Preliminary Procedures in Shareholder Derivative Litigation: A Beneficial Legal Transplant?

Jurisdictions around the world have developed different mechanisms to balance the need to enforce corporate law with the problem of non-meritorious litigation when derivative suits can be brought bring easily. One instrument to channel shareholder litigation is preliminary procedures, which typically constitute a screening stage before fact-finding. These have been adopted in several jurisdictions in recent years. This article argues that in jurisdictions applying the “loser pays” rule, preliminary procedures can serve as cutoff points for potential plaintiffs’ litigation cost risk, which often blunts incentives to litigate. To make preliminary procedures an effective instrument this article proposes two elements of institutional design. First, the risk of paying litigation costs should initially be limited to the preliminary procedure. Second, at the preliminary stage, shareholders should not be required to provide evidence about the merits of the suit or whether the company would benefit from it. Instead, as in the US, the emphasis of the preliminary stage should be on conflicts of interest of directors that make it unlikely that they bring such a suit themselves. Such a system would permit courts to screen our abusive lawsuits at an early stage while at the same time reducing incentive problems that have long plagued shareholder litigation.