Derivative Suits: A Shield for Minority Shareholders

The assignment explores the concept of derivative suits, a legal mechanism that allows minority shareholders to seek relief against company directors or officers who have caused harm to the corporation. The paper discusses the history and evolution of derivative suits in various jurisdictions, including the USA, UK, and Civil Law countries such as China, Italy, Germany, and France. It highlights the differences between derivative suits and shareholder class actions, and examines the requirements for filing a derivative suit in each jurisdiction. The paper concludes that derivative suits can be an effective mechanism for minority shareholders to hold company representatives accountable for their actions, but notes that there are limitations and variations in the way derivative suits are applied across different legal systems.

Introduction to the Study
In today’s world with the high focused media reports on the scandals prevailing in the
corporate world, links the financial crises to the negligible protection forwarded to the minority
shareholders. The studies linked to this topic of lesser protection to the minority shareholders
suggests that the majority shareholder have the tendency to expropriated minority shareholder,
and in so doing makes the maximum benefit out of it.1 The protection of minority shareholders is
important because, the growth in the economy gets stimulated by this and also the agency costs
of the firm gets reduced which benefits the firm as a whole, thereby resulting in the efficient
management of the firm. Furthermore, the protection of the minority shareholders helps in the
cross listing which is listing stock with the foreign stock exchange and also trading in the very
nation where the company is incorporated.2
The OECD set principles for countries to develop corporate governance for achieving
minimum standards for the protections and Fairness, Responsibility, Transparency,
Accountability are the major pillars of corporate governance. To achieve the standard of fairness,
the shareholder’s rights must be safeguarded by the laws and the regulations. In order to
incorporate responsibility, compliance to the operating laws is essential and transparency is
achieved providing the accurate information relating to the performance of the company to its
shareholders. Lastly, the accountability is achieved by focused responsibility which the directors
owe to their shareholders.
1 A Birds & J Boyle, Company Law at 381 (6 ed. 2007)
2 D French & S Mayson et. al, Company law at 515 (24 ed. 2013).
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Thus, for the protection of the minority shareholders, derivative suits are considered to be
the best approach for maintaining the corporate governance to get relief or remedy against any
company’s directors or officers on whom the benefit of the company is vested to assert their
rights3. But, for the minority shareholders, the derivative suits are allowed only if it is approved
by the General Assembly of the company.4 Therefore, this paper explore derivative suits laws
and regulations in developed countries.
The derivative action by the minority shareholder, dates back to Anglo-Saxon legal
system, where lawsuit is brought into action by the shareholder on company’s behalf, due to the
damages so borne by the actions of directors or any other people within the company or outside
it.5 The derivative suit challenges those damages and seeks judicial reparation.5 Therefore,
derivative suit can be defined as a requested by one or more shareholder to compel the company
to file a suit against board of directors or its executive offices, and the right of shareholders to
initiate the suit on behalf of the company upon a refusal of its general assembly.6 However, it is
important to differentiate derivative suit with shareholder class action which can be defined as a
lawsuit files by a shareholder on behalf of all shareholders against the company and its directors.7
The most critical difference between those two lawsuit is that derivative suit is files on behalf of
the company which makes the big differences in proving the damages.
3 A Reisberg, Derivative actions and corporate governance: theory and operation at 76 (2007).
4 Saudi Company Law, Article 81.
5 Harald Baum & Dan W. Puchniak, The derivative action, 7 The Derivative Action in Asia 1–8 (2012),
http://assets.cambridge.org/97811070/12271/excerpt/9781107012271_excerpt.pdf.
