Derivative suit

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A shareholder derivative suit is a lawsuit instigated by a shareholder of a corporation, not on the shareholder's own behalf, but on behalf of the corporation. The shareholder brings an action in the name of the corporation against the parties allegedly causing harm to the corporation. Often derivative suits are brought against officers or directors of a corporation for violations of fiduciary duties owed to the shareholders vis-a-vis the corporation. Any proceeds of a successful action are awarded to the corporation.

In most jurisdictions, shareholder derivative suits meet strong structural resistance. In the United States, corporate law is largely state-based. Although there are differences between the laws of each state, the most often utilized corporate charter states (Delaware, New York, and California), institute a number of barriers to derivative suits. In New York, for example, derivative suits must be brought to secure a judgment "in [the corporation's] favor." Eisenber v. Flying Tiger Line, Inc., 451 F.2d 267.

The procedure and circumstances in the United States to file a derivative action by a shareholder is usually as follows: A shareholder is upset that there has been harm to the corporation but the board of directors has not filed suit against the wrongdoer(s). Section 7.42 of the Model Business Corporation Act (MBCA) requires a demand to be filed by the shareholder to the corporation. There is no “futility” exception. The shareholder must usually wait 90 days after the demand before filing suit. MBCA § 7.42(2). The board can then either reject, accept or do nothing about the demand filed. If they accept the demand, the corporation themselves will then file the suit. However, if rejected or the board does nothing, after the required 90 days, the shareholder must meet the requirements of MBCA § 7.44(d) in his complaint should he want to still move forward with the lawsuit. If the shareholder fulfills the requirements of §7.44(d), the board may appoint a “special litigation committee” which may move to dismiss. If the special litigation committee makes the showing required by MBCA § 7.44(a), the case would be dismissed, however, if they fail in doing this, the suit will proceed.

Some reasons as to why a corporation may not want to file a suit are obvious. One would be to keep up good relations with those who the company works with. If, for example, a third party was contracted to provide the corporation with materials needed to produce their product and they don't fulfill that obligation, the corporation does have the right to sue. But what if there was an ambiguity in the contract? If the corporation feels as if this would be a dead end for a suit they may choose not to move forward. Or perhaps they have a good relationship with that third party and any litigation may strain that relationship. These reasons may restrain the corporation from filing suit and thereby, a shareholder may feel obligated to file suit for damages to the corporation. If this were the case, the corporation may see fit to hinder the shareholder in doing so.

In the U.K., an action brought by a minority shareholder is liable to be defeated by the Foss v. Harbottle principle. But exceptions have been evolved to the principle laid down in that case primary among them being "the ultra vires exception" and the "fraud on minority" exception. According to Blair and Stout's "Team Production Theory of Corporate Law", the purpose of the suit is not to protect the shareholders of the corporation but the corporation as a whole. That is why, they say, standing in such a suit can be shifted from shareholders to creditors as corporations near insolvency. (See: Credit Lyonnais Bank Nederaland v. Pathe Communication Corp) Civ. A. No. 12150, 1991 Del. Ch. LEXIS 215 (Del. Ch. Dec. 30, 1991).

In New Zealand 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.