Chapter 17 Shareholder Litigation

Ghada Amer, “Le Champ de Marghuerites” (2011)

Corporations:A Contemporary Approach

Chapter 17Shareholder Litigation

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• Derivative vs. direct actions– Derivative action: 2 suits in

1- enforce fiduciary duties to corporation

– Direct action: representative suit - protect Sh rights

– Distinction between two: who recovers?

• Demand requirement– Board decides lawsuit’s

merits– Aronson test: (1) director

disinterest + independence, (2) decision protected by BJR

Module VII – Fiduciary Duties

• Special litigation committee– Judicial review: BJR or

more?– MBCA: universal demand

+ board dismissal• Plaintiff standing

– Adequacy– Contemporaneous

ownership• Policy issues

– Who guards the guards?– Challenge of settlements– Nature of attorneys’ fees

Citizen of world

Law profession

Corporate practice

Bar exam



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1. Fundamentals– Introduction to firm– Corporate basics

2. Corporations and policy– Corporate federalism– Corporate social responsibility – Corporate political action

3. Corporate form– Organizational choices– Incorporation– Locating corporate authority

4. Corporate finance– Numeracy for corporate lawyers– Capital structure

5. Corporate externalities– Piercing corporate veil– Corporate environmental liability– Corporate criminal liability

6. Corporate governance – Shareholder voting– Shareholder information rights– Public shareholder activism

7. Fiduciary duties– Shareholder litigation– Board decision making – Board oversight – Director conflicts– Executive compensation – Corporate groups

8. Stock trading– Securities markets– Securities fraud class actions– Insider trading

9. Corporate deals– Sale of control– Antitakeover devices– Deal protection

10. Close corporations– Planning– Oppression





5. Corporate externalities– Piercing corporate veil– Corporate environmental

liability– Corporate criminal liability



10. Close corporations1. Planning2. Oppression



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Shareholder self-protection• Vote

– Approve fundamental transactions – Elect directors (annually, special

meetings)– Remove directors / fill vacancies– Initiate action (amend bylaws, adopt

resolutions)• Sue

– Enforce fiduciary duties (derivative suits)

– Protect rights (disclosure, voting, appraisal, inspection)

• Sell – Liquidity (except insider trading)– Takeovers (tender offer)

Prof. Robert Thompson



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Enforcement of fiduciary duties …



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Derivative suit(enforce duties to corporation)

CorporationShareholder(lawyer)

Fiduciaries

“on behalf of corporation”

violation of corporate duties

(recovery to corporation)

Delaware Supreme Court:

“if an action is derivative, the plaintiffs are then required to comply with the requirements of Court of Chancery Rule 23.1, that the stockholder:

(a) retain ownership of the shares throughout the litigation;

(b) make pre-suit demand on the board; and

(c) obtain court approval of any settlement. Further, the recovery, if any, flows only to the corporation.”



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Class action(enforce duties to shareholders)

Corporation

Sh rep(lawyer)

Insiders

“on behalf of class”

violation of direct duties

(recovery to shareholders)

Shareholderclass



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How distinguish …



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Tooley v. Donaldson, Lufkin & Jenrette (Del. 2004)

CS agrees to buy DLJ - through a $90 tender offer.

CS exercises its rights to delay the tender offer by 22 days, which the DLJ board accepts.

Tooley (and his law firm) claim the board violated duties to the public DLJ shareholders.

Why was lawsuit brought as class action?

Why is this not a derivative action?

Credit Suisse(new 71% SH)

Minorityshareholders

DLJ

Board

Plaintiffshareholder



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.. in determining whether a stockholder's claim is derivative or direct … That issue must turn solely on the following questions:

(1)who suffered the alleged harm (the corporation [derivative] or the suing stockholders, individually [direct]); and

(2)who would receive the benefit of any recovery or other remedy (the corporation [derivative] or the stockholders, individually [direct])?

