What is a Derivative Action?
Under California law, a corporate shareholder (or LLC member and, in many instances, a partner in a partnership) can bring a legal action for damages against management on a corporation’s behalf. The legal the theory is that management’s alleged wrongdoing harmed the business entity and therefore decreased the value of the plaintiff’s stock ,or other ownership interest
all of the shareholders.
An action is derivative if the basic complaint by the shareholder is for injury to the corporation, or to the whole body of its stock or property, rather than to the individual shareholder. For example, a shareholder who is embezzling money or business from the corporation has damaged the corporation as a whole and typically not one individual shareholder.
A derivative lawsuit is typically brought to recover assets for the corporation, or to prevent the loss of its assets. Shareholders may also bring a derivative action to enjoin or recover damages for breaches of fiduciary duty that directors and officers owe the corporation.
An injured shareholder must first make a formal demand that the corporation itself bring a lawsuit to recover from the wrongdoer. In small corporations and LLCs, however, the wrongdoer is often in charge of the corporation. Such a demand may be futile. In that case, the individual, on behalf of the corporation or LLC, can still proceed with the lawsuit. In derivative action case the corporation must be named as a nominal defendant, and the injured shareholder (not the corporation) will prosecute the case on behalf of the corporation. However, the damages will be awarded to the corporation.
If you need more information on a partnership, LLC or corporate disputes, please look for more articles on our websites (www.culvercitytaxandbusinesslaw.com, www.corporateattorney.com) or call us at (323) 292-4116.