Many actions between members of small businesses are brought as derivative suits, which means that the individual bringing the action is suing on the corporation’s behalf and seeks damages for harm that has been done to the corporation. Any shareholder may theoretically bring a derivative suit, but Massachusetts law requires that the shareholder first demand that the corporation take suitable action to correct the misconduct at issue. Only if the corporation rejects or ignores this demand may the shareholder commence the derivative litigation. It should be noted that members of limited liability companies do not have to deliver a written demand to the LLC prior to bringing a derivative action, if it is shown that such demand would be futile.
A corporation may force dismissal of a shareholder derivative suit if the corporation can show that a majority of shareholders or another “appropriate group” has determined that the maintenance of the derivative proceeding is not in the best interests of the corporation. What constitutes an “appropriate group” for purposes of this rule? An “appropriate group” may be either: (1) a majority of independent directors (meaning directors not involved in the underlying misconduct); (2) a majority of a special litigation committee of the board; (3) a majority of disinterested shareholders; or (4) a panel of independent third parties appointed by the court.
The Defendants in Kelleher v. Squires recently attempted to require the court to appoint a “panel of independent persons” in hopes of shutting down the Plaintiffs’ derivative suit. Kelleher involves a dispute between owners of a closely held corporation, The Squires of Hanover, Inc. (“The Squires”). Plaintiffs Madeline, James, Catherine, and Evelyn Kelleher (“the Kellehers”), who collectively own a one-half interest in The Squires, brought a derivative action against Paul Squires (“Mr. Squires”), who owns the other one-half interest in The Squires and is its sole officer and director. The Kellehers alleged that Mr. Squires had been grossly negligent in running the restaurant that is The Squires’ sole business, thereby causing The Squires to suffer damages. The Kellehers also alleged that Mr. Squires converted monies belonging to The Squires to his own use.
The Squires, led by Mr. Squires as its sole officer and director, sought to dismiss the suit by making a showing that an “appropriate group” would find that the lawsuit was not in the corporation’s best interests. The Squires petitioned the Court to appoint a panel of independent persons in hopes of them making that determination. The Court denied the request and found that The Squires’ motion constituted an impermissible attempt “to circumvent normal corporate decision making powers and processes and deprive the Kellehers of their rights, as shareholders, to decide whether this suit is in [The Squires]’ best interest.” Notably, The Squires had failed to present any evidence indicating that the lawsuit was contrary to its best interests. For example, there was no allegation that the lawsuit may interfere with The Squires’ ongoing business or future business opportunities.
This decision is interesting because it demonstrates that, despite the statutory language which raises the possibility of a court appointing an independent panel to assess a derivative suit, in practice, courts will be reluctant to impose such a procedure, particularly where there is no reason to question the business judgment of the shareholders who initiated the lawsuit. Judge Salinger noted in his decision that he could only find two cases nationwide in which a court appointed such a panel, and in both of those cases, the appointment was agreed to by all parties.