Tooley v. Donaldson, Lufkin & Jenrette (Del. 2004)

Chief Justice Norm Veasey



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ALI Principles

A derivative action …

(1) Creates recovery goes to the corporation [class action recovery shared by all shareholders in class]

(2) Has preclusive effect that spares corporation and defendants multiplicity of actions

(3) Entitles successful plaintiff to an award of attorneys' fees from corporation [class action, from the fund]

(4) Allows board to take over the action or to seek dismissal



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Hypos

1. Board issues new stock, but denies preemptive rights to existing shareholders. Sh sues.

2. Parent corporation refuses to allocate business opportunities to partially-owned sub. Sh of sub sues parent.

3. Board grants CEO a lifetime employment contract. Sh sues.



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Demand requirement …



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FRCP 23.1. Derivative Actions(a) Prerequisites. This rule applies when one or more shareholders … bring a

derivative action to enforce a right that the corporation may properly assert but has failed to enforce. The derivative action may not be maintained if it appears that the plaintiff does not fairly and adequately represent the interests of shareholders who are similarly situated in enforcing the right of the corporation or association.

(b) Pleading Requirements. The complaint must be verified and must:(1) allege that the plaintiff was a shareholder or member at the time of the

transaction complained of, or that the plaintiff's share or membership later devolved on it by operation of law;

(2) allege that the action is not a collusive one to confer jurisdiction that the court would otherwise lack; and

(3) state with particularity: (A) any effort by the plaintiff to obtain the desired action from the directors or comparable authority and, if necessary, from the shareholders or members; and (B) the reasons for not obtaining the action or not making the effort.

(c) Settlement, Dismissal, and Compromise. A derivative action may be settled, voluntarily dismissed, or compromised only with the court's approval. Notice of a proposed settlement, voluntary dismissal, or compromise must be given to shareholders or members in the manner that the court orders.



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Aronson v. Lewis (Del. 1984)

Meyers Parking gives its CEO (and 47% shareholder) a sweetheart employment and retirement package.

Shareholder Lewis (a serial plaintiff) claims this is waste. Why is this a derivative suit?

Who controls the corporation’s litigation decisions. Why doesn’t Lewis ask the board to sue?

Asking the board to sue all the directors is futile - no? Who dominates the board?

Where does the court start its analysis? Why the BJR? Directors

Shareholders

Corporation

Board




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Our view is that in determining demand futility the Court of Chancery in the proper exercise of its discretion must decide whether, under the particularized facts alleged, a reasonable doubt is created that:

(1) the directors are disinterested and independent and

(2) the challenged transaction was otherwise the product of a valid exercise of business judgment.

Hence, the Court of Chancery must make two inquiries, one into the independence and disinterestedness of the directors and the other into the substantive nature of the challenged transaction and the board's approval thereof.



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Quick quiz (Delaware law)

1. True or False. Fink “dominated” the directors since he owned 47% of the company’s stock and chose them to the board.

2. True or False. Shareholders can avoid making a demand on the board by suing all the directors, who become necessarily “interested” in the lawsuit.

3. True or False. Fink’s deal (where it was unlikely the corporation would receive any services) is a “waste of corporate assets” - nobody would say corporation got its money’s worth.

4. True or False. Despite academic claims of board “structural bias,” boards regularly decide to sue their own members.

5. True or False. Whether a lawsuit has merit is something judges know better than directors - no reason for BJR abstention.



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Board dismissal ….

Use of “special litigation committee”



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Derivative suit(board request for dismissal)


Directors





[When confronted with a request for dismissal from an SLC] first, the court should inquire into the independence and good faith of the committee and the bases supporting its conclusions. …. The second step provides a balance of corporate and shareholder interests … the Court should determine applying own independent business judgment whether to dismiss.”

Board(SLC)



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MBCA (demand in derivative litigation)

§ 7.42 DemandNo shareholder may commence a derivative proceeding until:(1) a written demand has been made upon the corporation to take suitable action; and(2) 90 days have expired from the date the demand was made unless … the demand has been rejected by the corporation or unless irreparable injury to the corporation would result by waiting ….

