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Suing the Directors: Derivative Litigation in California

What is it? A derivative action is the only remedy for shareholders where the defendants are in control of the corporation and, of course, have no interest in suing themselves. Unlike most lawsuits, the plaintiff does not seek recovery for self in a derivative lawsuit, but rather in behalf of a corporation of which plaintiff is a shareholder. Plaintiff sues in the name of the corporation for a wrong done to the corporation by one or more directors or officers. If the suit is successful, judgment is entered for the corporation and against the executives. CAL CORP. CODE ? 800.

Abusive Use and Correction Derivative lawsuits were initially a vehicle for abuse of corporations by plaintiff-shareholders seeking a shakedown (sometimes called a "strike suit"). Procedural protections for the executives were later added to the statute in an attempt to balance the rights of the parties. Before filing the lawsuit, plaintiff is now required to make demand on the executives to give them an opportunity to cure the wrongful acts. Failing demand, the plaintiffs must plead and prove that demand would have been futile, as for example when all directors of the corporation are alleged malefactors.

Demand for Bond The plaintiffs have an additional hurdle to leap: The defendants may move to require plaintiffs to post a bond of up to $50,000 against defendant's litigation expenses. The principal statutory grounds for requiring a bond are that "there is no reasonable possibility that the prosecution of the cause . . . will benefit the corporation or its shareholders." Most defendants in the reported cases seek a bond only for failure of demand or futility, likely because that may be the only factual basis that will meet the high standard of proof--"no reasonable possibility."

If the bond is not posted, the action must be dismissed. In the ruling California case, a poorly reasoned opinion held that such dismissal is without prejudice. F.N. Nevertheless, in these cases such dismissal cannot ordinarily be overcome, as plaintiff cannot amend and claim demand was made before the initial filing, when the bond hearing had determined that it was not. Query: For this reason would a plaintiff be better off not to appear at the bond hearing?

After a decision requiring a bond, plaintiffs have sought to circumvent it by dismissing their own case without prejudice, hoping to file a new lawsuit after making demand. C.C.P. ? 581(b and c). Such dismissal should be prohibited under C.C.P. ? 581(i) as the defendant's motion for a bond should be deemed a seeking of affirmative relief. F.N. Ensher v. Ensher, Alexander and Barsoom, 187 C.A.2d 407 (1960) (C) B. Keith Martin 2011

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