6 Aronson, S., & Mercer, K. Shareholder Derivative Actions: From Cradle to Grave, 1 (2009)
7 Thai Lang, Shareholder Class Actions: A Critical Analysis of the Procedure under Part IVA of the Federal Court of
Australia Act, UW Austl. L. Rev. 40 138-162, 138 (2015)
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In the USA, any shareholders, one or more has the right to in file a derivative suit on
behalf of the company upon the refusal of its general assembly.8 Thus, a shareholder before filing
derivative suit in court against board of directors or company’s executive officers is required to
submit a request to general assembly to file lawsuit against third party.9 However, there is a
exemption to this requirement which is the case when a shareholder intend to file a law suit
against all company board of directors, then it is clear that the decision make in this case will be
in a conflict of interest and submitting such a demand to the board of directors will be useless. 10
Another requirement is that shareholder must “with exception, own a share on the time of
initiating derivative suit.11 After a shareholder submit a demand to initiate lawsuit against a third
party, the board of director might review the demand and to be subject to business judgement
rule or create a special committee compose solely from independent directors and then the court
will only review the independency of the committee and their decision will be out of scope.12
In the UK legal System, derivative suit was greatly influenced by the decision in Foss
v. Harbottle13, where the shareholders of a company sued its managers and alleged harm caused
to the company along with the shareholders by the management and the then the defendants
contended that shareholders cannot in no way raise the suit but the company who is solely
responsible in doing that, and based on this contention the decision of the Court was along these
lines and the Court held that it is only the company or the corporation who can recover the
compensation, if it satisfies that the company is exposed to such damage. So, basically the Court
held that it is not the majority or the minority shareholders who can bring suit but this decision to
8 Zhong Zhang, The Shareholder Derivative Action and Good Corporate Governance in China: Why is the
Excitement Actually for Nothing?, 28 UCLA PACIFIC BASIN LAW, 174- 209, 188 (2011)
9 Zhong Zhang at 186
10 Id
11 Aronson & Mercer at 10
12 Aronson & Mercer at 52
13 (Foss v. Harbottle, 1843)
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take action can only be originated from the company itself through the general assembly. But,
based on today’s scenario, the derivative suit is different that a shareholder must obtain court
approval before initiate derivative suit against the company.14 The court then will determine
whether the derivative suit would be for the best interest of the company.15 The standard for the
court to determine that is for it is discretion to see if establishing the derivative suit is for the best
interest of the company or just merely a revenge or harm the company reputation with no clear
violation. However, there are factors that a court must considered when reusing a request to
initiate a derivative suit. First, if the person accused of wrong doing acted on the general duty of
a director for the successful of the company, and if the act of the accused person (s) is approved
in advance by ratified by the company.16
In Civil Law the case is different that to say it is not like USA and UK that a singular
shareholder has the right to initiate a derivative suit. For example, in China, under Article 153 or
the company law shareholder(s) with a minimum 1% ownership of company shares has/have the
right to file a derivative suit.17 it Italian legal system, shareholder (s) has the right under company
law to initiate derivative suit if jointly or individually hold 2.5% of company shares.18 In
Germany is different, the right to initiate derivative suit required a minimum shares ownership
1% or a value of 100,000 Euro and passed a judicial screening.19 What does that means is
shareholder(s) must submit first a request to the company to initiate a lawsuit against a third
14 Frank Wooldridge & Liam Davies, Derivative claims under UK company law and some related provisions of
German law, 2012 AMICUS CURIAE 5–10, 5 (2012)
15 Id
16 Slauchter, May, Companies act 2007: Directors’ Duties Derivative Actions and Other Miscellaneous Provisions,
1- 19, 10 (2007)
17 Scarlett at 220
18 Scott H. Mollett, Derivative Lawsuits Outside of Their Cultural Context: The Divergent Examples of Italy and
Japan, 43 UNIVERSITY OF SAN FRANCISCO LAW REVIEW 635–670, 654 (2008)
19 Martin Gelter, Why do Shareholder Derivative Suits Remain Rare in Continental Europe?, 37 BROOKLYN
JOURNAL OF INTERNATIONAL LAW, 844-892, 858 (2012)
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party after that must prove that the third party, directors or executive officers, committed
“dishonesty or serious violations of the law or the corporate charter,” after that the court will
approve continuing the derivative suit.20 Finally, a French legal system is similar to USA and UK
which does not required a minimum of shares ownership that to say any shareholders has the
right to file a derivative suit.
It is by the derivative suit the minority shareholders can raise their voice through litigation,
against the abuse of power so caused by the representatives of the company. But, in Saudi
Arabia, the Saudi derivative actions is utterly failed in protecting the minority shareholders
thorough this derivative suit. The Saudi corporate law sees the derivative suit very narrowly and
challenging the directors based on their reckless act thereby causing damage to the corporation is
only considered to be the derivative suit, thus, not granting the shareholders the rights to sue an
outsider, when that very outsider or outsiders caused damage to the company and the
management of the company is reluctant to take necessary course of action against them. Thus,
the shareholder has the right to submit a request to the general assembly to file a lawsuit against
company directors or officers, but if the general assembly decides “by the majority vote” not to
take action, then shareholder right is limited to file a civil lawsuit "direct action" which will be in
the name and the benefit of the shareholders and consequently must (1) prove a personal
damages on the shareholders and second prove the wrong action or decision or omission done by
the corporate directors or officers and the relationship between the damages and the wrongdoing
of the corporate representatives.
20 Id
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