SLG Provides Years of Experience in Delaware Stockholder Litigation
Filing lawsuits and being sued are not pleasant experiences. If you are a stockholder, suing the people you elected to run your company can bring about a whole host of mixed feelings. If you are a member of corporate leadership, being sued by the people who elected you can damage your reputation overnight and prompt your business decisions to be questioned in open court.
It is important to note that Delaware law permits stockholder litigation to move fast. Directors may find themselves under the yoke of court orders before they even realize what is going on.
At Shlansky Law Group, our attorneys help litigate these issues in court. We help our clients enforce their rights that are enshrined in Delaware law. These cases often play out quickly and aggressively, which is why you need experienced legal counsel. Call us today at 347.378.6990.
What Stockholder Litigation Actually Entails
Delaware law makes it clear that stockholders may own the company, but the directors are the ones who run it. If the stockholders make a bad business decision that costs the company millions, that is not enough to bring a lawsuit.
But if the directors acted in bad faith or violated one of their many fiduciary duties, then stockholders can absolutely sue the board. Delaware stockholder litigation can be done through two different means: directly or derivatively.
Direct claims make the most intuitive sense. They often arise when a stockholder claims that the company has directly harmed them. For example, if the company intentionally and improperly diluted an individual stockholder’s specific class of shares to freeze them out of their future profits, the stockholder has suffered direct harm. Thus, that stockholder can make a direct claim against the company.
Derivative lawsuits are a bit counterintuitive at first. In a derivative suit, a stockholder steps into the corporation’s shoes to sue the board of directors. The logic goes like this: “The board hurt the company. The company should sue the board to recover the money. But since the board controls the company, they are not going to sue themselves. Therefore, I, as a stockholder, will sue the board on behalf of the company.”
If the stockholder wins a derivative suit, he does not receive damages. Rather, the money recovered goes back into the business’s treasury. This is because the stockholder is suing on behalf of the corporation. So, the corporation is the one that gets the money. Stockholders receive indirect benefits through increased corporate value.
The Mechanics of Delaware Stockholder Litigation
Stockholder litigation under Delaware law does not look like standard civil litigation. You do not just file a complaint and start taking depositions.
Delaware forces stockholders to jump through intense procedural hoops to prevent frivolous lawsuits from strangling businesses. The biggest hurdle is the “pre-suit demand.” Because the board technically controls the company’s legal decisions, a stockholder must formally demand that the board file the lawsuit.
Obviously, a board is rarely going to agree to sue itself.
So, the stockholder must prove to the court that making the demand would be “futile.” To prove demand futility, the investor has to show that the directors are so deeply conflicted or corrupt that they could not possibly make an independent decision. If the stockholder cannot prove this, the judge dismisses the case outright. This is exactly where SLG often wins these cases for our corporate clients. We show the court that the board remains independent and fully capable of exercising its own business judgment.
How Delaware Stockholder Disputes Arise
Most stockholder litigation can be boiled down to one common accusation: the board breached its fiduciary duty to the business. The most common of these fiduciary duties are the duty of care and the duty of loyalty.
Mergers and Acquisitions (M&A) Cash-Outs
When a board sells a cash company, Delaware law requires the board to get the absolute highest price for the stockholders. Determining exactly what the “absolute highest price” is (and whether the board achieved it) often leads to litigation. These lawsuits often allege that company leadership failed in their duty to secure the highest price to enrich themselves.
Conflict of Interest Transactions
Directors have broad authority to run the business as they see fit, so long as they meet their fiduciary duty. Engaging in a transaction that benefits oneself at the company’s expense is probably the most blatant way to violate that duty. That transaction shows you were not loyal to the company and did not care about the company’s best interests.
However, conflict-of-interest transactions are not always so simple. For example, a director may lead a company seeking to acquire a manufacturing plant. That same director may also own significant shares of another company that is pivoting away from the manufacturing sector and wants to sell its manufacturing plant. If that director “greases the wheels” to get those two companies to enter a transaction, that is an immediate red flag. Even if the deal was fair in terms of price and process, proving that to the stockholders (and the court) is a risky endeavor.
Stockholder Litigation in Alternative Entities (LLCs and LPs)
A massive percentage of Delaware businesses are not traditional corporations at all. They are Limited Liability Companies (LLCs) or Limited Partnerships (LPs).
The rules change drastically here. Delaware allows LLCs to expand, restrict, or eliminate traditional fiduciary duties in their operating agreements. You can draft an LLC agreement that essentially says, “The manager can engage in severe conflicts of interest, and the members cannot sue them.”
Because of this contractual freedom, litigation in Delaware LLCs looks totally different. Instead of arguing about standard corporate duties, the fight focuses purely on the text of the operating agreement. Did the manager breach the implied covenant of good faith and fair dealing? Did the specific language of the contract actually shield the manager’s self-interested actions? At SLG, we constantly parse the specific wording of these agreements to figure out exactly what duties the managers owe to the members.