§ 7.44 Dismissal(a) A derivative proceeding shall be dismissed by the court on motion by the corporation if one of the groups specified in subsection (b) … has determined in good faith after conducting a reasonable inquiry upon which its conclusions are based that the maintenance of the derivative proceeding is not in the best interests of the corporation.(b) … the determination in subsection (a) shall be made by: (1) a majority vote of independent directors present at a meeting of the board of directors if the independent directors constitute a quorum; or (2) a majority vote of a committee consisting of two or more independent directors appointed by majority vote of independent directors present at a meeting of the board of directors, whether or not such independent directors constituted a quorum.(c) None of the following shall by itself cause a director to be considered not independent for purposes of this section:

(1) the nomination or election of the director by persons who are defendants in the derivative proceeding or against whom action is demanded;

(2) the naming of the director as a defendant in the derivative proceeding or as a person against whom action is demanded; or

(3) the approval by the director of the act being challenged in the derivative proceeding or demand if the act resulted in no personal benefit to the director.



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Derivative suit(board request for dismissal)


Directors




Wisconsin Supreme Court:

Independence depends on:1. Whether named as defendant2. Whether approved challenged

transaction 3. Whether have financial dealings with

corporation4. Whether have non-financial relationships

with insiders5. Whether acts as consultant, counsel6. Whether small SLC (less group think)7. Whether SLC is well advised by banker,

lawyer

Board(SLC)



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Delaware

Shareholder

MBCA

Shareholder

Board Board

Court Court

Demand

excused Universal

demand

Suit Suit(after 90 days)

Move to dismiss

Move to dismiss

SLC SLC


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1. Which of the following should be a derivative suit?a. Board enters into merger,

without necessary Sh approvalb. Board has Corp buy majority

Sh’s art collectionc. Board gives CEO “complete

control” over corporation

2. Delaware requires Shs make demand on board …a. Alwaysb. when time is of essencec. Unless excused as futile

3. Delaware excuses demand …a. When current board majority is

financially interested b. When majority of current board

not independentc. When BJR does not apply

4. In Aronson v. Lewis …a. Directors dominated because CEO

was 47% Shb. Directors interested because all

directors were suedc. Demand was not excused

5. After Aronson v. Lewis a Sh (pre-suit) must have particularized facts that …a. Old board was personally tied to

interested directorb. Majority of current directors

financially interested in transactionc. All directors interested/dominated

6. In Delaware, a Sh who makes demand on board …a. Concedes board is disinterested

and independentb. Can still sue and show board

interested and non-independentc. Can sue after waiting for 90 days for

board to actAnswers:

Chapter 29Planning in CHC



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The end



Slide 25of 17


• Derivative vs. direct actions– Derivative action: 2 suits in 1- enforce

fiduciary duties to corporation– Direct action: representative suit - protect

Sh rights– Distinction between two: who recovers?

• Demand requirement– Board decides lawsuit’s merits– Aronson test: (1) director disinterest +

independence, (2) decision protected by BJR

Module VII – Fiduciary Duties

Citizen of world

Law profession

Corporate practice

Bar exam



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5. Corporate externalities– Piercing corporate veil– Corporate environmental liability– Corporate criminal liability



8. Stock trading– Securities markets– Securities fraud class actions– Insider trading

9. Corporate deals– Sale of control– Antitakeover devices– Deal protection

10. Close corporations– Planning– Oppression





5. Corporate externalities– Piercing corporate veil– Corporate environmental

liability– Corporate criminal liability



10. Close corporations1. Planning2. Oppression



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Enforcement of fiduciary duties …



Slide 28of 17

Derivative suit(enforce duties to corporation)


Fiduciaries





“if an action is derivative, the plaintiffs are then required to comply with the requirements of Court of Chancery Rule 23.1, that the stockholder:

(a) retain ownership of the shares throughout the litigation;

(b) make pre-suit demand on the board; and

(c) obtain court approval of any settlement. Further, the recovery, if any, flows only to the corporation.”



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Class action(enforce duties to shareholders)

Corporation

Sh rep(lawyer)

Insiders

“on behalf of class”

violation of direct duties

(recovery to shareholders)

Shareholderclass



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Demand requirement …

[in Delaware]



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Aronson v. Lewis (Del. 1984)

Meyers Parking gives its CEO (and 47% shareholder) a sweetheart employment and retirement package.

Sh Lewis (a serial plaintiff – really a plaintiff’s law firm) claims this is waste. Why is this a derivative suit?

Who controls the corporation’s litigation decisions. Why doesn’t plaintiff ask the board to sue?

