One of the basic exposures that corporate directors and officers face is the risk of a shareholder derivative lawsuit. In the following guest post, Greg Markel, Giovanna Ferrari, and Sarah Fedner, all of the Seyfarth Shaw law firm, take a look at the basic features of shareholder derivative suits and conclude with ten basic takeaways for boards and others. I would like to thank the authors for allowing me to publish their article as a guest post on this site. I welcome guest post submissions from responsible authors on topics of interest to this site’s readers. Please contact me directly if you would like to submit a guest post. Here is the authors’ article.


In this article we will explain what is necessary to state a derivative claim, the role of the board and senior officers, the demand requirement, demand futility, tips on response to a demand and the pros and cons of demand refusal; why there should be early factual review by all parties, permitted early discovery and also the risks and potential benefits to the parties, their insurers and others who are affiliated with the parties.  At the end of the piece there are 10 takeaways for directors, board committees and others with interests in the topics covered.


Derivative actions are lawsuits in which shareholders  make claims on behalf of a corporation that has been wronged or harmed or injured in some way by other individuals or entities.  Such a claim  is commenced by one or more shareholders on behalf of and for the benefit of a corporation but  not commenced by the corporation itself.  Such lawsuits have become more common in recent years and it is important for Directors, Officers,  shareholders, insurers, employees, creditors, suppliers and financial advisors to understand what derivative actions are and what risks they present.  It is also important that directors and officers understand the basic rules of derivative actions as well as their fiduciary duties so that they can make it much more difficult to be sued in a derivative case, since they never know when they may become a target of  such a claim.  There are unique features of derivative claims and limits on who may bring them.  As a result we will start with covering the most basic rules that are applicable to these actions and some features of corporate governance that are highly relevant.  We note that the rules relating to these actions vary from state to state. Delaware law is  very influential and New York  and California law are also important sources of legal developments.  We will explain the procedural rules without listing every variation among states and we think we have achieved what we intended in informing directors and officers on the nature purpose and risks of derivative claims by focusing on the most common and important provisions of statutory and case law.


The authority within a corporation to commence lawsuits including derivative actions belongs to the board of directors.  It is within the power of the board to decide to bring a claim, or not  to bring one, on behalf of a corporation for damages or some other wrong or harm the corporation has suffered.  To qualify as part of the basis for a derivative claim, the damages or injury must be to the interests of the corporation itself.   

The Board of Directors has broad discretion to make decisions for and act on behalf of a corporation.

A board of directors generally has the ultimate authority to make decisions for a corporation including in particular the decision whether to commence litigation.  This is the case unless a majority of the board lacks independence on an issue or the majority of the board has conflicts of interest on an issue, or authority has been delegated by the board to either senior management or, more likely, to a board committee such as a special committee with no conflicts or self-interests in connection with the matter.

In general delegation of authority is permitted if it is reasonable under the circumstances to delegate the issue.  If it is delegated by the board, it should be done in a detailed  and careful description of the scope of delegated authority, recorded in a board resolution adopted by  a majority of the independent board members and the delegation is made and voted on  in good faith.

Decisions including on delegation, by independent directors of a board, or a special committee, which are consistent with their fiduciary duties of care and loyalty and oversight are usually protected by the business judgment rule as long as the board members are independent on the issue in question, they do not have a conflict of interest, the voting board members have been adequately informed of the relevant facts, and they act in what those directors believe is a reasonable way and in good faith.

The claims that are most often brought against corporate directors and officers for wrongdoing are for alleged failures to observe their fiduciary duties of care, loyalty and oversight and include, inter alia, breach of fiduciary duty, failure of oversight, usurpation of corporate opportunities and waste of corporate assets.

The Business Judgment Rule

The business judgment rule is a legal presumption that protects corporate directors and officers who have no personal interest in the outcome of board issues or actions, and who, while reasonably informed, act in good faith and with an honest belief that they are taking such actions with the lawful and legitimate interests of the corporation and shareholders in mind.  Directors and officers who meet these criteria, will normally have protection from liability for breaches of fiduciary duty under the Business Judgment Rule.

