A Derivative Action is a legal mechanism that allows a shareholder of a corporation to bring forward a lawsuit on behalf of the corporation against parties such as directors, officers, or other third parties accused of harming the corporation, especially when the corporation itself fails to take action.
Key Characteristics of Derivative Action
Legal Basis and Authority
Corporate Right
A derivative action is based on a primary right of the corporation, meaning that the right originally belongs to the corporation and not directly to the shareholders.
Shareholder Initiative
The action is initiated by a shareholder because the corporation, either deliberately or due to neglect, fails to assert the right itself.
Requirements and Conditions
Standing
To file a derivative action, a shareholder must typically demonstrate that they were a shareholder at the time of the complained-of act or were a shareholder at the time of filing and continue to be one during the litigation process.
Demand Requirement
Before a derivative action can be initiated, the shareholder usually must make a demand on the corporation’s board of directors to rectify the issue. The typical outcome is either that the board refuses to act or the demand is deemed futile.
Legal Process
Filing the Complaint
The shareholder files a complaint against the party believed to be harming the corporation, including allegations and proofs of the board of directors’ inaction or wrongful refusal.
Judicial Assessment
The court assesses the validity of the claim and whether the derivative action serves the best interests of the corporation and its shareholders.
Historical Context
Evolution of Shareholder Rights
The concept of derivative actions evolved as a means to empower shareholders and ensure that their investments are protected when corporate leaders fail in their fiduciary duties.
Landmark Cases
Key cases such as Smith v. Van Gorkom have helped to define the contours and enforceability of derivative actions.
Applicability and Examples
Common Scenarios
Derivative actions are often seen in cases involving:
- Self-dealing by corporate officers
- Breach of fiduciary duty
- Corporate waste or mismanagement
Illustrative Case
An example could involve a situation where a corporate officer uses company resources for personal benefit. If the corporation’s board refuses to act on this, a shareholder can initiate a derivative action seeking restitution for the corporation.
Comparisons and Related Terms
Direct vs. Derivative Actions
Direct Actions: These are lawsuits brought by the shareholders for harm done directly to them. Derivative Actions: These address harm done to the corporation, indirectly affecting shareholders.
Fiduciary Duty
An essential concept closely tied to derivative actions is the fiduciary duty owed by directors and officers to the corporation and its shareholders, underpinning many derivative lawsuits.
FAQs
What is the Purpose of a Derivative Action?
Can All Shareholders Initiate Derivative Actions?
What is a Demand Futility Exception?
References
- Corporate Law Cases and Materials by Melvin Aron Eisenberg, Robert B. Thompson (9th Edition)
- Smith v. Van Gorkom, 488 A.2d 858 (Del. 1985)
- Delaware General Corporation Law, Section 141(a)
Summary
A Derivative Action provides shareholders with a crucial tool to seek justice on behalf of the corporation when the corporation’s leadership fails to act on issues that harm the corporate entity. By allowing shareholders to step in, the legal system ensures that corporate governance standards are maintained and fiduciary duties are upheld.
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