Shareholder derivative lawsuits are initiated by individual corporate shareholders or limited liability company (LLC) members who believe something has harmed the business in which they have an ownership interest.
These disputes, often called derivative litigation, can involve businesses of any size from large publicly traded companies to a small business owned by family members. Derivative litigation can be complex and, sometimes, emotionally fraught due to personal relationships between owners.
A derivative lawsuit can be brought when an owner believes that the business has been harmed and that the officers, directors, or managers of the business haven’t addressed that damage. In other words, in a derivative case, the claimant sues on behalf of the company when it believes the company has failed to take necessary legal action.
As such, winning a derivative case typically doesn’t provide any immediate, direct benefit to the owner, as any remedy is awarded to the business and not the individual owner. Yet that owner does often benefit from a change in company management or an increase in company value if the lawsuit is successful.
Ward and Smith attorneys frequently represent claimants and defendants in these cases, and sometimes also represent the company, which can have its own interests separate from those of individual owners. Derivative litigation arises in many situations, including during ownership changes.
Legal Nuances of Derivative Lawsuits
Whether you’re pursuing a derivative claim, defending against one, or trying to ensure a dispute started by owners doesn't harm a company, it’s important to engage a lawyer who understands the nuances of derivative litigation. An attorney experienced in shareholder derivative lawsuits may be able to save time and money, no matter what side of the issue you’re on.
For example, the process of initiating a derivative claim can differ depending on which state the company was formed in. In North Carolina, a demand letter must be sent to the company before a derivative lawsuit can be filed. On the other hand, for Delaware companies, claimants can sometimes skip the demand letter by making a futility argument.
Another critical question is whether the claim is actually a derivative claim. To qualify as a derivative lawsuit, the individual bringing the claim must be able to show that the harm was to the company as a whole — which means all the owners have suffered equally proportionate to their share of ownership. Other claims, such as a dispute where some owners are harmed but others are not, or a dispute between owners may be dismissed by a judge who rules that they’re not derivative claims. Such a dispute may, in fact, be a direct claim an owner can bring against the company as opposed to on behalf of the company.
Additionally, many derivative disputes in North Carolina are litigated in North Carolina's Business Court. For this reason, it is important to engage an attorney who has experience with the Business Court and its specific rules, which are different than that of North Carolina's other trial courts.
Before filing a derivative lawsuit, it's also important to look at corporate documents such as Operating Agreements and Shareholders Agreements. Sometimes these documents will require that matters be handled through arbitration rather than in court — even though arbitration could be more expensive.
Beyond procedural issues, derivative lawsuits can also create other risks. Whether filing such a claim or defending against one, a skilled attorney will help you think through the pros and cons of derivative litigation. Will the company need to protect trade secrets and confidential information during discovery? Could the company be hurt by negative publicity about the lawsuit? If the owners have — or used to have — a personal relationship, how will litigation affect it?
In addition to their experience with derivative litigation and related business disputes, Ward and Smith litigators can also tap into the knowledge of the firm’s corporate attorneys to review, draft, and revise operating agreements and other documents. This can help reduce the possibility of expensive litigation in the future.
Ward and Smith attorneys are experienced at initiating and responding to independent, third-party investigations that sometimes are done before a court will hear a derivative lawsuit. These investigations result in reports that indicate to a judge whether a claim has merit. Ward and Smith has a network of highly credible, independent attorneys who can conduct these investigations.
Because Ward and Smith works primarily with closely-held small and mid-sized businesses, the firm’s lawyers also understand the personal and financial dynamics most often associated with these businesses and their owners.
These dynamics can lead to additional legal questions as well as emotional challenges. Our attorneys are experienced at advising clients through all phases of a derivative claim. And because Ward and Smith is a full-service law firm, it also has attorneys who focus on employment law, real estate law, family law, and other areas that may come into play in the course of a dispute.
Frequently, derivative litigation ends in a kind of “business divorce,” where one or more owners of a company agree to give up their ownership. These splits may resolve the conflict that led to the derivative claim, but there are still issues for owners and companies to consider. In some cases, companies may want a formal agreement that prevents a previous owner from profiting off of insider knowledge or competing in the future.
Ward and Smith’s business litigators and transactional attorneys have extensive experience in negotiating these resolutions. If you’re considering a derivative claim or facing one — or just worried that your company could be vulnerable to such litigation — a Ward and Smith lawyer can help you think through your options and choose the best course of action.