Derivative Suit over a Conflicted Software Purchase
A, B, and C are the three directors of X Co., a software company. A is CEO and owns 40%; B and C are outside directors. In March A proposes that X buy a customer-management system from Y Co., which is 50% owned by A's brother-in-law, for ¥45 million. Two independent quotes are ¥14-16 million. A tells the board Y's system is 'customized and worth the premium.' B and C approve at a 15-minute meeting; A abstains. The minutes say only 'board approved after discussion' and do not compare quotes. X sells the system two years later for ¥3 million. A shareholder gives X a 60-day demand to sue A, B, and C. X's board refuses. The shareholder files a derivative suit. X has no special committee and no independent counsel.
1. Is A liable for breach of duty?
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Yes. A's transaction with Y is a conflict-of-interest transaction: A is CEO and his brother-in-law owns 50% of Y. The board approved, but A abstained; the key issue is fairness. The price was roughly three times the independent quotes, and there was no valuation or negotiation. A had a duty of loyalty and care; the burden is on him to show the terms were fair. He cannot hide behind the business judgment rule because the process was tainted by conflict and the price is extreme. X's loss is the difference between the ¥45 million paid and the ¥3 million salvage, subject to any proven value. A is liable for that loss.
2. Are B and C liable for approving the transaction?
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Likely yes, or at least exposed. Outside directors must act with reasonable care and monitor red flags. B and C knew A's family connection and the price gap, yet approved in 15 minutes without seeing the quotes or asking for an independent fairness opinion. That is a breach of the duty of care. The business judgment rule protects informed, good-faith decisions; it does not protect a board that ignores obvious warning signs. Their liability may be proportionate or reduced by reliance on A, but reliance is unreasonable where the conflict is known. They should have formed a committee or obtained outside advice.
3. What procedural hurdles does the derivative suit face?
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The shareholder must have standing at the time of demand and through the suit, and must first demand that X sue. X refused after the 60-day demand, so the shareholder may proceed. If X had sued, the shareholder could not duplicate. The court may require security if the suit is abused. X can intervene, and the defendants can argue the demand was ineffective or that the shareholder lacks standing. The shareholder must sue for X's benefit, not personally. If A, B, and C settle, court approval may be needed. The shareholder should also demand documents and preserve board minutes.