Stockholders' Derivative Action

Definition

A Stockholders’ Derivative Action is a legal suit initiated by shareholders on behalf of a corporation to rectify a wrong done to the corporation, typically due to breaches of fiduciary duty by the corporation’s management or directors. While the corporation is the party that has directly suffered harm, the lawsuit is conducted by the shareholders as its representatives. This mechanism ensures that corporate officers and directors can be held accountable for actions that harm the company.

Examples

Breach of Fiduciary Duty: If a corporation’s directors engage in self-dealing or fraud that harms the corporation financially, shareholders may file a derivative action claiming that the directors breached their duty to act in the corporation’s best interests.
Failure to Act: If corporate officers neglect their duties resulting in significant losses for the corporation, shareholders can file a derivative lawsuit to compel the officers to take corrective action or to recover damages for the losses incurred.

Frequently Asked Questions (FAQs)

What is the purpose of a stockholders’ derivative action?

The purpose is to address wrongdoings committed against the corporation by its officers or directors that have harmed the corporation, with shareholders acting to enforce the rights of the corporation.

Who can file a derivative action?

Typically, any shareholder of the corporation can file a derivative action, provided they meet specific legal requirements, such as owning stock in the corporation at the time of the alleged wrongdoing.

What are the typical legal requirements to file a derivative action?

Legal requirements may include demonstrating ownership of stock in the corporation, maintaining ownership throughout the litigation, and making a demand on the corporation’s board to address the issue before filing the suit, unless such a demand is futile.

Can a derivative action result in monetary compensation?

Yes, if the court finds that the corporation suffered financial harm due to the actions of its officers or directors, the judgment may include monetary compensation to the corporation.

What is a demand futility exception?

A demand futility exception occurs when making a demand on the corporation’s board before filing a derivative lawsuit is deemed futile because the board members are implicated in the wrongdoing or are unable to act impartially.

Fiduciary Duty: The legal obligation of one party to act in the best interest of another. For corporate directors and officers, this means acting in the best interests of the corporation and its shareholders.
Self-Dealing: When a corporate director or officer engages in transactions that benefit themselves at the expense of the corporation.
Corporate Governance: The system of rules, practices, and processes by which a corporation is directed and controlled.
Hostile Takeover: A type of acquisition in which the acquiring company attempts to take over a target company against the wishes of the target’s management.
Class Action: A lawsuit filed by one or more plaintiffs on behalf of a larger group of individuals who share similar circumstances or claims.

Online References

Suggested Books for Further Studies

“The Principles of Corporate Law” by Brian R. Cheffins
“Corporate Governance: A Synthesis of Theory, Research, and Practice” by R.A.G. Monks and Nell Minow
“Fiduciary Duty and the Law of Trusts” by Tamar Frankel
“Corporate Governance and Ethics” by Zabihollah Rezaee

Fundamentals of Stockholders’ Derivative Action: Business Law Basics Quiz

### Who primarily suffers the harm that leads to a stockholders' derivative action? - [ ] The shareholders - [ ] Individual employees - [x] The corporation - [ ] The customers > **Explanation:** The harm addressed in a stockholders' derivative action is primarily suffered by the corporation itself, though the lawsuit is initiated by shareholders on behalf of the corporation. ### What is typically required before a shareholder can file a derivative action? - [x] A demand on the corporation's board to address the issue - [ ] Payment of a fee to the corporation - [ ] A vote by all shareholders - [ ] No prior action is required > **Explanation:** Shareholders usually need to make a demand on the corporation's board to address the issue before filing a derivative action. This requirement may be waived if the demand is deemed futile. ### What is a fiduciary duty? - [x] A legal obligation to act in the best interest of another party - [ ] The duty to maximize personal gain - [ ] The obligation to follow public opinion - [ ] None of the above > **Explanation:** Fiduciary duty refers to the legal obligation of corporate directors and officers to act in the best interests of the corporation and its shareholders. It is a central concept in corporate governance. ### What does the term 'demand futility' refer to? - [ ] Excessive demands by shareholders - [x] The concept that making a demand on the board would be pointless - [ ] Demand surpassing demand capacity - [ ] None of the above > **Explanation:** Demand futility refers to situations where making a demand on the corporation's board to address the grievance would be pointless, usually because the board members are implicated in the wrongdoing or would not act impartially. ### Can a derivative action benefit shareholders directly? - [ ] Yes, shareholders receive direct monetary compensation. - [x] No, any monetary compensation goes to the corporation. - [ ] It depends on the court ruling. - [ ] None of the above > **Explanation:** Any monetary compensation resulting from a derivative action benefits the corporation and not the individual shareholders directly, although this can indirectly benefit shareholders through a restored or increased corporate value. ### What kind of remedy can shareholders seek in a derivative action? - [ ] Personal damages - [ ] Termination of employee contracts - [x] Corrective actions or monetary compensation for the corporation - [ ] Criminal penalties > **Explanation:** In a derivative action, shareholders seek corrective actions or monetary compensation for the corporation to rectify the harm caused by the management's breach of fiduciary duty. ### Who usually conducts a derivative suit? - [ ] The corporation itself - [x] The shareholders as the corporation’s representatives - [ ] A government agency - [ ] A third-party arbitrator > **Explanation:** A derivative suit is conducted by shareholders on behalf of the corporation to address wrongs that have been suffered primarily by the corporation. ### When is making a demand on the board not required before filing a derivative lawsuit? - [x] When the demand is considered futile - [ ] When more than 50% of shareholders agree - [ ] When the corporation is in financial distress - [ ] Always required > **Explanation:** Making a demand on the corporation's board is not required if it is believed that the demand would be futile because the board members are implicated in the wrongdoing or cannot act impartially. ### Can a derivative action include a claim for personal damages by shareholders? - [x] No, it aims to address harm to the corporation - [ ] Yes, it can include personal damages - [ ] Sometimes - [ ] It depends on the jurisdiction > **Explanation:** A derivative action aims to address harm done to the corporation, not personal damages suffered by shareholders. Any compensation awarded goes to the corporation. ### Which of the following is not a potential outcome of a derivative action? - [ ] Fiduciary duties being upheld by management - [ ] Monetary compensation to the corporation - [ ] Corrective measures being imposed on management - [x] Personal financial gain for shareholders > **Explanation:** While derivative actions can result in management actions being corrected, fiduciary duties being upheld, and monetary compensation being awarded to the corporation, they do not result in direct personal financial gain for shareholders.

Thank you for exploring our detailed overview and engaging quiz on the concept and practice of stockholders’ derivative actions. Continue enhancing your understanding of corporate governance and legal mechanisms that protect corporate integrity!