Also known as: stockholder derivative suits · stockholders' derivative suit · shareholder derivative suit · shareholder derivative suits · derivative suit · derivative action
Written by attorneys — see sources below.
A procedural mechanism by which an owner of an entity enforces a right belonging to the entity when those in control have failed to act. The owner must satisfy contemporaneous ownership and demand requirements before proceeding. Any recovery belongs to the entity rather than the individual plaintiff.
Selena Singh acquired her membership interest in Solstice Ventures six months after managers diverted a corporate opportunity. When she later filed a derivative action to recover the opportunity for the LLC, the court dismissed the suit because Singh was not a member when the conduct occurred. The contemporaneous-ownership rule barred her claim even though she held an interest at the time of filing.
Spencer Silver sent a written demand to the general partner of Southland Foods requesting suit against a supplier for breach of contract. After four months of inaction and only vague assurances, Silver filed a derivative action. The court allowed the suit to proceed because the general partner had not brought an action within a reasonable time after the demand.
Santiago Sanchez prevailed in a derivative action on behalf of Sapphire Technologies that produced a $2 million judgment. The court ordered the entire recovery paid directly to the LLC rather than to Sanchez personally. Sanchez received only reimbursement of reasonable expenses from the LLC's recovery under the applicable statute.
Sydney Santos obtained a settlement in a derivative action for Starlight Media after proving the general partner had diverted funds. The court directed that the settlement proceeds be paid to the limited partnership. Santos could seek only an award of reasonable attorneys' fees and costs from the partnership's recovery.
Sean Steele won partial relief in a derivative action for Solstice Ventures that recovered misappropriated assets. The court awarded Steele reasonable attorneys' fees and costs from the LLC's recovery even though the suit did not succeed on every claim. The award reflected the benefit conferred on the entity.
Solomon Silver prosecuted a derivative action that invalidated an unfair voting trust and restored voting rights to all shareholders. Although no monetary fund was created, the court permitted Silver to recover litigation expenses from the corporation. The benefit to all shareholders justified spreading the costs across the entity.
Petitioners were shareholders of the Electric Auto-Lite Company until 1963, when it was merged into Mergenthaler Linotype Company. They brought suit on the day before the shareholders’ meeting at which the vote was to take place on the merger, against Auto-Lite, Mergenthaler, and a third company, American Manufacturing Company, Inc. The complaint sought an injunction against the voting by Auto-Lite’s management of all proxies obtained by means of an allegedly misleading proxy solicitation. However, it did not seek a temporary restraining order, and the voting went ahead as scheduled the following day. Several months later petitioners filed an amended complaint seeking to have the merger set aside. In Count II of the amended complaint, petitioners alleged that the proxy statement sent out by the Auto-Lite management to solicit shareholders’ votes in favor of the merger was misleading, in violation of § 14 (a) of the Act and SEC Rule 14a-9 thereunder. Before the merger, Mergenthaler owned over 50% of the outstanding shares of Auto-Lite common stock, and had been in control of Auto-Lite for two years. American Manufacturing in turn owned about one-third of the outstanding shares of Mergenthaler, and for two years had been in voting control of Mergenthaler and, through it, of Auto-Lite. Petitioners charged that in light of these circumstances the proxy statement was misleading in that it told Auto-Lite shareholders that their board of directors recommended approval of the merger without also informing them that all 11 of Auto-Lite’s directors were nominees of Mergenthaler and were under the control and domination of Mergenthaler. On petitioners’ motion for summary judgment with respect to Count II, the District Court for the Northern District of Illinois ruled as a matter of law that the claimed defect in the proxy statement was, in light of the circumstances in which the statement was made, a material omission. After holding a hearing on the issue of causation, the court found that under the terms of the merger agreement an affirmative vote of two-thirds of the Auto-Lite shares was required for approval of the merger, and that the respondent companies owned and controlled about 54% of the outstanding shares. At the stockholders’ meeting, approximately 950,000 shares, out of 1,160,000 shares outstanding, were voted in favor of the merger, including 317,000 votes obtained by proxy from the minority shareholders that were necessary and indispensable to the approval of the merger. The District Court concluded that a causal relationship had thus been shown and granted an interlocutory judgment in favor of petitioners on the issue of liability. The Court of Appeals affirmed the District Court’s conclusion that the proxy statement was materially deficient but reversed on the question of causation, ruling that the issue was to be determined by proof of the fairness of the terms of the merger. Claiming that the Court of Appeals had construed this Court’s decision in J. I. Case Co. v. Borak in a manner that frustrates the statute’s policy of enforcement through private litigation, the petitioners sought review in this Court. The Supreme Court granted certiorari, believing that resolution of this basic issue should be made at this stage of the litigation.
The plaintiff must be a member both when the action is commenced and when the underlying conduct occurred. The plaintiff must also make a demand on the managers or other members unless demand would be futile. These requirements ensure the plaintiff has a proper stake and that those in control first have an opportunity to act.
Supporting sources
…of treating a corporation as a resident of the incorporating State seems to me particularly appropriate in the context of a shareholder derivative suit, for the State realistically may perceive itself as having a direct interest in guaranteeing the enforcement of its corporate laws, in assuring the solvency and fair management of its…
…held applicable in a diversity action a state statute requiring plaintiffs, as a prerequisite to pursuit of a stockholder
…However, an increasing number of lower courts have acknowledged that a corporation may receive a “substantial benefit” from a derivative suit, justifying an award of counsel fees, regardless of whether the benefit is pecuniary in nature. A leading case is Bosch v. Meeker Cooperative Light & Power Assn. , 257 Minn. 362,…
The demand requirement is satisfied when the general partners fail to bring suit within a reasonable time after receiving a proper demand. Courts evaluate reasonableness by considering the complexity of the claim, any conflict of interest, and whether the general partner took concrete steps toward litigation. Vague assurances without action do not satisfy the requirement.
Supporting sources
Any judgment, settlement, or other benefit belongs to the entity itself, not to the individual plaintiff. The plaintiff may receive only reasonable expenses, including attorneys' fees, from the entity's recovery when the action succeeds in whole or in part. This rule prevents the plaintiff from obtaining a personal windfall.
Supporting sources
No. A derivative action on behalf of a limited liability company or limited partnership may not be voluntarily dismissed or settled without court approval. Notice to other owners may also be required so that they can object or participate in the decision.
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