Shareholder Derivative Actions

Chimicles & Tikellis (“C&T”) provides experienced service to investor clients regarding investor rights over a wide range of legal strategies, including the investigation and litigation of shareholder derivative actions.

What is a stockholder derivative action? Stockholders of corporations have many tools at hand to address injuries to their investment, including the device of a stockholder derivative action to remedy injuries to the corporation. A derivative action is a lawsuit brought by a stockholder, on behalf of the corporation, to enforce a claim belonging to the corporation. Generally, injuries to the corporation which hurt the value of the corporation’s stock or assets give rise to claims belonging to the corporation. A derivative action typically involves claims against a director or officer of the corporation for mismanagement or breach of fiduciary duty but can also include claims against others such as outside accountants or advisors. Directors (or other fiduciaries) of corporations or associations have duties to the investors and the corporation to act in good faith and with loyalty, due care and complete candor. A unit holder or limited partner in a limited partnership may also bring a derivative action on the partnership’s behalf.

Can any stockholder bring a derivative action? Under Delaware law, a stockholder is eligible to bring a derivative action if the holder held stock at the time of the challenged wrongdoing and continues from that time to hold stock throughout the course of the litigation. This is the “continuous ownership” rule which is a requirement for a stockholder to bring and maintain a derivative action. The law also requires the stockholder first to demand the Board of Directors of the corporation to assert the claims or the stockholder must state in the derivative action particular reasons why making such a demand would be futile.

What is the cost to a stockholder of bringing and maintaining a derivative action? C&T prosecutes derivative actions for clients on a contingency fee basis. The client will not receive a bill for legal fees and expenses. Counsel fees and expenses must be approval and awarded by the court. When the case is resolved and a benefit is achieved for the corporation, counsel must apply to the Court for a payment of fees and expenses and must provide certain detailed information to the court regarding the legal services.

What is the benefit of bringing a derivative action? Derivative actions can be brought to achieve a variety of benefits and remedies for the corporation which inure to the benefit of the stockholders, including injunctions to prevent threatened harmful action before it occurs, monetary damages to compensate the corporation for injury and corporate governance enforcement and reform. Monetary recoveries obtained as a result of a derivative action are paid to the corporation and thereby enhance the value of the stock and assets of the corporation for all current shareholders.

What is the benefit of corporate governance enforcement and reforms to the stockholders? The balance of power between stockholders and corporate executives and the policing of corporate executives has emerged to the forefront of investor concern in the wake of corporate collapses triggered by unchecked executives and Board rooms. In addition to monetary benefits, the relief achieved as the result of a derivative action may also include enforcement of governance standards in the bylaws or charter, or long term reforms by the corporate entity for the purpose of advancing the interests of the shareholders. Fundamental changes in the way a company operates and is governed may serve to protect shareholders from the recurrence of wrongdoing by the corporation (through its fiduciaries) and improve shareholder value.

What is a stockholder books and records demand? Delaware law prescribes the procedure and requirements for a written demand under oath to inspect the stocklist or books and records. It also requires the Company to respond to the demand within 5 business days and authorizes the Delaware Court of Chancery to compel the Company to permit the inspection for a “proper purpose” upon an application by the stockholder asserting a refusal or failure to respond to the demand. A “proper purpose” includes, for example, valuing the stock, communicating with other stockholders and investigating potential wrongdoing. C&T represents clients in formulating and making inspection demands, filing and prosecuting applications to compel inspections, inspecting and evaluating the books and records and filing and prosecuting further claims that may be indicated by the results of the inspection. A similar inspection right is usually available to unit holders and limited partners in a limited partnership (“LPs”) and holders of interests in alternative entities such as limited liability companies (“LLC’s”).