Asking the board to sue all the directors is futile - no? Who dominates the board?

Where does the court start its analysis? Why the BJR?

Directors

Shareholders

Corporation

Board




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Our view is that in determining demand futility the Court of Chancery in the proper exercise of its discretion must decide whether, under the particularized facts alleged, a reasonable doubt is created that:

(1) the directors are disinterested and independent and

(2) the challenged transaction was otherwise the product of a valid exercise of business judgment.

Hence, the Court of Chancery must make two inquiries, one into the independence and disinterestedness of the directors and the other into the substantive nature of the challenged transaction and the board's approval thereof.


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1. Which of the following should be a derivative suit?a. Board issues new stock,

without preemptive rights b. Board has Corp buy

majority Sh’s art collectionc. Board gives lifetime

employment to CEO2. Delaware requires Shs make

demand on board …a. Alwaysb. when time is of essencec. Unless excused as futile

3. Delaware excuses demand …a. When current board

majority $$ interested b. When current board not

independentc. When BJR not apply

4. In Aronson v. Lewis …a. Directors dominated because

CEO was 47% Shb. Directors interested because all

directors were suedc. Demand was not excused

5. After Aronson v. Lewis a Sh must have particularized facts that …a. Current directors personally tied

to interested directorb. Current directors financially

interested in challenged txc. All directors interested/dominated

6. In Delaware, a Sh who makes demand on board …a. Concedes board is disinterested

and independentb. Can still sue and show board

interested and non-independentc. Can sue after waiting for 90 days

for board to act

Answers: 1-b (c – either deriv, direct) / 2-c / 3-abc / 4-c / 5-b / 6-a




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Universal demand and board dismissal ….

[under MBCA]



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MBCA (demand in derivative litigation)

§ 7.42 DemandNo shareholder may commence a derivative proceeding until:

(1) a written demand has been made upon the corporation to take suitable action; and(2) 90 days have expired from the date the demand was made unless … the demand has been

rejected by the corporation or unless irreparable injury to the corporation would result by waiting ….

§ 7.44 Dismissal(a) A derivative proceeding shall be dismissed by the court on motion by the corporation if one of the groups specified in subsection (b) … has determined in good faith after conducting a reasonable inquiry upon which its conclusions are based that the maintenance of the derivative proceeding is not in the best interests of the corporation.(b) … the determination in subsection (a) shall be made by: (1) a majority vote of independent directors present at a meeting of the board of directors if the independent directors constitute a quorum; or (2) a majority vote of a committee consisting of two or more independent directors appointed by majority vote of independent directors present at a meeting of the board of directors, whether or not such independent directors constituted a quorum. (c) None of the following shall by itself cause a director to be considered not independent for purposes of this section:

(1) the nomination or election of the director by persons who are defendants in the derivative proceeding or against whom action is demanded;

(2) the naming of the director as a defendant in the derivative proceeding or as a person against whom action is demanded; or

(3) the approval by the director of the act being challenged in the derivative proceeding or demand if the act resulted in no personal benefit to the director.


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1. Which of the following should be a derivative suit?a. Board misleads Shs about

impending mergerb. Board has Corp buy CEO’s

wife’s art collectionc. Board announces revised

dividend policy

2. MBCA requires Shs make demand on board …a. Always (except emergency)b. When time is of essencec. Unless excused as futile

3. MBCA requires dismissal of derivative suit …a. When current board asksb. When majority of independent,

disinterested Ds ask c. When Sh makes demand

4. Under MBCA, derivative suit must be dismissed if in good faith and after reasonable inquiry …a. Ds constituting board quorum askb. Special litigation committee (properly

chosen/composed) asksc. Demand was not excused

5. Under MBCA, Ds aren’t independent …a. If they have personal ties to

interested directorb. If they have financial interest in

challenged txc. If they have been sue

6. In MBCA, Sh making board demand …a. Concedes board is disinterested and

independentb. Can still sue to show current Ds

interested and non-independentc. Can sue after waiting for 90 days for

board to actAnswers:




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The end

[of short Ch 17]



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Corporations(shareholder checklist)

• Structure of corporation• Financial rights• Corporate externalities (limited liability)• Corporate governance• Fiduciary duties (directors, controlling Shs)

