Derivative Claim
Overview
A derivative claim is a type of litigation initiated by a shareholder on behalf of a company to address wrongs or misconduct inflicted upon the company. This typically occurs when those responsible for such wrongs, such as directors or majority shareholders, are in control of the company, potentially preventing it from suing in its own name.
Examples
- Director Misappropriation: If company directors misuse company funds for personal gain, a shareholder may bring a derivative claim to recover the misspent funds.
- Violation of Corporate Duty: When majority shareholders act in a way that benefits them at the expense of the company’s minority shareholders, such as by approving unfair transactions, a derivative claim can be sought.
- Fraud or Breach of Trust: If directors engage in fraud or breach their fiduciary duties, a shareholder can file a derivative action to rectify these transgressions.
Frequently Asked Questions (FAQs)
Q: What is the primary purpose of a derivative claim?
A: The primary purpose is to allow shareholders to enforce the rights of the company and ensure those controlling the company cannot abuse their power to the detriment of the company and its shareholders.
Q: What must shareholders prove to bring a derivative claim?
A: Shareholders must prove to the court that the company has suffered from wrongs committed by those in control and that pursuing the claim is in the best interest of the company, among other legal prerequisites.
Q: Who benefits from a successful derivative claim?
A: The company and, indirectly, all its shareholders benefit from the successful resolution of a derivative claim since any recoveries or remedies are awarded to the company.
Q: Why doesn’t the company just sue directly?
A: In cases where those in control of the company, such as directors or majority shareholders, are the ones being accused of wrongdoing, a direct lawsuit may not be feasible or may be prevented by those in power.
Q: Can any shareholder bring a derivative claim?
A: Generally, shareholders must meet certain criteria, including showing they fairly represent the interests of similarly affected shareholders and that they have tried to resolve the issue internally before turning to litigation.
- Fiduciary Duty: The legal obligation of one party to act in the best interest of another. In companies, directors owe fiduciary duties to the company and its shareholders.
- Minority Shareholder: A shareholder who holds a smaller portion of a company’s shares, often possessing less influence over company decisions compared to majority shareholders.
- Corporate Governance: The system by which companies are directed and controlled, involving rules and practices that guide the board of directors in managing a company.
- Shareholder Agreement: A legal document outlining the rights and obligations of shareholders within a company.
Online References
Suggested Books for Further Studies
- “The Law of Derivative Actions in the US, UK, and Australia” by Ivan Paul Belli
- “Shareholder Derivative Litigation: Besieging the Board” by Lyman Johnson and David Millon
- “Corporate Governance Principles, Policies, and Practices” by Bob Tricker
Accounting Basics: “Derivative Claim” Fundamentals Quiz
### When is a derivative claim typically brought?
- [ ] When a company makes a profit.
- [ ] When shareholders want a merger.
- [x] When those in control of the company commit a wrong against it.
- [ ] When the company wants to increase stock prices.
> **Explanation:** A derivative claim is brought when those in control of the company, such as directors or majority shareholders, commit a wrong against the company.
### Who can initiate a derivative claim?
- [ ] Only company directors.
- [ ] Non-shareholder employees.
- [x] Company shareholders.
- [ ] Potential investors.
> **Explanation:** Company shareholders initiate a derivative claim on behalf of the company when wrongs are purportedly committed by those in control.
### Who benefits directly from a successful derivative claim?
- [ ] The initiating shareholder directly.
- [x] The company itself.
- [ ] Only the majority shareholders.
- [ ] The company's creditors.
> **Explanation:** The company itself benefits directly from any recoveries or remedies awarded, indirectly benefiting all its shareholders.
### What must a shareholder typically prove to bring a derivative claim?
- [x] The necessity of the claim and efforts to resolve the issue internally.
- [ ] The amount of lost profits last quarter.
- [ ] The company's quarterly tax filings.
- [ ] The business plan for the next five years.
> **Explanation:** A shareholder must prove that pursuing the claim is in the best interest of the company and that internal resolution efforts were made among other legal requirements.
### Are derivative claims only applicable to public companies?
- [ ] Yes, only public companies are subject to derivative claims.
- [ ] No, only private companies can be targeted.
- [x] No, they apply to both public and private companies.
- [ ] Only small businesses are implicated.
> **Explanation:** Derivative claims can be brought in both public and private companies if wrongs against the company by those in control are alleged.
### Who typically appears as the defendant in a derivative action?
- [ ] The shareholder who initiated the claim.
- [ ] The company's creditors.
- [x] The company itself.
- [ ] The employees.
> **Explanation:** The company appears as the defendant to ensure it is bound by and benefits from the court's decision.
### Why might the company not sue directly in a derivative claim?
- [ ] It lacks the legal authority to sue.
- [ ] It is a startup company.
- [x] The wrongdoers are in control of the company.
- [ ] It is not permitted by its corporate governance policies.
> **Explanation:** The company likely does not sue directly because the wrongdoers are in positions of control within the company, preventing a direct lawsuit.
### What is a key prerequisite for a shareholder to initiate a derivative claim?
- [ ] Having held stock for more than five years.
- [ ] The largest shareholder in the company.
- [x] Representing the interests of similarly affected shareholders.
- [ ] Having no connection to the company's decision-makers.
> **Explanation:** Shareholders must represent the interests of similarly affected shareholders and typically prove that internal resolution attempts were made.
### What can a derivative claim address?
- [ ] Shareholder votes.
- [ ] Share division ratios.
- [x] Breach of fiduciary duty by directors or majority shareholders.
- [ ] Annual general meetings.
> **Explanation:** Derivative claims often address breaches of fiduciary duty by directors or majority shareholders who control the company.
### What is the ultimate goal of a derivative claim?
- [ ] To increase company stock prices.
- [ ] To maximize shareholder profits.
- [x] To rectify wrongs done to the company.
- [ ] To change the corporate management structure.
> **Explanation:** The ultimate goal is to rectify wrongs done to the company and ensure it is managed fairly and legally.
Thank you for exploring the intricate world of derivative claims and testing your understanding with our comprehensive quiz! Pursue excellence in your financial and legal knowledge to protect your investments and corporate governance practices.
