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Shareholder and Partnership Disputes

Can a Corporate Shareholder Sue Their Corporation?

A corporate shareholder, commonly referred to as a stockholder, is an individual or entity that legally owns one or more shares of a corporation's stock. This basically means that they own a certain percentage of the corporation and will experience the same financial benefits and risks as its founder. 

In addition, corporate shareholders also enjoy certain rights, such as voting on important decisions that affect the corporation (e.g., electing board members), attending annual shareholder meetings, inspecting the corporation's records or books, and selling or purchasing shares. 

One other significant right that shareholders may exercise is the right to sue the corporation. However, this right is not always available. Specifically, there are certain circumstances that will permit a shareholder to sue their own company. For example, a corporate shareholder may sue a corporation when any of its directors or officers violate a fiduciary duty or conduct various other illegal activities like defrauding investors.

To find out whether you have grounds to sue your corporation as a corporate shareholder, you should consult a local business attorney for further legal advice. 

Can Shareholders Sue Anytime They Disagree with the Corporation?

It is important to note that shareholders cannot sue a corporation simply whenever they have a disagreement. This is due to a regulation known as the “business judgment rule”. The business judgment rule can be invoked during lawsuits in which a shareholder is claiming that a director violated its duty of care to the corporation. The rule acts as a presumption that requires the court to defer to the judgement of the corporation's board of directors. 

In other words, a court will uphold a director's decisions so long as they were made in good faith, executed with the level of care and judgment that a reasonably prudent person would use, and made with the reasonable belief that the director or board is acting in the best interests of a corporation. 

However, if the shareholders can prove that the director or the board engaged in fraud, other illegal activities, or were grossly negligent in managing a corporation, then the business judgment rule will not apply. Although these actions will give a shareholder grounds to sue, shareholders should only file a lawsuit against a corporation as a last resort.

If a shareholder does decide to take legal action against a corporation, they can only do so in one of two ways: either through a direct lawsuit or an indirect derivative lawsuit. The distinctions between the two will be discussed in further detail below. 

Direct Lawsuit: Shareholder-Plaintiffs Sue on Their Own Behalf

In a direct lawsuit, a shareholder-plaintiff will file an action against a corporate director, corporate officer, and/or the corporation itself, alleging some special or personal harm that occurred as a result of the directors' or officers' actions. 

Although the special or personal harm is usually one that is not shared by the majority of shareholders, a single shareholder may be appointed to represent other shareholders who have also experienced the harm in question. 

Some reasons that a shareholder who has suffered a personal or special harm might file a direct lawsuit include when a corporate officer or director:

  • Violated a specific shareholder's ownership rights;
  • Infringed on the shareholder's right to vote;
  • Denied the shareholder its right to inspect a corporation's books or records;
  • Refused or failed to pay dividends that were promised to the shareholder; and
  • Violated a shareholder's contractual or preemptive rights. 

It should be noted, however, that a corporate officer does not owe any fiduciary duties to a single shareholder. The one exception is if the officer and shareholder have a special relationship or have entered into a contract that specifies as much.

Additionally, depending on the facts of a case, there are some instances when these lawsuits may entail suing an individual of a corporation, such as when a corporation is accused of committing a tort (e.g., fraud) or if an individual commits some type of personal violation that is separate from their role at the corporation.    

Derivative Lawsuit: Suing Directors and Officers on Behalf of the Corporation

The second way that a shareholder can sue a corporation is through an indirect or derivative lawsuit. In these types of cases, an individual or shareholder will sue the corporation on behalf of the corporation itself. This may occur when a corporation's directors or officers have done something that has caused harm to the corporation, such as violating their fiduciary duties, breaching the corporate duty of care or loyalty, or wasting a corporation's assets.

A shareholder may only file suit on behalf of a corporation after they have attempted to resolve the issue with the board of directors and if the corporation has a valid cause of action, but refuses to sue. Prior to suing, the shareholder will also be required to file a written demand letter with the corporation that sets forth the details of the violation and includes a request to take legal action. 

Furthermore, 90 days must have passed since the demand letter was submitted before they can file suit. There are two exceptions to this general rule. First, the shareholder can file a claim before 90 days have passed if the corporation rejected the demands. Second, the shareholder may also file suit before 90 days have passed if the corporation would be in danger of irreparable injury should the shareholder have to wait.

