What is a Shareholder Derivative Suit ?  

        A shareholder derivative suit is a type of lawsuit that the shareholders bring against a third party on account of the management. Under normal circumstances, even though shareholders are considered to be owners, they do not have the rights to manage operations of an organization, and therefore, they cannot take legal action to defend the organization.

        In corporate law, it is the management of an organization that has the rights to sue or defend the organization against lawsuits. However, if the management fails to defend or take action, then shareholders can bring about a shareholder derivative suit.

        This type of lawsuit is quite different from the lawsuit that shareholders can file for a claim that is associated with their interests in the organization. In shareholder derivative lawsuit, the claims or proceeds will be given to the organization and not the shareholders.

        Each state in the US follows a different law when it comes to shareholder derivative suit. For instance, in California, the lawsuit follows the MBCA or the Model Business Corporation Act.

        Here are the steps that have to be followed before a derivative suit can be filed:

  • It has to be first established that some harm has come to the organization, and the board of directors did not take appropriate action to prevent the harm.
  • The shareholders have to demand in writing that the board of directors take appropriate action against the person or corporation that harmed the organization. However, just shareholders who have a certain minimum value of shares for a particular duration of time can take this step.
  • The board of directors can accept, reject or decide not to act on the shareholders' demand. In case board decides to accept, then the organization files the lawsuit.
  • In case the board decides not to act or rejects the demand, then shareholders have to fulfill some more criteria.
  • Once the additional criteria are fulfilled, the board will appoint a committee that will study all the facts and then decide whether to proceed with the lawsuit.
  • If the committee decides in favor of the lawsuit, then the derivative lawsuit will go ahead.

 

        Basically, the management controls the organization, and it is not going to take any legal action against itself. Therefore, a derivative lawsuit ensures that the shareholders have a legal way to impose the claims of the organization against the management.

        Another importance of the derivative lawsuit is to control the amount of damage done by the management. It is quite possible that the management might be involved in illegal acts on behalf of the organization. These acts can damage the image of the organization. Through the lawsuit, further damage can be avoided.

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What is a Shareholder Derivative Suit ?
 

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