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FROM: SEP-OCT 2008 ISSUE | BY VERN KRISHNA
The business press is reporting an alarming number of conflicts between corporations and their executives and shareholders. Many of these conflicts are resolved through negotiations; others go on to expensive and protracted litigation with uncertain results.
In corporate law, there are a swamp of conflict rules. And there are two types of shareholder litigation: direct and derivative. In direct litigation, a shareholder sues the corporation because it may have denied her personal rights. If the shareholder is successful, she will personally recover any remedial damages.
In a derivative suit, the alleged injury is to the corporation. For example, corporate directors may breach their fiduciary duty by appropriating for themselves a contract that rightfully belongs to the corporation. The shareholders suffer collectively through the lost corporate opportunity. In these circumstances, the shareholders can sue the corporation derivatively – that is, by naming it as a nominal defendant and the directors personally as the real defendants. If the shareholders succeed, damages go into the corporate treasury and not to the shareholders.
Derivative actions cause conflicts and privilege problems for legal counsel. The first conflict pertains to the types of defences that the corporation may raise as a nominal defendant. For example, if directors appropriate a contract from the corporation, it is in their personal interest to have the corporation raise as many procedural and substantive defences as possible.
A second problem arises in the matter of representation. It is clear that the corporation and the directors should have separate legal counsel, particularly in respect of settlement discussions.
There are also difficult problems of solicitor/client privilege. The corporation’s legal counsel is privy to information that is confidential and that he would previously have derived from the directors. Legal counsel cannot properly draw a wall between the information that she derives from the corporation through its directors and officers.
It’s been said that “the greatest conflicts are not between two people but between one person and himself.” Shareholder litigation – whether direct or derivative – is expensive and corporations should avoid it with proper counsel.
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