What is a Shareholder Derivative Suit?

Underwood-Blog-Images-3-300x300 Shareholder derivative suits are lawsuits that allow and assist shareholders in bringing legal action against the board of directors or officers in a corporate entity for illegal action. 

Read on to find out about the relationship between shareholders and derivative suits.

What is a shareholder?

Shareholders are everyday individuals who have what is called a “stake” in the company. The “stake” is considered to be a very small segment or even a fraction of a percentage segment in the ownership of a corporate organization or company. 

Individual shareholders have very little power, if any, to control the daily in and out of the management of a company they have invested in. In a way to manage this very little power, corporate organizations can have their shareholders elect a “Board of Directors” to oversee management. 

Next, the Board of Directors will elect “officers” to manage the daily affairs of the company. Both the Board of Directors and Officers are supposed to work the corporate activities to ensure compliance with all relevant legal regulations both corporate and not. 

A derivative suit is usually started or brought against a corporate organization or business to redress any wrongdoings against the board of directors or elected officers of a company. 

What is required for a shareholder derivative suit?

There are many legal steps that one must take before they bring a derivative lawsuit though, such as bringing a pre-suit demand upon the board of directors to take the requested action. (see Corp. Code § 800; Jones v. Martinez (2014) 230 Cal.App.4th 1238.) If the requested action demand is not created properly, the derivative lawsuit may not proceed through the appropriate court channels and process. 

One important step that must occur before a shareholder derivative suit occurs is the notice requirement. In many legal actions, but in particular, derivative suits, the board of directors or corporate officers must have noticed your intent to file. This is so that if it is possible, they can rectify the legal issue without having to deal with the time and financial constraints of a lawsuit. It can be inferred that discussing the financial implications against the company if the lawsuit were to proceed is necessary as a tool to get these suits to settle before a costly and time-consuming trial is necessary.

Similarly, when a shareholder brings a derivative lawsuit, the court may require the plaintiff to post security in the form of a bond. Code of Civil Procedure section 800(c) states that “the corporation or the defendant may move the court for an order, upon notice and hearing, requiring the plaintiff to furnish a bond as hereinafter provided.” Section 800, subdivision (d), states that a court may require security when it determines that the moving party establishes a “probability in support of any of the grounds upon which the motion is based.” (Donner Mgmt. Co. v. Schaffer (2006) 142 Cal.App.4th 1296, 1304.) 

Derivative suits are unique within the corporate legal world because usually the management of a corporate entity or an organization would be the one normally responsible for bringing and defending a lawsuit against the company. 

What is a shareholder derivative suit?

A shareholder derivative suit is a type of lawsuit that is enacted or brought on by a shareholder on behalf of a corporation. The legal definition of a shareholder derivative suit states that a shareholder can only sue on behalf of a corporation when the corporation has a valid cause of action but has refused to use it. 

Additionally, the legal definition states that this often happens when the defendant in the suit is someone with a close connection to the company, such as a corporate office or a director. 

If the lawsuit is successful, the proceeds go towards the corporation, not the shareholder who brought the suit. 

The goal behind these types of lawsuits is to remedy any wrongs or harms to the corporate company or organization in question because the officers or the board of directors will not address the problem themselves. 

To protect the corporate entity and all of its shareholders, the shareholders must be able to take legal action when those in a position of power in the business fail to meet their legal obligations. 

What are some examples of shareholder derivative lawsuits?

  • Decisions made by the company that put the shareholders at financial risk
  • Conduct that instigates an investigation between the Department of Justice (DOJ), or other government entities 
  • Insider trading
  • Corporate asset wasting
  • Accounting problems
  • Breaches of fiduciary duties
  • Fraudulent business activity such as tax fraud, accounting fraud
  • Invalid stock options
  • Illegal activities 
  • Unfair compensation of company executives
  • Patterns of unnecessary company losses or risks

The shareholder does not need actual notice that the above-named, or other applicable actions took place in order to start to bring a shareholder derivative lawsuit. If a shareholder suspects that these problems have occurred or are likely to occur in the near future, then the shareholder can file a shareholder lawsuit action against the corporate entity for purpose of stopping the illegal action and assessing damages owed to the company, if applicable. 

However, it is important to note that the right to bring an action against a company via a shareholder derivative lawsuit is not absolute. While it is a legal remedy for fraud or unlawful activity, it is not a legal remedy for airing out complaints as a shareholder of the corporate entity or company.

How can the attorneys at Underwood Law Firm can assist you:

Lawsuits of any kind can be tricky to navigate, but when you add in shareholder derivative lawsuits, it is a whole different lawsuit entirely. The knowledgeable attorneys at Underwood Law Firm are able to use their years of combined corporate business litigation knowledge to assist you with your available options or help prepare you for bringing a shareholder derivative suit against the officers or board of directors of the organization. 

Contact Information