SHAREHOLDERS: DERIVATIVE SUITS

Question 1

SHAREHOLDER AS PLAINTIFF AND
RECOVERY

Answer 1

• In a derivative suit, shareholder is suing to enforce corp’s claim, not her own personal claim.
• In other words, if shareholder believes corp has been wronged but directors have not done anything to enforce its rights w/ respect to the wrong, shareholder may be able to bring a shareholder derivative suit to enforce corp’s rights.
• It’s a case in which corp is not pursuing its own claim, so a shareholder steps in to prosecute it for corp.
• So, you should always ask: could corp have brought this suit? If so, it’s a derivative suit.

Question 2

Compare—Direct Actions

Answer 2

• A direct action may be brought for a breach of a fiduciary duty owed to shareholder by an officer/director.
• To distinguish breaches of duty owed to the corp & duties owed to shareholder, ask:
  (1) who suffers the most immediate & direct damage, corp/shareholder; and
  (2) to whom did D’s duty run, corp/shareholder?
• In a shareholder direct action, any recovery is for the benefit of the individual shareholder.

Question 3

Recovery to Corporation

Answer 3

• In a derivative action, shareholder is asserting corp’s
  rights rather than her own rights.
• So if a shareholder-P wins a derivative suit, who gets the money from the judgment? The corporation.
  Remember, it is the corp’s claim.

Question 4

Court May Order Payment of Expenses

Answer 4

• Shareholder-P may recover costs & attorneys’ fees, usually from the judgment won for corp (after all, shareholder did a favor for the corp by suing & winning).
• If shareholder-P loses the derivative suit, she cannot recover costs & attorneys’ fees.
• If ct finds the action was commenced/maintained w/o reasonable cause/improper purpose, it may order P to pay reasonable expenses of D.
• So shareholder may be liable to D she sued for D’s attorneys’ fees if she sued w/o reasonable cause.

Question 5

REQUIREMENTS FOR DERIVATIVE SUITS
8.2.1 Standing
a. Stock Ownership at Time of Wrong

Answer 5

• To commence & maintain a derivative proceeding, a
  shareholder must have been a shareholder at time claim arose/must have become a shareholder through transfer by operation of law from someone who did own stock at time claim arose.
• Examples of “transfer by operation of law” include getting stock through inheritance/by divorce decree.

Question 6

Adequate Representation

Answer 6

• Shareholder must also fairly & adequately represent corp’s interest.

Question 7

Demand Requirements

Answer 7

Under the MBCA, the shareholder must make a written
demand on the corporation (usually, that means the board) to
take suitable action. In some states, this demand must always
be made, and the shareholder cannot sue until 90 days after
making this demand, unless: (1) the shareholder has earlier
been notified that the corporation has rejected the demand;
or (2) irreparable injury to the corporation would result by
waiting for the 90 days to pass. In other states, shareholders
are not required to make this demand if the demand would be
futile. A good example of such a case is when the directors
(on whom demand is being made) would be the defendant

Question 8

Corporation Joined as Defendant

Answer 8

• Corp must be joined to suit as D.
• Even though suit asserts corp’s claim, since corp did not do so, it is joined as D

Question 9

Dismissal or Settlement Requires Court Approval

Answer 9

• Parties can settle/dismiss a derivative suit only w/ ct approval.
• Ct may give notice to shareholders & get their input on whether to settle/dismiss.
• After derivative suit is filed, corp may move to dismiss.

Question 10

Dismissed If Found Not in Corporation’s Best
Interests

Answer 10

• Dismissal must be based upon an independent investigation that concluded that suit is not in corp’s
  best interest (ex. it has a low chance of success/ expense of case would exceed recovery corp would win).

Question 11

Investigation By Independent Directors or Panel

Answer 11

• Investigation must be made by independent directors/court-appointed panel of one/more
  independent persons. (Usually, it’s a “special litigation
  committee” of independent directors.)

Question 12

Court Determination

Answer 12

• In ruling on motion to dismiss, if ct finds
  (1) those recommending dismissal were truly independent &
  (2) they made a reasonable investigation, in most states, ct will dismiss

Question 13

Burden of Proof

Answer 13

• To avoid dismissal, in most cases shareholder
  bringing suit has the burden of proving to ct
  that the decision was not made in good faith after
  reasonable inquiry.
• However, if a majority of directors had a personal interest in controversy, corp will have burden of showing that decision was made in good faith after reasonable inquiry.