DEERFIELD NEWS CONNECTION

October 22, 2023

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Derivative Lawsuits and the Role of the Receiver

 

A derivative lawsuit is generally filed by shareholders or members on behalf of a corporation or association in order to defend a legal right to remedy or prevent a wrong to the corporation. In this type of lawsuit, the shareholders or members are plaintiffs and fiduciaries for the corporation, and the corporate officers or directors are defendants. Below is a brief overview explaining this type of suit and the role of a court receiver.

 

Derivative Lawsuit

 

A derivative lawsuit may be filed by shareholders on behalf of a corporation or by members on behalf of an association. Suits are brought by current shareholders or members under state corporate law and allege that the officers or members of the board of directors have breached their fiduciary duties. These lawsuits are referred to as “derivative” because shareholders/members do not bring the action directly on behalf of themselves as individuals. Instead, they sue on behalf of the corporation that is being injured by the action or inaction of the officers or directors. In other words, the value is derived by the shareholders/members through improvements made to the corporation as any damages recovered belong to the corporation or association, not to the representative plaintiffs. 

 

To correct alleged wrongs, the shareholders/members step into the shoes of the corporation to compel it to correct its course. Those bringing derivative legal action do not do so for monetary gain, but as an impetus to force the company to hold its officers and directors accountable and liable for actions they have taken on the corporation’s behalf.  No direct benefits accrue to the individual stakeholders/members that originally filed the lawsuit. The benefit of a derivative suit is that it results in improvements in corporate governance, policies, and financial management. (Tenn. Code § 48-56-401, Derivative Suits)

 

In most jurisdictions, shareholders/ members must satisfy statutory requirements to prove that they have “standing” to bring the action. In other words, the right of a party to challenge the conduct of another party in court. Before a derivative lawsuit can proceed, the stakeholders/members are required to demonstrate that they petitioned the corporation for redress of their concerns. If the corporation refuses to comply with the request made in accordance with Tennessee law, then the lawsuit may proceed. Hence, derivative lawsuits must meet a high standard in order to proceed through the court, as the court’s permission is required to continue the claim. When courts find that directors and officers have violated their fiduciary duties, their Directors & Officers insurance will not cover the cost of their litigation or potential damages; and corporate financial resources may not be used to pay for these costs either. Board members will be held personally responsible for all costs associated with the lawsuit. (Tenn. Code § 48-28-108, Standing to Maintain Derivative Suit)

 

Role of Receiver 

 

A receivership estate is established by a court and thus derives its authority from the appointing court.  Selected under the authority of the receivership estate, the receiver as a neutral party who temporarily maintains possession of property belonging to one or more litigants in a lawsuit, and may not be a party to the lawsuit, attorney for either party, interested person or relative of the judge. The parties to a lawsuit may nominate a candidate for appointment by the judge or the judge may choose the person to act as receiver. (2021 Tennessee Code, Title 29 – Remedies and special Proceedings, Chapter 40 – Uniform Commercial Real Estate Receivership Act)

 

Receiver as Fiduciary

 

The receiver acts as a fiduciary for the court and all claimants or parties interested in the property held in the receivership estate. As an agent for the appointing court, the receiver holds title and possession of the property until the receivership estate is terminated by the court.  Since the receiver occupies a fiduciary relationship to persons interested in the property, the receiver must perform duties with the high degree of care demanded of a trustee or other similar fiduciary and may not deal with property under the receiver’s control in such a way as to benefit the receiver. (Tenn. Code § 29-40-106, Appointment of Receiver) 

 

Powers of the Receiver and the Court

 

Deriving its authority from the court, the receiver acts under the direction and control of the court. The court that appoints the receiver determines the scope of that receiver's authority, and the receiver's powers are fixed by court's orders, or other state statutes governing receivership operation. (Tenn. Code, § 29-40-112, Power and Duties of Receiver)

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Note:  For the lawsuit, Daniel J. Valle, et. al v. Fields Development Company et. al, the court appointed a receiver for Deerfield Resort Homeowners Association, Inc. To better understand the scope of the appointed Receiver’s authority, please follow these links to the Order of Receivership: Amended Court Order of Receivership, No. 7CHI-2019-CV-237, October 8, 2021, and Order of Receivership, No. 7CHI-2019-CV-237, May 12, 2021

 

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Management of the Receivership Estate

 

The basic purpose of receivership is the conservation of the property. The receiver is charged with the custody of the property to protect and preserve it and must exercise the same care and diligence that an ordinary prudent person would in handling their own property.  While in possession of real property, the receiver stands in the shoes of the owner and, potentially, an appointing creditor. Thus, the receiver has a duty to maintain the property in the same manner as the owner. (Tenn. Code, § 29-40-112, Power and Duties of Receiver)

 

Receivership Protected Against Interference

 

Charged with a duty of managing the receivership estate, the receiver is entitled to be free from outside interference. Thus, a receivership protects the receiver against interference without the prior consent of the court related to the receiver’s custody, possession, management, and control.  Since property in a receivership is in the possession of the court, no one, including a party to the legal action, has the right to interfere with the court’s possession through its receiver. Unsolicited interference may be sanctioned as civil contempt. When persons other than the receiver have property in their hands which should be in the hands of the receiver, or when any person diverts or attempts to divert receivership assets, the receiver not only may, but must, take all appropriate steps in law to recover possession, management, and control of the property. (Tenn. Code § 29-40-114, Stay – Injunction)

 

In conclusion, in a derivative lawsuit, the shareholders/members are fiduciaries for the corporation/association and cannot seek personal benefit. These types of suits may be difficult and unpredictable, and frequently are settled. All aspects of a settlement must go through judicial review and receive court approval. The court must determine that the settlement is fair, reasonable, and adequate in light of the claims being settled.