Shareholder Derivative Actions

A shareholder derivative suit is a lawsuit brought by a shareholder on behalf of the corporation against the corporation’s directors, officers, or other third parties who breach their duties, causing harm to the company.

By Brad Nakase, Attorney

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Table of Contents

1. What is a shareholder derivative suit?

2. What leads to shareholder derivative suit?

What is a shareholder derivative suit?

A shareholder derivative suit (also known as shareholder derivative action) is a legal mechanism that enables shareholders of a corporation to bring a derivative lawsuit against corporate officers, board members, or executives who are believed to have breached their fiduciary duty and acted against the best interests of the company. Shareholders, as owners of the corporation, have a vested interest in the success and proper management of the business. When those in positions of power within the company make decisions or engage in actions that could potentially harm the company’s value or operations, it can also harm the shareholders’ investments.

Corporate officers have a fiduciary obligation to act in the best interests of the company, which includes making decisions that enhance its overall well-being and profitability. If they fail to fulfill this duty and instead make choices that are detrimental to the company’s success, both the company itself and its shareholders can suffer financial losses.

In such cases, shareholders may not directly sue the corporate officers for their alleged misconduct or breach of fiduciary duty. Instead, they can initiate a shareholder derivative suit with the assistance of an attorney. This legal action essentially allows shareholders to step into the shoes of the corporation and file a derivative lawsuit on its behalf, seeking remedies for the harm caused by the alleged wrongful actions of the insiders.

A shareholder derivative suit can be complex and raise various legal issues, requiring a deep understanding of corporate law and litigation. It is recommended that shareholders consult with a qualified business lawyer who specializes in this area of law, such as a California business lawyer with a proven track record in representing clients involved in these types of cases. Such legal professionals can navigate the intricacies of the process, gather evidence, and present a compelling derivative lawsuit on behalf of the shareholders to hold the corporate officers accountable for their actions.

In sum, a shareholder derivative suit is a legal avenue that empowers shareholders to take action against corporate insiders who have allegedly violated their fiduciary duty, thereby protecting the company’s interests and the investments of its shareholders.

What leads to shareholder derivative suit?

A shareholder derivative suit is a crucial legal recourse employed by individual shareholders or groups of shareholders, acting as representatives, to take legal action on behalf of the company in which they hold ownership stakes. Rather than directly suing the corporation’s board members, executive directors, or other influential individuals, these shareholder plaintiffs initiate the lawsuit on behalf of the corporation itself. This mechanism serves as a means to address and rectify instances where corporate insiders’ actions may be detrimental to the company’s well-being.

Typically, the focus of a shareholder derivative suit lies in allegations of breach of fiduciary duty committed by executives, managers, or board members. Such breaches could manifest in various ways, including when these insiders prioritize their personal interests over the company’s best interests. Examples of situations that can lead to the initiation of shareholder derivative actions include:

Breach of Fiduciary Duty: This encompasses instances where board members or executives fail to uphold their fiduciary obligation to act in the best interests of the company and its shareholders.

Misaligned Interests: Shareholder plaintiffs might bring a case when corporate insiders make decisions that serve their own interests rather than the company’s overall welfare.

Illegal or Fraudulent Activities: Allegations of illegal, unlawful, or fraudulent behavior by company officials can lead to derivative actions.

Conflicts of Interest: Instances where the interests of company insiders clash with those of the corporation can warrant legal action.

Financial Wrongdoing: Activities like backdating stock options, insider trading, and misappropriation of corporate assets can trigger shareholder derivative actions.

Accounting Irregularities: Misleading or false financial statements issued by the company’s insiders can prompt legal intervention.

Executive Compensation Issues: If there are suspicions of improprieties related to executive compensation, shareholders may pursue derivative actions.

Regulatory Violations: Conduct leading to investigations by regulatory bodies like the Securities and Exchange Commission (SEC) or the Department of Justice (DOJ) can be a catalyst for these actions.

Environmental and Consumer Protection Violations: Shareholders may bring a derivative lawsuit if company insiders make decisions that put the company at risk by violating environmental or consumer protection laws.

When shareholders detect signs of these or other detrimental activities within the company, they can initiate a shareholder derivative suit with the objectives of halting harmful behavior and quantifying the damages incurred. The potential outcomes of such legal actions encompass the removal of insiders causing harm, monetary compensation for the corporation or its shareholders, restitution of unlawfully acquired gains, and the implementation of changes such as reforming corporate governance practices.

Beyond safeguarding the interests of individual shareholders, shareholder derivative suit also play a pivotal role in identifying instances of fraud and misconduct within large corporations. By doing so, they not only protect the company itself but also shield the general public from deceitful corporate practices. In sum, shareholder derivative suit constitute a powerful means for stakeholders to uphold their interests, promote corporate integrity, and ensure responsible governance.

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