After determining whether a plaintiff has proper legal standing to sue a corporation in a derivative lawsuit, a court must then make sure the complaint states a valid cause of action. In this type of case, a complaint must normally allege disloyal acts committed by the corporation (or one of its chief officers) – or state that a duty of care owed to shareholders and others was breached.
If such an allegation is not found in the complaint, it may need to be refiled as a “direct action” lawsuit – especially if the corporation allegedly did something like violating a shareholder’s voting rights or wrongfully denied a valid shareholder request to inspect specific corporate records. (Otherwise, the complaint may be dismissed.)
Once these threshold issues have been addressed, the court will normally allow a valid derivative lawsuit to proceed.
The following complaints are just some of those that shareholders might raise during valid derivative lawsuits against corporations.
Acts or Omissions That Can Render Corporations Liable in Derivative Suits
Self-dealing transactions. All corporations must avoid situations where one or more key individuals (like members of the board of directors, a corporate officer or a major shareholder) are actively negotiating from different sides of a specific corporate transaction. In other words, a key corporate party’s interest in a transaction is directly opposite of that of the corporation. Courts may choose to cancel a highly questionable transaction or award damages for reasonable losses that such a transaction is likely to cause;
Wrongful competition with the corporation. Let’s assume that the ABC Corporation runs discount auto repair shops in a given region. If a shareholder learns that one of the corporate officers (or several of them) recently purchased an auto repair business that directly competes in the same region as the ABC Corporation – that’s very likely to be viewed as disloyal to ABC and could cause ABC to lose profits;
Failure to use corporate assets appropriately. Let’s assume that the fictional Ace Corporation leases out an extensive collection of construction equipment to many of its clients for their various building projects. Now assume that Mr. Brown, a member of the Ace board of directors, decides to allow a past company client to use some of this equipment over a long holiday weekend for no fee, without even drawing up a contract. During this long weekend, several major pieces of equipment are damaged – and one or two bulldozers are now nonfunctional. Brown's misuse of corporate assets in this manner, even if arguably done to win favor with a former client, can cause financial losses and create liability for the company since Brown allowed corporate assets to be used in a manner not fully approved by the proper corporate officers and/or the board of directors;
Misuse of a “corporate opportunity.” Assume that John Doe, the fictitious owner of “Milwaukee Accounting Professionals” offers his firm's services at a deep discount to Ed Martin of “Corporation B.” Although Ed knows this offer is actually being made to him as a key representative of “Corporation B” for that corporation’s benefit, he decides to personally take advantage of the offer on behalf of a separate company he runs that he knows can provide Doe’s firm with ample business. Furthermore, Ed Martin never informs “Corporation B” of this offer. If this transaction is later discovered by one or more “Corporation B” shareholders, they're likely to prevail in a lawsuit claiming that Ed Martin , a corporate officer, harmed the corporation by failing to convey this offer to “Corporation B” in a timely manner -- which might have saved the company considerable accounting fees over many future years.
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