What is a Shareholder Derivative Suit?

Published: 16th September 2009
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A shareholder derivative suit refers to a lawsuit brought by the shareholders in behalf of the corporation against a third party.

This is not traditional practice in corporate law, normally management is the one responsible for bringing up charges or defending the corporation from lawsuits.

Shareholders on the other hand are not exactly empowered to control the operations of the corporation even if they are considered as the owners.

That is why a shareholder derivative suit can only be made if the management has failed to take action.

This is also different from direct lawsuits that are usually filed by shareholders to enforce a claim that is connected to their interests in the corporation.

That is more personal while a derivative suit represents the corporation more than the shareholders.

In fact, the proceeds of a successful shareholder derivative suit goes to the corporation and not the shareholders.

In California, a shareholder derivative suit follows the Model Business Corporation Act (MBCA).

Here are the procedures followed before a derivative suit is allowed:

• Establish that there has been harm in the corporation but the board of directors has not taken any action.

• Eligible shareholders should file a demand on the board to take measures against the wrongdoer/s. A shareholder must satisfy some requirements to prove that he/she has a valid standing in the corporation before he/she can proceed.

An example of those requirements is the minimum value of the shares and the duration it is held by the shareholder.

• The board of directors can reject, accept or not act upon the demand. If the board accepts, then the corporation itself will file the lawsuit.

• If the demand is rejected or not acted upon then the shareholders must meet additional pleading requirements.

• If the requirements are met, the board may appoint a special litigation committee who can vote to dismiss.

• If the committee makes a required showing then the case will be dismissed, if not, then the shareholder's derivative suit will proceed.

The main purpose of a shareholders derivative suit is that it gives shareholders legal means to enforce the corporation's claims against its managing directors and executives.

This is because the directors and executives are in control of the company and they are not inclined to take legal actions against themselves.

Through a derivative suit, the shareholders can pursue these claims against the involved executives in behalf of the company.

Another purpose of a shareholder derivative suit is that it prevents multiple lawsuits to the corporation. If the directors or executives are performing illegal acts in behalf of the corporation, then they may receive complaints and lawsuits that may damage the image of the corporation.

This could be seen as a preemptive method as well before the accused executive or director creates more damage to the corporation.

A shareholder derivative suit can be complicated; it is recommended that you consult with a good corporate lawyer to help you establish your validity as a shareholder and to make sure that you are following the right process.

Visit our website to help you understand shareholder derivative suits. Call us toll free for legal assistance.

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