Although the board of directors of a corporation wields considerable authority over corporate affairs, shareholders are a corporation's ultimate authority. Shares represent ownership stakes in a corporation and when corporate directors undertake actions that harm the corporation, they harm the value of corporate shares. U.S. law authorizes shareholders to sue corporate directors for wrongful acts that harm the corporation or the value of its shares. These are called shareholder class actions and shareholder derivative suits.
Corporate directors are subject to the fiduciary duties of care and loyalty. The duty of care requires a director to exercise due care when managing corporate assets. The duty of loyalty requires a director to avoid undisclosed conflicts of interest. Generally, he may not engage in self-dealing by profiting from acts undertaken on behalf of the corporation, other than to receive any compensation authorized by the corporation. This rule is sometimes relaxed when the transaction in question is also approved by disinterested parties. A board may also generally may not take advantage of any business opportunities received as a result of its relationship to the corporation. Fiduciary duties can be used to define many different types of wrongful acts that may or may not be explicitly prohibited by statute but it generally fiduciary duty means that the board member must put the interests of the corporation before his own individual interests.
The Business Judgment Rule
The "business judgment rule" insulates a director from liability for simply making bad decisions. As long as he can establish that he acted in good faith, did not engage in self-dealing, and kept himself reasonably well-informed of corporate activities, he is likely to be protected by the business judgment rule. The purpose of the business judgment rule is to allow directors room to exercise independent judgment without having to fear a lawsuit by someone who disagrees with their decision or who is disgruntled by its ultimate outcome.
Two types of lawsuits against directors may be brought by shareholders: shareholder class action lawsuits and shareholder derivative lawsuits. The difference between the two is largely a difference in form. In a shareholder class action lawsuit, a shareholder is appointed to represent a class of plaintiffs, namely, the other shareholders of the corporation who have been harmed by the actions of the defendant director. Shareholder class action lawsuits are particularly useful for action against directors of large public companies that have thousands of shareholders. In a shareholder derivative lawsuit, a shareholder represents the corporation itself, rather than its shareholders, and sues for a wrong committed by the director against the corporation itself for which the corporation refuses to seek redress, or "make right." Before filing a shareholder derivative lawsuit, the shareholder must first demand that the corporation redress the injury, unless such a demand would be obviously futile. The shareholder may sue the director on behalf of the corporation only if the corporation -- effectively, its directors and officers -- refuse to redress the harm for which the lawsuit is to be filed.
Read More: What Happens to a Shareholder in a Dissolved Corporation?
Although most lawsuits against individual directors are filed by shareholders, non-shareholders may sue individual corporate directors if they have been personally harmed by the actions of the defendant. Harm to the corporation or to its shareholders is not grounds for filing a lawsuit by a third party. Directors can face civil liability for a variety of wrongful acts such as breach of employment contracts, defamation, sexual harassment and fraud.
- Advisen: Shareholder Derivative Suits: A Growing Concern for Corporate Directors and Officers
- Robbins Umeda LLP: Shareholder Derivative Litigation
- Oganization for Economic Cooperation and Development: The Principal Fiduciary Duties of Boards of Directors
- USLegal: Business Judgment Rule
- AICPA Member Insurance Programs: So You've Been Asked to Sit on a Board of Directors: Are you Aware of Your Personal Liability?
David Carnes has been a full-time writer since 1998 and has published two full-length novels. He spends much of his time in various Asian countries and is fluent in Mandarin Chinese. He earned a Juris Doctorate from the University of Kentucky College of Law.