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A shareholder derivative suit is a
lawsuit - A lawsuit is a proceeding by a party or parties against another in the civil court of law. The archaic term "suit in law" is found in only a small number of laws still in effect today. The term "lawsuit" is used in reference to a civil acti ...
brought by a
shareholder A shareholder (in the United States often referred to as stockholder) of a corporation is an individual or legal entity (such as another corporation, a body politic, a trust or partnership) that is registered by the corporation as the legal ow ...
on behalf of a
corporation A corporation is an organization—usually a group of people or a company—authorized by the state to act as a single entity (a legal entity recognized by private and public law "born out of statute"; a legal person in legal context) and ...
against a third party. Often, the third party is an insider of the corporation, such as an executive officer or director. Shareholder derivative suits are unique because under traditional corporate law, management is responsible for bringing and defending the corporation against suit. Shareholder derivative suits permit a shareholder to initiate a suit when management has failed to do so. To enable a diversity of management approaches to risks and reinforce the most common forms of corporate rules with a high degree of permissible management power, many jurisdictions have implemented minimum thresholds and grounds (procedural and substantive) to such suits.


Purpose and difficulties

Under traditional corporate business law, shareholders are the owners of a corporation. However, they are not empowered to control the day-to-day operations of the corporation. Instead, shareholders appoint directors, and the directors in turn appoint officers and/or relatively less powerful executives to manage day-to-day operations. Derivative suits refer to one or more shareholders bringing an action (
lawsuit - A lawsuit is a proceeding by a party or parties against another in the civil court of law. The archaic term "suit in law" is found in only a small number of laws still in effect today. The term "lawsuit" is used in reference to a civil acti ...
) in the name of the corporation against a party or parties allegedly causing harm to the latter. If the directors, officers, or employees of the corporation are not willing to file an action, a shareholder may first petition them to proceed. If such petition fails, they may take it upon themself to bring an action on behalf of the corporation. Any proceeds (damages and interest in English law) of a successful action are awarded to the corporation and not to the shareholder(s) as the controlling claimant. In recent years, “appraisal arbitrage” has developed as a form of shareholder quasi-litigation or court litigation. Popular among hedge funds and risky equity ventures seeking to take advantage of favorable case law on valuation, such arbitrageurs buy shares in the target company of a transaction about to close (in any scintilla or longer window after agreement, before legal finality on all aspects) and file suit claiming that the fair value of the company is higher than the price agreed. The financial incentive is cashing in on a quite often higher court-determined price plus default interest at 5% above the Federal Reserve discount rate, compounded quarterly. It relies on there having been a lack of thoroughness of the total company valuation and thus most suited to companies with complex assets or having been very conservatively valued.


Procedure

In most jurisdictions, a shareholder must satisfy various requirements to prove that he has a valid standing before being allowed to proceed. The law may require the shareholder to meet qualifications such as the minimum value of the shares and the duration of the holding by the shareholder; to first make a demand on the corporate board to take action; or to post bond, or other fees in the event that he does not prevail.


Derivative suits in the United States

In the
United States The United States of America (U.S.A. or USA), commonly known as the United States (U.S. or US) or America, is a country primarily located in North America. It consists of 50 states, a federal district, five major unincorporated territo ...
, corporate law is based on state law. Although the laws of each state differ, the laws of the states such as
Delaware Delaware ( ) is a state in the Mid-Atlantic region of the United States, bordering Maryland to its south and west; Pennsylvania to its north; and New Jersey and the Atlantic Ocean to its east. The state takes its name from the adjacent De ...
,
New York New York most commonly refers to: * New York City, the most populous city in the United States, located in the state of New York * New York (state), a state in the northeastern United States New York may also refer to: Film and television * ...
,
California California is a state in the Western United States, located along the Pacific Coast. With nearly 39.2million residents across a total area of approximately , it is the most populous U.S. state and the 3rd largest by area. It is also the mo ...
, and
Nevada Nevada ( ; ) is a state in the Western region of the United States. It is bordered by Oregon to the northwest, Idaho to the northeast, California to the west, Arizona to the southeast, and Utah to the east. Nevada is the 7th-most extensive, ...
where corporations often incorporate, institute a number of barriers to derivative suits. Generally in these states, and under the American Bar Association
guidelines A guideline is a statement by which to determine a course of action. A guideline aims to streamline particular processes according to a set routine or sound practice. Guidelines may be issued by and used by any organization (governmental or pri ...
, the procedure of a derivative suit is as follows. First, eligible shareholders must file a demand on the board. The board may either reject, accept, or not act upon the demand. If after a period of time the demand has been rejected or has not been acted upon, shareholders may file suit. If the board accepts the demand, the corporation itself will file the suit. If rejected, or not acted upon, the shareholder must meet additional pleading requirements.MBCA § 7.44(d) On the requirements being met by the shareholder, the board may appoint a “special litigation committee” which may move to dismiss. If the special litigation committee makes a required showing, the case will be dismissed. If the committee fails to make a showing, the shareholder suit may proceed. This model approach is followed to a greater or lesser degree among various states. In
New York New York most commonly refers to: * New York City, the most populous city in the United States, located in the state of New York * New York (state), a state in the northeastern United States New York may also refer to: Film and television * ...
, for example, derivative suits must be brought to secure a judgment "in he corporation'sfavor."
Delaware Delaware ( ) is a state in the Mid-Atlantic region of the United States, bordering Maryland to its south and west; Pennsylvania to its north; and New Jersey and the Atlantic Ocean to its east. The state takes its name from the adjacent De ...
has different rules in regards to demand and bond requirements too. The famous case of '' Shaffer v. Heitner'', which ultimately reached the
United States Supreme Court The Supreme Court of the United States (SCOTUS) is the highest court in the federal judiciary of the United States. It has ultimate appellate jurisdiction over all U.S. Federal tribunals in the United States, federal court cases, and over Stat ...
, originated with a shareholder derivative suit against
Greyhound Lines Greyhound Lines, Inc. (commonly known as simply Greyhound) operates the largest intercity bus service in North America, including Greyhound Mexico. It also operates charter bus services, Amtrak Thruway services, commuter bus services, and ...
.


