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.