Chapter 2-8 Derivate Shareholder Suits

• Jurisdiction: United States

2-8 Derivate Shareholder Suits

2-8:1 Overview

Corporate shareholders have no say in the day to day decisions affecting the corporation they own. However, when the corporation refuses to rectify a wrong done to it by a third party—often a member of the board of directors or a corporate officer—shareholders may step in and litigate on behalf of the corporation. The current framework for Derivative Shareholder Suits strikes a balance between the autonomy of the corporate board of directors and the need for shareholders to police the corporation they own.

2-8:1.1 Related Causes of Action

Officer and Director Liability, Breach of Partnership Duty, Usurpation of Business Opportunity, Securities Litigation, Class Action Suits

2-8:2 Elements

(1) Corporation suffers an injury

• Any action by a third party which has harmed the corporation.¹⁷⁷

(2) Corporation does not enforce its right to redress the injury

• Corporation does not enforce its right to redress the injury. Essentially, the corporation refuses to act.¹⁷⁸

(3) Shareholder has standing to sue

• The shareholder:

• Satisfies one of the following:

• Was a shareholder at the time the act or omission complained of occurred; or
• Became a shareholder by operation of law from a person who was a shareholder at the time the act or omission complained of occurred; and

• The shareholder fairly and adequately represents the interests of the corporation in enforcing the right of the corporation.¹⁷⁹

(4) Shareholder makes written demand on the board of directors

• The shareholder must make a written demand of the board of directors which:

• States with particularity the act, omission, or other matter which is the subject of the claim or challenge;¹⁸⁰
• Requests that the corporation take suitable action;¹⁸¹ and
• Identifies the shareholder(s) by name.¹⁸²

• However, if the converted entity in a conversion is a corporation, a shareholder of that corporation may not institute or maintain in a derivative proceeding unless:

• The proceeding is not based on an act or omission that occurred before the date of the conversion; or
• The shareholder was an equity owner of the converting entity at the time of the act or omission and the shareholder fairly and adequately represents the interest of the corporation.¹⁸³

(5) 91 days have passed since the shareholder has made his written demand, unless: (a) the shareholder has been notified that the demand has been rejected by the corporation; (b) the corporation is suffering irreparable injury; or (c) irreparable injury to the corporation would result by waiting for the expiration of the 90-day period.

• 91 days must pass after the shareholder makes his written demand.¹⁸⁴

Exceptions:

• The shareholder has been notified that the demand has been rejected by the corporation;
• The corporation is suffering irreparable injury; or
• Irreparable injury to the corporation would result by waiting for the expiration of the 90-day period.¹⁸⁵

2-8:3 Damages and Remedies

2-8:3.1 Generally

The damages and remedies available to a plaintiff will be determined by the underlying cause(s) of action.¹⁸⁶

The corporation will recover any damages or receive the benefit of any equitable relief.¹⁸⁷

There are circumstances where the court may award damages directly to the shareholder-plaintiff.¹⁸⁸

2-8:3.2 Cost Shifting

• Any party may be ordered to pay the expenses of another party¹⁸⁹

• "Expenses" includes
• Attorney's fees;
• Costs in pursuing an investigation of the matter that was the subject of the derivative proceeding; or
• Expenses for which the corporation or a corporate defendant may be required to indemnify another person.¹⁹⁰

The corporation must pay the shareholder-plaintiff's expenses upon a court finding that the shareholder-plaintiff obtained a substantial benefit for the corporation.¹⁹¹

The shareholder-plaintiff must pay the corporation's expenses incurred in investigating and defending the proceeding upon a court finding that the litigation has been instituted or maintained without reasonable cause or for an improper purpose.¹⁹²

Any party must pay the expenses incurred in relating to the filing of a motion, pleading or other paper if the motion, pleading or other paper was improper.¹⁹³

2-8:3.3 Indemnification

A corporation shall indemnify a defendant director or officer for actual expenses incurred in a wholly successful defense.¹⁹⁴

A corporation may indemnify an officer or director who is threatened to be named in a proceeding for reasonable expenses, in advance of the final disposition of the proceeding when:

(1) The corporation receives a written affirmation by the person of the person's good faith belief that the person has met the standard of conduct necessary for indemnification under Chapter 8 of the BOC;
and
(2) The corporation receives a written undertaking by or on behalf of the person to repay the amount paid or reimbursed if the final determination is that the person has not met that standard or that indemnification is prohibited by Section 8.102.¹⁹⁵

2-8:4 Defenses

2-8:4.1 Procedural Defenses

No demand or an insufficient demand made on the board of directors is an appropriate defense.¹⁹⁶

Premature filing of a lawsuit following the shareholder-plaintiff's demand is also an appropriate defense.¹⁹⁷

2-8:4.2 Defenses Held by the Defendant Third Party

The defendant corporation may assert all of the defenses held by the defendant third party.

• Statute of Limitations:

• The applicable limitations period is determined by the underlying cause of action.¹⁹⁸
• Statute of limitations accrues on the date of the legal injury to the corporation.¹⁹⁹
• A written demand filed with the corporation under Business Organizations Code Section 21.533 tolls the statute of limitations on the claim on which demand is made until the later of:

(1) The 31st day after the expiration of any waiting period under Section 21.553; or
(2) The 31st day after the expiration of any stay granted under Section 21.555, including all continuations of the stay.²⁰⁰

• Res Judicata:

• Bars relitigation of derivative claims which arise out of the same subject matter and could have been brought in the first lawsuit.²⁰¹
• Res Judicata does not bar claims if the absent shareholders were not adequately represented.²⁰²

2-8:4.3 Defenses Against the Shareholder-Plaintiff

A defendant corporation and a defendant third party may assert the following defenses against the shareholder-plaintiff:

• Shareholder's standing to sue;
• The plaintiff participated in, consented to, or acquiesced in the misconduct he seeks to challenge on the corporation's behalf;²⁰³
• The plaintiff purchased his stock with knowledge of prior misconduct;²⁰⁴
• The plaintiff is guilty of laches in bringing the suit;²⁰⁵ or
• The plaintiff purchased his shares from someone who participated in the misconduct in question.²⁰⁶

2-8:5 Procedural Implications

2-8:5.1 Forum

• Derivative shareholder suits may always be brought in state court.²⁰⁷
• Derivative shareholder suits may be brought in federal court given the proper jurisdictional facts.²⁰⁸
• Plaintiffs might prefer federal court because there are fewer procedural mechanisms.

2-8:5.2 Venue

• Corporations will generally be classified as plaintiffs for venue purposes.²⁰⁹
• If the corporation will be adversely affected by the lawsuit, the defendant corporation will be deemed to be a defendant for venue purposes.²¹⁰

2-8:5.3 Claim Joinder

• A shareholder-plaintiff must bring all direct claims arising out of the same subject matter.²¹¹
• Shareholders who are not an actual party to the lawsuit are not required to bring any direct claims.²¹²

2-8:5.4 Demand

• The shareholder must make a written demand of the board of directors which:

• States with particularity the act, omission or other matter which is the subject of the claim or challenge;²¹³
• Requests that the corporation take suitable action;²¹⁴ and
• Identifies the shareholder(s) by name.²¹⁵

A shareholder may not institute a derivative proceeding until the 91st day after the date the shareholder makes his written demand.²¹⁶

Exceptions:

• The shareholder has been notified that the demand

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