Derivative lawsuits present a unique set of challenges for small and mid-size businesses. These lawsuits, where shareholders, members or partners sue on behalf of the company, typically alleging that the company’s management or directors have failed in their fiduciary duties, leading to harm to the business. In Colorado, bringing and defending against these claims requires a deep understanding of both state and federal substantive and procedural laws, as well as the ability to navigate complex legal strategies. Enlisting the help of an experienced attorney is essential for businesses facing shareholder derivative actions from either side.
Understanding Derivative Lawsuits
In a derivative lawsuit, the plaintiff, usually a shareholder (but can be LLC member or partner) asserts claims against the company’s directors or officers. These lawsuits are brought not technically for personal gain but rather *on behalf of the company* to rectify a wrong done *to the company* (not, necessarily to the shareholder directly). Common claims include breach of fiduciary duty, mismanagement, and fraud.
Relevant Rules and Statutes
In Colorado, shareholder derivative lawsuits are governed by both the Colorado Business Corporation Act (CBCA) and the Colorado Rules of Civil Procedure (C.R.C.P.).
Colorado Business Corporation Act (CBCA)
The CBCA, specifically C.R.S. § 7-107-401, outlines the requirements and procedures for initiating a derivative suit. Key provisions include:
- Demand Requirement: Shareholders must first make a demand on the board of directors to address the alleged misconduct before filing a lawsuit. The board then has 90 days to respond, unless the shareholder can show that waiting would cause irreparable harm to the corporation.
- Standing: The plaintiff must have been a shareholder at the time of the alleged wrongdoing and must remain a shareholder throughout the litigation.
- Security for Costs: In some cases, plaintiffs may be required to post a bond to cover the corporation’s legal costs if the court finds the lawsuit to be frivolous. C.R.S. 7-107-402(3)
Colorado Rules of Civil Procedure (C.R.C.P.)
The procedural aspects of derivative lawsuits are covered under the C.R.C.P., particularly Rule 23.1 and applying caselaw, which details the requirements for pleading a derivative action. This includes:
- Detailed Allegations: Plaintiffs must provide specific allegations of the efforts made to obtain the desired action from the board or the reasons why such efforts were not made.
- Verification: The complaint must be verified by the plaintiff, ensuring that the claims are made with factual support.
Challenges in Defending Derivative Lawsuits
Defending against a shareholder derivative lawsuit or member/partner derivative claims is complex and can be particularly challenging for small and mid-size businesses. Here are some of the key challenges:
1. Complex Legal Standards
The legal standards governing fiduciary duties, including the duties of care and loyalty, are nuanced and require a sophisticated understanding of corporate governance. An experienced attorney can help navigate these standards and build a robust defense.
2. Demand Futility
One of the first hurdles in a derivative lawsuit is whether the demand requirement was met or if the plaintiff can demonstrate demand futility – that making a demand would have been pointless because the board was incapable of making an impartial decision. This requires intricate legal arguments that an attorney is best equipped to handle.
3. Discovery Process
The discovery process in derivative lawsuits can be particularly burdensome. Plaintiffs will seek extensive documentation and communications from the corporation, which can be time-consuming and costly to produce. Experienced counsel can manage the scope of discovery, protecting the corporation from overly broad or irrelevant requests.
4. Potential Conflicts of Interest
Derivative lawsuits often involve conflicts of interest since the directors or officers being sued are usually still part of the corporation’s management. An attorney can help navigate these conflicts, ensuring that the defense strategy aligns with the best interests of the corporation as a whole.
5. Settlement Negotiations
Given the high costs and risks associated with litigation, settlement is often a viable option. Attorney involvement can assist with negotiation of favorable settlement terms, potentially including changes in corporate governance practices to prevent future issues.
Conclusion
For small and mid-size businesses in Colorado, the complexities of defending a shareholder derivative lawsuit or derivative suits by members or partners are additional legal and procedural complexities that ordinary business disputes (such as breach of contract claims) simply do not face. From navigating the intricacies of the applicable corporate code and rules of procedure to managing the procedural and substantive challenges of these claims, legal counsel plays an indispensable role in protecting the corporation’s interests. Early involvement by experienced business counsel can effectively address these lawsuits, mitigate risks, and focus resources appropriately.