This doctrine is a common law rule which is based in part on the concept that courts are ill-equipped and infrequently called upon to make business judgments on how corporations should be run or managed.  Judges generally recognize that officers and directors  of corporations are more familiar with and better informed of what is best for the operation of the business than judges.

Courts afford great deference to board actions taken by independent directors and non-conflicted directors who are reasonably informed on the issue in question and act in good faith in accordance with the duties of care, loyalty, and oversight.

The business judgment rule presumption is rebuttable and may be rebutted by evidence that the directors breached a fiduciary duty by engaging in self-dealing, making decisions tainted by conflicts of interests, or acting fraudulently, dishonestly, or in bad faith, or failing to act with reasonable diligence in informing herself of relevant facts and circumstances.

D&Os’ Fiduciary Duties to Corporation and Shareholders

Duty of CareDuty of Loyalty
Duty to Disclose/CandorDuty of Oversight

Duty of Care: Directors must act in good faith and with care to set up systems of information flow in order to be reasonably  informed in taking actions necessary to make informed, thoughtful and educated decisions on behalf of the corporation.

Duty of Loyalty: Directors must act in the best interest of the corporation and its shareholders. Corporate interests should take precedence over any personal interest of a director, officer or controlling shareholder

Duty to Disclose/Candor: When the board decides to ask shareholders to vote on an issue or a vote is required, directors must stay informed on efforts to fully disclose to shareholders  all material and relevant information within the directors  knowledge after reasonable inquiry

Duty of Oversight:  The duty of oversight has been the subject of a number of cases recently, which apply to oversight by both directors and officers.  With respect to directors, the Marchand case in Delaware has clarified the duty of oversight to include establishing reasonable information flow systems to assess the adequacy of directors meeting their obligations to cause themselves to be informed on a regular basis about material issues and risks within the corporation. Recently cases have also confirmed  that officers have similar obligations. Post Marchard oversight claims are less often dismissed early in a case as was previously quite common under the “Caremark standard.”[1]

Responsibilities of Directors

Subject to exceptions relating to those directors who lack independence, have conflicts of interest or by the delegation of responsibility on the issues to others, Directors are responsible for:

  • Making all major decisions on behalf of the corporation which have not been properly delegated to management or a committee
  • Seeing to it that the company has set up reasonable compliance and risk oversight systems that give regular reports to the board, particularly where the information involved is important for the board and officers to be knowledgeable about, in order to properly meet their respective duties and obligations.  Such systems should be set up with reasonable care and with a reasonable expectation on the part of the directors that the system will be adequate to keep board members and some officers, reasonably informed.
  • Determining overall business goals and objectives.
  • Overseeing utilization of resources and budgeting expenses.
  • Overseeing management of the business and deciding who will manage its daily operations.
  • Under the emerging law of oversight duties of directors’ it is important for directors and officers to be alert so as to identify and address promptly and with care significant risks to the corporation and its shareholders and other stakeholders, employees, its business, and its reputation and brand.

Duties of Officers

  • Fiduciary duties of officers of a corporation are similar to those of the board of directors but the breadth of the obligations are less broad and in some cases less stringent than those that apply to the board.
  • Clearly officers are expected to carry out the duties entailed in their employment and there is a great deal officers are expected to do and not to do.  Of most relevance in this article are the previously described instances where a board delegates responsibilities to an officer or officers
  • Clearly, officers are expected to carry out any such duties with care and loyalty to the corporation.  Self-dealing and letting personal interests outweigh the interests of the corporation will expose officers to liability for breach of the duty of loyalty.
  • Negligence with respect to duties assigned to an officer is a breach of the duties of care and loyalty and possibly, depending on the circumstances’ the duty of oversight. 
  • Recently, there has been an increase in the number of cases that have been filed by shareholder plaintiffs as derivative claims against individual officers who fail to carry out their duties with care and loyalty to the corporation‘s interests.

The Demand Requirement

In order for a shareholder to have standing to commence a shareholder derivative action, generally a shareholder must make a demand upon the corporation’s board of directors asking the board to pursue such claim.   A shareholder will be excused from making a demand if the court agrees with such shareholder that a demand would be futile.

