Shareholders own the corporation, but the directors and the officers they employ run it. Making sure that corporate officers act in the best interests of the shareholders, who own the company, rather than themselves, is one of the fundamental problems of corporate law.
A corporate officer has a fiduciary duty to the corporation and must put the corporation’s interests ahead of her own. There is a wealth of court decisions and scholarly literature examining the scope of that duty. Briefly, corporate officers have:
A duty of loyalty: They must act in the corporation’s best interest. In particular, they cannot put their own interests ahead of the corporation’s. Thus, for example, they cannot make corporate decisions for their own benefit rather than that of the corporation. Nor can they take advantage of a business opportunity personally when the opportunity would benefit the corporation. And, of course, they cannot use or take corporate assets as their own.
A duty of care: While there are different formulations of this rule, basically, a corporate officer must care for the corporation’s business and property with the same care and diligence as if it were her own. However, corporate officers are—in general—protected by the business judgment rule, which means that when there is no evidence that the officer has a personal interest in a decision (for example, she would personally profit by it), and provided that the officer took steps to inform herself of the facts and acted in good faith, a court will give great deference to her decisions.
What Can You Do?
The directors can discharge an officer who is harming the corporation. And, if the corporate officer has harmed the company, the company can sue her.
But what about you, a shareholder? Other than pressuring the directors to act (or replacing them), what can you do?
In certain circumstances, a shareholder can bring a lawsuit on behalf of the corporation against the corporation’s officers or directors for harm they have caused to the corporation. This is called a derivative action.
The rules for derivative actions vary based on the state in which the corporation was formed, but normally, before you bring a derivative action, you have to show that (1) you made a demand on the board of directors that they act or (2) you should be excused from making the demand for just cause, such as where the directors are implicated in the wrongdoing, so you would be asking the board to sue itself. Typically, if you make a demand on the board and it decides not to take the action you demanded, you could be liable for the corporation’s legal expenses if you persist in the suit.
If you go forward with the lawsuit, it is generally like any other lawsuit, except that you would be litigating a claim on behalf of the corporation, not yourself. This is an important distinction, because the claim is the corporation’s and the recovery goes to the corporation, not directly to you.
If the recovery goes to the corporation, not you, why should you take the time and expense to bring a derivative action? The short answer is that sometimes this is the only way you can protect your interests as a shareholder. And, if you are successful, the corporation might be ordered to pay your legal fees, so it may end up not costing you anything.
The decision on what to do when you think a corporation’s management is not acting in the corporation’s best interest involves many issues. And there are several ways of addressing this situation, including a derivative action, which is sometimes is the only way a shareholder can protect her interest in a corporation. We have extensive experience in counselling clients on this decision. We would be happy to help you if you believe that an officer of a corporation you own is taking advantage of the corporation.