What Is a Shareholder’s Derivative Action?

A shareholder’s derivative action is a type of legal action or lawsuit that is brought by one or more shareholders on behalf of a corporation in order to protect the organization and its shareholders from wrongful or illegal activity. It is a way for shareholders to pursue a claim in a court of law on behalf of the company when there are no instructions in the company’s bylaws to do so.

In a shareholder’s derivative action, the shareholder will act as a representative of the corporation and, when successful, any damages achieved will go to the corporation rather than directly to the shareholder. An example of such a lawsuit is a company director who doesn’t fulfill her legal duties. The shareholder can bring a lawsuit as the corporation’s representative to seek damages from the director.

These actions are sometimes seen as controversial because shareholders get to decide whether to pursue a derivative action even if the company’s board does not wish it. Any decision is typically reviewed by a court to ensure it is going to benefit the company.

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Why Use a Shareholder’s Derivative Action?

The goal of shareholder’s derivative action is to ensure that shareholders are able to receive adequate and fair compensation for wrongdoings. For example, if a company has directors who have signed a contract with another company that subsequently causes financial harm to the corporation, shareholders can bring a derivative action against the directors to recover the lost funds. In some cases, the company can even be awarded punitive damages if the court rules that the directors were grossly negligent.

Shareholders can also use derivative action as a means of stopping illegal or unethical conduct by the company’s executive officers. For example, if the officers are found to be taking part in insider trading, a derivative action can be brought to demand that the officers cease the activity and that the company be compensated for any losses associated with the misconduct.

Related Legal Concepts

Understanding shareholder’s derivative action often goes hand in hand with shareholders’ agreement and shareholders’ meeting, as these documents and proceedings establish the framework for shareholder rights and corporate governance. This type of legal action falls under the broader category of civil action, and shares similarities with class action lawsuits in that they allow parties to pursue claims on behalf of others. The concept is closely related to other forms of derivative action and represents one specific type of cause of action available to protect corporate interests.

The Bottom Line

Shareholder’s derivative actions serve as an important mechanism for corporate accountability, allowing shareholders to protect their company’s interests when management fails to act. These lawsuits help ensure that directors and officers fulfill their fiduciary duties and that corporations can recover damages from internal wrongdoing. For guidance specific to your situation, always consult a qualified, licensed attorney.