Double Derivative Actions

The concept of derivative actions, where a shareholder brings a lawsuit on behalf of a corporation, has been part of American jurisprudence since the 1800s. However, in some instances the corporation being harmed is not the corporation in which the shareholder owns shares but a subsidiary of that corporation. In such cases, a shareholder of the parent corporation may bring an action on behalf of the subsidiary. Such suits are known as double derivative actions.

In recognizing double derivative actions, courts have said that parent corporations owe a duty to use its control of a subsidiary to bring suit to remedy wrongs against the subsidiary and a double derivative action is one in which the shareholder of the parent may in effect compel specific performance of this duty. In a double derivative complaint, the plaintiff alleges that a wrong has been done to the subsidiary and that the parent had the right and obligation to bring a derivative action to redress the wrong but failed to do so. In closely held corporations particularly it is not uncommon for the parent and the subsidiary to both be controlled by the persons who have inflicted the injury on the subsidiary.

Generally speaking, a derivative plaintiff must be a shareholder of the entity being harmed to have standing to sue derivatively on behalf of that entity. Double derivative actions relax this contemporaneous ownership requirement in order to prevent unscrupulous individuals from exploiting this requirement to insulate harm to subsidiaries from redress. In order to bring a double derivative action, a plaintiff must be a shareholder in the corporation that controls or dominates the company that actually possesses the cause of action.

By allowing a shareholder of the parent corporation to bring a claim on behalf of a subsidiary of the parent, the double derivative action avoids instances where the parent corporation’s board cannot make an impartial decision concerning bringing suit on the subsidiary’s behalf. The ultimate beneficiary of a double derivative action is the subsidiary corporation that possesses the primary right to sue. In cases involving levels of intermediate subsidiaries, courts have recognized other types of multi-tier derivative actions.

Throughout the years, different courts have provided differing legal justifications for recognizing the validity of double derivative actions. Some have framed the issue in terms of highly technical interpretations of fiduciary duties. Other courts have relied on more equitable grounds characterizing the plaintiff shareholder of the parent corporation as an “equitable owner” of some proportional interest in the parent’s equity interest in its subsidiary. Despite the legal justification, courts have generally agreed that such suits encourage shareholders to seek redress for corporate mismanagement, and serve as important considerations of public policy.

Double derivative actions are also a recognition that harm to a subsidiary indirectly but actually affects the parent corporation and its shareholders. As such, the wrong sought to be remedied in a double derivative action is not only that wrong done directly to the corporation’s subsidiary but also that which filters up and harms the parent corporation as well. In recognition of this, some jurisdictions make it a fundamental requirement of a double derivative suit that the plaintiff allege that the harm to the subsidiary resulted in an identifiable injury to the corporate parent in which the plaintiff-shareholder holds stock.

In derivative actions, there is generally a pre-suit demand requirement where the plaintiff is required to allege that the board ignored the plaintiff’s demand to pursue the claim or that such a demand was excused. Double derivative actions also have a pre-suit demand requirement, though many courts recognize a “double demand” requirement where the demand must be made to the boards of both the parent and subsidiary corporations. However, most courts do not insist on a double demand when the boards of the parent and subsidiary are comprised of the same individuals.

Lubin Austermuehle’s business dispute and shareholder’s rights attorneys have more than three decades of experience helping shareholders and business clients unravel the complexities of Illinois and out-of-state corporate and LLC laws. Our Chicago derivative action litigation lawyers serve clients throughout Illinois and the Midwest. If you’re a shareholder of a parent corporation whose subsidiary is being harmed or you are a business owner facing a direct or derivative action, the experienced Illinois shareholder rights and complex business litigation attorneys at Lubin Austermuehle can help. To set up a consultation with one of our Chicago shareholder dispute attorneys, please call us toll-free at 630-333-0333 or contact us online.