Steps a Business Can Take When Trouble Brews
Lock Down Your Documents Immediately
Implement a litigation hold the second you suspect a dispute. Stop deleting emails. Tell your IT department to suspend auto-delete protocols. When stockholders prepare to sue, they hunt for evidence. If board meeting minutes or text messages mysteriously disappear, the court assumes you destroyed evidence. You lose credibility instantly, and the judge will infer that the deleted documents contained proof of your wrongdoing.
Establish a Special Litigation Committee
If a stockholder alleges that the board is corrupt, you have a structural problem. The board cannot objectively investigate itself. The best strategic move is often forming a Special Litigation Committee (SLC).
You appoint independent, disinterested directors (ideally newly elected ones who had absolutely nothing to do with the bad deal) and give them sole power to investigate. If the SLC determines the lawsuit lacks merit, they can ask the court to dismiss it. Delaware Chancellors take SLC recommendations seriously, but only if the committee actually did real, exhaustive investigative work. A rubber-stamp committee will get thrown out of court.
Review D&O Insurance Policies
Directors and Officers (D&O) insurance covers your legal defense costs. The moment you get wind of a stockholder dispute, notify your insurance broker. Do not try to handle it quietly and wait for the formal lawsuit to drop. Late notice gives the insurance company an easy excuse to deny coverage entirely, leaving the directors to pay the legal bills out of their own pockets.
Why You Need an Attorney Who Understands Delaware Law
Delaware corporate law is a highly specialized arena. Federal securities fraud falls under the SEC. Local contract breaches happen in state civil courts. But corporate governance fights involving Delaware entities land squarely in the Court of Chancery.
This court moves incredibly fast. There are no juries to sway with emotional appeals. The Chancellors are corporate law scholars who issue detailed, heavily footnoted opinions. You cannot walk into Chancery Court with a general business lawyer and expect a good outcome.
At SLG, we understand the specific nuances of the Delaware General Corporation Law (DGCL). We know how the court views conflicts of interest. We know how to aggressively defend against overly broad document demands. Your business needs legal counsel who knows exactly how to leverage statutory safe harbors to get cases dismissed early, before discovery drains the company’s bank accounts. We enforce indemnification rights to ensure directors have their legal bills paid by the company, and we review corporate bylaws to trap derivative claims in favorable venues.
You need a team that knows the unwritten rules of Delaware corporate litigation. We step in, evaluate the threat, and develop a strategy grounded in decades of Chancery Court precedent.
Frequently Asked Questions (FAQs)
What is a “Section 220” demand in Delaware Stockholder Litigation?
Under Section 220 of the DGCL, a stockholder has the right to inspect the company’s books and records if he has a “proper purpose.” Usually, that proper purpose is investigating suspected corporate wrongdoing.
Stockholders use Section 220 demands as a weapon. They want to force the company to hand over internal emails, board presentations, and financial ledgers before they file a formal lawsuit. The company must comply with the law, but it should aggressively challenge overly broad demands. You do not have to hand over every internal document just because a stockholder asks. We regularly help companies narrow these requests to protect sensitive communications.
What is a Caremark claim?
A Caremark claim is a specific type of derivative lawsuit where stockholders sue the board for failing to properly oversee the company. They occur when a company commits a major crime or regulatory violation, and stockholders blame the directors for ignoring red flags.
For example, if a pharmaceutical company is fined billions for illegally marketing drugs, stockholders might sue the board for failing to implement a compliance-monitoring system. These claims open directors up to personal financial liability. Fortunately for boards, they are extremely difficult to win. The stockholder must prove the directors acted in bad faith and intentionally neglected their oversight duties.
What is a Special Litigation Committee (SLC)?
An SLC is a group of independent directors authorized to investigate a derivative lawsuit on behalf of the company. When stockholders claim the entire board is conflicted, the board temporarily hands its power over to the SLC.
The SLC hires its own independent legal counsel, interviews witnesses, and reviews documents. After the investigation, the SLC decides whether to pursue the lawsuit in the corporation’s best interests. If they say no, the court will typically defer to their judgment and dismiss the stockholder’s case.
What is the Business Judgment Rule?
The Business Judgment Rule is the ultimate defense for corporate directors under Delaware law. It is a legal presumption that in making a business decision, the directors acted on an informed basis, in good faith, and in the honest belief that the action was in the best interests of the company.
If the rule applies, the court will not second-guess the board’s decision. Even if the decision lost the company millions of dollars, the directors are protected from personal liability. The only way a stockholder can pierce the Business Judgment Rule is by proving the board was grossly negligent, entirely conflicted, or acted maliciously.
Trust SLG to Protect Your Delaware Business
Stockholder litigation disrupts the daily operations of the business and can lead to significant penalties for corporate leadership. If your company is going through litigation, you cannot take the risk of hoping things pan out. The side that takes the initiative almost always comes out on top.
The attorneys at SLG have many years of experience guiding companies and stockholders through these lawsuits. We understand how the Court of Chancery operates and form persuasive arguments to help you get the best possible outcome for your business. Call the SLG team today for a consultation at 347.378.6990.
