Derivative Suits

An action is derivative if “the gravamen of the complaint is injury to the corporation, or to the whole body of its stock or property without any severance of distribution among individual holders, or if it seeks to recover assets for the corporation or to prevent the dissipation of its assets.” (Jones v. H.F. Ahmanson & Co. (1969) 1 Cal.3d 93, 106-107.) Shareholders may bring a derivative suit to, for example, enjoin or recover damages for breaches of fiduciary duty directors and officers owe the corporation. (Friedman, Cal. Practice Guide: Corporations (The Rutter Group 2004) ¶ 6:604, p. 6-128.2.)  Accordingly, “[t]he essence of a derivative action is that, although the company has been damaged, it has taken no action to protect itself. When a shareholder then steps forward as a derivative plaintiff, the injury it must allege is the one suffered by the company and not by the shareholder itself.” (Counseling California Corporations (3d ed Cal CEB 2008) §3A.19.)

For example, in Oakland Raiders v. National Football League (2005) 32 Cal. Rptr. 3d 266, the Court dismissed a breach of fiduciary claim, reasoning that the claim was “plainly derivative” because “ ‘the gravamen of the wrong alleged’ [citation] was the mismanagement of the [defendant corporation] and the resultant diversion of its assets.” (Id. at p. 289)

Likewise, in Avikian v. WTC Financial Corp. (2002) 98 Cal.App.4th 1108, the plaintiff shareholders alleged the defendant officers and directors mismanaged or looted corporate assets and entered into self-serving deals to sell assets to third parties, culminating in the corporation’s involuntary liquidation. (Id. at pp. 1111, 1112, 1115.) The trial court held the claims were derivative in nature. The court explained the plaintiffs’ “damages are nothing other than a claim of damage to the corporation generally.” (Id. at p. 1116.)

Similarly, in Nelson v. Anderson (1999) 72 Cal.App.4th 111, minority shareholder alleged that the majority shareholders of the corporation negligently managed the corporation and exercised complete authority, power, legal and financial control over the corporation, including all aspects of its business and management decisions to the exclusion of the minority shareholders. (Id. at p. 125.) The court concluded that the plaintiff could not maintain the suit as a direct action: “Because the gravamen of the complaint is injury to the whole body of its stockholders, it was for the corporation to institute and maintain a remedial action. [Citation.] A derivative action would have been appropriate if its responsible officials had refused or failed to act.” (Id. at pp. 125-126.) The court went on to note that the damages were the loss of corporate profits. (Id. at p. 126.) Since “[s]hareholders own neither the property nor the earnings of the corporation,” any damages that the plaintiff alleged that resulted from such loss of corporate profits “were incidental to the injury to the corporation.” (Id.)

What is more, Corporations Code §800(2)(b), states that: “No action may be instituted” “by any holder of shares,” unless “[t]he plaintiff alleges in the complaint with particularity plaintiff’s efforts to secure from the board such action as plaintiff desires, or the reasons for not making such effort, and alleges further that plaintiff has either informed the corporation or the board in writing of the ultimate facts of each cause of action against each defendant or delivered to the corporation or the board a true copy of the complaint which plaintiff proposes to file.”

Therefore, before filing any derivative lawsuit, the plaintiff must make a demand on the board of directors.

At Kashfian & Kashfian, LLP, we have experience defending and asserting derivative claims, and as your counselor, we will fight vigorously on your behalf. Contact our offices to learn more about the services that we provide.

Please note that Kashfian & Kashfian, LLP makes available the information on this website for general informational purposes only. Internet subscribers and online readers should not rely nor construe the information on this website as legal advice or as a substitute for obtaining legal advice from an attorney licensed in your state.

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