The shareholder’s agreement is a legal contract that protects the rights and outlines the duties and responsibilities of everyone who owns shares in the company. In addition to ownership, shareholder rights include the ability to vote and transfer ownership, as well as entitlement to dividends.
When a shareholder, director or corporate insider puts the value of those shares at risk, other shareholders have the right to file a lawsuit. This litigation is a shareholder derivative action.
Written notice of breach
Before filing a derivative action, a shareholder should inform the executive management in writing of the breach to provide the opportunity to correct the issue. This is a critical component in the process for more than one reason.
Ideally, it will result in conflict resolution outside of court. However, if it does not, the shareholder will need evidence that he or she took this step in an attempt to resolve the matter, and that the attempt was unsuccessful.
Notice to other shareholders
All shareholders must receive notification about the action’s initiation so they may join the lawsuit. The shareholder files the action on behalf of the corporation. If the action succeeds in court, any recovery of damages goes to the corporation and not the individual shareholders.
Burden of proof
If the court finds a shareholder liable, he or she may have to pay damages. The plaintiffs have the burden of proof in the case, though. Not only do they have to provide evidence that the breach of the shareholder agreement occurred, but they must also show proof that the company suffered material damages as a direct result of the breach.
Some shareholder agreements include penalty clauses with a set compensation amount that a breaching shareholder must pay for a contract violation. However, a judge may amend this amount if it is not proportional to the damages that the shareholder caused.