Derivative Suit Analysis: Protecting Minority Shareholders' Rights

This report examines the concept of derivative suits as a mechanism for protecting minority shareholders, particularly in light of corporate scandals and the potential for majority shareholders to exploit minority interests. It emphasizes the importance of minority shareholder protection for economic gr...Read More

[Type the company name]
Derivative Suit
protection of minority shareholders

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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.1The
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
1(Birds, 2007)
2(French, 2007-2008)
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achieved by focused responsibility which the directors owe to their
shareholders.
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.4Therefore, 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.5The
derivative suit challenges those damages and seeks judicial
reparation.5Therefore, 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.6However, it is important to differentiate derivative suit with
3(Reisberg, 2007)
4 Saudi Company Law, Article 81.
5(Puchniak, 2012)
6Aronson, S., & Mercer, K. Shareholder Derivative Actions: From Cradle to Grave, 1 (2009)
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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.
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.9However,
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.11After 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
7Thai 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)
8Zhong 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
10Id
11Aronson & Mercer at 10
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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
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
12 Aronson & Mercer at 52
13(Foss v. Harbottle, 1843)
14Frank Wooldridge & Liam Davies, Derivative claims under UK company law and some
related provisions of German law, 2012 AMICUS CURIAE 5–10, 5 (2012)
15Id
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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.19What does that means is shareholder(s) must
submit first a request to the company to initiate a lawsuit against a third
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.
16Slauchter, May, Companies act 2007: Directors’ Duties Derivative Actions and Other
Miscellaneous Provisions, 1- 19, 10 (2007)
17Scarlett 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)
20Id
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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 omissiondone by the corporate directors or officers and
the relationship between the damages and the wrongdoing of the corporate
representatives.
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