Necessity of Shareholder’s Pre-Lawsuit Demand to the Board of Directors
The law requires the shareholder to make reasonable attempts to assist the corporation in suing before seeking derivative action. For a shareholder to file a derivative action lawsuit, the shareholder must first demand that the corporation’s management file a claim. An exception is made if this would be a futile demand, for example, if the corporation’s directors were the wrongdoers.
The corporation’s directors must be given a chance to correct the wrong. For example, if the company’s accountants allegedly commit malpractice, the shareholder must demand that the directors sue the accounting firm. However, if the shareholder can prove that the demand is futile because the company’s directors benefited from the malpractice, they can skip this step. If a shareholder makes a demand, we invite you to contact our California derivative action lawyer for a free consultation on strategy and tactics.
The shareholder files a derivative action and posts a bond
When the shareholder makes a demand on the board, the board is responsible for correcting the issue. If they do not address the issue, the shareholder has grounds to file a derivative action lawsuit.
If the board addresses the shareholder’s demand but decides not to act, the court will determine if the shareholder can continue with the derivative action.
In California, the shareholder must post a bond of $50,000 during this step. The bond will cover the corporation’s litigation costs if the shareholder does not win the action.
The court determines whether the board’s refusal was rational
Upon hearing the shareholders’ case, the court will evaluate what has happened up to that point. If the refusal of the shareholder’s demand was not biased and was in good faith, then any reasonable and rational decision will be upheld. However, if there is doubt that the board is unbiased or acting in good faith, the court may allow the derivative action to proceed.
The shareholder must demonstrate that the board’s decision was not independent
There may be many reasons for the board’s decision, but if the shareholder can show that the board’s decision was “contaminated” or biased, then they have a case. For example, if the shareholder demanded to sue a board member, but the board denied the request. Showing that the other board members are relatives and regularly vote in line with each other shows contamination. Showing evidence of the board’s contamination or lack of independent decision will strengthen the shareholder’s derivative action.
The court makes its final decision
Court rulings vary widely in derivative action lawsuits. If the shareholder wins the derivative action, the court will outline steps the board must take to correct the company’s damage. If the company wins, the shareholder’s bond will cover the company’s litigation costs.