Derivative suit
Encyclopedia
A shareholder derivative suit is a lawsuit
brought by a shareholder
on behalf of a corporation
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. Because derivative suits vary the traditional roles of management and shareholders, many jurisdictions have implemented various procedural requirements to derivative suits.
Derivative suits permit a shareholder to bring an action
in the name of the corporation against the parties allegedly causing harm to the corporation. 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, the shareholder may take it upon himself to bring an action on behalf of the corporation. Any proceeds of a successful action are awarded to the corporation and not to the individual shareholders that initiate the action.
, corporate law is largely based upon state law. Although the laws of each state differ, the laws of the states such as Delaware
, New York
, and California
, where corporations often incorporate, institute a number of barriers to derivative suits.
Under the Model Business Corporation Act
(MBCA), the procedure of a derivative suit is as follows. There has been harm to the corporation but the board of directors has not taken a measure against the wrongdoers. First, eligible shareholders must file a demand on the board. The board may either reject, accept, or not act upon the demand. If after 90 days 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 still meet additional pleading requirements. 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.
The MBCA
is not a law itself, but rather a model statute suggested for passage by different jurisdictions. Individual states adhere to the MBCA procedures to varying degrees. In New York
, for example, derivative suits must be brought to secure a judgment "in [the corporation's] favor." Delaware
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, originated with a shareholder derivate suit against Greyhound Bus Lines.
, an action brought by a minority shareholder may not be upheld under the doctrine set out in Foss v Harbottle
in 1843. Exceptions to the doctrine involve ultra vires
and the "fraud on minority". According to Blair and Stout's "Team Production Theory of Corporate Law", the purpose of the suit is not to protect the shareholders, but to protect the corporation itself. Creditors, rather than shareholders, may bring an action, if a corporation faces insolvency
. (See: Credit Lyonnais Bank Nederaland v. Pathe Communication Corp) Civ. A. No. 12150, 1991 Del. Ch. LEXIS 215 (Del. Ch. Dec. 30, 1991).
The Companies Act 2006
provided a new procedure, but it did not reformulate the rule in Foss v Harbottle. In England and Wales, the procedure slightly modified the pre-existing rules, and provided for a new preliminary stage at which a prima facie case must be shown. In Scotland where there had been no clear rules on shareholder actions on behalf of the company, the Act sought to achieve a result similar to that in England and Wales.
these can be brought under the Companies Act 1993 section 165 only with the leave 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.
Lawsuit
A lawsuit or "suit in law" is a civil action brought in a court of law in which a plaintiff, a party who claims to have incurred loss as a result of a defendant's actions, demands a legal or equitable remedy. The defendant is required to respond to the plaintiff's complaint...
brought by a shareholder
Shareholder
A shareholder or stockholder is an individual or institution that legally owns one or more shares of stock in a public or private corporation. Shareholders own the stock, but not the corporation itself ....
on behalf of a corporation
Corporation
A corporation is created under the laws of a state as a separate legal entity that has privileges and liabilities that are distinct from those of its members. There are many different forms of corporations, most of which are used to conduct business. Early corporations were established by charter...
against a third party. Often, the third party is an insider
Insider
An insider is a member of any group of people of limited number and generally restricted access. The term is used in the context of secret, privileged, hidden or otherwise esoteric information or knowledge: an insider is a "member of the gang" and as such knows things only people in the gang...
of the corporation, such as an executive officer or director. Shareholder derivative suits are unique because under traditional corporate law
Corporation
A corporation is created under the laws of a state as a separate legal entity that has privileges and liabilities that are distinct from those of its members. There are many different forms of corporations, most of which are used to conduct business. Early corporations were established by charter...
, 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. Because derivative suits vary the traditional roles of management and shareholders, many jurisdictions have implemented various procedural requirements to derivative suits.
Purpose and difficulties
While, under traditional corporate law, shareholders are the owners of a corporation, 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 or executives.Derivative suits permit a shareholder to bring an action
Lawsuit
A lawsuit or "suit in law" is a civil action brought in a court of law in which a plaintiff, a party who claims to have incurred loss as a result of a defendant's actions, demands a legal or equitable remedy. The defendant is required to respond to the plaintiff's complaint...
in the name of the corporation against the parties allegedly causing harm to the corporation. 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, the shareholder may take it upon himself to bring an action on behalf of the corporation. Any proceeds of a successful action are awarded to the corporation and not to the individual shareholders that initiate the action.
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 StatesUnited States
The United States of America is a federal constitutional republic comprising fifty states and a federal district...
, corporate law is largely based upon state law. Although the laws of each state differ, the laws of the states such as Delaware
Delaware
Delaware is a U.S. state located on the Atlantic Coast in the Mid-Atlantic region of the United States. It is bordered to the south and west by Maryland, and to the north by Pennsylvania...
