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What Are Some Examples of Derivative Actions and Corporate Governance?

What Are Some Examples of Derivative Actions and Corporate Governance?

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What Are Some Examples of Derivative Actions and Corporate Governance?

Business litigation encompasses a wide variety of legal topics, from filing a breach of contract lawsuit to notifying the Equal Employment Opportunity Commission (EEOC) about a violation of an employment law. One type of business litigation is called a derivative action, which represents a lawsuit filed on behalf of a corporation. 
You have probably heard the timeless question, “Which came first, the chicken or the egg?” A similar question concerns derivative actions and corporate governance. The answer to the question, “Which comes first, derivative actions or corporate governance?” is corporate governance. Corporate governance is the set of rules and procedures followed by a company. The reason for establishing rules and procedures is to reach a balance between protecting the interests of shareholders and a corporation.

Derivative actions arise when a company fails to implement strong enough rules and procedures to protect shareholders. Without a strong corporate governance program, shareholders would be vulnerable to actions that go against their best interests. A company needs to establish strong corporate governance to prevent the filing of derivative actions.

For more than three decades, the business litigation attorneys at Morgan & Morgan have witnessed several changes to derivative action statutes at the state and federal levels. We also have watched corporate governance policies strengthen to protect the interests of shareholders. However, some shareholders remain exposed to the unethical business practices implemented by the insiders of corporations.

If you are a shareholder who wants to file a derivative action on behalf of a corporation, schedule a free case evaluation with one of the business litigation lawyers at Morgan & Morgan.

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FAQ

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  • What Is the Difference Between a Direct and Derivative Action?

    A derivative action involves the creation of equity that a shareholder uses to seek just compensation on the behalf of a corporation. For example, a shareholder who files a derivative action files a claim on behalf of the corporation. Derivative actions provide shareholders with a legal check against violations of the law committed by those that control a corporation.

    A direct action seeks legal action for an individual, not an organization. An example of a direct action is a shareholder filing a claim to gain access to a corporation’s financial records. The shareholder files a direct claim on behalf of the individual, which means the legal action does not address any violations of the law that harm the corporation.

  • What Are Shareholder Derivative Actions?

    A shareholder derivative action represents a legal maneuver that one or more shareholders take on behalf of the corporation. Shareholders file most derivative actions against board members, executive directors, or anyone that has obtained a position of power within an organization. The legal action taken on behalf of a corporation often concerns some form of misconduct committed by people in positions of significant power. 

    Examples of the derivative actions taken by shareholders include suing a manager or executive for a breach of fiduciary duty. Corporate leaders that act on their personal best interests instead of the best interests of the corporation represent another reason to file a derivative action. Shareholders file lawsuits on behalf of the corporation because of unlawful or fraudulent activities. Conflicts of interest between corporate insiders and a corporation is another reason why shareholders file derivative actions.

    Shareholders file derivative actions against corporate insiders for violating financial laws and standards. Examples of financially motivated derivative actions include insider trading, backdating stock options, issuing inaccurate financial statements.  Executives that receive unjust compensation also have committed an act that is not in the best interest of the corporation. Any conduct that violates the laws regulated by the Securities and Exchange Commission (SEC) is just cause for a shareholder to file a derivative action against a corporation.

  • What Is Corporate Governance?

    Understanding the legal relationship between derivative actions and corporate governance starts by defining the meaning of corporate governance. Corporate governance refers to a set of rules, policies, and procedures that controls the behavior of the individuals that run a corporation. Although shareholders have an indirect role, corporate governance mostly concerns managers, executives, and the board of directors. Corporations that create strong governance programs attract the interest of investors. Strong corporate governance helps companies build trust in the community, as well as with potential investors.

    Promoting a company’s corporate governance program represents a key element of building relationships with investors and members of a community. Documents such as bylaws, articles of incorporation, and stock ownership standards all verify that a company has established a strong corporate governance program. For a majority of shareholders, investing in a profitable company is not enough to build a long-term relationship with the company. The corporation also must demonstrate that it cares about following state and federal laws, as well as the policies developed by the insiders of a corporation.

  • What Is the Relationship Between Corporate Governance and a Board of Directors?

    The board of directors is the most influential group of insiders that influence corporate governance programs. Shareholders elect directors, while other members of the board might have the power to appoint them. The board of directors makes the most important decisions that determine the strength of a corporate governance program. In many cases, the policies created by a board of directors extend well beyond financial issues. The Board of directors also can establish policies of corporate governance that impact social and environmental issues.

