What Is Derivative Action? Explained for Business Professionals

Derivative action is a legal proceeding in which a corporation’s shareholders file a lawsuit on behalf of the company; it is filed against other shareholders, third parties or the corporation itself when a management team is not representing the interests of the corporation in an appropriate manner. This process is used to protect the corporation’s interests, typically in the face of an alleged breach of fiduciary duty.

The Basics of Derivative Action

In basic terms, a derivative action is when a group of shareholders initiates a lawsuit on behalf of the corporation. Even if the board of directors is not willing to take legal action, a common forum of shareholders is legally empowered to file a lawsuit if a situation exists that may damage the company.

The Role of the Plaintiffs

The plaintiffs – the shareholders taking action — generally adopt a representative role. This allows them to act on behalf of all other shareholders when a misconduct of duty, breach of contract or struggle of corporate control is apparent. The plaintiff(s) must present facts toshow reasonable basis that the defendant’s actions adversely affect the company.

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Recently Filed Derivative Actions

The derivative action process is still an efficient mechanism for shareholder justice. For example, in 2019, a derivative action was successfully filed against a hedge fund claiming the fund had withheld corporate information from the board in an attempt to take control of the company. In 2019, a derivative action brought by shareholders also forced a company to halt an unconstitutional stock buyback.

Related Legal Concepts

Understanding derivative action often goes hand in hand with shareholder’s derivative action and stockholder’s derivative action, which are essentially synonymous terms for the same legal mechanism. These proceedings differ significantly from a class action, where shareholders sue for their own individual damages rather than on behalf of the corporation. Derivative actions also relate to broader concepts of civil action and cause of action, as they must establish valid legal grounds for the lawsuit to proceed.

The Bottom Line

Derivative actions serve as a crucial corporate governance tool that empowers shareholders to protect their company’s interests when management fails to act appropriately. This legal mechanism ensures accountability within corporations by allowing shareholders to pursue justice on behalf of the entity itself, rather than seeking individual compensation. For guidance specific to your situation, always consult a qualified, licensed attorney.