  • The laws of Delaware, New York and many other states require that the complaint set forth with particularity the efforts of the plaintiff to secure the initiation of such action by the board or state with particularity why it would be futile to make such a request. It is often  not easy for shareholders to convince a court that a demand not made would have been futile. In any case the shareholder must  set forth   the reasons for not making a demand.
  • Although corporate law provides individual shareholders with recourse when they are treated unfairly by the board or overruled by the majority of the shareholders, minority shareholders are not empowered unilaterally to effect changes in corporate policy.
  • Where individual shareholders seek to take control from the board of the decision on whether to commence litigation they are required to meet the demand requirement that they demand the board bring the claim.
  • That requirement reflects the basic principle of corporate governance that the decisions of a corporation–including the decision to initiate litigation–should be made by the board of directors or the majority of shareholders.

Making a proper demand

  • Demand should generally be made on the board of directors.[2] Communications to other parties, e.g., corporate officers, shareholders, or attorneys, may not be considered effective. Not all states provide any specific instruction for making demand and courts have held that the “[d]emand to sue need not assume a particular form nor need it be made in any special language.”
  • At the same time, courts require that the demand be made in “earnest, not a simulated effort. …”.  A demand that simply recites “well-publicized business setbacks and problems … without indicating with any specificity the causes of action available to the corporation or those persons potentially liable,” will not likely be considered adequate.

Although demand may be made orally, it is best to make the demand in writing and it is common  to do so. As a practical matter, it should be addressed to the board of directors as a group, to the chairman of the board, or to the board through the chairman, and sent to the corporation’s principal place of business. The demand letter should:

(1) identify the alleged wrongdoers;

(2) describe the factual basis of the allegations of  wrong doing and the harm caused to the corporation;

(3) request that the directors bring suit against those culpable;

(4) provide the directors with sufficient time to consider and act upon the demand; and

(5) indicate if it is the case that litigation likely will result if the board improperly refuses to sue.

(6) the allegations set forth in the demand letter should be detailed, not conclusory.

(7) moreover, while certainly not required, a draft of a complaint delivered to the directors can sometimes also be helpful in demonstrating that the demand is made with particularity and clearly and directly informs the directors of the plaintiff-shareholder’s claims and intentions. This process may in some cases open up channels of negotiation between interested parties.

Because the judiciary prefers that the shareholder and the corporation attempt to pursue reasonable, it is expected that following demand, the shareholder “must make reasonable efforts to assist the corporation” in investigating the claims.

Waiver of the right to claim futility

In some states, including Delaware, if a plaintiff-shareholder makes demand upon the board, he or she waives the right to claim demand futility in the future in that case and moots any such arguments made in the case in the past.  Practitioners should carefully consider the applicable law in the relevant state and the pros and cons of serving a demand upon the board. See a later section for a description of the Internal Affairs Doctrine for information on the applicable law.

The Corporation’s Response to a Demand

Once the board of directors is apprised of a demand, its role is to determine the course of conduct that is in the best interests of the corporation. While the directors are under no obligation to go forward with litigation, they do have a fiduciary duty to consider carefully, and often investigate, the claims raised by a shareholder and any corporate interests that will likely be affected by a law suit. With that in mind, the shareholder should allow the directors a reasonable amount of time to complete their analysis of the claims and decide upon a course of action.

Board Committees

Where appropriate on conflict and independence grounds, the board may delegate authority to conduct the inquiry to an existing committee such as the audit committee or risk committee if independent on  the issue or a special litigation committee composed of independent board members.  Among additional desirable characteristics of committee members are.  In making the determination that of who should be a member of a special committee, the board should consider the expertise of any likely candidate or candidates and make sure of the absence of any conflict of interest or domination by a controlling party of the candidate.  Other factors to considering selecting committee members include their having sufficient time to devote to meet their duty of care, experience as a board or committee member, expertise on an issue and, importantly, having good judgment.  There are two common types of delegations: (i) a delegation to investigate and report back to the board with a recommendation for further action and (ii) authority to make a decision on the issue in question including whether or not to prosecute a lawsuit. 

