Boards exist to protect shareholders based on the fiduciary duties of care, loyalty, and good faith. If shareholders feel that those duties have not been met by a board or board member, they can take legal action against them.
The “business judgment rule” protects boards and board members from lawsuits for simply making bad choices. As LegalMatch shares, “The business judgment rule requires that courts defer to the board of directors in business matters.
The only exception to the business judgment rule is if shareholders can show that the board of directors engaged in fraud, illegal activities, or were grossly negligent while managing the corporation.”
In other words, boards are afforded the right to make bad business choices as long as there is evidence they were acting in good faith. If there is a belief that the board or a board member has engaged in one of those wrongful practices, there are two options for types of shareholder lawsuits: a direct lawsuit (also called shareholder class action lawsuit) or a derivative lawsuit.
With direct lawsuits, “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.” In this type of suit, the designated shareholder-plaintiff seeks to prove a degree of personal harm committed by the corporation.
When this occurs, the defendants of the case usually include the board of directors as well as the corporation itself. These types of cases often include hundreds or even thousands of shareholders.
Derivative lawsuits are different in that “an individual or shareholder of the corporation would bring suit against the corporation on behalf of the corporation, rather than as an individual person. Derivative suits are usually brought against insiders of the corporations like directors, officers, board members who have been accused or suspected of acts that caused harm against the corporation.”
To put it more simply, a shareholder files a suit on behalf of the corporation against a person or party who has injured said organization. According to Justia, derivative lawsuits have an additional prerequisite.
“State laws and federal procedures almost universally require that the shareholder show that he or she attempted to bring the problem to the attention of company’s directors, but they chose not to pursue the action.”