Derivative Action - Brown Law PLLC

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A derivative action is a lawsuit brought by a shareholder or member of a corporation or limited liability company (LLC) on behalf of the entity, typically against its directors or officers. This type of action is taken when the entity itself has failed to enforce its rights or pursue a claim for wrongdoing, often involving issues like fraud, mismanagement, or breach of fiduciary duty.

In a derivative action, the shareholder must demonstrate that they have made a demand on the company’s board of directors to take action to address the alleged wrongs, and that this demand was either refused or ignored. If demand is deemed futile due to the board’s involvement in the alleged misconduct or a lack of independence, the shareholder may proceed with the lawsuit without making a demand.

For example, if a company’s executive is accused of embezzling funds and the board fails to address this issue, a shareholder could file a derivative action seeking to recover the misappropriated funds for the benefit of the corporation. The proceeds from any successful claim would typically go back to the company, not the individual shareholder who initiated the lawsuit.

This mechanism serves to protect the interests of the corporation and its shareholders by allowing individuals to hold management accountable for their actions, thereby ensuring proper governance and adherence to fiduciary duties.

Key Points:

A derivative action is initiated by a shareholder on behalf of a corporation or LLC.
It addresses grievances that the corporation itself fails to pursue, often involving serious misconduct by management.
The shareholder must usually demonstrate a demand was made to the board before filing the lawsuit, unless such demand would be futile.
Any recovery from a successful derivative action typically benefits the corporation, not the individual bringing the lawsuit.

Glossary: Derivative Action
A lawsuit brought by shareholders on behalf of a corporation.

Alternative Meanings:

Derivative Action
Derivative Action

A derivative action is a lawsuit brought by a shareholder or member of a company on behalf of the corporation to enforce a right or claim that the corporation itself has failed to pursue. This type of legal action is typically initiated when the management or board of directors neglects their duties, allowing wrongs to occur that may harm the company and, consequently, its shareholders.

In a derivative action, the plaintiff must demonstrate that they are a current shareholder and that they made a demand on the corporation to take action, or that such a demand would be futile. The action is considered derivative because any recovery from the lawsuit typically goes to the corporation, rather than directly to the shareholder who initiated the suit.

For example, if a company’s board of directors engages in self-dealing or fraud that harms the company, a shareholder may file a derivative action to hold the directors accountable and seek remedies that would benefit the corporation as a whole, such as financial damages or changes in governance practices.

In many jurisdictions, the procedural requirements for filing a derivative action can be quite strict, often necessitating an initial demand to the board of directors or satisfying specific conditions under corporate law to ensure that the action is warranted and in the best interest of the corporation.

Overall, derivative actions serve as a mechanism for shareholders to protect their interests and ensure that the company is managed properly, promoting accountability among those in control of the corporation.

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