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Simple English definitions for legal terms
shareholder's derivative action
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A quick definition of shareholder's derivative action:
A shareholder's derivative action is when a shareholder or group of shareholders sue a corporation's directors, officers, or other third parties who have breached their duties. The lawsuit is brought on behalf of the corporation, not the shareholder, and any damages awarded go to the corporation. Shareholders can only sue if the corporation has a valid cause of action but has refused to use it. The purpose of the lawsuit is to protect the interests of the corporation. Shareholders must meet certain requirements to bring a derivative action, including being a shareholder at the time of the act or omission complained about and making a demand in writing requiring the corporation to take suitable action before the lawsuit. The lawsuit can be dismissed if most of the qualified directors determine in good faith that it is not in the best interests of the corporation.
A more thorough explanation:
A shareholder's derivative action is a lawsuit brought by a shareholder or group of shareholders on behalf of a corporation against its directors, officers, or other third parties who breach their duties. The purpose of the suit is to protect the interests of the corporation, not the individual shareholder. The shareholder can only sue when the corporation has a valid cause of action but has refused to use it. The damages awarded in the suit go to the corporation, not the shareholder. The shareholder may ask for a reasonable cost paid for litigation.
Example 1: A corporation's board of directors makes false statements that cause the corporation to suffer a loss in share value. The corporation refuses to take action against the board of directors. A shareholder can bring a derivative action on behalf of the corporation to hold the board of directors accountable for their breach of duty.
Example 2: A corporation's CEO embezzles funds from the corporation. The corporation takes action against the CEO, but the damages awarded are not enough to fully compensate the corporation for its losses. A shareholder can bring a derivative action on behalf of the corporation to recover additional damages from the CEO.
These examples illustrate how a shareholder's derivative action is used to protect the interests of the corporation when the corporation has a valid cause of action but has refused to use it.