A derivative action, also known as a shareholder derivative suit, is a lawsuit brought by a shareholder on behalf of a corporation against a third party. Often, this third party is an insider of the corporation, such as an executive, director, or officer, accused of harming the corporation through wrongful acts or omissions.
The shareholder steps in to sue because the corporation itself has failed to take action against the wrongdoer, typically due to the wrongdoer's influence within the corporation. Any damages or remedies awarded in the lawsuit are granted to the corporation, not the individual shareholder who initiated the action.
Derivative actions serve as a means for shareholders to address harm done to the corporation when those in control are unwilling or unable to act in the corporation's best interest.
This kind of lawsuit is particularly important in cases of fraud, breach of fiduciary duty, mismanagement, and other acts that can damage the corporation's value and shareholder interests.
Key aspects of derivative action include:
Standing to Sue: To file a derivative lawsuit, a shareholder must typically demonstrate that they owned shares at the time of the wrongful acts and that they attempted to resolve the issue internally before resorting to litigation.
Demand Requirement: Shareholders are usually required to make a formal demand on the corporation's board to take suitable action against the alleged wrongdoers, unless such a demand would be futile.
Corporate Benefit: Any recovery or benefit from the lawsuit goes to the corporation. This can include financial damages, restorative actions, or changes in corporate governance practices to prevent future misconduct.
While the concept of derivative action is primarily associated with corporate law, the principles behind it can apply in various organizational contexts, such as non-profit organizations or partnerships, where members or partners might take legal action on behalf of the entity.
The specific rules and requirements for initiating a derivative lawsuit can vary significantly between jurisdictions, reflecting different legal frameworks and corporate governance models.
One common misconception is that a derivative action benefits the individual shareholder or members who initiate the lawsuit.
While these individuals may indirectly benefit from improvements in the corporation's health and governance, any direct financial recovery is made on behalf of the corporation itself.
Another misunderstanding is that derivative actions are straightforward and only involve disputes over financial mismanagement.
In reality, these lawsuits can address a broad spectrum of wrongful conduct affecting the corporation, and they often involve complex legal and procedural requirements.
Lastly, some believe that derivative actions are frequent or easy to pursue.
Although these actions provide a critical avenue for redress, the legal barriers to filing such a lawsuit—such as the demand requirement and proving standing—are significant. These barriers ensure that derivative actions are not initiated frivolously and reflect genuine concerns for the corporation's welfare.
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