DIRECT SUITS AND DERIVATIVE ACTIONS: RETHINKING SHAREHOLDER PROTECTION IN COMPARATIVE CORPORATE LAW.

• Author: Koh, Alan K.

INTRODUCTION 394 I. FORM AND FUNCTION IN SHAREHOLDER LAWSUITS: AN ANALYTICAL FRAMEWORK OF DIRECT SUITS AND DERIVATIVE ACTIONS 398 A. Form: Subject Matter, Parties, Outcomes, and Cost Allocation 398 1. Direct suits 398 2. Derivative actions 400 B. Function: Director Liability Versus Shareholder Protection 404 1. Director Liability 404 2. Shareholder Protection 405 3. Direct suits and derivative actions: distinct but overlapping functions 406 II. SHAREHOLDER LAWSUITS IN THE DOING BUSINESS REPORTS: OR HOW THE WORLD BANK LEARNED TO STOP WORRYING AND FORGET DIRECT SUITS 407 A. The Doing Business Reports' Methodology and the Case of "Mr James" 410 B. Exposing the Basic Premises Underlying the DBR's Protecting Minority Investor (PML) Indices 413 1. Mr. James is liable first (if not only) to the company 413 2. Mr. James is liable qua director 415 3. The shareholder suit used against Mr. James is a derivative action 416 C What the DBR Is Really About: Director Liability, Not Shareholder Protection: Derivative Actions, Not Direct Suits 417 III. TOWARDS A COMPARATIVE TAXONOMY OF DIRECT SUITS 419 A. Direct Monetary Claims 420 B. Withdrawal 423 C. Appraisal 424 D. Challenges Against Corporate Acts or Proceedings 426 E. Injunctions 430 F. Director Removal 432 G. Regulation of the Company's Affairs 433 CONCLUSION: THE DIVERSITY OF SHAREHOLDER LAWSUITS AND THEIR IMPLICATIONS FOR COMPARATIVE CORPORATE LAW AND GOVERNANCE 434 INTRODUCTION

The use of shareholder lawsuits as a means of minority shareholder protection has fascinated comparative corporate law scholars and legally untrained economists alike. Scholarly interest in the private enforcement of corporate law exploded with the rise of the "Law and Finance" movement--also known by the labels "law matters" and "legal origins thesis" (1)--beginning in the late 1990s. In a highly cited (2) series of quantitative empirical studies, a leading group of US-based Law and Finance economists (known collectively as "LLSV" or "DLLS" (3)) sought to link economic development with, amongst other things, legal rules relevant to minority shareholder protection, (4) such as shareholder lawsuits. (5) The impact of Law and Finance did not stop at academic citations, as the World Bank began the Doing Business series of annual reports ("DBR") (6) measuring and ranking most of the world's jurisdictions using the methodology from articles authored by LLSV or DLLS. (7) Since the landmark 2008 article by DLLS on "The Law and Economics of Self-Dealing" ("DLLS Article"), (8) shareholder lawsuit mechanisms have become an established component of the DBR's "Protecting Minority Investors" indicator, and a matter of real stakes for the world's jurisdictions seeking to do well in such rankings.

Reducing over 100 complex regimes of shareholder lawsuits around the world into simple--and mostly binary--data points fit for ranking and quantitative analysis in the DBR (9) would appear at first glance to be a triumph for economists in academia and the World Bank. While the initial LLSV articles and overall Law and Finance project were received with skepticism by some corporate law scholars, (10) neither the DLLS Article nor the DBR's shareholder lawsuit components have received the same level of scrutiny. (11) Leading corporate law critiques of the DBR fall into two categories. The first focuses on errors or other issues with the coding of specific jurisdictions' regimes, such as Singapore, (12) Italy, (13) and the US. (14) The second challenges DBR's relevance on the ground that high rankings derived from its "law in books" methodology belie the anemic reality of "law in action," using the case of the DBR's Related Party Transaction Index ("RPTI") as applied to Asian Anglo-Commonwealth jurisdictions. (15) No corporate law scholar (16) has, however, set out to critically examine whether the DBR data collected on minority shareholder protection--regardless of whether it reflects reality--is even meaningful for multiple civil and common law jurisdictions.

