Shareholder derivative lawsuits are complex legal actions that allow shareholders to bring claims on behalf of the corporation against directors, officers, or other parties for breaches of fiduciary duty or other wrongdoing. While these lawsuits can be an important tool for holding corporate leaders accountable, they also pose significant risks and challenges for both plaintiffs and defendants. In this article, we will explore eight common traps that parties involved in shareholder derivative lawsuits should be aware of.
Understanding Shareholder Derivative Lawsuits
A shareholder derivative lawsuit is a type of lawsuit where a shareholder brings a claim on behalf of the corporation, rather than in their own individual capacity. These lawsuits typically involve allegations of breaches of fiduciary duty, such as self-dealing, gross mismanagement, or failure to disclose material information. To bring a derivative lawsuit, a shareholder must typically meet certain requirements, including owning shares in the corporation at the time of the alleged wrongdoing and demonstrating that the corporation has failed to take action to address the issue.
Trap 1: Failing to Meet Demand Requirements
Before filing a derivative lawsuit, shareholders are typically required to make a demand on the corporation’s board of directors to take action to address the alleged wrongdoing. This demand requirement is designed to give the board an opportunity to investigate and respond to the allegations before a lawsuit is filed. However, if the demand is not made or is not properly documented, the lawsuit may be dismissed. It is essential for shareholders to carefully review the corporation’s bylaws and relevant state laws to ensure that they comply with all demand requirements. Fiduciary duty is a critical concept in this context, as shareholders must demonstrate that the board has breached its duty to the corporation.
| State | Demand Requirements |
|---|---|
| Delaware | Must make a written demand on the board, which must be documented in the corporation's records |
| California | Must make a written demand on the board, which must include a description of the alleged wrongdoing and the relief sought |
Trap 2: Insufficient Pleading of Fiduciary Duty Breaches
To succeed in a derivative lawsuit, shareholders must plead specific facts demonstrating that the directors or officers breached their fiduciary duties. This requires a detailed understanding of the corporation’s internal workings and the actions taken by the board and management. Shareholders must be able to demonstrate that the board’s actions were not in the best interests of the corporation. Gross negligence is a key concept in this context, as shareholders must show that the board’s actions were so egregious that they constituted a breach of fiduciary duty.
Challenges in Proving Fiduciary Duty Breaches
Proving fiduciary duty breaches can be challenging, as it requires a detailed analysis of the corporation’s financial records, minutes of board meetings, and other internal documents. Shareholders must also be able to demonstrate that the board’s actions caused harm to the corporation, which can be difficult to quantify. It is essential for shareholders to work with experienced experts, such as forensic accountants and corporate governance specialists, to build a strong case.
Trap 3: Failure to Demonstrate Demand Futility
In some cases, shareholders may be able to bypass the demand requirement if they can demonstrate that making a demand would be futile. This typically requires showing that the board is incapable of making an impartial decision due to conflicts of interest or other factors. Shareholders must be able to plead specific facts demonstrating that the board is unable to act independently. Conflict of interest is a critical concept in this context, as shareholders must show that the board’s interests are not aligned with those of the corporation.
Common Defenses in Shareholder Derivative Lawsuits
Defendants in shareholder derivative lawsuits often raise a number of defenses, including the business judgment rule, which protects directors and officers from liability for decisions made in good faith and in the best interests of the corporation. Shareholders must be prepared to rebut these defenses with strong evidence and expert testimony. Business judgment rule is a key concept in this context, as defendants will often argue that their actions were protected by this rule.
Trap 4: Inadequate Representation of the Shareholder Class
Shareholder derivative lawsuits typically involve a class of shareholders, and the plaintiff must demonstrate that they are adequate representatives of the class. This requires showing that the plaintiff’s interests are aligned with those of the class and that they will fairly and adequately represent the class’s interests. Shareholders must be able to demonstrate that they have a strong understanding of the class’s interests and are committed to representing them. Class representation is a critical concept in this context, as shareholders must show that they are able to represent the interests of all class members.
Settlement and Mediation in Shareholder Derivative Lawsuits
Many shareholder derivative lawsuits are resolved through settlement or mediation, rather than trial. Shareholders must be prepared to negotiate effectively and make strategic decisions about when to settle or mediate. Settlement strategy is a key concept in this context, as shareholders must carefully consider the pros and cons of settling versus proceeding to trial.
Trap 5: Failure to Comply with Corporate Governance Requirements
Corporations are subject to a range of corporate governance requirements, including those related to disclosure, internal controls, and board composition. Shareholders must be able to demonstrate that the corporation has complied with all relevant corporate governance requirements. Corporate governance is a critical concept in this context, as shareholders must show that the corporation has adequate controls and procedures in place to prevent wrongdoing.
Role of the Board in Preventing Shareholder Derivative Lawsuits
The board of directors plays a critical role in preventing shareholder derivative lawsuits by ensuring that the corporation is managed in a responsible and ethical manner. Boards must be proactive in addressing potential issues and taking steps to prevent wrongdoing. Board oversight is a key concept in this context, as boards must be vigilant in monitoring the corporation’s activities and addressing any potential issues.
Trap 6: Inadequate Expert Testimony
Shareholder derivative lawsuits often involve complex financial and technical issues, and expert testimony is critical in building a strong case. Shareholders must be able to retain qualified experts who can provide credible and persuasive testimony. Expert testimony is a critical concept in this context, as shareholders must show that their experts are qualified and have a strong understanding of the relevant issues.
Challenges in Retaining Expert Witnesses
Retaining expert witnesses can be challenging, as it requires finding qualified individuals who are available and willing to testify. Shareholders must be prepared to invest time and resources in finding and retaining the right experts. Expert witness is a key concept in this context, as shareholders must show that their experts are qualified and have a strong understanding of the relevant issues.
Trap 7: Failure to Manage Discovery Effectively
Discovery is a critical phase of the litigation process, and shareholders must be able to manage it effectively to build a strong case. Shareholders must be able to identify and produce relevant documents, and prepare witnesses for deposition and trial. Discovery management is a critical concept in this context, as shareholders must show that they are able to manage the discovery process efficiently and effectively.
Best Practices in Discovery Management
Effective discovery management requires a range of best practices, including careful planning, document management, and witness preparation. Shareholders must be able to work with experienced counsel to develop a discovery plan and manage the process effectively. Discovery plan is a key concept in this context, as shareholders must show that they have a clear understanding of the discovery process and are able to manage it effectively.
Trap 8: Inadequate Trial Preparation
Trial preparation is critical in shareholder derivative lawsuits, and shareholders must be able to prepare effectively to present their case. Shareholders must be able to work with experienced counsel to develop a trial strategy and prepare witnesses and evidence. Trial preparation is a critical concept in this context, as shareholders must show that they are able to prepare effectively for trial and present their case persuasively.
What are the key elements of a shareholder derivative lawsuit?
+The key elements of a shareholder derivative lawsuit include a