, New York
New York
New York is a state in the Northeastern region of the United States. It is the nation's third most populous state. New York is bordered by New Jersey and Pennsylvania to the south, and by Connecticut, Massachusetts and Vermont to the east...
, and California
California
California is a state located on the West Coast of the United States. It is by far the most populous U.S. state, and the third-largest by land area...
, where corporations often incorporate, institute a number of barriers to derivative suits.
Under the Model Business Corporation Act
Model Business Corporation Act
The Model Business Corporation Act is a model set of law prepared by the Committee on Corporate Laws of the Section of Business Law of the American Bar Association and is followed by twenty-four states.-History:...
(MBCA), the procedure of a derivative suit is as follows. There has been harm to the corporation but the board of directors has not taken a measure against the wrongdoers. First, eligible shareholders must file a demand on the board. The board may either reject, accept, or not act upon the demand. If after 90 days 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 still meet additional pleading requirements. 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.
The MBCA
Model Business Corporation Act
The Model Business Corporation Act is a model set of law prepared by the Committee on Corporate Laws of the Section of Business Law of the American Bar Association and is followed by twenty-four states.-History:...
is not a law itself, but rather a model statute suggested for passage by different jurisdictions. Individual states adhere to the MBCA procedures to varying degrees. In New York
New York
New York is a state in the Northeastern region of the United States. It is the nation's third most populous state. New York is bordered by New Jersey and Pennsylvania to the south, and by Connecticut, Massachusetts and Vermont to the east...
, for example, derivative suits must be brought to secure a judgment "in [the corporation's] favor." Delaware
Delaware
Delaware is a U.S. state located on the Atlantic Coast in the Mid-Atlantic region of the United States. It is bordered to the south and west by Maryland, and to the north by Pennsylvania...
has different rules in regards to demand and bond requirements too.
The famous case of Shaffer v. Heitner
Shaffer v. Heitner
Shaffer v. Heitner, 433 U.S. 186 , was a case in which the Supreme Court of the United States established that in order for an American state to assert personal jurisdiction, due process under the Fourteenth Amendment requires minimum contacts over and above the mere ownership of stocks...
, which ultimately reached the United States Supreme Court, originated with a shareholder derivate suit against Greyhound Bus Lines.
Derivative suits in the United Kingdom
In the United KingdomUnited Kingdom
The United Kingdom of Great Britain and Northern IrelandIn the United Kingdom and Dependencies, other languages have been officially recognised as legitimate autochthonous languages under the European Charter for Regional or Minority Languages...
, an action brought by a minority shareholder may not be upheld under the doctrine set out in Foss v Harbottle
Foss v Harbottle
Foss v Harbottle 67 ER 189 is 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 rule in Foss v Harbottle", and the several important exceptions that have been...
in 1843. Exceptions to the doctrine involve ultra vires
Ultra vires
Ultra vires is a Latin phrase meaning literally "beyond the powers", although its standard legal translation and substitute is "beyond power". If an act requires legal authority and it is done with such authority, it is...
and the "fraud on minority". According to Blair and Stout's "Team Production Theory of Corporate Law", the purpose of the suit is not to protect the shareholders, but to protect the corporation itself. Creditors, rather than shareholders, may bring an action, if a corporation faces insolvency
Insolvency
Insolvency means the inability to pay one's debts as they fall due. Usually used to refer to a business, insolvency refers to the inability of a company to pay off its debts.Business insolvency is defined in two different ways:...
. (See: Credit Lyonnais Bank Nederaland v. Pathe Communication Corp) Civ. A. No. 12150, 1991 Del. Ch. LEXIS 215 (Del. Ch. Dec. 30, 1991).
The Companies Act 2006
Companies Act 2006
The Companies Act 2006 is an Act of the Parliament of the United Kingdom which forms the primary source of UK company law. It had the distinction of being the longest in British Parliamentary history: with 1,300 sections and covering nearly 700 pages, and containing 16 schedules but it has since...
provided a new procedure, but it did not reformulate the rule in Foss v Harbottle. In England and Wales, the procedure slightly modified the pre-existing rules, and provided for a new preliminary stage at which a prima facie case must be shown. In Scotland where there had been no clear rules on shareholder actions on behalf of the company, the Act sought to achieve a result similar to that in England and Wales.
- Roberts v Gill & Co Solicitors [2010] UKSC 22
Derivative suits in New Zealand
In New ZealandNew Zealand
New Zealand is an island country in the south-western Pacific Ocean comprising two main landmasses and numerous smaller islands. The country is situated some east of Australia across the Tasman Sea, and roughly south of the Pacific island nations of New Caledonia, Fiji, and Tonga...
these can be brought under the Companies Act 1993 section 165 only with the leave 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.