What Is a Shareholder Derivative Lawsuit?

This article will help to define and discuss what a Shareholder Derivative lawsuit is and what a board member or shareholder needs to know.  A corporation operates like a well oiled machine when it is operating properly. There are numerous moving parts in the form of a Board of Directors, Officers, managers, and shareholders that all do their part to make the business successful. As a general rule, a single shareholder has very little influence on the day to day operation of the corporation. Instead, the Board of Directors is responsible for actually running the business. What can a shareholder do, however, if the Board of Directors is doing something, or refusing to do something, that is potentially harmful to the corporation? As the Irvine business litigation attorneys at Brown & Charbonneau explain, one available course of action may be to file a derivative lawsuit.

Corporation Basics

A corporation itself is a separate legal entity. In a traditional corporation, the “owners” of the company are the shareholders. The shareholders, however, do not typically have much – if anything – to do with running the business. Instead, the shareholders elect a Board of Directors which is then responsible for overseeing the management of the business. The Board of Directors will then appoint Officers of the corporation and those officers will hire managers who supervise the actual employees. In a large corporation, shareholders may only find out crucial information about the business at an annual shareholders meeting. In fact, many shareholders don’t even attend the annual meeting, preferring instead to simply read the annual report issued to shareholders. Despite the fact that shareholders are not usually “hands-on,” it is important to remember that they do have a legal ownership interest in the corporation. It is that interest that may allow a shareholder to pursue a shareholder derivative lawsuit.

How Can a Shareholder Address Wrongdoing?

While most shareholders do not actually participate in the running of the corporation, they certainly have a legitimate interest in how the corporation is being run by the Board and the corporate Officers. If the Board of Directors and/or Officers of the corporation are engaged in wrongdoing or are not fulfilling their obligations to the corporation, it will almost always eventually impact the corporation’s bottom line. That, in turn, impacts all the shareholders of the corporation. Examples of conduct that might prompt a shareholder to pursue legal action against the Board of Directors or Officers include things such as:

• Breach of fiduciary duty
• Wrongful sale of corporate control
• Accounting wrongdoing
• Self-dealing

Because an individual shareholder does not typically have any direct power over the Board of Directors or Officers of a corporation, the law allows a shareholder to initiate a shareholder derivative action.  A shareholder derivative action allows a shareholder to file a lawsuit in the name of the corporation. In other words, the shareholder is acting for the corporation and is filing as a “friend of” the corporation. As such, any remedies available to the shareholder actually apply to the corporation, not to the shareholder personally. Likewise, any financial award ordered as part of a derivative lawsuit goes to the corporation, not the shareholder.

Shareholder derivative lawsuits are complex in nature and are largely governed by state law. Consequently, the procedures you must follow prior to being able to file a derivative lawsuit can vary from ne state to another. In some states, for example, you must submit a demand to the Board/Officers first before you are eligible to file a lawsuit whereas in other states doing so can actually harm your chances of prevailing in the subsequent lawsuit. For these reasons, it is in your best interest to consult with an experienced business litigation attorney if you are contemplating a shareholder derivative lawsuit or if you believe you may be required to defend a shareholder derivative lawsuit.

Contact Our Southern California Business Litigation Attorneys

If you are a shareholder and you believe you have the basis for filing a derivative lawsuit, or if you are a member of the Board of Directors who is facing a shareholder derivative action, contact the experienced Orange County business litigation attorneys at Brown & Charbonneau, LLP for more information. Contact the team today by calling 714-406-4397  to schedule your appointment.