When a shareholder of a corporation develops a grievance against a corporation with a separation of ownership and management, he must choose between two different approaches, depending on the nature of the complaint and the circumstances: direct action or derivative action. A shareholder must generally choose between these two options – a single complaint will either be eligible for resolution through a direct action lawsuit or a shareholder’s derivative lawsuit, but not both.

Direct Action Lawsuits

In a direct action lawsuit, the shareholder alleges that the company has directly violated his rights in some way (refusing to distribute a dividend he is entitled to, for example, or by refusing to count his vote). The right violated must belong to him specifically, not to the corporation in general. In other words, he cannot maintain a direct action lawsuit if his complaint is based on injury to the corporation.

To maintain a direct action, the shareholder must show that the company’s behavior impacts some but not all of the shareholders. Or, the shareholder must show that the complaint can otherwise be characterized as a complaint about direct injury to him as a shareholder rather than to the corporation itself.

Derivative Action Lawsuits

In a derivative action lawsuit, the shareholder alleges that the directors have indirectly violated his rights by failing to look out for the best interests of the corporation. Since a corporation is a fictional entity, corporate directors act as representatives of the corporation; as such, they are subject to a fiduciary duty to act in the best interests of the corporation. This, of course, indirectly benefits the corporation’s shareholders.

A shareholder who files a derivative lawsuit is alleging that the corporation’s officers and/or directors have failed to properly look out for the corporation by performing acts (or by failing to perform acts) in a manner that is not in the best interest of the company. This indirectly harms the shareholders by reducing the value or marketability of the company’s shares.  

Demand and Futility: Before filing a shareholder’s derivative lawsuit, a shareholder is generally required to issue a formal demand to the company’s board of directors the rectify the complaint. If the board fails to do so within a reasonable time, the shareholder will have standing to file a derivative lawsuit. The demand requirement can be excused if the shareholder shows that any demand would be futile.  

Remedy: Since the shareholder’s claim against the company is derivative, the shareholder’s benefit is also derivative. If the shareholder wins the lawsuit, the court will order the board to remedy the shareholder’s complaint by acting, or ceasing to act, in a manner that will remedy the complaint (by refraining from further licensing its technology to a competitor owned by one of its former directors, for example).

Contact Us ASAP

If your company is subject to or anticipates shareholder litigation or if you are a shareholder contemplating litigation against the company that you hold shares in, call CKB Vienna LLP at 909-980-1040 or fill out our online contact form to learn how we can help you. We serve clients from the Rancho Cucamonga area, including Alta Loma, Etiwanda, Upland, Fontana, Ontario, Chino Hills, and Claremont.

Comment