A derivative action is when shareholders file a lawsuit against their own corporation. The lawsuit is a response to wrongdoing by someone within the corporation. The shareholders believe that the corporation is at risk and pursue legal action to recover damages or stop the detrimental activity.
Taking derivative action against a corporation
The first step in taking a derivative action is for the shareholders to approach the board of directors. The board will have a chance to rectify the situation before the shareholders file a lawsuit. The board can make a decision on its own or appoint a committee consisting of unbiased directors.
If the board takes action, the shareholders can stop the derivative action. The board of directors will handle the situation. But if the board decides to do nothing, the shareholders can pursue business litigation and file a lawsuit.
Purpose of taking derivative action
Taking derivative action against a corporation helps shareholders keep the corporation honest and protect their interests. As shareholders, it’s in their best interest to make sure that the corporation does well.
Taking derivative action also means the corporation’s officers and directors are accountable for their actions. They can face punishment for actions that are detrimental to the corporation. It’s also beneficial because shareholders have an alternative when the board of directors refuses to address the wrongdoing within the corporation.
The lawsuit might result in compensation for damages suffered by the corporation. If compensation is received, it goes directly to the corporation. Shareholders don’t receive the money, even though the shareholders filed the lawsuit. Shareholders benefit from the outcome indirectly because of the shares they hold in the corporation.