What is a shareholder derivative lawsuit?

 A shareholder derivative lawsuit is a legal action filed by an individual shareholder, in the name of the company, to redress wrongs or harms to the company that the Board of Directors or Officers will not address themselves.  

Individual shareholders normally have little power to control the day-to-day management of a company.  Instead, the shareholders elect a Board of Directors to oversee management.  The Board of Directors, in turn, appoints Officers to manage the day-to-day affairs of the company.  The Directors and Officers are in charge of protecting the company and its shareholders.

But what happens when the Directors and Officers are themselves harming the company?   The Directors and officers will never sue themselves.   In such situations, the law allows individual shareholders to file a lawsuit against the Directors and Officers to redress the harm done to the Company.  The individual shareholder stands in the shoes of the company and derives his or her right to sue (hence the name derivative) from the rights of the company itself.

Derivative shareholder lawsuits are frequently brought to redress the following types of wrongdoing by the Board of Directors and/or Officers of a company:

  • Breach of fiduciary duty
  • Fraud or other unlawful activity
  • Self-dealing or greed by insiders
  • Conflict of interest
  • Waste of corporate assets
  • Accounting wrongdoing
  • Inflated, false, or misleading financial statements
  • inflated executive compensation
  • Management or board decisions that expose the company to harm, violate consumer protection or other laws.

Note, however, that the law imposes numerous and complicated limitations on shareholder derivative actions.  As an example, in many states, the individual shareholder must make a pre-suit demand upon the Board of Directors to take whatever action is requested in the derivative lawsuit.  If the pre-suit demand is not properly made, the lawsuit may fail.

Other states follow a different rule and consider the making of a pre-suit demand to constitute a waiver of any right to claim that the Board of Directors has a conflict of interest.  In these states, making a pre-suit demand may cause the lawsuit to fail.

In short, the legal rules governing the procedures for derivative lawsuits differ from state to state and are extremely complicated.  Before considering any shareholder derivative lawsuit, you should consult an attorney who is skilled and knowledgeable in this area of law.

Please Note:  McCabe Rabin, P.A. provides these FAQ’s for informational purposes only, and you should not interpret this information as legal advice.  If you want advice as to how the law might apply to the specific facts and circumstances of your case, please click here to contact one of our attorneys.

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