Definition
Derivative Action is a legal remedy that allows a shareholder to sue on behalf of a corporation. This type of lawsuit is brought forward when the corporation itself fails, deliberately or otherwise, to enforce its rights. The shareholder steps into the shoes of the corporation to protect the corporation and its shareholders from harm caused by a third party, often a director or officer of the corporation, who has failed in their fiduciary duties.
Examples
Breach of Fiduciary Duty: A company’s directors engage in self-dealing by entering into lucrative contracts with businesses they own without disclosing the interests to the corporation.
Mismanagement: The executives in a corporation make poor decisions that result in significant financial losses, and the corporation’s board refuses to take action against them.
Fraud: A CEO falsifies financial documents to present a better picture of the company’s financial health. When this falsification is discovered, and the corporation does not pursue legal actions, a shareholder may initiate a derivative action.
Frequently Asked Questions
What is the purpose of a derivative action?
The primary purpose is to protect the corporation and its shareholders from harm when the corporation’s management fails to act. It ensures that the corporation can seek redress for wrongs committed against it.
Who can bring a derivative action?
Generally, any shareholder with sufficient standing can bring a derivative action. This means the shareholder must have been a shareholder at the time of the alleged wrongdoing and must fairly and adequately represent the interests of the corporation.
What are the procedural requirements for initiating a derivative action?
The shareholder must first make a demand on the corporation’s board of directors to address the issue unless such a demand is deemed futile. If the board refuses, or if a demand is not required, the shareholder can file the derivative lawsuit in court.
Can shareholders benefit personally from a derivative action?
No, any recovery from a derivative action goes to the corporation, not to the individual shareholder who brought the suit. However, the shareholder may be entitled to reimbursement for legal fees.
How is a derivative action different from a direct lawsuit?
A derivative action is on behalf of the corporation for harm done to the corporation, while a direct lawsuit is initiated by shareholders for harm done directly to them.
Related Terms
Fiduciary Duty: The legal obligation of one party to act in the best interest of another. In corporate settings, this duty involves the directors and officers acting in the best interest of the corporation and its shareholders.
Shareholder Rights: The rights held by individuals or entities that own shares in a corporation, which include voting rights, dividends, and access to important company information.
Corporate Governance: The mechanisms, processes, and relations used to control and to direct corporations, typically involving the board of directors, managers, shareholders, and other stakeholders.
Online References
- Cornell Law School - Legal Information Institute: Derivative Action
- Investopedia: Derivative Suit
- American Bar Association - Derivative Lawsuits: By the Shareholders, for the Corporation
Suggested Books for Further Studies
- “Smith and Roberson’s Business Law” by Richard A. Mann and Barry S. Roberts
- “Corporate Law and Governance” by Jeffrey N. Gordon and Wolf-Georg Ringe
- “Principles of Corporate Governance” by Donald Nordberg
Fundamentals of Derivative Actions: Business Law Basics Quiz
Thank you for exploring the complexities of derivative actions and testing your knowledge with our quiz. Take charge of your corporate governance understanding!