The Role of Counsel to A Board Committee

  • Generally, a committee (particularly a special committee) will retain outside counsel who are not closely tied to the corporation or the board members and is not conflicted, to advise it on best practices for board committees, how to maintain the committee’s independence, avoid conflicts of interest and corporate governance principles.
  • Committee counsel should explain fiduciary duties, including the fiduciary duties of care, loyalty and oversight
  • Committee counsel should also educate the committee on privilege and how to preserve privilege.

From the time the demand is made, the corporation’s counsel (not committee counsel) should advise the full board of its responsibilities and fiduciary duties. Counsel should also:

  • Determine the extent of the directors’ and officers’ insurance coverage for the claim and whether or not an insurance carrier should  be notified.
  • Consider whether delegation to a committee is in the best interests of the corporation and whether directors and officers have interests sufficiently divergent from those of the corporation that they should retain separate counsel.
  • Corporate counsel, or committee counsel as the case may be, should also communicate in writing with shareholder’s counsel to inform them that the board of directors has been advised of the demand and, as many demand letters fail to provide necessary information, demand that shareholder submit missing details regarding the allegedly improper behavior.
  • In some situations, the board may undertake the lawsuit which is the subject of the demand and sue on the corporation’s behalf. Often, however, the board will refuse demand, which is highly likely to lead to the filing of a derivative complaint by the plaintiff-shareholder against board members and/or officers and or third parties.

Demand refusal

Once a board of directors refuses to initiate suit, a plaintiff-shareholder will likely file a derivative complaint for the benefit of the corporation often essentially repeating the allegations already made to the board in the demand letter.

  • The corporation then has the option to move to dismiss the complaint which should be based on the board’s business judgment that the suit is not in the best interests of the corporation. 
  • The shareholder may counter the motion to dismiss by arguing that refusal was wrongful or self-interested and that their complaint states a claim. 
  • While the demand requirement necessitates that a plaintiff plead with particularity that a demand was made or the specific reasons why no demand was made, there is no such pleading standard requiring allegations that the board wrongfully rejected the demand. Board members, as described must meet their fiduciary duties described above
  • If the refusal was issued by a special litigation committee, a shareholder can try to establish that the committee’s refusal was wrongful if the shareholder can successfully challenge the independence of members of the committee or the appropriateness of the investigative procedures chosen and pursued by the committee. 
  • On the other hand,, courts are generally deferential to those to whom the business judgment rule applies.

The Contemporaneous Ownership Rule

In addition to a demand, under New York law and the law of many other states, only complainants who were shareholders at the time of the filing of the action and at the time of the challenged transaction or board action have standing to bring a derivative action. 

  • A claim may be brought under the rights of a domestic or foreign corporation to procure a judgment in its favor, by a holder of shares or of voting trust certificates of the corporation or of a beneficial interest in such shares or certificates.

Applying this statute

  • Some courts have held that the shareholder does not need to be a stockholder of record; it is sufficient if he or she is the equitable owner of the stock. 
  • In many cases a trustee of a trust holding stock in a corporation is entitled to institute a shareholder derivative action as a Trustee  on behalf of that corporation unless otherwise disqualified.  Importantly, the percentage interest or the value of the plaintiff’s holdings of stock is irrelevant to whether there is a right to bring an action.
  • The policy underlying the requirement of ownership of stock at the time of the alleged wrongdoing and at the time of the transaction under the “contemporaneous-ownership” rule, is twofold:
  • (1) to prevent potential derivative plaintiffs from ‘buying a lawsuit’ by purchasing stock; and
  • (2) to insure that derivative actions are brought by shareholders who have actually suffered injury and have an interest in the outcome of the case.”  Because the contemporaneous ownership rule seeks to foster public policy by discouraging speculation in litigation, it is usually rigorously enforced.
  • Some courts, however, have recognized a limited exception to the contemporaneous ownership rule where the plaintiff alleges a continuous wrong. Under the “continuous wrong” theory, a plaintiff can challenge a corporate action that occurred before he or she became a shareholder if that action was part of a continuing fraud or impropriety that had begun but had not concluded at the time the plaintiff became a shareholder. 
  • In determining whether a wrong complained of is a continuous one, courts examine when the specific acts of the alleged wrongdoing occurred, not when their effect was felt.

