3.6 Derivative actions

3.6 DERIVATIVE ACTIONS

A derivative action, also known as a shareholder derivative suit, is a legal mechanism that allows shareholders to bring a lawsuit on behalf of a company against a third party, typically directors, officers, or other insiders of the company.

Key points to understand about derivative actions:

Purpose– Derivative actions are brought when a shareholder believes that the company has suffered harm due to the wrongdoing of its directors, officers, or other insiders.

– The purpose of a derivative action is to allow shareholders to seek redress for the harm caused to the company and recover damages on behalf of the company.

– The ultimate objective is to hold accountable those responsible for the harm and protect the interests of the company and its shareholders.

Standing to bring a derivative action

– Shareholders who have continuous ownership of shares during the relevant period, and who meet other eligibility requirements specified by law, typically have standing to bring a derivative action.

– The shareholder must demonstrate that they are suing on behalf of the company and not in their personal capacity.

– In some jurisdictions, the shareholder may need to make a demand on the company’s board of directors before filing a derivative action, giving the board an opportunity to address the alleged wrongdoing.

Requirements for filing a derivative action

– To file a derivative action, the shareholder must typically allege and provide evidence of specific facts supporting the claim of wrongdoing by the directors, officers, or insiders.

– The shareholder must show that they have made a good faith effort to exhaust internal remedies, such as making a demand on the board or showing that such demand would be futile.

– The shareholder must comply with procedural requirements, such as notifying the company and obtaining court approval to proceed with the derivative action.

Conducting a derivative action

– Once a derivative action is initiated, the court will evaluate the merits of the claim and determine whether the action can proceed.

– If the court allows the action to proceed, the shareholder acts as the plaintiff on behalf of the company.

– The company becomes the nominal defendant, and the named defendants are the alleged wrongdoers.

– The shareholder’s recovery, if successful, typically goes to the company, rather than the shareholder personally.

Role of the company

– The company’s board of directors and management have the opportunity to defend against the derivative action and protect the company’s interests.

– In some cases, the company may choose to initiate an internal investigation or take corrective actions to address the alleged wrongdoing before or during the derivative action.

Legal remedies and outcomes

– If successful, the court may order remedies such as damages, restitution, injunctive relief, or changes in corporate governance.

– The court may also award attorneys’ fees and costs to the prevailing party.

– However, it’s important to note that the outcome of a derivative action can vary depending on the specific circumstances, applicable laws, and the court’s evaluation of the evidence and arguments presented.