In the name of the company: when shareholders interfere in the board of directors | Skadden, Arps, Slate, Meagher & Flom LLP

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  • Corporations may face a flurry of shareholder actions claiming to enforce their own legal rights, ranging from requests for books and records to derivative suits and litigation demands.
  • Unlike class actions, there are few established procedures for resolving these disputes in a centralized forum, so companies often find themselves responding to many similar claims and lawsuits, sometimes in multiple jurisdictions.
  • Shareholder actions can be both costly and inconvenient for companies, even if they are intended to benefit the company.
  • Companies can impose some order by requiring all derivative lawsuits to be filed in a single jurisdiction and responding uniformly to all requests for books and records.

It is a cardinal tenet of corporate law that directors, not shareholders, manage the affairs and affairs of the corporation. Indeed, under the business judgment rule, a cornerstone of Delaware law, an independent and disinterested board of directors cannot be legally guessed by courts or shareholders. This is true even when a company has supposedly been harmed. The board retains the power to decide how to respond, including whether the company should take action against those – including its own officers and directors – who may have harmed it.

But Delaware law provides controls over management and the board of directors that allow shareholders to insert themselves into the management process. They can request access to company books and records; they can require the board to take legal action against its officers and directors; and they may bring derivative suits to assert claims on behalf of the company against its officers and directors that the company has not yet pursued.

Companies often find themselves watching as shareholders jostle for control of corporate litigation or rush to be the first to demand corporate governance reforms. At times, companies will simultaneously receive more than a dozen requests for shareholder books and records, as well as multiple derivative litigation requests and lawsuits, and securities class action lawsuits – all arising out of substantially the same facts and underlying claims.

As a director, this issue is probably frustrating and confusing, because significant corporate funds and resources are required to meet these shareholder actions, even though the claims do in fact belong to the corporation and the Boards of directors are generally well equipped to manage them without the intervention of shareholders.

Below we outline the legal framework that justifies these shareholder actions, and some ways that boards can attempt to achieve order to protect the real stakeholder: the company.

An overview of shareholder action

When negative events — for exampledisappointing profits, a government investigation, a regulatory setback or allegations of internal wrongdoing – cause a company’s stock to plummet, litigation often ensues, and often much, in multiple forums, by multiple actors and under of multiple forms.

Class actions. Following such news, shareholders often sue the company to settle their own direct losses, usually claiming that the company concealed information or misled them. These are the shareholders’ own claims and they are almost always brought as class actions on behalf of all shareholders in a similar situation.

This litigation can create major financial exposure for companies, but all related cases are usually consolidated in one court where the lead attorney is appointed for the putative class, so companies are unlikely to face litigation. erupted before various courts. Additionally, federal statutory reforms enacted by Congress in 1995 and subsequent case law have circumscribed some of the more egregious litigation that was previously routine. Importantly, and unlike litigation described below, discovery in federal class actions is now generally stayed pending determination of initial motions by defendants.

Derivative costumes. Ironically, companies face an entirely different scenario in derivative litigation, when shareholders take action on behalf of the company. Few mechanisms exist to require consolidation or coordination between these shareholders, even though they all claim to pursue the interests of a single party, the company.

In a derivative suit, a shareholder seeks to gain control of the company’s own legal claims. In practice, the main allegations in these lawsuits generally parallel class action lawsuits filed by other shareholders. For example, a derivative lawsuit could claim that mismanagement led to a dispute that cost the company money to resolve. In the derivative action, a shareholder will seek to recover these costs from the alleged offenders – usually officers or directors of the company – for the benefit of the company.

There is no limit to the number of shareholders who can pursue derivative claims related to the same matter. Although derivative actions filed in the same forum may be grouped together, financial incentives may compel shareholders to deliberately file in separate forums in hopes of retaining control and seeking compensation for allegedly conferring a benefit on the company.

Requests for books and records. Shareholders who can meet legal requirements may also request access to company books and records to support derivative lawsuits they intend to file. Delaware courts have long recognized that pretrial investigation is an appropriate purpose for requiring books and records. Over the past few years, they have narrowed companies’ defenses to these claims and as a result, companies are often inundated with requests for books and records. See our October 7, 2021, Informed Board article, “It’s Not Your Grandparents’ Demand for Books and Papers.”

There is no limit to the number of shareholders who may request books and records relating to the same matters. Shareholders are also not required to search for the documents before pursuing derivative litigation. Thus, companies already defending derivative claims by one or more shareholders may be required to respond simultaneously to multiple requests for nearly identical books and records from other shareholders. Shareholders who obtain books and records can use them to support their own derivative lawsuits, potentially giving them an edge over any shareholder who filed a derivative claim without nonpublic information.

It remains to be seen whether the Delaware courts will at some point swing the pendulum the other way after seeing how requests for books and records have come to replace, at least partially, the discovery process in class actions and derivative disputes, without procedural protections. But, to date, the courts have expanded, not taken away, these access rights.

Litigation Requests. Still other shareholders will demand that the board of directors itself take legal action against managers or directors who have harmed the company. Although sending a request for litigation is a tacit concession that the board of directors is disinterested and independent, and can therefore decide for itself whether to take legal action against the alleged wrongdoers, these shareholders can always take legal action if the council chooses not to initiate proceedings, arguing that the refusal was unreasonable. The substance of these “claim denied” cases is generally the same as that of other derivative lawsuits, but, because the original procedural issues are distinct, they almost always proceed on a different track from other derivative litigation.

There is no limit to the number of shareholders who can file contentious claims related to the same issues.

Excessive use of shareholder shares harms the company

The intense posture of control among shareholders who are all trying to supplant the board can be both costly and distracting. The company is the one who foots the bill, including the advance of legal costs for its officers and directors involved in derivative lawsuits. Thus, shareholders are causing exactly what they seek to repair – monetary damages allegedly caused by fiduciaries – where the company is unlikely to be reimbursed for the expenses it has advanced. Worse still, it can happen, and often does, to companies that are run by totally disinterested and independent boards that don’t need shareholder protection.

Derivative litigation and litigation claims are intended to provide shareholders with a limited ability to pursue claims belonging to the company only when the board of directors is disqualified from exercising its authority due to an invalidating interest. Similarly, requests for books and records in the context of litigation are intended, in part, to help determine whether corporate governance may have failed. Unfortunately, shareholders can and do interfere even when directors have no conflicts of interest and the board has conducted its own investigation and dealt with the matter appropriately.

What businesses can do

There is no existing statutory or judicial mechanism to enforce lawsuits and shareholder claims pursuing corporate rights. However, companies can assert a modicum of control in several ways:

  • Companies can adopt and enforce regulations requiring all derivative lawsuits to be filed in a single jurisdiction (for example., the Delaware Court of Chancery for Delaware-incorporated companies). This increases the chances that parallel prosecutions will be consolidated or coordinated in some way.
  • Similarly, companies can coordinate shareholder claims arising from a board’s refusal to accept litigation requests.
  • To promote efficiency, the company may disclose the identities of shareholders seeking books and records, offer the same documents to each, and condition production on an agreement that any dispute over the claim will take place in the same court. , according to the same schedule and in a coordinated manner. way.
  • Companies can request that derivative actions be stayed until resolution of any underlying class action lawsuits arising from the same events.

Until there is a statutory or judicial remedy, these measures can create some order for corporations facing duplicate shareholder actions and can reduce the expense and distractions that come with it.

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