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Shareholder Direct and Derivative Actions

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How can shareholders enforce their rights?

Shareholders may generally enforce their rights against the corporation (or its officers and directors) in one of two ways.

  • Direct Actions – A shareholder may directly sue the corporation, an officer, or director if one of these individuals takes actions that result in direct harm to the shareholder. This situation is rare, because it’s difficult for a shareholder to demonstrate that she has suffered a specific harm as a result of actions by the officers or directors.
    • Example: ABC corporation denies a shareholder the right to convert her preferred shares into common shares in accordance with her contract rights. The shareholder may personally sue the corporation, officer, or director for the harm she suffers.
  • Shareholder Derivative Suits – In this type of shareholder litigation, the plaintiffs allege that the corporation itself was harmed by a defendant’s conduct. Shareholders sue the corporation’s directors or officers, alleging a breach of fiduciary duties of loyalty or care to the corporation. Any damages to the shareholders are indirect through the overall negative impact on the corporation.
    • Example: ABC Corporation CEO makes reckless decisions in several large corporate deals. These decisions have caused a significant decrease in stock price. Shareholders are angry and sue the CEO on behalf of the corporation. If the shareholders win, the corporation will receive a judgment against the CEO. All shareholders benefit equally from the litigation by recovering damages for the corporation.
  • Discussion: How do you feel about a shareholder’s options for protecting and enforcing her rights? Does the ability to bring a direct action or a derivative action adequately protect shareholder rights? Why or why not?
  • Practice Question: Mike is a director and CEO of Murphy Corp. When Mike decides to retire, he chooses his friend David to replace him as CEO. Mike has such control and power over the board that they hire David and offer him and incredible contract without seeking the expertise of executive compensation consultants. After one year of poor performance, the Board fires David and learns that it will have to pay out the value of his contract. Shareholders are angered by the poor performance and David’s payout. What are a shareholder’s options to protect her rights?

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