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What a Minority Shareholder Must Do Before Bringing a Lawsuit in New York

 

Contrary to popular belief, if you're a minority shareholder of a New York corporation, bringing a derivative shareholder lawsuit is not simply a matter of hiring a lawyer to draft and file a complaint; there are other hoops he will have to jump through (which, in legalese are called "conditions precedent") before going ahead with the lawsuit.

 

As a threshold matter, the reason for suing the corporation in this capacity, i.e., as a shareholder, instead of doing so in an individual capacity is because New York's courts have long held that even when the individual has been harmed by losing the value of his investment in the corporation, "[F]or a wrong against a corporation a shareholder has no individual cause of action, though he loses the value of his investment" (Abrams v. Donati, 66 NY2d 951, 953 [1985]).

 

The Conditions Precedent to Bringing a Minority Shareholder Derivative Action

 

In a derivative suit brought by a minority shareholder on behalf of a corporation, the complaint must set forth with particularity the shareholder's demand upon the board of directors to bring the action, or the reasons that a demand would have been futile (Business Corporation Law §626[c]).

 

To that end, the demand will be considered "futile," as defined by Business Corporation Law §626, and therefore excused, when a complaint alleges with particularity the following:

(1) that a majority of the board of directors has a vested interest in the challenged transaction;

 

(2) that the board of directors did not fully inform themselves about the challenged transaction to the extent reasonably appropriate under the circumstances; or,

 

(3) that the challenged transaction was so egregious on its face that it could not have been the product of sound business judgment of the directors.

 

(See, e.g., Bansbach v. Zinn, 1 NY3d 1, 9 [2003]; Marx v. Akers, 88 NY2d 189, 200-201 [1996]).

 

The significance of this rule is apparent at the beginning of the lawsuit: without meeting these strict criteria, the court may be obliged to dismiss the case - even before discovery.