The shareholder who files the derivative lawsuit must also have standing to bring the action. This means that they must have been a corporate shareholder at the time of the violation or became one through an inheritance from a person who was a shareholder at that time. They must also be able to fairly and adequately represent the interest of the corporation, not just their own personal stake.

Given the complexity involved in these types of lawsuits, it is best to consult a local business attorney before filing. Otherwise, the suit may be dismissed. 

Who Is Entitled to the Damages: Corporation or Shareholders?

In a direct lawsuit, the prevailing shareholder will be entitled to any remedies or damages received. In contrast, in a successful derivative lawsuit, the corporation will be the one to receive any damages. Such damages will then be distributed towards the prevailing corporation's assets. It should be noted that since a shareholder is the person who brings a derivative lawsuit on behalf of a corporation, they will be entitled to collect attorneys' fees. 

If a shareholder loses a derivative lawsuit, however, then they will not be allowed to recover any attorneys' fees or associated costs. Additionally, if a shareholder filed a derivative lawsuit in bad faith, then they will also be liable for the opposing party's attorneys' fees and related costs. 

Lastly, a shareholder who both loses and files a derivative lawsuit in bad faith, will prevent the other shareholders from bringing the same claim against the defendant since the prior shareholder already lost the suit. 

What is a Fiduciary Duty in a Business Relationship?

To understand what it means to have a fiduciary duty in a business relationship, you must first understand who a fiduciary is. A fiduciary is simply a person responsible for taking care of money or other assets for another person or entity.

The relationship between the fiduciary and the principal, or the person who benefits from the work done by the fiduciary, creates a legal duty in the fiduciary. For example, corporate executives must act in the best interests of the company they work for and the shareholders that back the company if the company is publicly traded.

Fiduciary duty is one of the highest duties imposed by the United States legal system. The term fiduciary duty is used to describe the legal obligation of the fiduciary to act accordingly in the best interests of the principal. A fiduciary duty is composed primarily of two equal duties: the duty of loyalty and the duty of care.

In the business setting, a fiduciary owes the principal a duty of loyalty, meaning the fiduciary must act at all times in the business's best interest. This means that the fiduciary must avoid any conflicts of interest that may arise between their interests and the interests of the principal. They also must avoid any conflicts that may arise between other clients of the fiduciary and not self-deal or profit from their relationship with the principal (unless they get the express and informed consent of the principal).

The duty of care refers to the legal responsibility that the fiduciary act accordingly to a standard of reasonable care. This typically means providing the best possible service or advice that they are capable of. To run a successful business, business partners and business investors must trust that the fiduciary is acting in the business's best interests.

When the fiduciary does not act in the business's best interests or otherwise violates their fiduciary duty, then a civil suit may be initiated by the injured party to recover for the breach of fiduciary duty that has occurred.

What Constitutes a Breach of Fiduciary Duty?

Suppose you believe that you may have a case for breach of fiduciary duty. In that case, it is important to make sure that you can prove every element of your case before filing a civil lawsuit, as civil lawsuits can often be very expensive.

The elements needed to prove that there was a breach of fiduciary duty include the following:

  1. It must be proved that a fiduciary relationship existed between the plaintiff and the defendant at the time of the dispute;
  2. The plaintiff must show the scope of the relationship and the duties of the fiduciary;
  3. That the defendant breached the duties as outlined within the scope of the relationship, and caused harm to the plaintiff; and
  4. That there is a remedy available for the harm that occurred due to the breach.

If you can prove the above elements, you may be able to initiate a suit against the fiduciary. However, sometimes when fiduciary relationships are outlined in an agreement, there are arbitration clauses that may prevent you from being able outright to sue a business for breach of fiduciary duty. This means that if you signed a contract agreeing to arbitrate such disputes, you would have to resolve the business dispute through arbitration instead of civil court.

How Can a Fiduciary Duty in a Business Relationship Be Breached?

As can be seen, there is some form of fiduciary duty between the executives, shareholders, or partners of the business in a business relationship. The most common place to look for a fiduciary duty is in the company's organizational documents, which will outline the fiduciary duties present. The organization documents are like the company's charter and basis for the company's entire structure, purpose, and running.

Between business partners, the duty of loyalty is even stronger, meaning there should be full disclosure of everything that might affect the partnership and a full accounting of all profits and property relevant to the partnership. One example of breaching fiduciary duty in a business partnership is where one partner hides assets from the other partner or engages in self-dealing.

