Duty of Corporate Directors to Shareholders in Maryland

Generally, a board of directors manages the business and affairs of a corporation in Maryland. Unless a transaction or decision must, under Maryland law or under the corporate charter, be approved by the shareholders, the directors exercise the powers of the corporation-either directly or by virtue of the officers they appoint. See C.A. § 2–405.1(b). Ordinarily, shareholders are not permitted to interfere in the management of the company. This is because they are the owners of the company, but not its managers. Thus, “any exercise of the corporate power to institute litigation and the control of any litigation to which the corporation becomes a party rests with the directors or, by delegation, the officers they appoint.”

As a check on this broad managerial authority, directors’ actions in Maryland are subject to fiduciary duties. Originally, corporate directors, with respect to management of the corporation, owed fiduciary duties of care and loyalty to both the corporation and the shareholders. Over time, however, the law became that, generally, directors owed corporate management duties to the corporation alone—not the shareholders. The standard of care owed by directors to the corporation is currently codified at C.A. § 2–405.1, which requires directors to perform their duties (1) “in good faith;” (2) “in a manner reasonably believed to be in the corporation’s best interests;” and (3) “with the care that an ordinarily prudent person in a like position would use under similar circumstances.” C.A. § 2–405.1(a). The statute effectively constitutes a limitation on liability to the corporation that would otherwise exist under common law.

Because directors’ fiduciary duties relating to management do not extend to shareholders, a minority shareholder in Maryland generally does not have a direct action for breach of those duties against the directors, except in cases affecting fundamental shareholder rights ( e.g., a shareholder’s right to require the corporation to buy its stock, known as an appraisal right). As a result, the shareholder’s derivative action developed at common law “in the mid–19th Century as an extraordinary equitable device to enable shareholders to enforce a corporate right that the corporation failed to assert on its own behalf.”

A corporate derivative action is essentially a suit by the shareholders to compel the corporation to sue and, simultaneously, a suit by the corporation, asserted by the shareholder on its behalf, against a defendant or defendants. This type of suit is derivative because the plaintiff “derives” its right to sue from the ability of the entity whose rights the plaintiff is asserting. Usually, the proceeding is only necessary for minority shareholders, since a majority or controlling shareholder can typically persuade the corporation to sue in its own name.

An action for damages for injuries to a corporation must be brought derivatively in the name of the corporation. In other words, “if the wrong alleged was committed against the corporation, then the stockholder may not sue individually but only derivatively.” Conversely, “if the wrong alleged was committed against the stockholder rather than the corporation, then the stockholder must bring the action as a direct action—either individually or as a representative of a class—and not as a derivative action.”

Reasons for derivative actions include: (1) the prevention of several lawsuits by shareholders against the same defendants; (2) protection of corporate creditors by putting assets back into the corporation; and (3) protection of all shareholder interests by increasing the value of their shares. At the same time, derivative suits adequately compensate claimant shareholders by increasing the value of their shares.

In part because a derivative action intrudes on directors’ managerial prerogatives, the law limits shareholders’ ability to bring such actions. Before filing suit on behalf of the corporation, shareholders must first make a good faith effort to have the corporation act directly. This effort is known as making “demand” upon the corporation. Once demand is made, the board of directors must conduct an investigation into the allegations in the demand, and decide whether litigation would be in the corporation’s best interests. The board can appoint a committee of disinterested directors to undertake this investigation. If the corporation fails to bring suit, the shareholders may then bring a “demand refused” action. The plaintiff can still allege that the board, in fact, did not act independently, or that the board’s refusal to bring suit was wrong. To determine whether the board wrongly refused to bring suit, courts review the board’s investigation under the strict business judgment rule. Id. Under that rule, courts defer to the board or committee’s decision not to bring suit “unless the stockholders can show either that the board or committee’s investigation or decision was not conducted independently and in good faith, or that it was not within the realm of sound business judgment.”

Shareholders can avoid the demand requirement only if demand is excused as “futile.” The futility exception is viewed as a very limited exception, to be applied only when the allegations or evidence clearly demonstrate, in a very particular manner, either that (1) a demand, or a delay in awaiting a response to a demand, would cause irreparable harm to the corporation, or (2) a majority of the directors are so personally and directly conflicted or committed to the decision in dispute that they cannot reasonably be expected to respond to a demand in good faith and within the ambit of the business judgment rule.

We aggressively represent clients in various commercial litigation matters ranging from shareholder and partnership disputes, breach of contract disputes, lawsuit between different entities such as corporations and LLCs. Call us for an appointment if you need additional information from a Maryland business trial lawyer regarding representation as a business attorney Rockville MD. (301-309-9002; ask@kamkarilaw.com).

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