Homeowners Can Employ Derivative Actions When Their Board Refuses to Pursue Claims

Frequently homeowners in common interest developments that are controlled by homeowners associations find that their board of directors is unwilling to take legal action that the homeowners want to have pursued. An area where this issue is often debated concerns construction defect claims. Not all association boards are receptive to retaining legal counsel to pursue construction defect claims against the parties who are believed to be responsible for the defects such as the developer of the project, the general contractor, certain subcontractors, and/or design professionals. While there could be legitimate reasons that an association’s board of directors does not want to pursue litigation, there are also situations where the refusal is not in the best interests of the association members. Such refusals can be due to such things conflicts of interest, personal relationships between board members and developer personnel, developer control of the association’s board, and general adversity to litigation and lawyers. What is the recourse for homeowners when their board of directors refuses to pursue an action that the homeowners want pursued?

The remedy that the law provides for corporate shareholders and association members in organizations that are controlled by a board of directors who refuse to take action is the “derivative action.” A derivative action is a form of a lawsuit in which one or more shareholders of a corporation, or homeowners in a homeowners association, are able to commence a legal action “on behalf of” the corporation or association. A prerequisite to filing such an action is a refusal by the corporation or association to take the action on its own. When that occurs, the individual shareholder(s) or member(s) become the plaintiff in the lawsuit and assume the position of the corporation or association to pursue the claims that the association refused to pursue.

There are federal and state laws that address the requirements for shareholders and association members filing of derivative actions. Generally, state laws impose requirements that are contained in Rule 23.1 of the Federal Rules of Civil Procedure, which include:

• The plaintiff(s) must fairly and adequately represent the interests of other shareholders or members who are similarly situation;
• The plaintiff(s) were shareholder(s) / member(s) at the time of acts complained of or their interest later devolved by operation of law;
• The action is not a collusive action that is designed to confer jurisdiction on a court that would otherwise lack jurisdiction over the matter;
• The claims are stated with particularity;
• A showing of the effort by the plaintiff(s) to obtain the desired action from the corporation’s or association’s board of directors, or a showing of the reasons for not making the effort.

The statutes also contain provisions that govern the settlement, dismissal, and compromise of derivate actions. Typically, before a derivate action can be settled, dismissed, or compromised, court approval must be obtained following the delivery of notice to all of the shareholders / association members.

Derivative action lawsuits enable corporate shareholders and homeowner association members to pursue legal rights against third parties when their boards of directors fail and refuse to assert those rights. Pursuing a derivate action necessitates the use of experienced legal counsel who should be retained by the plaintiff(s) who are going to file the action. While there may be some types of derivative actions that would not be appropriate for contingent fee arrangements, typically construction defect actions are taken by attorneys on a contingent fee basis. The percentage of the contingent fee that is paid to the attorney is generally negotiable and depends on various factors such as who is paying the litigation costs and the stage at which the case is finally resolved.

See copy of: Federal Rules of Civil Procedure, Rule 23.1