In Focus: Shareholder Derivative Lawsuits

• Posted on: Feb 12 2018

Directors and officers of publicly traded companies have a fiduciary duty to their shareholders. In the face of corporate misconduct, executives are often reluctant to take legal action against their peers. However, shareholders may bring a derivative lawsuit against the board of directors and other responsible parties. The goal is to compel the board to remedy the damages sustained by company and to protect the interests of investors. Nonetheless, a successful claim depends on the skills of an attorney with experience handling complex litigation.

What is a derivative lawsuit?

A shareholder derivative lawsuit may arise when a company’s value is diminished because of mismanagement or unlawful conduct by directors and officers. A derivative lawsuit is filed by an investor, or a class of investors, for the benefit of both the corporation and the shareholders.

The plaintiffs are not seeking compensation. Instead, the objective is to protect their investment by imposing management changes and corporate governance reforms. Any proceeds of a successful action are awarded to the corporation, not the shareholders. Before filing a lawsuit, a shareholder must demand that the board take legal action. If the board rejects the demand or refuses to act, then the lawsuit is permitted to proceed.

Shareholders may file lawsuits to remedy all types of corporate misconduct, including:

• Breach of Duty of Care – Directors and officers have a duty of care to act responsibly, and in good faith, when managing the company’s affairs. Examples of breaches include a director or officer not exercising rational judgment, acting in bad faith, or not being reasonably informed when making a decision.
• Breach of Duty of Loyalty – Directors and officers cannot profit at the expense of the corporation and have a duty to put the financial interests of the shareholders first. A breach this duty may involve self-dealing, misuse or waste of corporate assets, or abuse of corporate privileges, such as using a corporate jet for personal travel.
• Accounting Malpractice – Financial statements must be prepared in accordance with generally accepted accounting principles (GAAP). Corporate executives are prohibited from using aggressive accounting techniques and overstating or manipulating earnings. A derivative lawsuit can be brought to remove the directors and officers who had knowledge of any improprieties. Shareholders may also seek to compel the company to establish stricter governance measures that will prevent similar activities in the future.
• Improper Mergers and Acquisitions – Shareholders can also pursue legal action to challenge proposed mergers or acquisitions. If the directors and officers approve a deal that fails to maximize shareholder value, a breach of fiduciary duty may have occurred.
• Other Misconduct – A derivative lawsuit can also be filed if a company’s executives fail to address violations of environmental regulations, wage and hour laws, workplace safety guidelines, or other state and federal regulations.

The Takeaway                                                                                                                                                 

A successful shareholder derivative lawsuit can result in corporate governance reforms, prevent future wrongdoing, and increase shareholder value. In some cases, the court may also approve an incentive reward to compensate the plaintiffs for the time and inconvenience associated with pursuing a legal action. In the end derivative lawsuits and class actions give shareholders power legal recourse to protect their interests.