This Article argues that--even accepting the DBR's data as accurate and the "law in books" approach as not unsound--there are fundamental errors in the DBR's understanding of, and their approach to, minority shareholder protection via the legal mechanism of shareholder lawsuits. A set of unarticulated but critical premises about shareholder lawsuits and minority shareholder protection has made its way into the DBR data collection process and manifested in how the relevant indices for "Protecting Minority Investors" have been defined and scored. These premises arose from the economists' failure to appreciate two sets of distinctions in shareholder lawsuits and how they interact. The consequences: the neglect of a critical category of shareholder lawsuits and the perpetuation of a misleading picture of "shareholder protection" by one of the world's most influential institutions. This has serious ramifications for jurisdictions around the world who may seek to improve their performance on the DBR through shareholder litigation reforms.

This Article makes three contributions to the comparative corporate law literature. The first is to provide a clear and concise analytical framework illuminating the two critical pairs of distinctions in the form and function of shareholder lawsuits. Shareholder lawsuits comprise two categories distinct as a matter of legal form: derivative actions and direct suits. The former is a comparatively uniform set of mechanisms predominantly centered on one objective: suing a director on behalf of the company for compensation. (17) By contrast, the latter, direct suits, are a diverse grouping that comprises mechanisms deployable in vastly different factual scenarios to achieve various legal outcomes.

Another relevant distinction concerns the two functions of shareholder lawsuits: Director Liability and Shareholder Protection. Explored in Part I.B, Director Liability refers to how directors may be held civilly liable for their actions through litigation; this is the primary function of derivative suits. By contrast. Shareholder Protection focuses on the interests of shareholders by providing some tangible advantage or alleviation of some specific detriment to the shareholder-plaintiff, shareholders generally, or both, through a wide range of monetary and non-monetary outcomes. Notwithstanding the longstanding emphasis of corporate law and governance scholarship on aspects of Director Liability, Director Liability does not necessarily achieve Shareholder Protection. This is because Director Liability fails to address or remedy the wide range of scenarios in which shareholder interests can be harmed, including the acts or conduct of other shareholders or of the company itself. (18)

The second contribution of this Article is to show how the World Bank (and Law and Finance) economists fell short in their purported goal of scoring and ranking jurisdictions on "Protection of Minority Investors" through shareholder lawsuits. When non-legal scholars treat corporate law rules and systems as just another type of "data" to be collected and crunched for easy consumption by a broader non-jurist market, it invites over-simplification and error. Only lawyers have specialized subject-matter expertise, the ability to make judgment calls, and a grasp of fundamental legal principles; this is no less true for the field of corporate law and governance. (19) By failing to appreciate the distinction between the Director Liability and Shareholder Protection functions of shareholder lawsuits, the DBR methodology as constructed by economists prioritized the narrow function of Director Liability over the broader possibilities of Shareholder Protection. Further, the DBR fixated on the mechanism corresponding to Director Liability--derivative actions. This checkered vision has come at the expense of a larger subset of shareholder lawsuits--direct suits. The resulting picture of shareholder lawsuits as mechanisms of Shareholder Protection around the world is therefore not just incomplete, but also misleading.

The Article's third contribution is to illustrate the existing and potential applications of direct suits. It offers a basic taxonomy of direct suits that illuminates, on a "law in books" (20) basis, both the range of detriments that a shareholder may suffer from and the diversity of possible legal responses. Drawing on numerous examples of direct suits from leading common law and civil law jurisdictions from Asia-Pacific, Europe, and the US, this Article makes a preliminary case for how the diverse range of legal mechanisms comprising direct suits offer protection for shareholders in a wide range of scenarios. As compared to the DLLS Article, the more inclusive taxonomy and broader range of jurisdictional examples in this Article lay the juridical and conceptual foundations for more rigorous data collection on and scholarly analysis of direct suits. These, in turn, have applications such as the latest round of DBR reform (21) or the development of comparable but better corporate law indices. In addition, the taxonomy may also prove useful as a framework for a subsequent "law in action", in-depth empirical micro-comparison of a small number of jurisdictions.

This Article proceeds as follows: Part I lays out the legal and conceptual framework by explaining distinctions between direct suits and derivative actions as a matter of legal form and function. Part II explains the premises underlying leading corporate law and governance indices in the World Bank's DBR and what this reveals about the legal and conceptual flaws in the methodology, as well as their implications for direct suits. Part III presents a survey of direct suit mechanisms in major jurisdictions including Germany, Japan, Korea, the United States, and key Anglo-Commonwealth nations and territories (United Kingdom, Canada, Australia, Singapore, and Hong Kong) as a comparative taxonomy of...