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Birmingham Bar Association Bulletin - Summer 2014

Stephen D. Wadsworth; Leitman, Siegal, Payne & Campbell, P.C. Double-Derivative Corporate Law Litigating Double-Derivative Actions Through Multiple Layers of Corporate Ownership In commercial litigation, even seemingly simple, closely-held business entities are often part of complex corporate family trees. A simple example, common in banking litigation, is a holding company which holds as its sole asset the stock of its subsidiary—the bank itself. The company’s investors have stock in the holding company and only the holding company holds shares in the subsidiary bank. In a more complicated example from a recent shareholder dispute our firm was involved in, two individuals owned shares in multiple holding companies. These holding companies owned several subsidiaries, many of which had subsidiaries of their own. This corporate family tree went five levels deep in some places, yet the real parties in interest—the individuals who owned and jointly operated all the holding companies and subsidiaries—held stock only in the first level of the corporate family. This corporate layering creates an interesting problem which is common in shareholder litigation: If a fiduciary breaches duties and harms a subsidiary, who has standing to sue? Under Alabama law—and the law of most states—the claim for damage would be derivative because it is “incidental to the shareholder’s status as a stockholder in a corporation . . . .”1 But, in order to maintain a derivative action on behalf of a company, an individual must own stock in the company harmed by the breach of duties.2 This rule caused many investors—and their attorneys— to wonder if they have standing to bring a derivative action against the directors or officers of a controlled-subsidiary in which they hold no stock. The short answer is yes, the aggrieved shareholder may bring a double derivative action on behalf of parent company and the subsidiary. An example may make the workings of a double derivative action clearer. A corporate officer, director, or majority shareholder performs an action on behalf of a subsidiary which breaches duties owed to the subsidiary. The breaches of fiduciary duty damage the subsidiary financially by reducing its value as an ongoing concern. This harm is passed to the holding company which owns all or most of the subsidiary’s stock. Because the holding company’s value is tied closely to that of its subsidiary, the decline in value of the subsidiary is passed on ultimately to the shareholders of the holding company. “...an aggrieved shareholder may bring a double derivative action on behalf of parent company and the subsidiary.” A shareholder in the parent company seemingly finds himself in a predicament. In this example, the harm was inflicted on the subsidiary—a corporation in which the aggrieved shareholder owns no stock. Technically, the right to sue derivatively would belong to the parent corporation. However, because the officers and directors of the holding company are often the same people who harmed the subsidiary, they are unlikely to prosecute a derivative suit on behalf of the holding company. In other words, these directors or officers are unlikely to sue themselves. Seemingly, this corporate layering presents a derivative harm without a corresponding derivative remedy. To resolve this problem, courts have created an equitable remedy known as a “double derivative action” that allows shareholders of a parent company to enforce a right belonging to a subsidiary controlled by the parent company. The double derivative action is appropriate whenever the injury to the shareholder’s corporation “results from injuries to another related corporation.”3 The rationale for a double derivative action is that a “holding company owes a duty to use its control of the subsidiary to sue to right wrongs to it . . . .”4 In a double derivative action, a shareholder essentially compels “specific performance of these connected duties” by forcing the parent corporation to bring a derivative action against its subsidiary. 5 While there are no Alabama cases directly on point, courts around the country have given “near universal acceptance” to the double derivative action.6 In order to prosecute a double derivative action, a plaintiff must show that (1) the plaintiff is a shareholder in a parent corporation; 7 (2) the parent company holds a controlling interest in a subsidiary;8 (3) the parent company has an enforceable right which may be pursued by the shareholder;9 and (4) the plaintiff made a presuit demand on the board of directors of the parent company pursuant to Rule 23.1 or demonstrated that such a demand was futile as a matter of law.10 This remedy is not restricted to double derivative suits. Indeed, “double, triple or multiple” derivative suits may be maintained, as long as these elements are satisfied.11 While these above-listed elements are sufficient to prove a shareholder’s right to bring a double-derivative action, a review of caselaw provides several procedural issues attorneys should keep in mind when bringing 26 Birmingham Bar Association


Birmingham Bar Association Bulletin - Summer 2014
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