Shareholder Rights and Derivative Actions


The vast majority of corporations registered to transact business in Massachusetts and Rhode Island are closely held.  Despite its legal status as a corporation, a closely-held corporation is said to be more akin to a partnership.  The stock of a closely-held corporation is often owned by members of a family or by a relatively small number of unrelated parties; in both cases, the stock is not available for purchase by the general public.  The owners of the closed corporation, that is, the shareholders, are directly impacted by the decisions that the directors and corporate officers (who frequently are also shareholders in the corporation) make. Therefore, the law requires those individuals in a position of power and influence to always act in the best interests of the corporation and the shareholders, particularly when considering significant corporate actions.  Also, given its partnership-like qualities, shareholders of a closely-held corporation also owe a duty of utmost good faith and loyalty to each other.

No matter whether it’s a director, officer or fellow shareholder, shareholders must be able to take legal action when corporate malfeasance occurs.  One such action available to the shareholder is a so-called “derivative action.”  A derivative action is a lawsuit filed by one or more individual shareholders on behalf of the corporation to seek redress for alleged harm to the corporation.  In a true derivative action, the individual shareholder is affected only indirectly, in proportion to his or her ownership of corporate stock.  However, where the individual shareholder’s suit alleges an injury distinct from the injury suffered generally by all shareholders as owners of corporate stock, then the claim is a direct one.  In cases where the dispute is among members of a close corporation, the distinction between derivative claims and direct claims can be difficult to draw.  Often, the injury suffered by the shareholder plaintiff is the direct result of some benefit that the other shareholders have obtained for themselves at the plaintiff’s expense. Because of the difficulty in discerning whether a claim is direct or derivative in the context of a close corporation, courts have often allowed plaintiff to plead both.  The key substantive difference between them lies in the recovery: if the action is ultimately determined to be derivative, then recovery would be by the corporation, not the individual shareholders.  A successful derivative action can result in removal of insiders who are harming the business; compensation to the company or shareholders; return of ill-gotten gains; or changes such as reform of corporate governance.

Derivative actions are not limited to closely held corporations, though.  In fact, a member of a limited liability company, an increasingly popular form of business within which to own a business, may also file a derivative action.  Historically, Massachusetts, like many other jurisdictions throughout the United States, allowed a corporation shareholder to file suit on behalf of a company, derivatively, if he or she could demonstrate that it would have been futile for the shareholder seeking to sue to make a written demand on the company asking that the company itself bring suit.  Ultimately, however, Massachusetts enacted legislation that provided that no shareholder may commence a derivative proceeding until written demand has been made upon the corporation to take suitable action.  Unlike closely held corporations, however, members of limited liability companies in Massachusetts are not presently required to make written demand on the limited liability company before filing a derivative action.

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