Introduction
A derivative action is a unique legal mechanism that allows a shareholder to sue on behalf of a corporation. This type of lawsuit is typically brought against insiders such as directors and officers who have allegedly failed in their corporate duties.
Nature and Purpose of a Derivative Action
The nature of a derivative action is rooted in the principle of corporate law that management is responsible for running the company. However, there are instances where the management may act in their own interests, rather than those of the corporation and its shareholders. In such cases, a derivative action serves as a tool for shareholders to protect the corporation’s interests.
The purpose of a derivative action is to remedy wrongs done to the corporation. It is not intended to compensate individual shareholders, but rather to recover assets or funds for the corporation that have been misappropriated or wasted due to mismanagement or fraud.
How the Process Works
The process of a derivative action involves several steps:
- Demand Requirement: Before filing a derivative suit, the shareholder must typically make a demand on the board of directors to rectify the alleged wrong. The board then has the opportunity to correct the issue internally.
- Filing the Lawsuit: If the board fails to address the issue, the shareholder may file a derivative suit. The shareholder must demonstrate that they are a legitimate shareholder and that they tried to resolve the issue before resorting to litigation.
- Litigation: The shareholder, acting on behalf of the corporation, litigates against the party that caused harm to the corporation. Any damages awarded go directly to the corporation, not the individual shareholder.
The Relief Claimed
The relief claimed in a derivative action is typically restitution to the corporation. This can include financial compensation, changes in corporate governance, or other remedies that benefit the corporation as a whole.
Defenses Against Derivative Actions
There are several defenses that can be raised against derivative actions:
- Business Judgment Rule: This rule presumes that directors act in good faith and in the best interest of the corporation. If directors can demonstrate that their actions were informed and rational, courts will typically defer to their judgment.
- Failure to Make a Demand: If a shareholder fails to make a proper demand on the board before filing suit, the case may be dismissed.
- Lack of Standing: If a shareholder cannot demonstrate a direct and personal injury from the alleged corporate wrong, they may lack standing to sue.
Derivative actions serve as an important check on corporate management, ensuring they uphold their fiduciary duties to the corporation and its shareholders. While the process can be complex, it is a vital tool in maintaining corporate integrity.
The information provided in this article does not, and is not intended to, constitute legal advice; instead, all information, content, and materials available in this article are for general informational purposes only. Readers of this article should contact us or any other attorney to obtain advice with respect to any particular legal matter. No reader, user, or browser of this article should act or refrain from acting on the basis of information on this article without first seeking legal advice. Only your individual attorney can provide assurances that the information contained herein – and your interpretation of it – is applicable or appropriate to your particular situation. All liability with respect to actions taken or not taken based on the contents of this article are hereby expressly disclaimed. The content on this posting is provided “as is;” no representations are made that the content is error-free.