The requirement that ownership continue until commencement of the derivative action is rooted in practical considerations.  Although in a theoretical sense a derivative action is brought for the benefit of the corporation, in order to avoid plaintiffs who are not engaged in achieving a benefit for the corporation plaintiff-shareholder should have some interest in the recovery by the corporation.  In many states, where the shareholder voluntarily disposes of the stock or loses title to his stock, his rights as a shareholder cease, and his interest in the litigation is also lost.

Security for Expenses

To attempt to reduce nuisance or strike actions by small shareholders, a small number of states have enacted statutes which require that, in shareholder derivative actions instituted or maintained by less than a certain percentage of shareholders of the corporation or by shareholders whose aggregate holdings are less than a certain amount, that the corporation must require the plaintiff or plaintiffs to give security for expenses, which may be incurred by the corporation in connection with such action and by other parties in connection therewith for which the corporation may become liable.

Double and Multiple Derivative Litigation

Double and multiple derivative litigations are complex forms of shareholder litigation recognized in New York and a number of other states involving actions initiated by a shareholder of a parent company because of harm done to a subsidiary of the corporation which is adversely affected by the injury to the subsidiary.

As noted above, the primary purpose of derivative litigation is to address wrongs committed against a corporation.  In many derivative lawsuits, a shareholder is suing on behalf of the corporation allegedly because the directors or officers have failed to take appropriate action in the face of demand by the shareholder that they do so against a perceived wrongdoing.  The shareholder essentially stands in the shoes of the corporation, and any recovery goes to the corporation, not to the individual shareholder initiating the lawsuit.

  • In a double derivate action, a shareholder of a parent corporation sues on behalf of a subsidiary corporation for wrongs committed against the subsidiary. 
  • The need for double derivative cases arises when the parent corporation controls the subsidiary, and the directors or officers of the parent corporation refuse to bring a suit on behalf of the subsidiary. In that situation a shareholder may be able to sue on behalf of the subsidiary.
  • Multiple derivative litigation extends this concept even further, with a shareholder in a parent corporation suing on behalf of a subsidiary of a subsidiary. 
  • Such double derivative and multiple derivative cases are relatively rare but may occur in complex corporate structures where layers of ownership and control create obstacles to addressing wrongs affecting subsidiaries or a subsidiary of the subsidiary

There are ongoing debates among legal scholars and practitioners about the appropriateness of double and multiple derivative actions.  Some argue that these suits provide an important tool for shareholders to hold corporate directors and officers accountable, particularly in complex corporate structures.  Others, however, worry that they can be misused and can lead to excessive litigation, or undermine the deference traditionally given to the decisions of corporate directors under the business judgment rule.

Investigation and Discovery

Before making a demand, shareholder plaintiff’s counsel and defense counsel should make as thorough as reasonably possible a review of public sources for factual information by searching through all available public and private information, “including media reports, internet information, relevant corporate filings, and when permitted … counsel should interview persons with knowledge of the allegations.”  States vary in pre-complaint document review permitted to shareholders. New York for example, allows shareholders both a statutory and a common-law right to inspect the corporation’s minutes and certain other corporate documents. 

Internal Affairs Doctrine 

This doctrine is the law in many states including Delaware and New York. 

  • Pursuant to the doctrine, “claims concerning the relationship between the corporation, its directors, and a shareholder,” such as shareholder derivative actions, “are governed by the substantive law of the state or country of incorporation” of the corporation at issue.
  • Where the corporation is a foreign corporation, the law that governs is the law of the country of incorporation. 
  • The basic reasoning behind the Internal Affairs Doctrine is that, by choosing to incorporate in a particular state or country, the shareholders of a corporation have made a choice, for their own reasons and considerations, as to what law will govern the internal affairs of the corporation and the conduct of its directors, officers and shareholders.
  • Having made that choice, a corporation and its directors, officers and shareholders have a right and reasonable expectation that the laws of such state will be applied to any derivative action or other internal corporate affairs dispute that may arise against them or the corporation.
  • Federal diversity jurisdiction requires that the amount in controversy in a federal diversity claim must exceed $75,000.  In determining whether the suit meets the amount in controversy requirement, courts examine the amount at stake for the corporation, rather than for its individual shareholders. Because the shareholders in a derivative suit enforce rights that belong to the corporation, the amount of each individual shareholder’s interest is not relevant.

