Derivative suit

A shareholder derivative suit is a lawsuit brought by

a shareholder on behalf of a corporation against a third
party. Often, the third party is an insider of the corporation, such as an executive ocer or director. Shareholder
derivative suits are unique because under traditional
corporate law, management is responsible for bringing
and defending the corporation against suit. Shareholder
derivative suits permit a shareholder to initiate a suit when
management has failed to do so. Because derivative suits
vary the traditional roles of management and shareholders, many jurisdictions have implemented various procedural requirements to derivative suits.

being allowed to proceed. The law may require the shareholder to meet qualications such as the minimum value
of the shares and the duration of the holding by the shareholder; to rst make a demand on the corporate board to
take action; or to post bond, or other fees in the event that
he does not prevail.

2.1 Derivative suits in the United States

In the United States, corporate law is largely based upon
state law. Although the laws of each state dier, the laws
of the states such as Delaware, New York, and California,
where corporations often incorporate, institute a number
of barriers to derivative suits.

Purpose and diculties

Under the Model Business Corporation Act (MBCA),

the procedure of a derivative suit is as follows. There
has been harm to the corporation but the board of directors has not taken a measure against the wrongdoers. First, eligible shareholders must le a demand on
the board.[2] The board may either reject, accept, or not
act upon the demand. If after 90 days the demand has
been rejected or has not been acted upon, shareholders
may le suit.[3] If the board accepts the demand, the corporation itself will le the suit. If rejected, or not acted
upon, the shareholder must still meet additional pleading
requirements.[4] On the requirements being met by the
shareholder, the board may appoint a special litigation
committee which may move to dismiss.[4] If the special
litigation committee makes a required showing, the case
will be dismissed. If the committee fails to make a showing, the shareholder suit may proceed.[5]

Under traditional corporate business law, shareholders

are the owners of a corporation. However, they are not
empowered to control the day-to-day operations of the
corporation. Instead, shareholders appoint directors, and
the directors in turn appoint ocers or executives to manage day-to-day operations.
Derivative suits permit a shareholder to bring an action in
the name of the corporation against parties allegedly causing harm to the corporation. If the directors, ocers, or
employees of the corporation are not willing to le an action, a shareholder may rst petition them to proceed. If
such petition fails, the shareholder may take it upon himself to bring an action on behalf of the corporation. Any
proceeds of a successful action are awarded to the corporation and not to the individual shareholders that initiate
the action.

The MBCA is not a law itself, but rather a model statute

suggested for passage by dierent jurisdictions. Individual states adhere to the MBCA procedures to varying degrees. In New York, for example, derivative suits must
be brought to secure a judgment in [the corporations]
favor.[6] Delaware has dierent rules in regards to demand and bond requirements too.

In recent years, appraisal arbitrage has developed as

a form of shareholder litigation. Popular among hedge
funds seeking to take advantage of favorable case law on
valuation, such arbitrageurs buy shares in the target company of a transaction about to close and le suit claiming that the fair value of the company is higher than the
ultimate price paid by the acquirer in the acquisition.
The nancial incentive is cashing in on a higher courtdetermined price plus default interest at 5% above the
Federal Reserve discount rate, compounded quarterly.[1]

The famous case of Shaer v. Heitner, which ultimately

reached the United States Supreme Court, originated
with a shareholder derivative suit against Greyhound Bus
Lines.

Procedure

2.2 Derivative suits in the United Kingdom

In most jurisdictions, a shareholder must satisfy various In the United Kingdom, an action brought by a minority
requirements to prove that he has a valid standing before shareholder may not be upheld under the doctrine set out
1

in Foss v Harbottle in 1843. Exceptions to the doctrine involve ultra vires and the fraud on minority. According
to Blair and Stouts Team Production Theory of Corporate Law, the purpose of the suit is not to protect the
shareholders, but to protect the corporation itself. Creditors, rather than shareholders, may bring an action, if
a corporation faces insolvency. (See: Credit Lyonnais
Bank Nederaland v. Pathe Communication Corp) Civ.
A. No. 12150, 1991 Del. Ch. LEXIS 215 (Del. Ch.
Dec. 30, 1991).
The Companies Act 2006 provided a new procedure, but
it did not reformulate the rule in Foss v Harbottle.[7] In
England and Wales, the procedure slightly modied the
pre-existing rules, and provided for a new preliminary
stage at which a prima facie case must be shown. In Scotland where there had been no clear rules on shareholder
actions on behalf of the company, the Act sought to achieve
a result similar to that in England and Wales.
Roberts v Gill & Co Solicitors [2010] UKSC 22

2.3

Derivative suits in continental Europe

Derivative shareholder suits are extremely rare in continental Europe. The reasons probably lie within laws that
prevent small shareholders from bringing lawsuits in the
rst place. Many European countries have company acts
that legally require a minimum share in order to bring a
derivative suit. Larger shareholders could bring lawsuits,
however, their incentives are rather to settle the claims
with the management, sometimes to the detriment of the
small shareholders.[8][9]

2.4

Derivative suits in New Zealand

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 benets to company must outweigh the
costs of taking action.

2.5

Derivative suits in India

In India, derivative suits are brought under the clauses of

oppression and mismanagement.

See also
Business judgment rule

REFERENCES

4 References
[1] Gerstein, Mark; Connelly, Blair; Lightdale, Sarah;
Rowen, Zachary. Delaware Courts Recent Decisions on
Appraisal may Discourage Opportunistic Appraisal Arbitrageurs. ISSN 2329-9134.
[2] MBCA 7.42
[3] MBCA 7.42(2)
[4] MBCA 7.44(d)
[5] MBCA 7.44(a)
[6] Eisenberg v. Flying Tiger Line, Inc., 451 F.2d 267.
[7] Explanatory Notes on Companies Act 2006 pages 74&
[8] Kristoel Grechenig & Michael Sekyra, No derivative
shareholder suits in Europe: A model of percentage limits and collusion, International Review of Law and Economics (IRLE) 2011, vol. 31 (1), p. 16-20 (link).
[9] Why do Shareholder Derivative Suits Remain Rare in
Continental Europe?, 37 BROOKLYN J. INT'L L. 843892 (2012).

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