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Derivative Action

By
Lia Kopin-Green
/
December 11, 2022

What is Derivative Action?

In the field of business and corporate law, derivative action, also known as a derivative suit or shareholder derivative suit, is a legal action taken against a party that is brought by shareholders on behalf of a corporation. As a general rule, shareholders hold the right to sue on behalf of a corporation if there is a valid cause of action that is not pursued. In other words, if directors of a certain corporation choose not to pursue litigation against parties who have harmed the company, the shareholder is able to do so on the corporation’s behalf. If the derivative action suit is successful, the proceeds acquired will go to the corporation instead of the shareholder who brought on the suit.

Key Takeaways

  • Derivative action, also referred to as a derivative suit or shareholder derivative suit, is a lawsuit against another party brought on by shareholders on behalf of a corporation.
  • Shareholders may pursue derivative action if the corporation has a valid cause of action that has not been pursued. 
  • In almost all United States jurisdictions, any damages recovered from a derivative lawsuit belong to the corporation rather than the shareholders that initiated the suit.

Why Are Shareholder Derivative Suits Filed?

When a corporation refuses to file a lawsuit on its own behalf, shareholders are able to step in and pursue legal action against a certain officer or director. The party being sued in these cases may be a corporate director, a member of upper management or other shareholder. Typically, derivative action is taken against parties for breach of contract or breach of fiduciary duty. Moreover, derivative action may be pursued when situations involving  poor management, fraud or lack of integrity or good faith are being overlooked by a corporation’s board of directors.

What is the Difference Between a Direct and Derivative Claim?

As soon as an investor buys a corporation's stock, he or she becomes an active owner of the company. As a result, shareholders hold the right to make a number of decisions or take certain actions that can greatly affect the future of a company. For instance, shareholders are able to pursue lawsuits against particular officers or directors within the corporation.

In the United States, there are two main types of legal actions that can be taken against a corporation: direct claims and derivative claims. In direct claims, the shareholder seeks legal relief for harm to that particular individual, as opposed to damage to the company itself. The shareholder in a direct claim uses his or her name to bring a lawsuit against the corporation. In some cases, direct claims are filed in order to seek justice for discrimination. 

When it comes to derivative action, as explained above, the shareholder steps into the shoes of the corporation itself and seeks justice on their behalf. Simply put, derivative action is taken as a result of injury to the entity itself. In derivative action, the shareholder is obligated to act in the best interests of the company and its shareholders. 

Bottom Line

Are you an individual shareholder interested in safeguarding your rights through a direct claim? Are you interested in filing a derivative claim on behalf of your corporation? Either way, you’ll need the support of an experienced business law attorney. Get in touch with a professional business attorney today with Attorney At Law.

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