10 Practical Takeaways for the Board

  1. Engage Counsel:  The Board should make sure existing board counsel is familiar with shareholder demands and derivative litigation.  If not, it should retain new counsel for this assignment.
  2. Assess Board Composition and Qualifications:  The board should periodically evaluate its composition and the corporate structure and  the charter of the company to determine whether there is sufficient experience and expertise and diversity on the board to address relevant issues facing the company; assess whether any board members are conflicted and make sure there is an absence of conflicts on the part of board members.
  3. Assess Whether Board Members are Controlled by a Conflicted Controlling Person: The board needs to determine whether a Controlling Person could or would adversely affect the board’s ability to act in accordance with its fiduciary duties of care, loyalty or oversight.  The duty of loyalty requires that directors always keep the best interests of the corporation as their primary goal when assessing options in decision-making and not their own personal interests.
  4. Delegation of Authority:  The board should determine what topics or issues it should reasonably delegate to a special committee, to another committee of the board, or to management.  In making the determination of who on the board should be on a special committee, the board should consider the expertise of any likely candidate or candidates and, in particular, make sure of the absence of any conflict of interest and of any domination by a controlling party on the part of the candidate.  Other factors to consider in selecting committee members include having sufficient time to devote to meet their duty of care, experience as a board or committee member, expertise on an issue and, importantly, having good judgment.
  5. Counsel for a Committee: In addition the committee should be sure its choice of counsel is familiar with derivative litigation and demands.  If not, the board should consider retaining different counsel for this assignment.  It is a specialized field.
  6. Hire Outside Experts: The board or committee charged with oversight of an issue should consider hiring subject matter experts  to deal with technical and difficult issues for example dealing with the adequacy of  cybersecurity measures.
  7. Reporting Structures for Risks to the Company:  In order to comply with its duty of oversight, the board must arrange for an adequate information flow to that board.  In doing so, the board must carefully consider what information it needs to properly oversee risks and build reporting structures for important business issues, particularly mission critical business issues that the company faces, as well as how it will receive that information in time to make it useful for the benefit of the corporation and the board decision-making process.
  8. Create and Review Internal Controls:  The board should ensure that an adequate system of internal controls exists or should properly create such a system of controls.  Sufficient internal monitoring of compliance with company policies and government laws and regulations should be in place.  The board should perform assessments of these internal controls and regularly get the report of an expert on such controls and understand how the company performance compares with industry standards.
  9. The Board and Company Policies:  The board should adopt and fully  understand significant company policies and procedures and understand how management is engaging with the corporation’s shareholders.  They should keep in mind the corporate purpose adopted by the company.  The board should also consider information flow to and, depending on the corporations’ corporate purpose, the treatment of other stakeholders such as employees, investors, customers, business partners, suppliers, the environment, the value of diversity and other factors.
  10. The Board Should Evaluate The Performance of Senior Management Regularly:  As a part of its duties of oversight and care, the board, or a board committee, should perform regular reviews of the performance of senior management and take reasonable steps to improve performance where needed.

[1] Gregory A. Markel et al., A Director’s Duty of Oversight after Marchand in C HARV. L. SCHOOL FORUM ON CORP. GOVERNANCE (Jan. 23, 2022),

[2] Ferrara et al., Shareholder Derivative Litigation: Besieging the Board §4.03[1] at 4-10 (2014). States “Note that Fed. R. Civ. P. 23.1 allows demand to made upon the board or upon any other “comparable authority.” Nevertheless, the federal courts have permitted demand only upon the board, rejecting as insufficient demand upon corporate officers or counsel. If the corporation is in bankruptcy, however, demand under Rule 23.1 also may be considered proper if demand is made upon the receiver or trustee. Demand upon the trustee of a bankrupt corporation also may be appropriate if the derivative action will be filed in state court.”