    Most board of directors include both insiders and independent members to develop a balance that ensures the actions taken by a board of directors represent the best interest of the corporation and the community. A Board of directors packed exclusively with insiders is the most likely to violate laws and standards that require the filing of a derivative action.

  • What Are Some Examples of Corporate Governance?

    As an investor who wants to become a shareholder in a company, you want the company to implement strong corporate governance policies and practices. Although most companies follow the rules established by state and federal laws, three examples of poor corporate governance have unfolded since Morgan & Morgan opened its doors in 1988.

    Enron and WorldCom

    The Enron and WorldCom scandals not only highlighted the relationship between derivative actions and corporate governance, but the scandals also received attention from Hollywood. Both scandals, which occurred around the same time, led to the passage of the Sarbanes-Oxley Act. The landmark legislation created much more stringent recordkeeping requirements in addition to the establishment of severe penalties for violating corporate governance laws.

    Volkswagen AG

    The support of illegal activities by insiders of a corporation can produce serious consequences on a company’s financial health. Such is the case with Volkswagen AG, which faced derivative actions that started in September of 2015. In one derivative action, Volkswagen faced a lawsuit claiming the automaker intentionally altered the design of its engine emission equipment to register false positive readings. Revelations of the manipulations caused a sharp drop in the company’s stock price, as well as a dramatic decline in sales.

    PepsiCo

    Not all of the high-profile corporate governance cases involve illegal business practices. One positive example of corporate governance comes from PepsiCo. While crafting its 2020 proxy statement, the board of directors at PepsiCo encourages input from investors to create new corporate governance policies. Investors that participated in developing the proxy statement focused on six areas, including creating an ethical corporate culture, addressing sustainability issues, and conducting an analysis concerning compensation.

  • What Does a Business Litigation Attorney Do?

    Business litigation lawyers understand the complex legal relationship between derivative actions and corporate governance. If you are a shareholder who wants to take legal action against insiders that have harmed a corporation, hiring an experienced business litigation lawyer from Morgan & Morgan can help you build a persuasive case.

    Conducts an Investigation

    During the free case evaluation, one of the business litigation attorneys from Morgan & Morgan asks several questions to determine how to proceed with a thorough investigation. You should bring evidence to the meeting that confirms the illegal actions taken by the insiders of a corporation. Evidence includes documents that demonstrate financial improprieties and a timeline of actions taken by the board of directors that negatively impact the financial health of the corporation.

    The business litigator assigned to your case also interviews witnesses, which can include other shareholders and insiders that have knowledge of the illegal actions taken by other insiders. One or more insiders, such as executives and board members, might provide documentation that strengthens your case. Witness accounts of improper corporate governance bolster the strength of a derivative action.

    Files the Proper Documents on Time

    Filing the proper legal documents on time is one of the most important steps in filing a civil lawsuit against the insiders of a corporation. Your legal counsel drafts the motions and pleadings required to move the derivative action along in the judicial system. After sending the proper paperwork to the other party, the other party has to respond to the complaint in either a positive or negative manner. Your legal counsel must file a derivative action before the expiration of the statute of limitations. For example, Texas gives plaintiffs four years after the last illegal act to file a derivative action.

    Participates in Discovery

    The discovery phase of the litigation process requires both parties to exchange information that pertains to the case. Both parties interview witnesses, as well as examine the documents provided by the other party. The discovery phase of the litigation process can lead to both parties agreeing to negotiate a settlement. Negotiating a settlement prevents a derivative action from reaching the trial phase of the litigation process.

  • Work With the Team of Business Litigation Attorneys at Morgan & Morgan

    Although the highly-rated team of business litigation lawyers at Morgan & Morgan tries to reach favorable settlements, we never hesitate to take a derivative action to the trial phase of the litigation process. This is the point when a shareholder needs the legal support of a state-licensed business litigation attorney. Filing a derivative action to address a violation of corporate governance standards sometimes deserves the judgment issued by a civil court judge.

    To learn more about derivative actions and corporate governance, as well as to see whether you and your fellow shareholders have a strong enough case to file a civil lawsuit, schedule a free case evaluation today with one of the business litigation attorneys from Morgan & Morgan.

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