Shareholder Litigation

It is often said that corporate fiduciary duties are a U.S. specialty. It would be more accurate to say that shareholder litigation is the U.S. specialty. Fiduciary duties or something resembling them exist in all corporate laws that we know of. Most jurisdictions, however, severely limit shareholder litigation that could enforce these duties, relying instead on prohibitions, shareholder approval requirements, or perhaps even criminal law enforcement. Not so the U.S., particularly Delaware.

U.S. law provides two avenues for shareholders to enforce fiduciary duties in court: the direct action, and the derivative action. The direct action is a suit in the shareholder-plaintiff’s own right (usually brought as a class action in the name of all such shareholders), whereas the derivative action is a suit on behalf of the corporation. The test for distinguishing direct vs. derivative actions in Delaware is

(1) who suffered the alleged harm (the corporation or the suing stock-holders, individually); and (2) who would receive the benefit of any recovery or other remedy (the corporation or the stock-holders, individually)?

— Tooley v. DLJ, 845 A. 2d 1031, 1033 (Del. 2004).

In practice, this means that shareholders can sue directly over mergers and other transactions that affect their status as shareholders, but not over transactions such as executive compensation that affect shareholders merely financially. For example, of the shareholder suit cases you have read so far, Van Gorkom was a direct (class) action, while Sinclair, Disney, and Marchand were derivative actions. The distinction matters because the demand requirement and the powers of the special litigation committee (see section A. below) apply only to derivative suits.

Like most litigation, shareholder litigation presents an obvious dilemma. On the one hand, fiduciary duties are toothless without shareholder litigation to enforce them. That is why courts encourage it with generous fee awards (see Americas Mining below). On the other hand, litigation is extremely expensive, especially the corporate sort. In particular, defendants can incur substantial costs in discovery even if the case never goes to trial, let alone results in a verdict for the plaintiff. In fiduciary duty suits, the main cost is the disruption caused by depositions of directors and managers and, more generally, their distraction from ordinary business. Opportunistic plaintiffs may threaten such litigation costs to extract a meritless settlement.

In other words, Delaware’s reliance on fiduciary duties creates a conundrum: how to encourage meritorious suits while discouraging deleterious nuisance suits. Meritorious suits are necessary to enforce fiduciary duties and allow the courts to flesh out their content, whereas nuisance suits can be a costly drag on the system. Do the procedural peculiarities introduced in this section succeed in sorting the good shareholder litigation from the bad?