How Do Shareholder Derivative Suits in Corporations Work?
We’ve written on this blog about how “derivative actions” work under Florida’s Revised LLC Act. As we’ve previously explained, a derivative action is a method by which a minority member can bring a claim in court in the name of the company. Often, these suits are used to recover damages from controlling shareholders or officers whose actions are harming the company.
In the context of a corporation, Florida’s Business Corporations Act says that any person or entity who is a shareholder at the time the harm occurred may bring the suit. Included in the definition of “shareholder” is any person who is the beneficial owner of shares held in a voting trust. Before filing suit, the shareholder must first make a demand on the board of directors to correct the harmful conduct. Once the demand is made, the corporation has 90 days to respond. If the corporation rejects the demand, the shareholder may file suit, alleging with particularity the specifics of the demand and the board’s response.
Unlike the Florida Revised LLC Act, the Business Corporations Act does not explicitly authorize a suit where a demand on the board of directors would be futile. Nevertheless, two Florida courts have found that “demand is not necessary if the directors . . . whether by reason of hostile interest or guilty participation in the wrongs complained of, cannot be expected to institute suit.” Belcher v. Schilling, 309 So. 2d 32, 35 (Fla. 3d DCA 1975) (quoting Orlando Orange Groves Co. v. Hale, 144 So. 674 (Fla. 1932)). Of course, neither of these cases construed the current version of the Business Corporations Act, so the safer practice would be to make a demand on the board of directors, notwithstanding any perceived futility of such demand.
Once the case is filed, the court may stay the case if the board of directors commences an investigation of the harmful conduct. The court may also dismiss the case if a panel of independent directors or a court-appointed, neutral investigator determines that the derivative suit is not in the best interest of the corporation. No derivative case can be settled or dismissed without court approval. The court can require one or more parties to provide notice to the shareholders, if the settlement will substantially affect those shareholders’ interests in the corporation.
Finally, the court may award attorney’s fees to a successful derivative plaintiff or a successful defendant. Plaintiffs may recover attorney’s fees when they receive any relief on behalf of the corporation, whether by judgment, compromise or settlement. When the relief benefits only the individual plaintiff-shareholder, fees are not authorized. Attorney’s fees for a defendant may be awarded if the court finds that the case was filed without reasonable cause.
As noted above, derivative actions are generally filed when the corporation’s directors, officers, or controlling shareholders are abusing their duties to the corporation, whether that be through self-dealing, improper payment of dividends or distributions, or corporate waste. If you are a shareholder and you suspect malfeasance by the corporation’s directors, we will discuss the facts of the case with you to determine if the case would make an appropriate derivative lawsuit.