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Shareholder Derivative Suit vs Direct Claim [With Examples]

As a shareholder in a company, you are an owner. In most cases, you can vote on what the business does and how it functions on a long-term or “big picture” level. 

While you may not have day-to-day control, shareholders have invested in the company, so they should have input in big decisions.

The corporation must act in a way that is beneficial to its shareholders. In general, the overall goal is to ensure that the company continues to make a profit for years to come. The company then shares that profit with its investors.

Business men and women around table having a meeting

There are occasions, however, where the management or board of directors in the business fails to act in the best interests of the shareholders. In those situations, the shareholders might have a lawsuit against the board or the company. 

They do that by using a derivative suit or a direct claim against the Board of Directors, others who may be in a management role, and even third parties.

What is a Shareholder Derivative Suit?

When the Board of Directors is not acting in the best interests of the company, they may not be motivated to take legal action against themselves. 

Nonetheless, the corporation may have a potential claim against them if they have committed some wrongdoing or failure to act appropriately. 

However, because they are the management of the corporation, there is no one else to start the lawsuit—except the shareholders.

The shareholders can file a claim on behalf of the company. Because it is not an individual claim, the suit is said to be “derived” from the corporation. This derivative action helps the corporation, but not necessarily the individual shareholder. 

It is asserted on behalf of the corporation rather than for the individual shareholders themselves.

Direct Claims

A shareholder can also have a claim for the direct damage that a Board of Directors caused to the shareholders individually. Direct litigation is a much more common type of business law litigation.

Direct claims usually arise from a breach of the Board of Directors’ fiduciary duties, which include:

  • Loyalty (refraining from self-dealing)
  • Obedience
  • Care
  • Good faith and fair dealing
  • Disclosure

When a board member has a conflict that benefits him or her, but not the company, for example, they might violate their duty of disclosure, good faith and fair dealing, and loyalty by acting in a way that benefits them, but not the company.

In many direct claims, it is a minority shareholder that asserts a lawsuit against a majority shareholder or the Board of Directors for taking action that harms the minority.

Examples of direct claims might include:

  • Fraud
  • Conspiracy
  • Breach of fiduciary duties
metal words "corporate fraud" laying in shredded paper

In a direct claim, the individual shareholder must show that they have been personally damaged. This is not the same thing as showing that the company lost money—the shareholder must be directly harmed by the action or inaction.

Direct claims are also sometimes classified as class action lawsuits when there a large number of shareholders. The benefits from this type of action go to the class of shareholders—not the company as a whole.

Shareholder Derivative Claims

A shareholder can also bring a derivative claim on behalf of the company. This type of claim only arises if management should or should not have done something. It may not directly harm the shareholder individually, but it harms the company as a whole.

If the lawsuit is successful, then any proceeds from the derivative action will go to the company, not the shareholder themselves.

Requirements for Derivative Lawsuits in Arizona

There are very specific procedural requirements for derivative litigation. This is a unique area of business law that is based almost entirely on Arizona statutes.

In Arizona, someone who is starting derivative litigation must:

  1. Establish that the person who wants to start the lawsuit is an owner of the company at the time of the alleged wrongdoing or omission
  2. Fairly and adequately represent the interests of the company (rather than the interests of the individual shareholder)
  3. Make a written demand on the corporation to take action to correct the wrongdoing or recover the losses alleged
  4. Wait 90 days from the date of the written demand unless the request was rejected before the 90 days is up

This demand requirement is sometimes overlooked. However, shareholders must make this demand to have a valid derivative claim. Otherwise, the lawsuit could be dismissed outright.

Examples of Shareholder Derivatives Suits

Self-dealing and fraud are by far the most common reasons that shareholders start derivative lawsuits. Below are a couple of real-life examples of derivative actions.

Activision and Blizzard

In 2013, Activision, the marker of video games like Call of Duty and World of Warcraft, and an entity controlled by two of Activision’s senior officers acquired over 50% of Activision’s outstanding shares from Vivendi S.A, its controlling stockholder. 

They paid roughly $8 billion in cash for the acquisition.

Several stockholders filed lawsuits to challenge the stock purchase. They argued that the acquisition should be put to a vote by all shareholders. Instead of moving forward with the lawsuit, however, they settled out of court for $275 million.

Vivendi, the third-party seller, was among the defendants to help pay for the settlement costs. They also added two more people to the Board of Directors to help increase oversight as part of the settlement.

This case, although it did not proceed to trial, is a good example of self-dealing that might trigger a derivative claim.

Wells Fargo Fake Account Scandal

In the largest shareholder derivative action to date, Wells Fargo settled with shareholders for $320 million (with a $240 million cash component). 

The lawsuit stemmed from the bank’s high-pressure sales policy, which led employees to create fake deposit and credit card accounts.

yellow road sign with words "credit card fraud ahead"

There were as many as 2.1 million accounts that were created under fake names or under real names and information, but without customer authorization.

Wells Fargo also faced additional fines as well, including:

  • $100 million in fines from the Consumer Financing Protection Bureau
  • $35 million to the Office of the Comptroller of Currency
  • $50 million to the City and County of Los Angles
  • $110 million in a class-action lawsuit

They also imposed clawbacks on compensations of former bank executives of over $180 million.

Other Examples of Derivative Lawsuits

Derivative lawsuits can arise out of a variety of fact patterns. Some of the most common involve:

  • Breach of any fiduciary duty
  • Breach of confidentiality
  • Conspiracy
  • Violation of statutory duties under state or federal law

As long as the business itself was harmed, shareholders can assert virtually any type of claim as a derivative lawsuit. However, there are some limitations.

Derivative Lawsuits and the Business Judgment Rule

It is important to note that shareholders cannot simply file a lawsuit when they disagree with the actions that management or a Board of Directors take on behalf of the company. 

Instead, there must actually be a violation of the fiduciary duties of the board or some other type of fraud or unfair dealing.

The “business judgment rule” protects management and boards from lawsuits. This rule states that decisions that are made with reasonable business judgment will usually not be set aside by a court. 

Business owners and managers should be able to make decisions on behalf of their company on a day-to-day basis without worrying about a lawsuit at every turn.

Business decisions are more likely to be set aside; however, if the management or Board of Directors overstepped in making their roles in business decisions.

Getting Help from an Experienced Business Law Attorney

Derivative lawsuits are unique, and you must meet procedural requirements to assert them in Arizona. Our team can help with that process. Contact Cronus Law PLLC for more information or to set up an appointment with one of our business law attorneys.

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