The Survival of the Derivative Suit: An Evaluation and a Proposal for Legislative Reform

Abstract

The shareholder derivative suit today faces extinction. Long considered the "chief regulator of corporate management," and a recognized form of litigation in American courts at least since 1855, it now confronts the second great challenge of its history. Thirty-odd years ago, commentators foresaw the derivative suit's demise when state legislatures began adopting security-for-expenses statutes to curb the abuses of "strike suit" litigation. These reports of its death proved exaggerated, however, as plaintiffs discovered various tactics by which to outflank these statutes. As a result, by the late 1960's, the crisis was past, and a revival in the action's popularity was duly noted by leading academics.\nToday, the new threat is judicial, rather than legislative, and if the prophecies of doom are again to prove false, countervailing legislation may be necessary. In the aftermath of the Supreme Court's decision in Burks v. Lasker, a number of courts have upheld the capacity of disinterested directors, in the exercise of their business judgment, to terminate a derivative suit on the grounds that it is adverse to the corporation's best interests. As a practical consequence of this extension of the business judgment rule, a veto power over derivative actions may now rest with a corporation's often only nominally independent directors.\nWhat has caused this transition? Curiously, no court has explicitly reevaluated the derivative suit, condemned it on policy grounds, cited any new consideration, or even reached any legal conclusion that could be described as original. Rather, the basic process has been a triumph of legal formalism: in theory, the derivative action asserts a corporate right, and hence, as a matter of formal logic, the right should be one that the board can waive or compromise. Such a conclusion has the force of logic, but not of experience. Realism suggests that an unqualified recognition of such a power may make the derivative suit an endangered species of legal action.

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