A breach of fiduciary duty in a business relationship is simply any actions taken that are contrary to a client's interests or the business, failure to disclose pertinent information or actions taken for the fiduciary's self-interest. Common breaches of fiduciary duty in a business relationship include:

  • Acting in a way that is contrary to the best interests of a client or against the best interests of the business;
  • Self-dealing, or otherwise acting in the fiduciary's self-interest, rather than the best interests of the client or business;
  • Misappropriating funds (also known as embezzlement);
  • Misrepresenting important facts, such as lying to a company's shareholders about the company's financial data; or
  • Otherwise neglecting one's duties or responsibilities to the business.

Can You Go to Jail for Breaching Your Fiduciary Duty?

Each state dictates what remedies may be applied to breach fiduciary duty. Additionally, the available remedies depend on the severity of the breach and the breach itself. The most common remedies for a breach of fiduciary duty include paying fines such as reimbursing any lost profits and out-of-pocket losses.

For example, compensatory damages may be awarded to shareholders who filed a civil lawsuit against the CEO of a company for making a bad business decision that resulted in a big loss to company shares.

However, to win this case, the shareholders would first need to show that the CEO both breached their fiduciary duty and show a precise calculation of the money shareholders lost because of it. Often, this requires hiring an economist to prove the number of damages that resulted from the breach.

Although most cases for breaching fiduciary duty often only result in civil liability, such as having to pay fines, some breaches of fiduciary duty may result in criminal liability as well. For example, a Chief Executive Officer or Chief Financial Officer may be imprisoned for falsifying certain corporate financial reports or certifying misleading corporate financial statements under the Sarbanes-Oxley Act of 2002, enacted in response to financial scandals such as the Enron scandal.

Additionally, a fiduciary may be criminally liable for embezzling business or client funds. Other breaches of fiduciary duty that may result in criminal liability include other forms of self-dealing, committing securities and commodities fraud, or criminal insider trading. Consequences for committing the above-listed breaches of fiduciary duty may include lengthy prison sentences, heavy fines, or both.

What Fiduciary Duties Might Apply to My Business?

As noted above, your company's organizational documents or partnership agreement will likely outline the fiduciary duties present and often the consequences that will result from a breach of fiduciary duty. For a small business, this often means that there is a duty to operate in good faith and fair dealing, meaning that one party cannot take any action that would prevent the purpose of the business from being achieved.

Fiduciary duties will vary according to the business structure of the business and the relationships outlined in the organizational documents. Thus, it is important to read through your business's organizational documents or partnership agreement.

What Can be Done About a Breach of Fiduciary Duty?

As noted above, each state has its specific laws regarding fiduciary duties, relationships, and what remedies are available for fiduciary breaches. However, suppose you believe that a breach of fiduciary duty has occurred and that breach has resulted in measurable losses for you. In that case, you may be able to file a civil lawsuit to recover your damages.

First, you must be able to prove the elements as outlined above. If you can do so, you should initiate a civil lawsuit against the fiduciary or business according to the civil procedure rules outlined by your local jurisdiction. Often this means drafting a complaint, serving the business, conducting discovery, and possibly appearing in court.

Once again, however, arbitration may be the remedy that you have to follow if arbitration is mentioned in your business's organization document or partnership agreement. In that case, you will have to proceed through the arbitration process, and you won't be able to file a civil lawsuit. Since arbitration agreements are common, it's important to check if you have an agreement before proceeding.

Should I Contact a Business Attorney?

If you are a corporate shareholder and believe you have grounds to file a direct or derivative lawsuit against your corporation, it is strongly recommended that you contact a local business attorney for further guidance. An experienced business attorney will be able to identify the type of lawsuit you should file and can ensure that you follow the necessary procedures before filing a claim. 

Your attorney can also ensure that your claim is viable and that you have proper standing to file it. Additionally, your attorney can help you draft a demand letter and any other correspondence required before taking legal action. Finally, your attorney can also provide representation on your behalf in court.

The laws and regulations involved in a breach of fiduciary duty claim are often complex and vary by jurisdiction. Thus, if you suspect that there has been a breach of fiduciary duties in your business relationship, it may be in your best interests to consult with a well-qualified and knowledgeable corporate attorney.

An experienced business attorney will help inform you of your local state's laws, evaluate your claim, file a civil lawsuit on your behalf, and even represent you in court, if necessary.

Call our office today at 212-994-7777 or complete the convenient online contact form to set up a consultation.