What Is a Shareholder Derivative Action?

A shareholder derivative suit is a lawsuit brought by a shareholder on behalf of a corporation against a third party. Often, the third party is an insider of the corporation, such as an executive officer or director.

1. Why Are Derivative Suits Filed?

   Because shareholders, subject to certain limitations, are generally allowed to file a lawsuit in the event that a corporation has refused to file one on its own behalf, many derivative suits are brought against a particular officer or director of the corporation for breach of contract, self-dealing, or breach of fiduciary duty. Derivative actions may also be filed against accountants and other advisers who have somehow harmed the corporation, although there is generally no limitation on the type of claim made by a derivative suit. Any recovery goes to the corporation, not the shareholders.

2. What Are the Requirements of a Derivative Lawsuit?

   Only shareholders of a corporation can bring a derivative suit. Some states allow a person to bring a derivative suit as long as he or she held the company*s stock at the time of the incident that gave rise to the suit. Others require that the shareholder owns stock in the company at the time of the inciting action and continuously throughout the resolution of the lawsuit. This is referred to as the *continuous ownership requirement.* If the shareholder*s interest in the company was lost, or devolved, because of the inciting action, many states allow the suit to be filed.
   
   Under federal and most states' laws, a derivative plaintiff must either first demand that the corporation's management assert the claim prior to filing suit or allege with particularity his effort to have the directors bring suit for the corporation or the reasons for not making such an effort. The demand requirement is not merely pro forma, but is a question of state substantive law. The plaintiff shareholder must make a serious effort to pursue the intra corporate remedy before bringing a derivative suit and must also make reasonable efforts to assist the corporation in bringing suit. On the other hand, traditionally, the plaintiff need not make a futile demand. Far example, a demand would traditionally be unnecessary where the directors are the wrongdoers and could not otherwise be expected to bring suit against themselves.
   
   In federal court, once a derivative action has been filed, it may only be voluntarily dismissed or settled with approval of the court, which must inform the shareholders of such a proposed action ahead of time.