#11140 - Shareholder Litigation - Corporations

Shareholder Litigation

1. Direct Action or Derivative Suit

   1. TEST: Whether a stockholder's claim is derivative or direct turns solely upon the following questions: "(1) who suffered the alleged harm (the corporation or the suing stockholders, individually); and (2) who would receive the benefit of any recovery or other remedy (the corporation or the stockholders, individually)?" Tooley v. Donaldson, Lufkin, & Jenrette, Inc. - pg. 948

      1. TEST re (1): "[H]as the plaintiff demonstrated that he or she can prevail without showing an injury to the corporation?" Tooley v. Donaldson, Lufkin, & Jenrette, Inc. - pg. 949

      2. TEST re (2): "The second prong of the analysis should logically follow." Tooley v. Donaldson, Lufkin, & Jenrette, Inc. - pg. 949

         • EXCEPTION re Close Corporations: The court, at its discretion may treat an action raising derivative claims as a direct action IF it finds that to do so will not (i) unfairly expose the corporation or the defendants to a multiplicity of actions, (ii) materially prejudice the interests of creditors to the corporation, or (iii) interfere with a fair distribution of the recovery among all interested persons.

   2. Direct Action (OFTEN Class Action - See Fed. R. Civ. P. 23)

      1. (1) Adequacy: A named plaintiff must be capable of adequately and fairly representing the interests of the class on whose behalf suit has been brought.

         • SATISFIED where a plaintiff (1) is represented by a qualified attorney and (2) does not have interests antagonistic to the class or the corporation

           • Adequacy requirement satisfied where "no evidence that [Plaintiff] has interests antagonistic to the interests he purports to represent, or that class counsel is incompetent or inexperienced . . . ." In Re Fuqua Industries Shareholder Litigation - pg. 953

             • "[L]ack of proficiency in matters of law and finance and poor health" are irrelevant "so long as he or she has competent support from advisors and attorneys and is free from disabling conflicts." In Re Fuqua Industries Shareholder Litigation - pg. 952

      1. (2) Typicality: Requires contemporaneous ownership of stock (at the time of wrong)

         • If a plaintiff did not hold stock at the time of the alleged wrongful conduct, his injuries, if any, will differ from those of shareholders who did hold stock and his claim will not be typical of those asserted on behalf of the purported class

   3. Derivative Action (See Fed. R. Civ. P. 23.1/Del. Ch. Ct. R. 23.1)

      1. (1) Adequacy: A named plaintiff must be capable of adequately and fairly representing the interests of the shareholders on whose behalf suit has been brought.

         • SATISFIED where a plaintiff (1) is represented by a qualified attorney and (2) does not have interests antagonistic to the class or the corporation

           • Adequacy requirement satisfied where "no evidence that [Plaintiff] has interests antagonistic to the interests he purports to represent, or that class counsel is incompetent or inexperienced . . . ." In Re Fuqua Industries Shareholder Litigation - pg. 953

             • "[L]ack of proficiency in matters of law and finance and poor health" are irrelevant "so long as he or she has competent support from advisors and attorneys and is free from disabling conflicts." In Re Fuqua Industries Shareholder Litigation - pg. 952

      1. (2) Standing: Plaintiff must (1) have been a shareholder at the time of the wrong, (2) must be a shareholder at the time suit is brought, and (3) remain a shareholder throughout the litigation

         • MBCA § 7.40(e) includes in its definition of "shareholder" a person whose shares are held in a voting trust.

         • The ALI allows double derivative suits "[w]here the shareholder's corporation holds at least de facto controlling interest in the injured subsidiary." ALI Principles, § 7.02 Comment f.

           • See, e.g., Brown v. Tenney (allowing the shareholder of P Corporation for alleged injury to S Corporation, a wholly owned subsidiary of P Corporation, where both P and S were controlled by the same alleged wrongdoers).

      2. (3) Demand Requirement - JURIS SPLIT

         • Traditional Approach (DELAWARE)

           • Fed. R. Civ. P. 23.1 provides that a complaint in a derivative suit shall "allege with particularity the efforts, if any, made by the plaintiff to obtain the action plaintiff desires from the directors and the reasons for the plaintiff's failure to obtain the action or for not making the effort." See also, Del. Ch. Ct. R. 23.1.