– Shareholder litigation– Board decision making– Board oversight– Director self dealing (conflicts)– Executive compensation– Duties within corporate groups

• Liquidity rights– Stock trading– Corporate deals

• Close corporation

"Delaware’s Balancing Act"

JOHN ARMOUR, University of Oxford - Faculty of Law, Oxford-Man Institute of Quantitative Finance, European Corporate Governance Institute (ECGI)BERNARD S. BLACK, Northwestern University - School of Law, Northwestern University - Kellogg School of Management, European Corporate Governance Institute (ECGI)BRIAN R. CHEFFINS, University of Cambridge - Faculty of Law, European Corporate Governance Institute (ECGI)

Delaware’s courts and well-developed case law are widely seen as integral elements of Delaware’s success in the competition among states for incorporations. Today, however, Delaware’s popularity as a venue for corporate litigation is under threat. Increasingly, as the empirical evidence summarized in this paper shows, corporate cases involving Delaware-incorporated companies are being brought and decided elsewhere. This paper examines the implications of this “out-of-Delaware” trend, emphasizing in so doing a difficult balancing act that the Delaware courts face. If Delaware accommodates litigation too readily, plaintiffs’ attorneys will file a plethora of “weak” cases and companies, fearful of lawsuits, may begin to incorporate elsewhere. On the other hand, if plaintiffs’ attorneys believe the Delaware judiciary is unwelcoming, they will tend to file cases in other courts. Delaware could then lose its status as the de facto national corporate law court and may no longer offer the rich body of up-to-date case law precedent upon which “users” of Delaware corporate law depend. Delaware’s overall corporate law “brand” could in turn become less valuable, thus jeopardizing its pre-eminence in the competition for incorporations.


Chapter 14Shareholder Voting Rights

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Group Hypo

Your group is the Council of the Section of Corporation Law of the State of Delaware. As such, you are responsile for formulating and recommending to the Delaware General Assembly amendments to the Delaware General Corporation Law.

the Recently, as shareholder litigation has become a fixture of mergers and acquisitions (M&A) practice, some corporations have experimented with putting fee-shifting provisions in the corporate bylaws. The purpose has been to discourage groundless shareholder claims, particularly in M&A transactions where more than 90 percent of such transactions are challenged, often by multiple shareholders. See §39.2.3. Are such bylaws valid, when unilaterally created by corporate boards without shareholder approval? In 2014, the Delaware Supreme Court addressed the enforceability of a board-passed, fee-shifting bylaw. ATP Tour, Inc. v. Deutscher Tennis Bund (German Tennis Federation), 91 A.3d 554 (Del. 2014) (en banc). The case, brought by a member of the Association of Tennis Professionals Tour, challenged a board-passed bylaw amendment that provided any member that brought an intracorporate claim and failed to obtain “a judgment on the merits that substantially achieves the remedy sought” could be compelled to reimburse the ATP Tour for its defense costs.

The court ruled that the ATP bylaw was facially valid, given that it dealt with an intracorporate matter – a proper subject

for the bylaws. The court explained, however, that a facially-valid bylaw might be invalid if it had an improper purpose, though the court pointed out that deterring litigation was not an improper purpose. The court said that corporations could create a fee-shifting bylaw “midstream” even against members who had joined the corporation before the bylaw’s adoption.

The ATP decision -- though involving a not-for-profit, non-stock corporation -- has potentially far-reaching implications for

for-profit corporations. If used by corporate boards to discourage – if not squelch – shareholder litigation in M&A transactions, it could lead to such litigation being brought by shareholders as “packaged settlements” in which management would be asked to enter into a settlement agreement without actual litigation. It could lead to shareholder activists proposing their own bylaw amendments to either rescind or prevent board-passed, fee-shifting bylaws. See §7.1.4. It could lead to retaliatory “just say no” votes against directors who had approved such bylaws. And, as has happened in Delaware, it could lead to state legislative proposals that would preclude boards from unilaterally creating fee-shifting bylaws. Time will tell.

http://www.dsba.org/sections-committees/sections-of-the-bar/corporation-law/

Chapter 17 Shareholder Litigation

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