Shareholders' Lawsuits

Lots of people struggle with the subjects that fall under the category of "business associations."  Corporations is one of those subjects and it's tested frequently on the Multistate Essay Exam.  A large number of the questions dealing with corporations include issues regarding shareholders, and this post will address one of those issues.

Direct Actions by a Shareholder:

There are times in which a shareholder might feel that a fiduciary duty was breached by either a director or an officer of the corporation and that the shareholder is affected directly by the breach.  The shareholder (rather than the corporation itself) is affected directly if the shareholder suffers the most immediate and direct damage and if the defendant's duty of care ran directly to the shareholder rather than to the corporation. If a shareholder sues in such a situation that is known as a direct action by the shareholder, and considerations are important because in a direct action by the shareholder, recovery is for the benefit of the individual shareholder and not the corporation.

Derivative Actions by a Shareholder:

I see derivative actions tested a bit more frequently than direct actions.  In a derivative action, the shareholder is asserting the corporation's rights (rather than the rights of the individual shareholder).  Recovery here generally goes to the corporation rather than to the shareholder, and yet interestingly the corporation is still named as the defendant.  There is a process here to keep in mind if a shareholder is to bring a derivative action.

The shareholder must have been a shareholder at the time of the act or omission complained of or must have become a shareholder through transfer by operation of law from one who was a shareholder at that time. In addition, the shareholder must adequately and fairly represent the interests of the corporation.  Assuming these requirements are satisfied, the shareholder must make a written demand on the corporation to take suitable action and the derivative proceeding may not be commenced until 90 days have elapsed from the date of that demand.  The 90-day requirement will not be enforced, however, if the shareholder has been notified that the corporation has rejected the demand or if irreparable injury to the corporation would result if required to wait 90 days.

If a majority of directors (at least 2) who have no personal interest in the controversy find in good faith after reasonable inquiry that the suit is not in the best interest of the corporation, then the suit may be dismissed on motion by the corporation.  To avoid such dismissal, the shareholder will have the burden to prove that the decision was not made in good faith after reasonable inquiry.  The burden will shift to the corporation, however, if it's not true that a majority of directors had no personal interest in the controversy.  In that case, the corporation will have the burden to prove that the decision was made in good faith after reasonable inquiry.

Once the derivative action has ended, the court may order the corporation to pay the plaintiff's reasonable expenses if it finds that the action has resulted in a substantial benefit to the corporation. If, however, the court finds that the action was maintained without reasonable cause, the court may order the plaintiff to pay reasonable expenses to the defendant.