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E-MailMartin Gelter is Professor of Law at Fordham University School of Law. This post is based on a forthcoming book chapter by Professor Gelter.
I recently posted my book chapter, Mapping Types of Shareholder Lawsuits across Jurisdictions (forthcoming in the Research Handbook on Shareholder Litigation, edited by Jessica Erickson, Sean Griffith, David Webber and Verity Winship) on SSRN.
When corporate law scholars explore shareholder litigation abroad, they often start by looking for types of shareholder litigation familiar from the US. In particular, scholarship often explores derivative litigation in various jurisdictions. The objective of the paper is to go beyond this relatively limited comparative analysis and the typical dichotomy between derivative and direct suits. Other jurisdictions sometimes employ different types of shareholder lawsuits that fulfill similar functions. To that end, this chapter attempts to create a functional (but likely incomplete) international taxonomy of shareholder lawsuits. This objective also necessitates a review of corporate conflict of interest, which are to some extent contingent on the type and ownership structure of the corporation.
First, a corporation may itself suffer harm through the careless business decisions or interested transactions. Shareholders are typically harmed only indirectly because of the loss in value of their shares. Comparative corporate governance scholarship emphasizes how dispersed ownership prevails in the US and the UK, setting these jurisdictions apart from other large economies at least historically. A corporation may also suffer harm from actions of a controlling shareholder. Managers are thought to be largely held in check by large shareholders, but besides the occasional squabble within the controlling coalition, conflicts of interests typically erupt between outside investors on the one hand, and controlling shareholders on the other under concentrated ownership.
Second, shareholders may suffer harm directly without any corresponding loss to the corporation, typically by diluting their ownership stake in some way that benefits the majority shareholder. This typically happens when new shares are issued (for example, to a majority shareholder at a low price), when the corporation repurchases shares, or in the course of a merger where (some) shareholders received inadequate compensation. Again, these types of problems are particularly salient in firms (and jurisdictions) with concentrated ownership.
Third, formally corporations may sometimes treat shareholders equally, but a particular conduct, or the absence of such conduct, has a more significant impact on some shareholders than on others, resulting in particular harm to the former. This happens especially in closely-held firms, where conflicts of interest typically arise between a majority shareholder (or a controlling coalition) and minority shareholders, although the impact on whoever ends up in the minority are often more severe. Patterns of oppression often combine harm to the corporation and to minority shareholders.
In analyzing the available remedies across key jurisdictions, we can identify a number of patterns that reflect ongoing influence between countries. When we look at suits seeking to redress harm to the corporation, US law is comparatively liberal in permitting shareholder litigation of this type, allowing derivative suits, while UK and other Commonwealth laws is more restrictive. Continental European and other civil law countries have historically been divided as to whether they even provided for a derivative suit in the narrow sense. While some countries provide for an individual right to enforce directors’ liability claims, in lawsuits against directors were historically a collective right of shareholders that could be initiated in the shareholder meeting. Under the latter system, only if the majority decided against a lawsuit, a minority exceeding a specified percentage can petition a court to appoint a special representative to enforce the claim on behalf of the corporation. Most Continental European countries provide for some form of minority enforcement mechanism, although often it is similarly limited to a qualified minority, and to claims against directors, but not, for example, controlling shareholders. For a variety of reasons, derivative suits remain rare in Europe; however, they spread as a relatively prevalent enforcement mechanism to a number of Asian civil law jurisdictions across the divide between common and civil law, among which at least Japan and Korea have seen a fair number of lawsuits. By contrast, in the UK and other “Commonwealth” jurisdictions, the derivative suit is often much less significant by the “unfair prejudice” or “oppression” remedy, which tends to be popular because of the broad spectrum of remedies available. In some jurisdictions, it has taken over functions served by the derivative suit in the US.
Regarding suits providing redress for harm to shareholders, the taxonomy is more complicated. While direct suits exist in many other jurisdictions, class actions are typically not available, or they are based on an opt-in model that does not give the same level of bargaining power to plaintiff’s attorneys. In a number of civil law jurisdictions, such as Germany, Spain or Korea, lawsuits where minority shareholders seek to rescind or nullify decisions of the shareholder meeting often take over the function of direct suits. There are at least two reasons for this. First, typically shareholder votes are required for a larger number of significant transactions than in the US, especially in Europe, e.g. dividends, increases and reductions of capital as well as mergers and divisions. Consequently, a suit against a shareholder decisions that the controlling shareholder pushed through is equivalent in effect to a direct suit. This is significant in particular in light of the higher frequency of concentrated ownership structures. Second, a suit against a transaction automatically has a class effect because it affects all shareholders. Depending on the applicable substantive law, this may allow a court to review whether a majority shareholder violated the duty of loyalty or engaged in conduct considered abusive. Given the hurdles that derivative suits sometimes face in these jurisdictions, this type of lawsuit is often the main mechanism keeping controlling shareholders in check, at least in certain circumstances.
The paper further identifies common policy issues that determine whether particular types of suits are likely to be prevalent in a jurisdiction. These including limits to standing to sue, such as minimum ownership thresholds. Furthermore, the allocation of cost and risk in the suit is important. This includes the policy decision whether to reimburse the winner for litigation cost (or some of it), the availability of contingency or conditional fees for plaintiff lawyers, and statutes that require plaintiffs to post bonds to sue. Finally, the paper discusses access to information, such as discovery and functional equivalents, as a key element to the success of a litigation mechanism.
Finally, the paper surveys an example of a common law of lawsuit that American readers typically are not familiar with, namely German rescission lawsuits. Because the requirements for prevalent lawsuits were met in these cases, up to the late 2000s litigation was extremely common and arguably exploited by a set of repeat plaintiffs that used lawsuits to make a profit of publicly traded firms. With a number of key legislative changes, the level of litigation appears to have decreased to a reasonable level in recent years. Contrary to the assumption of some of the literature, in Germany and other Continental European jurisdictions corporate law does not appear to suffer from underenforcement, as far as harm to shareholders by means of dilution is concerned.
The full paper is available for download here.
