Costs Awards In Derivative Actions
1. Nature of Derivative Actions
A derivative action arises when:
Corporate management fails to enforce the corporation’s rights.
A shareholder sues in the name of the corporation.
Any recovery typically belongs to the corporation, not the shareholder personally.
Because the shareholder acts as a private attorney general for the company, courts often apply equitable principles when determining litigation costs.
2. General Rules Governing Cost Awards
Cost allocation in derivative actions depends on the outcome of the case and the benefits produced.
(a) Successful Derivative Actions
If the lawsuit produces a financial recovery or corporate governance benefit, courts may award:
reimbursement of litigation expenses
attorneys’ fees
court costs
These costs are usually paid by the corporation because the lawsuit benefits the company.
(b) Unsuccessful Actions
If the plaintiff loses, courts may:
require the plaintiff to bear their own costs
order the plaintiff to pay defendants’ costs if the claim was frivolous or brought in bad faith
(c) Settlement-Based Cost Awards
Derivative actions often settle with corporate governance reforms. In such cases, courts evaluate whether the settlement produced substantial corporate benefit before awarding fees.
3. The Corporate Benefit Doctrine
A central principle governing cost awards in derivative actions is the corporate benefit doctrine.
Under this doctrine:
A shareholder who produces a substantial benefit for the corporation may recover litigation costs.
The benefit does not have to be purely financial; governance reforms may qualify.
Examples of corporate benefits include:
recovery of misappropriated funds
adoption of stronger compliance policies
removal of conflicted directors
improvements in internal controls
4. Court Considerations in Cost Awards
Courts generally evaluate several factors:
1. Success of the Litigation
Whether the derivative suit produced a tangible benefit for the corporation.
2. Reasonableness of Legal Fees
Courts examine whether the requested fees are proportional to the benefit achieved.
3. Conduct of the Parties
Bad faith or abusive litigation tactics may influence cost awards.
4. Role of the Plaintiff
The shareholder must demonstrate meaningful participation rather than acting merely as a nominal plaintiff.
5. Leading Judicial Decisions on Costs in Derivative Actions
1. Mills v. Electric Auto-Lite Co. (1970)
The Supreme Court recognized that shareholders who successfully challenge corporate misconduct may recover attorneys’ fees under the corporate benefit doctrine.
Significance:
Established that non-monetary benefits, such as improved corporate governance, may justify fee awards.
2. Hall v. Cole (1973)
The Court reaffirmed the principle that plaintiffs who produce a common benefit for a group or organization may recover litigation costs.
Impact on derivative actions:
Strengthened equitable authority for courts to award attorneys’ fees.
3. Boeing Co. v. Van Gemert (1980)
The Supreme Court addressed fee awards in common-benefit litigation, holding that attorneys’ fees may be drawn from funds recovered for beneficiaries.
Importance:
Influenced cost allocation principles in shareholder derivative actions.
4. Alyeska Pipeline Service Co. v. Wilderness Society (1975)
The Court limited broad “private attorney general” fee awards unless authorized by statute or recognized equitable doctrines.
Significance:
Reinforced reliance on the corporate benefit doctrine rather than general policy arguments.
5. Kamen v. Kemper Financial Services, Inc. (1991)
The Supreme Court addressed procedural requirements for derivative actions, particularly the demand requirement on corporate boards.
Although primarily procedural, the case influenced litigation dynamics and cost risks in derivative suits.
6. Cohen v. Beneficial Industrial Loan Corp. (1949)
This landmark case upheld statutes requiring derivative plaintiffs to post security for litigation costs in certain circumstances.
Importance:
Designed to deter frivolous derivative litigation.
Allowed defendants to recover costs when claims lacked merit.
6. Security-for-Costs Requirements
Some jurisdictions require derivative plaintiffs to post security for defendants’ litigation expenses.
Purpose:
Prevent abuse of derivative actions
Protect corporations and directors from speculative lawsuits
Security requirements are typically imposed when:
the plaintiff owns only a small number of shares
the claim appears weak or speculative
7. Cost Awards in Settled Derivative Actions
Derivative suits frequently settle before trial. Courts must approve settlements and examine:
fairness of the settlement
benefit to the corporation
reasonableness of attorneys’ fees
Fee awards in settlements may be based on:
percentage of recovery
lodestar method (hours × reasonable rate)
value of corporate governance reforms
8. Corporate Governance Implications
Cost rules significantly affect corporate governance and shareholder oversight.
Positive effects include:
encouraging shareholders to challenge misconduct
promoting director accountability
strengthening corporate compliance
However, courts remain cautious to prevent:
strike suits
nuisance settlements
excessive legal fees
9. Conclusion
Costs awards in derivative actions reflect the unique nature of shareholder litigation, where individuals sue on behalf of the corporation. Courts apply equitable principles to ensure that shareholders who produce genuine benefits for the company are compensated, while those bringing frivolous claims may face financial penalties.
Judicial decisions such as Mills v. Electric Auto-Lite Co., Hall v. Cole, Boeing Co. v. Van Gemert, Alyeska Pipeline Service Co. v. Wilderness Society, Kamen v. Kemper Financial Services, Inc., and Cohen v. Beneficial Industrial Loan Corp. illustrate how courts balance shareholder enforcement with protection against abusive litigation.
As corporate governance continues to evolve, derivative litigation remains an important mechanism for holding corporate management accountable while ensuring fair allocation of litigation costs.
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