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Massachusetts Civil Procedure Rule 23.1: Derivative Actions by Shareholders

[Disclaimer]

In a derivative action brought by one or more shareholders or members to enforce a right of a corporation or of an unincorporated association, the corporation or association having failed to enforce a right which may properly be asserted by it, the complaint shall be verified by oath and shall allege that the plaintiff was a shareholder or member at the time of the transaction of which he complains or that his share or membership thereafter devolved on him by operation of law from one who was a stockholder or member at such time. The complaint shall also allege with particularity the efforts, if any, made by the plaintiff to obtain the action he desires from the directors or comparable authority and, if necessary, from the shareholders or members, and the reasons for his failure to obtain the action or for not making the effort. The derivative action may not be maintained if it appears that the plaintiff does not fairly and adequately represent the interests of the shareholders or members similarly situated in enforcing the right of the corporation or association. The action shall not be dismissed or compromised without the approval of the court, and notice of the proposed dismissal or compromise shall be given to shareholders or members in such manner as the court directs.

Effective July 1, 1974.

Reporter's Notes (1996): With the merger of the District Court civil rules into the Mass.R.Civ.P., Rule 23.1 of the Mass.R.Civ.P. governing shareholder derivative actions is made applicable to District Court proceedings.

Reporters' Notes (1973): Rule 23.1 with some minor changes is the same as Federal Rule 23.1. Prior to the 1966 amendments to the federal rules, Federal Rule 23.1 was part of Federal Rule 23, "Class Actions" (Rule 23(b)). The 1966 change was effected because derivative suits are not class actions and have distinctive aspects which warrant treatment in a separate rule. A derivative suit is brought on behalf of a corporation or other association for a wrong done to the corporation or association. The corporation is an indispensable party in a derivative suit. Turner v. United Mineral Lands Corp., 308 Mass. 531, 538-539, 33 N.E.2d 282, 286-287 (1941). It is joined as a party defendant. While the shareholder controls the action, any recovery is for the corporation. Shaw v. Harding, 306 Mass. 441, 448, 28 N.E.2d 469, 473 (1940). The plaintiff has no direct or personal interest in the suit, except as the value of his stock might be enhanced by recovery by the corporation. The bill cannot be maintained to enforce any personal right of the plaintiff. Id.

A class action, on the other hand, is brought to redress a wrong committed directly against the members of the class. It may be maintained where a few individuals are fairly representative of the legal and equitable rights of a large number of individuals who cannot readily be joined as parties. Spear v. H.V. Greene Co., 246 Mass. 259, 266, 140 N.E. 795, 797 (1928). Thus if an action is brought by shareholders against the directors of the corporation for mismanagement, the action is derivative because the harm is directly to the corporation and only indirectly to the shareholders. If, however, an action is brought by the shareholders against the directors to compel the payment of dividends arbitrarily withheld, the action would be in the nature of a class suit because the harm is directly to the shareholders. cf. Fernald v. Frank Ridlon Co., 246 Mass. 64, 140 N.E. 421 (1928).

Rule 23.1 makes a few minor changes in Federal Rule 23.1. The language of Federal Rule 23.1 pertaining to the conferring of jurisdiction is deleted as inapplicable to state practice. Also, Rule 23.1 adds the words "by oath" to the verification requirement. It is hoped that this language will tend to discourage "strike suits" which suits are brought primarily for the purpose of coercing "corporate managers to settle worthless claims in order to get rid of them." Surowitz v. Hilton Hotels Corporation, 383 U.S. 363, 86 S.Ct. 845, 15 L.Ed.2d 807 (1966).

Rule 23.1 includes the contemporaneous-ownership-of-stock requirement of Federal Rule 23.1. The purpose of this requirement is to prevent an individual from purchasing stock solely for the purpose of maintaining a derivative suit with the hope of coercing the corporate managers to make a personal settlement. Massachusetts, by statute, requires contemporaneous-ownership-of- stock with respect to derivative actions against the corporation's stockholders, directors or officers. G.L. c. 156B, § 46. Rule 23.1 broadens the requirement of G.L. c. 156B, § 46, making it applicable in all derivative actions rather than merely those actions against the corporation's stockholders, directors or officers. The language "from one who was a stockholder at such time" was added to Rule 23.1 to bring it in harmony with G.L. c. 156B, § 46, and to make clear that a person receiving stock under a will or by intestacy cannot maintain a particular derivative suit unless the decedent could have done so prior to death.

Before a shareholder can maintain a derivative suit in Massachusetts he must first make a demand upon the corporation's board of directors for action, unless such a demand would be futile because a majority of the directors are not disinterested. S. Solomont & Sons Trust, Inc. v. New England Theatres Operating Corporation, 326 Mass. 99, 113, 93 N.E.2d 241, 248 (1950). If the board is thus disqualified, or if, after such a demand, the directors refuse to act, the shareholder must make demand upon the corporate shareholders, unless such demand would be futile because a majority of them are not disinterested. Most of the cases decided subsequent to Solomont, applying this principle, arose in the federal courts. Pomerantz v. Clark, 101 F.Supp. 341, 344, 346 (D.Mass.1951), held, applying Massachusetts law that the Solomont requirements must usually be satisfied no matter how many and how scattered were the corporation's shareholders. This view was, by dicta, subsequently repudiated in Levitt v. Johnson, 334 F.2d 815, 818-819 (1st Cir.1964). See also In re Kauffman Mutual Fund Actions, 479 F.2d 257, 263-264 (1st Cir.1973).

While quite similar, the requirements of Solomont go further than those imposed by Rule 23.1. Solomont held that a vote of a majority of the shareholders of a corporation, undominated and uncontrolled, acting reasonably and in good faith, can bar the bringing of a derivative suit by a minority shareholder or shareholders, regardless of the nature of the cause of action. 326 Mass. at 114-115, 93 N.E.2d at 248-249. The rationale is that from a business viewpoint it is not always best to insist upon all of one's legal rights; and since honest and intelligent men differ as to business policy, the will of the majority, acting fairly, should control. Halprin v. Babbit, 303 F.2d 138 (1st Cir.1962), applying Massachusetts law, held that if, after a demand upon the shareholders, the shareholders fail to act, the minority shareholder may proceed with the action. In other words, under the Solomont rule, the minority shareholder does not need the express approval of the majority of the shareholders in order to bring the action. Inaction on their part is sufficient.

The Advisory Committee believes that the holding of Solomont is not repealed by implication by Rule 23.1 and that a majority of the shareholders, undominated and uncontrolled, acting reasonably and in good faith, can bar the bringing of a derivative suit.