Derivative Action

What Is a Derivative Action?

A derivative action is a representative lawsuit in which a shareholder sues to enforce a right belonging to the corporation when corporate management has failed or refused to act. Any recovery goes to the corporation, not to the shareholder plaintiff. The doctrine exists because directors and officers may be unwilling to sue themselves or fellow insiders for breaches of duty.

Procedural Requirements

• The plaintiff must have owned shares at the time of the alleged wrong and throughout the litigation - A pre-suit demand must be made on the board to take action, unless excused as futile - The plaintiff must fairly and adequately represent shareholder interests - Settlement or dismissal generally requires court approval

Common Claims and Defenses

Derivative claims often involve breach of fiduciary duty, waste of corporate assets, self-dealing, usurpation of corporate opportunities, and securities violations. The business judgment rule provides a strong defense, presuming that directors acted on an informed basis, in good faith, and with a rational belief that their decisions served the corporation's best interests. To rebut the presumption, plaintiffs must show fraud, illegality, conflict of interest, or gross negligence. Delaware courts hear most major derivative litigation because of the high concentration of incorporated entities in that state.