Quis custodiat custodium? Corporate Oversight Through Derivative Action
| Autor | Rafael Pagán-Colón |
| Cargo | University of Puerto Rico School of Law, J.D. Candidate, May 2011 |
| Páginas | 35-51 |
QUIS CUSTODIAT CUSTODIUM?
CORPORATE OVERSIGHT THROUGH DERIVATIVE ACTION
RAFAEL PAGÁN-COLÓN*
I. Introduction ............................................................................................................................................................. 35
II. Derivative Actions: Concept Definition ...................................................................................................... 38
A. Requirements to undertake a derivative actio n ............................................................................... 40
B. Directors v. Shareholders: the Business Jud gement Rule as Defense ..................................... 44
C. The Derivative Action And Corporate Oversi ght .............................................................................. 49
III. Conclusion .............................................................................................................................................................. 51
I. INTRODUCTION
Corporations are legal entities subject to the pertinent statutes that govern
them.1 In Trustees of Dartmouth College v. Woodward, the U.S. Supreme Court
defined a corporation as “. . . an artificial being, invisible, intangible and
existing only in contemplation of law. Being a mere creature of law, it
possesses only those properties which the charter of its creation confers
upon it either expressly or as incidental to its very existence”2; and also as:
. . . a collection of individuals, united into one collective body under a
special name and possessing certain immunities, privileges and
capacities in its collective character which do not belong to the
natural persons composing it. Among other things, it possesses the
capacity of perpetual succession and of acting by the collected vote
or will of its component members, and of suing and being sued in all
things touching its corporate rights and duties. It is, in short, an
artificial person, existing in contemplation of law and endowed with
certain powers and franchises which, though they must be exercised
through the medium of its natural members, are yet considered as
subsisting in the corporation itself as distinctly as if it were a real
personage. Hence, such a corporation may sue and be sued by its
own members, and may contract with them in the same manner as
with any strangers.3
* University of Puerto Rico School of Law, J.D. Ca ndidate, May 2011.
1 DAVID G. EPSTEIN, RICHARD D. FREER, MICHAEL J. ROBERT S & GEORGE B. SHEPARD, BUSINESS
STRUCTURES 148 (2nd ed., Thomson/West 2007).
3 Id. at 667-668.
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U.P.R. Business Law Journal
Vol. 2
Epstein4 lists the principal sources of laws that define and govern a
corporation (i.e., corporate law) as (1) state statutes, (2) the corporations’
articles of incorporation, (3) case law, and (4) federal statutes. The authors
explain that, regardless of the jurisdiction, state corporation statutes provide
that (1) a corporation is a legal entity separate from its owners and, (2) as a
general rule, these owners (called shareholders) are not personally liable for
the debts of the corporation. At most, the owners’ potential loss or liability is
limited by the amount of their investment in the corporation; a concept
known as limited liability.5
The order in which Epstein et al.4 list the previous sources is not by
coincidence. Federal courts grant great latitude to state courts except in
situations where an exclusive federal statute applies. In Burks v. Lasker,6 the
U. S. Supreme Court stated that “federal courts should apply state law
governing the authority of independent directors to discontinue derivative
suits to the extent such law is consistent with the policies of the [Investment
Company Act of 1940] and [Investment Advisers Act of 1940].”7
Estes8 infers from Burks that in the absence of a strong congressional
expression of intent to the contrary, the Supreme Court still considers state
law as controlling in corporate governance matters. He adds that “most state
laws have provisions requiring that directors shall manage - or direct the
management of - the business of the corporation. Individual versions of this
mandate have not resulted in the development of significantly different lines
of cases from state to state, as a general proposition.”9
Davis10 believes that in comparison to the corporate laws of other
countries, the United States’ corporate law is flexible and loose. He is of the
opinion that those who control and manage a corporation are given ample
leeway. Davis identifies two underlying institutions whose strength makes
this possible. One is a disclosure system that ensures a full picture to
investors of the operational and fiscal state of the corporation. The other is
the fiduciary concept, which replaces standardized prohibitions with the
opportunity to evaluate managerial conduct on a more holistic basis. The
fiduciary concept filters self-opportunistic behavior by those in control of a
corporation without deterring good faith efforts to further shareholder
welfare in ways that might run afoul of a more technical set of restrictions.
4 EPSTEIN ET AL., supra note 1, a t 151.
5 EPSTEIN ET AL., supra note 1, a t 148.
7 Id. at 486.
8 Robert M. Estes, Corporate Governance in the Courts, 58(4) HARV. BUS. REV. 50, 51-52
(1980).
9 Id. at 64.
10 Kenneth B. Davis Jr., The Forgotten Derivative Suit, 61 VAND. L. REV. 387, 388 (2008).
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