We are independent & ad-supported. We may earn a commission for purchases made through our links.
Advertiser Disclosure
Our website is an independent, advertising-supported platform. We provide our content free of charge to our readers, and to keep it that way, we rely on revenue generated through advertisements and affiliate partnerships. This means that when you click on certain links on our site and make a purchase, we may earn a commission. Learn more.
How We Make Money
We sustain our operations through affiliate commissions and advertising. If you click on an affiliate link and make a purchase, we may receive a commission from the merchant at no additional cost to you. We also display advertisements on our website, which help generate revenue to support our work and keep our content free for readers. Our editorial team operates independently of our advertising and affiliate partnerships to ensure that our content remains unbiased and focused on providing you with the best information and recommendations based on thorough research and honest evaluations. To remain transparent, we’ve provided a list of our current affiliate partners here.
Finance

Our Promise to you

Founded in 2002, our company has been a trusted resource for readers seeking informative and engaging content. Our dedication to quality remains unwavering—and will never change. We follow a strict editorial policy, ensuring that our content is authored by highly qualified professionals and edited by subject matter experts. This guarantees that everything we publish is objective, accurate, and trustworthy.

Over the years, we've refined our approach to cover a wide range of topics, providing readers with reliable and practical advice to enhance their knowledge and skills. That's why millions of readers turn to us each year. Join us in celebrating the joy of learning, guided by standards you can trust.

What is a Shareholder Derivative Suit?

By Barbara Wells
Updated: Jan 30, 2024
Views: 8,699
Share

A corporate shareholder who believes a corporation-damaging wrong has been committed can file what is known as a shareholder derivative suit. The shareholder does not file on his own behalf but on behalf of the corporation. Such a suit often is filed against the corporation's board of directors or someone else in the corporation's management hierarchy, and it often alleges some form of mismanagement that the shareholder believes is harming the corporation.

A shareholder has the right to bring such a suit as of the date of the alleged wrong and after establishing standing and following the correct corporate procedure. Typically, a shareholder derivative suit is appropriate when a board of directors' refusal to enforce a corporate right may be damaging to the corporation. This type of action is pursued by shareholders on behalf of the corporation, and the corporation becomes the plaintiff in the case.

Generally, a board of directors has engaged in some type of fraud, is being overpaid or is taking corporate opportunities when a shareholders derivative suit is brought. A derivative suit is different from a direct action. In a direct action, a board of directors' act must have had a direct impact on a shareholder's personal finances. Typically, a direct action is taken when a board of directors is in breach of a fiduciary duty. By contrast, a shareholder derivative suit isn't personal; instead, it seeks to protect the corporation as an entity.

A shareholder must have standing to commence a shareholders derivative suit. This means that the representative shareholders must have been shareholders at the time of the alleged act or omission and must be majority shareholders. Corporate procedure varies from state to state but, whatever the procedure, the shareholder has to follow it. Corporate procedure generally dictates that the shareholders first demand, in writing, that the board of directors itself pursue the action. If the board of directors refuses, a shareholder derivative suit may be filed within a mandated period of time.

In most states, the cost of bringing such a suit is related to the end result. If a shareholder derivative suit results in a substantial benefit to the corporation, then the corporation must pay the shareholder's legal costs. Conversely, if a shareholder derivative suit has been brought without reasonable cause or for an improper purpose, the corporation/plaintiff may be ordered to pay the legal expenses.

Many states have a statutory provision called the "business judgment rule." The business judgment rule is derived from common law and dictates that a shareholder derivative suit requires a clear showing of abuse of discretion. It also specifies that a court will not become involved in the business decisions of a board of directors, if the board has acted in good faith. If no abuse of discretion or bad faith can be shown, the board of directors will be shielded in a closed case.

Share
WiseGeek is dedicated to providing accurate and trustworthy information. We carefully select reputable sources and employ a rigorous fact-checking process to maintain the highest standards. To learn more about our commitment to accuracy, read our editorial process.

Editors' Picks

Discussion Comments
Share
https://www.wise-geek.com/what-is-a-shareholder-derivative-suit.htm
Copy this link
WiseGeek, in your inbox

Our latest articles, guides, and more, delivered daily.

WiseGeek, in your inbox

Our latest articles, guides, and more, delivered daily.