paid as a fraction of the recovery when there is a “substantial benefit” created by the suit (value is created) and deviates from the convention.

Question 17

Why do we create an exception in these cases and pay attorney’s fees as a fraction of recovery? (2)

Answer 17

1) It creates incentives to bring cases

2) It can prompt corporate governance changes that generate value, even if that value is not directly quantifiable.

Question 18

What is the rule for whether or no paying attorney’s fees in a shareholder suit is appropriate?

Answer 18

The tests is the “substantial benefit” rule, and it is used to determine if value has been created, thus allowing for attorney’s fees to be included in the recovery.

Question 19

What is an example of a substantial benefit?

Answer 19

A restructuring of the board that removes a treasurer with excessive salary and creates a common fund for the shareholders.

Question 20

Does the fact that a suit created a common fund indicate that there was a substantial benefit which will warrant the repayment of attorneys fees?

Answer 20

Yes!

But this is not the only way a benefit may be derived.

There might be non-monetary benefits, but those benefits are less clear.

Question 21

What are some costs associated with shareholder suits?

Answer 21

1) Atorneys fees being paid out can encourage meritless suits
2) There are direct costs
3) There is a circularity problem with D&O insurance. (The corporation pays for premiums for D&O insurance which in-turn pays for the attorney’s fees in a settlement.

Question 22

What are the procedural requirements for bringing a DERIVATIVE suit?

Answer 22

1) The standing requirement

2) The demand requirement

Question 23

What is the standing requirement?

Answer 23

Only an injured party can sue.

Question 24

What are the specific conditions of the sanding requirement?

Answer 24

1) The shareholder must fairly and adequately represent the interest of the shareholder. (i.e., they must own shares for the duration of the action.)
2) The shareholder must own shares at the time of the alleged injury (contemporaneous ownership rule.)

Question 25

What are the justifications for the “fair and adequate representation” requirement of standing, i.e., the shareholder must own shares for the duration of the suit)

Answer 25

Current shareholders have incentives to pursue actions (or settlements) that increase firm value,

Question 26

What are the justifications for the “shareholder must own shares at the time of the alleged injury” requirement for standing?

Answer 26

1) The law doesn’t want individuals to buy shares just so they can sue.
2) The law wants the recovery to go to the people that were actually injured.

Question 27

Do the standing requirements represent a significant barrier?

Answer 27

No, it’s easy enough to find a shareholder that fits these requirements.

Question 28

What is the demand requirement?

Answer 28

The shareholder must request the board to bring the action (or have a good reason for not doing so) before going to court.

Question 29

Can demand be “futile” in some cases and therefore can be waived?

Answer 29

Yes! we will learn more about this in a minute.

Question 30

What must the demand to the corporation include?

Answer 30

The complaint must allege with particularity the effort made by the plaintiff to obtain the action the plaintiff desires from the directors or comparable authority.

Question 31

What is the demand futility test as articulated in Aronson/Levine?

Answer 31

The demand is futile if there are particularized allegations that create a reasonable doubt that the:

1) The directors are disinterested and independent regarding whether or not to bring a suit (unless rebutted with well pleaded facts)

OR

2) The challenged transaction was product of reasoned business judgment.

Question 32

What will make a board “interested” relating to the first prong of the demand futility test (there is a doubt that the directors were disinterested and independent).

Answer 32

The majority of the board has a financial interest in the transaction. (Interest in the transaction generally means that they are interested in the outcome of potential litigation)

But, financial interest is not the only kind of relevant interest in the demand futility test (there can be friendship interest of a longstanding debt of gratitude.)

Question 33

What will make a board not independent as it relates to the first prong of the demand futility test

Answer 33

The board is either dominated or significantly influenced by the officer or director involved in the transaction.

Note, that interest in the challenged transaction, can lead to reasonable doubt that the directors made a sound business decision, which in turn can also lead to doubt about whether or not they have interest in bringing the suit. (You can satisfy both.)

Question 34

How does a plaintiff satisfy the second prong of the demand futility test? (i.e., there is a doubt that the decision was the product of sound business judgment)

Answer 34

Well, he does not have to overcome the BJR. He just has to create a reasonable doubt that the BJR may not protect the transaction.

Question 35

In practice, is the second prong really as easy to overcome as it sounds?

Answer 35

No, it is still hard. Generally, you have to show that it is not covered by the business judgment rule.

Question 36

When is the second prong of the demand futility test articulated in Aronson/Levine irrelevant? (the court will not apply)

Answer 36

The court will not look at the second requirement (even consider) the second prong of the demand futility test when:

1) A majority of the directors making the original decision have been replaced
2) The subject of the derivative suit is not a business decision of the board
3) The decision being challenged was made by the board of a different corporation.

Question 37

What is a double-derivative suit?

Answer 37

A suit in which the shareholder’s right to sue is derivative of the parent company’s right to sue, which in turn is derivative of a subsidiary’s right to sue the subsidiary’s former officers or directors.

In these types of suits, the second prong of the demand futility test will not be considered because it is the subsidiary that made the decision not the parent company.

Question 38

What is the demand futility test according to Rales

Answer 38

Whether today’s board is impartial regarding the decision to pursue the action.. I.e., the first prong. (maybe, but we’ll see)

Question 39

Does the mere threat of liability (being scared) mean that directors are not independent or disinterested? (Aronson)

Answer 39

No.

Question 40

When will the Rales demand utility test be used?

Answer 40

1) If the board of a company was replaced
2) If there was no business decision to consider (insider trading allegations, etc.)
3) It is a double derivative action (i.e., difference corp made the decision)

Question 41

Is there a universal practice of no-demand in Delaware?

Answer 41

Yes.

Question 42

Are board likely too reject most demands?

Answer 42

Yes.

Question 43

Does a demand to the board to instigate a derivative suit mean that the plaintiff concedes (admits that they are not, or surrenders) the board’s independence?

Answer 43

Yes. According to Speigal.

Question 44

What are the other approaches to demand?

Answer 44

In the RMBCA and according to the American Law Institute demand is always met, they need not request the board and then show demand futility.