Could the company you serve sue you? Shareholder derivative lawsuits pit a company against its directors or board members. This leads to a complicated legal situation, in which the company may be unable to provide indemnification. Does your D&O insurance provide sufficient coverage for such a scenario?
Understanding Derivative Claims
In a shareholder derivative lawsuit, one or more shareholders bring a lawsuit on behalf of their corporation. The shareholders position themselves as representatives of the corporation and allege that the defendant has caused the corporation harm in some way.
Shareholder derivative lawsuits frequently target the board members, officers, or directors of a corporation. The allegations may accuse the defendant of causing damages to the corporation through a number of actions, such as:
· Fraudulent or unlawful activities
· Conflicts of interest or self-dealing
· Mismanagement or breach of fiduciary duty
How Shareholder Derivative Lawsuits Differ from Direct Shareholder Lawsuits
Shareholder derivative lawsuits may be similar to direct shareholder lawsuits. In fact, many of the allegations overlap. In a direct shareholder lawsuit, though, a shareholder sues the corporation and/or the directors and officers based on his own losses. Any settlements or awards go to the shareholder. In a shareholder derivative lawsuit, the corporation (represented by the shareholder) sues the directors and officers based on its losses. Any settlements or awards go to the corporation.
The distinction is significant. The exact rules and legal precedence surrounding shareholder derivative lawsuits depend on the jurisdiction where they are filed. However, it’s important to note that, as the lawsuit pits the corporation against the directors and officers, the corporation may be unable to indemnify the directors and officers.
Shareholder Derivative Lawsuit Examples
Since shareholder derivative lawsuits are common, it’s not difficult to find examples of them.
One recent example involves Intel Corporation. According to ICLG, shareholders have filed a derivative class action lawsuit against two senior executives and several other board members, alleging breaches of fiduciary duty, violations of the Security Exchange Act of 1934, unjust enrichment, and mismanagement of corporate resources.
Another recent example shows that – like direct shareholder lawsuits – derivative shareholder lawsuits are often costly. According to Stock Titan, Peloton Interactive has announced a $1.75 million settlement agreement for multiple derivative actions occurring in three different jurisdictions.
Parallel Direct and Derivative Lawsuits
Since there is considerable overlap between the allegations and defendants in direct and derivative shareholder lawsuits, you may wonder how shareholders decide which type of lawsuit to file. They frequently don’t have to decide – they can file both.
According to D&O Diary, securities class action lawsuits often involve parallel shareholder derivative litigation. A recent example of this is the litigation against Lululemon, centering on the corporation’s DEI program – or IDEA, as Lululemon calls it. When parallel litigation occurs, the allegations are frequently similar. However, this lawsuit is interesting in that the derivative lawsuit includes additional allegations.
Shareholder Derivative Lawsuits and D&O Insurance
In both shareholder direct and derivative lawsuits, it’s common to name individual directors and officers, who may be held personally liable for the damages. D&O insurance therefore provides important financial protection for both the company and the individuals who serve it.
However, directors and officers should not assume they have full coverage simply because the company has D&O insurance. Variation in the specific circumstances of the lawsuit as well as in the policy terms may impact coverage. Some of these issues become important in shareholder derivative claims.
To understand the issue, it’s important to know a little about the three sides of D&O coverage:
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Side A provides coverage when the corporation cannot indemnify the directors or officers. It provides direct coverage to the directors and officers named in the lawsuit.
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Side B provides coverage when the corporation can indemnify the directors and officers. In doing so, it reimburses the corporation for its covered costs.
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Side C provides entity coverage for claims made directly against the corporation. It applies when both the individuals and the corporation are named as codefendants.
In the case of a shareholder derivative lawsuit, the corporation may be legally barred from indemnifying the directors and officers. Such situations are why Side A coverage is necessary.
In light of this, directors and officers should check whether their companies have sufficient Side A coverage. Instead of assuming the corporation will indemnify you – which is not always possible – it’s important to ensure you have adequate Side A coverage.
Do you have the Side A coverage you’d need in the case of a shareholder derivative claim? NSI Insurance Group can help you review your coverage needs. Learn more or request a free D&O analysis.
