#11688 - Derivative Suit Litigation - Business Association (Duke Cox)

P requirements in a derivative suit

1. Standing

   1. Must be a SH contemporaneous with act

   2. And throughout action

2. Diversity jurisdiction

3. Demand

4. Intervention

   1. Whether someone can attach to the suit for economic gain (ex. Caremark: derivative suit filed, parasitic to gov’t action)

5. Settlement

6. Equitable defenses

7. Counterclaims

Test to distinguish between direct and derivative actions:

1. Who suffered the alleged harm? If the corporation, then derivative

2. Who would receive the benefit of the recovery or other remedy?

3. Does the suit threaten the rights of creditors? If so, it should be derivative.

4. Would allowing direct suit for the alleged wrong result in multitudinous litigation by a large number of plaintiffs, and/or induce individual plaintiffs to sue early on in order to secure their portion of the liability? If so, it should be derivative.

5. Is the decision to sue or not sue otherwise more properly in the hands of the corporation than the SH? If so, it should be derivative.

Examples

1. CEO steals 1 M from corporation= derivative: corporation is harmed, all SH harmed equally

2. Self-dealing by directors= derivative: the corporation is harmed

3. Corporation says shares are worth 50 (when they are actually worth 40) and Jerry buys the shares at 40= direct action because the corporation is not injured, only the SH

4. Corporation did not pay any dividends even though it earned large profits

   1. Companies pile up cash pay more taxes= harmful to the corporation, derivative

VICARIOUS INCAPACITY DOCTRINE: If a company is bought for a fair price and then find out that the seller (or former managers) misbehaved, the corporation cannot sue the seller because that would cause a windfall to the buyer. To allow the corp. to recover would produce a windfall for the new owners whose purchase price presumably took into account any losses caused by the earlier wrongs.

CONTEMPORANEOUS OWNERSHIP REQUIRMENT: in order to bring derivative suit, a plaintiff must have been a SH at the time of the alleged wrong, and must continue as SH throughout the suit.

1. Date of acquisition for inherited shares is the date the decedent acquired the shares.

Demand in MBCA Jurisdictions:

1. Prior to instituting a derivative suit, the plaintiff must make a demand for the board to consider whether such a derivative suit is in the best interests of the corporation. MBCA § 7.42(1). Once the Plaintiff makes such demand, the board has 90 days to respond. MBCA § 7.42(2).

2. Upon receiving a demand from a plaintiff, the board must evaluate the demand, and accept or reject it. The board must first decide what entity is qualified to evaluate the demand, and then have that entity do the actual evaluation.

3. Choosing the evaluation entity:

   1. If the board has a quorum of qualified (disinterested) directors, then the board can choose to evaluate the demand either (a) itself or (b) by a committee of qualified (disineterested) directors appointed by the board.

   2. If the board does not have a quorum of qualified (disinterested) directors, then the board must evaluate the demand (b) by a committee of qualified (disineterested) directors appointed by the board.

4. Whichever entity the board chooses (the board itself or a committee), that entity shall “determine in good faith, after conducting a reasonable inquiry upon which its conclusions are based, whether the maintenance of the derivative proceeding is not in the best interests of the corporation.” MBCA § 7.44(a).

5. § 7.44(d) If, notwithstanding the board’s presumed rejection, the prospective plaintiff would still like to litigate the case, he may commence a suit. P must establish either

   1. that a majority of the board of directors did not consist of qualified directors at the time the determination was made, or

   2. that the requirements of subsection (a) have not been met.

6. Finally, even if a plaintiff has already overcome this barrier to entry, a derivative proceeding shall be dismissed by the court on motion by the corporation if one of the groups specified in subsection (b) or subsection (f) has determined that the maintenance of the derivative proceeding is not in the best interests of the corporation. § 7.44(a)

Demand in Delaware

1. Delaware has a demand excuse doctrine. Demand can be excused if it is futile.

2. Demand is futile if: plaintiff has the burden of showing a reasonable doubt that:

   1. Directors are not disinterested and independent, and

   2. Transaction was not the product of a valid exercise of business judgment

Procedure

1. In a derivative suit, P makes a demand

2. Board make decisions

   1. If the board has a quorum of qualified (disinterested) directors, then the board can choose to evaluate the demand either (a) itself or (b) by a committee of qualified (disineterested) directors appointed by the board.

   2. If the board does not have a quorum of qualified (disinterested) directors, then the board must evaluate the demand (b) by a committee of qualified (disineterested) directors appointed by the board.

      1. 7.44(b)(2) selected by majority vote of disinterested directors

      2. Each member of the committee must be independent

3. Board/committee decides not to pursue the law suit

4. MBCA/ Del Zapata

   1. MBCA- P has the burden of proof, otherwise the court must dismiss the lawsuit

   2. Del- Committee has the burden of proof

Zapata: 2 part test:

1. Committee has burden of proving independence, good faith, a reasonable investigation, and reasonable basis for decision

   1. Hire an outside law firm for report to maintain independence and hire outside experts

2. Court’s independent assessment

Del. § 145(a)-(g)

1. (a) applies generally to indemnification for any kind of suit (civil, criminal, etc.)

   1. May indemnify director, officer, employee or agent of corporation

   2. Must be in connection with his duties in the corporation

   3. Against expenses (including attorney’s fees), judgments, fines and amounts paid in settlement

   4. Actually and reasonably incurred if

      1. She acted in good faith

      2. In a manner she reasonably...