Derivative suits in the United Kingdom

In the
United Kingdom The United Kingdom of Great Britain and Northern Ireland, commonly known as the United Kingdom (UK) or Britain, is a country in Europe, off the north-western coast of the continental mainland. It comprises England, Scotland, Wales and No ...
, an action brought by minority shareholder(s) could only in exceptional circumstances be upheld under the doctrine of ''
Foss v Harbottle ''Foss v Harbottle'' (1843) 2 Hare 46167 ER 189is a leading English precedent in corporate law. In any action in which a wrong is alleged to have been done to a company, the proper claimant is the company itself. This is known as "the proper pl ...
'' in 1843 as to who is the "proper claimant/plaintiff". Exceptions involve ''
ultra vires ('beyond the powers') is a Latin phrase used in law to describe an act which requires legal authority but is done without it. Its opposite, an act done under proper authority, is ('within the powers'). Acts that are may equivalently be termed ...
'' and, similarly, fraud on minority. According to Blair and Stout's ''Team Production Theory of Corporate Law'', the purpose of such permissible suits is never to protect the shareholders, but to protect the corporation itself. Thus highly irregular emoluments or share reward schemes to the board of directors themselves or their personal extrinsic interests lend themselves to such suits. Creditors may bring an action, if a corporation inextricably faces
insolvency In accounting, insolvency is the state of being unable to pay the debts, by a person or company ( debtor), at maturity; those in a state of insolvency are said to be ''insolvent''. There are two forms: cash-flow insolvency and balance-sheet in ...
. Sections 302 to 306 of the
Companies Act 2006 The Companies Act 2006 (c 46) is an Act of the Parliament of the United Kingdom which forms the primary source of UK company law. The Act was brought into force in stages, with the final provision being commenced on 1 October 2009. It largel ...
provides no new statutory class of suits but must be followed, setting out the required standard procedure. In England and Wales, this entails a ''prima facie'' case must be shown stage. This preliminary case avoids wasted time and costs. In Scotland where there had been even less clear rules on shareholder actions on behalf of the company, particularly procedurally, alike sections assist. A confirmation of the statutory procedure being in almost all cases applicable first occurred in the leading reported case of: *''
Roberts v Gill & Co Solicitors Roberts may refer to: People * Roberts (given name), a Latvian masculine given name * Roberts (surname), a popular surname, especially among the Welsh Places * Roberts (crater), a lunar impact crater on the far side of the Moon ;United Sta ...
'' [2010
UKSC 22


Derivative suits in continental Europe

Derivative shareholder suits are extremely rare in continental Europe. The reasons probably lie within laws that prevent small shareholders from bringing lawsuits in the first place. Many European countries have company acts that legally require a minimum share in order to bring a derivative suit. Larger shareholders could bring lawsuits, however, their incentives are rather to settle the claims with the management, sometimes to the detriment of the small shareholders.Why do Shareholder Derivative Suits Remain Rare in Continental Europe?, 37 BROOKLYN J. INT'L L. 843-892 (2012).


Derivative suits in New Zealand

In New Zealand these can be brought under the Companies Act 1993 section 165 only with the of the court. It must be in the best interest of the company to have this action brought so benefits to company must outweigh the costs of taking action.


Derivative suits in India

In India, derivative suits are brought under the clauses of oppression and mismanagement.


See also

*
Business judgment rule The business judgment rule is a case law-derived doctrine in corporations law that courts defer to the business judgment of corporate executives. It is rooted in the principle that the "directors of a corporation... are clothed with hepresumptio ...


References

{{reflist, 2 Corporate law Lawsuits Shareholders