Monday, October 27, 2014

Corporate Counsel Section: Dismissing A Derivative Action

By Caroline Johnson Levine
Corporations are managed by elected directors. Shareholders, of course, are the owners of the corporation, at least for the period of time that they retain ownership of stock. Occasionally, a shareholder may file a “direct” lawsuit against the corporation, claiming that the individual shareholder has suffered a distinct injury from the other shareholders. These suits involve statutory or contract rights and seek to recoup dividends or examine corporate records.

However, a “derivative” lawsuit is one filed by a shareholder on behalf of the corporation for claims of fraud, mismanagement, or self-dealing by the directors and officers of the corporation. See Kamen v. Kemper Fin. Servs., Inc., 500 U.S. 90 (1991). Importantly, if the derivative action is successful, the corporation reaps the proceeds rather than the shareholder. Additionally, other remedies may result from a derivative action, such as governance reforms, removal of officers or directors, and remuneration of financial losses. Derivative suits by shareholders permit enforcement of corporation claims, ensure equitable recovery by all shareholders, and protect creditors or shareholders from asset distribution to an individual shareholder.

It is important to note that the derivative plaintiff, throughout the litigation, must retain a “legitimate stake in the corporation so that its interests are adequately represented.” See Timko v. Triarsi, 898 So. 2d 89 (Fla. 5th DCA 2005). In Timko, the court found that the derivative plaintiff forfeited his standing in the action upon the sale of his shares in the corporation, by stating that in creating section 607.0740, Florida Statutes, the “legislature has simply manifested its intent to place additional limits upon this preexisting right to ensure that a plaintiff’s stake in the lawsuit is ‘legitimate,’ meaning an ownership interest that is not acquired for predatory purposes.” Id. at 91.

Section 607.07401(3), Florida Statutes, provides an avenue for directors to move to dismiss the derivative action with prejudice. In order to dismiss the action, the directors must appoint an independent investigator who will issue a written report. If the report recommends dismissal and the report was made in good faith and entitled to deference under the “business judgment rule,” the court may dismiss the action. See Klein v. FPL Group, Inc., 2003 WL 22768424 (S.D. Fla. 2003).

Unfortunately, this method of dismissal has generally been difficult to obtain because the courts often question the independence of the investigators. See Kloha v. Duda, 226 F. Supp. 2d 1342 (M.D. Fla. 2002); see also McDonough v. Americom Int'l Corp., 905 F. Supp. 1016 (M.D. Fla. 1995). Another major hurdle is proving that the investigation was “reasonable and objective.” See Batur v. Signature Props. of Nw. Florida, Inc., 903 So. 2d 985 (Fla. 1st DCA 2005); see also Demoya v. Fernandez, 559 So. 2d 644 (Fla. 4th DCA 1990).

Corporations may wish to consider moving to dismiss derivative actions to reduce litigation costs. However, obtaining a dismissal based upon a section 607.07401 investigative report is often an uphill battle.