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Against derivative shareholder strike suits



In the 1998 case of Felzen v. Andreas, the Seventh Circuit suggested that it was looking for an opportunity to take action against derivative shareholder strike suits, suits where a shareholder purportedly sues on behalf of the corporation, but in reality is seeking legal extortion to drop the suit:

Rule 23.1 provides for notice to shareholders only in the event of dismissal or settlement, so that other investors may contest the faithfulness or honesty of the self-appointed plaintiffs; we do not doubt that this monitoring is often useful and that intervention to facilitate an appeal could be justified. Many thoughtful students of the subject conclude, with empirical support, that derivative actions do little to promote sound management and often hurt the firm by diverting the managers' time from running the business while diverting the firm's resources to the plaintiffs' lawyers without providing a corresponding benefit. Janet Cooper Alexander, Do the Merits Matter? A Study of Settlements in Securities Class Actions, 43 Stan. L.Rev. 497 (1991); Reinier Kraakman, Hyun Park & Steven Shavell, When are Shareholder Suits in Shareholder Interests?, 82 Geo. L.J. 1733 (1994); Roberta Romano, The Shareholder Suit: Litigation Without Foundation?, 7 J.L. Econ. & Org. 55 (1991); Mark L. Cross, Wallace N. Davidson & John H. Thornton, The Impact of Directors' and Officers' Liability Suits on Firm Value, 56 J. Risk & Insurance 128 (1989); Daniel R. Fischel & Michael Bradley, The Role of Liability Rules and the Derivative Suit in Corporate Law: A Theoretical and Empirical Analysis, 71 Cornell L.Rev. 261 (1986). The two shareholder-appellants in this case believe that the modest settlement, half of which will be paid to counsel, exemplifies this problem.

Unfortunately, the appeal in Felzen was thrown out on technical grounds, and no one has taken up the challenge, perhaps because it's more lucrative to agree to be paid off for withdrawing an objection to a bad settlement than for successfully challenging the bad settlement.

Until now. Plaintiffs brought a meritless derivative-shareholder suit over an alleged technical violation of the Clayton Act; the corporation found it cheaper to pay the plaintiffs' attorneys $925,000 to go away than to defend the suit. But the shareholders get nothing, so they're worse off because of the litigation.

Unfortunately for the plaintiffs, not only did they sue in the Northern District of Illinois, they sued a corporation, Sears Holding Corporation, where I own shares. After attempting to foreclose objections by mailing out notice three days before objections were due, the parties agreed to a new notice schedule, and I have moved to intervene and dismiss the action for failure to meet the Rule 23.1(a) standard for shareholder representation. The case is Robert F. Booth Trust v. Crowley, No. 09-5314 (N.D. Ill.) and the fairness hearing is August 27 in Chicago. (The Manhattan Institute is not associated with this litigation.)

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Isaac Gorodetski
Project Manager,
Center for Legal Policy at the
Manhattan Institute
igorodetski@manhattan-institute.org

Katherine Lazarski
Press Officer,
Manhattan Institute
klazarski@manhattan-institute.org

 

Published by the Manhattan Institute

The Manhattan Insitute's Center for Legal Policy.