             • WHERE DEMAND MADE

               • FAILURE TO REJECT DEMAND: Lawsuit moves forward

               • WHERE DEMAND REJECTED

                 • Plaintiff must demonstrate, without the benefit of discovery, that (1) the board rejected her demand without informing itself of the issues involved OR (2) the board relied on attorneys who also represented or had represented the alleged wrongdoer. See Stepak v. Addison - pg. 966

             • WHERE DEMAND NOT MADE, must plead Demand Futility

               • To show demand futility, plaintiffs must allege facts with particularity that raise a reasonable doubt that "(1) the directors are disinterested and independent [or] (2) the challenged transaction was otherwise the product of a valid exercise of business judgment." Aronson v. Lewis - pg. 962

                 • TEST (1)

                 • Interested: (1) A director personally receives a benefit (or suffers a detriment), (2) as a result of, or from, the challenged transaction, (3) which is not generally shared with (or suffered by) the other shareholders of his corporation, and (4) that benefit (or detriment) is of such subjective material significance to that particular director that it is reasonable to question whether that director objectively considered the advisability of the challenged transaction to the corporation and its shareholders OR the director stands on both sides of the challenged transaction. Orman v. Cullman - pg. 752

                 • Independent: Whether the director's decision resulted from that director being controlled by another Orman v. Cullman - pg. 753

                 • A director is controlled by another where (1) that director is in fact dominated by the other, whether by close personal or familial relationship or through force of will, OR (2) the director is beholden to the controlling entity of which occurs when the allegedly controlling entity has the unilateral power (whether direct or indirect) to decide whether the challenged director continues to receive a benefit, financial or otherwise, upon which the challenged director is so dependent or is of such subjective material importance to him that the threatened loss of that benefit might create a reason to question whether the controlled director is able to consider the corporate merits of the challenged transaction objectively. Orman v. Cullman - pg. 753

                 • BUT, the mere threat of personal liability for approving a challenged transaction is insufficient to challenge either the independence or the disinterestedness of directors. Aronson v. Lewis - pg. 962

                 • TEST (2)

                 • Alleging facts to sufficiently plead (2) of Aronson Test is a "task closely akin to proving that the underlying transaction could not have been a valid exercise of business judgment." (In re InfoUSA - pg. 755)

                 • But see McPadden v. Sidhu - pg. 795 (excusing demand under the second prong of Aronson where the board tasked Daubreville with the sale process of TSC when the board knew that Dubreville was personally interested in purchasing TSC).

                 • DGCL § 220 grants to shareholders inspection rights as an information gathering tool to be able to allege facts with particularity.

               • BUT Aronson Test does not apply (1) where a business decision was made by the board of directors, but a majority of the directors making the decision have been replaced; (2) where the subject of the derivative suit is not a business decision of the board; and (3) where the decision being challenged was made by the board of a different company. Rales v. Blasband - pg. 967

                 • In such a case, "examine whether the board that would be addressing the demand can impartially consider its merits without being influenced by improper considerations." Rales v. Blasband - pg. 967

                 • THUS, the inquiry is "whether or not the particularized factual allegations . . . create a reasonable reasonable doubt that, as of the time the complaint is filed, the board of directors could have properly exercised its independence and disinterested business judgment in responding to the demand." Rales v. Blasband - pg. 967

           • TERMINATION When Demand is Excused

             • Where demand is excused, a Special Litigation Committee (SLC) is often formed to determine whether to dismiss the lawsuit; if the committee determines that the lawsuit should be terminated, it will cause the corporation to file a motion to dismiss.

               • Two-Part Test (Zapata Corp. v. Maldonado - pg. 968-69)

                 • Step One: The court inquires into "the independence and good faith of the committee and the bases supporting its conclusions" Zapata Corp. v. Maldonado - pg. 968

                 • The corporation has "the burden of proving independence, good faith and a reasonable investigation, rather than presuming independence, good faith and reasonableness." Zapata Corp. v. Maldonado - pg. 968-69

                 • But see Oracle - pg. 773 (applying the "contextual approach" to the determination of independence in the SLC context and finding a reasonable doubt with respect to the SLC's ability to impartially consider whether to dismiss the suit where one member of the SLC had substantial connections with one of the directors to face suit through Stanford University)

                 • Step Two: "The court should determine, applying its own independent business judgment, whether the motion should be granted." Zapata Corp. v. Maldonado - pg. 969

                 • "The second step...