A shareholder can file a derivative action lawsuit on behalf of a company if they believe mismanagement is harming the company. The lawsuit is appropriate when a board’s refusal to enforce a corporate right may be harmful to the company. The shareholder must have standing and follow the correct corporate procedure. If successful, the company must pay the shareholder’s attorney fees, but if the lawsuit was brought without reasonable cause, the company may be ordered to pay attorneys’ fees. The “business judgment rule” protects the board of directors if they acted in good faith.
A corporate shareholder who believes that a mistake was made that was harmful to the company can file a so-called derivatives action lawsuit. The shareholder does not deposit for his own account but on behalf of the company. Such a lawsuit is often brought against the company’s board of directors or someone else in the company’s management hierarchy, and often alleges some form of mismanagement that the shareholder believes is harming the company.
The shareholder has the right to do so starting from the date of the alleged offense and after having ascertained the legitimacy and having followed the correct corporate procedure. Typically, a shareholder derivatives lawsuit is appropriate when a board’s refusal to enforce a corporate right may be harmful to the company. This type of action is pursued by the shareholders on behalf of the company and the company becomes the plaintiff in the case.
Typically, a board of directors has engaged in some type of fraud, been overpaid, or is taking corporate opportunities when a shareholder derivative lawsuit is filed. A derived seed is different from a direct action. In a direct action, an act of the board must have had a direct impact on a shareholder’s personal finances. Typically, direct action is taken when a board of directors breaches a fiduciary duty. Conversely, a lawsuit for a shareholder derivative is not personal; instead, it seeks to protect the company as an entity.
A shareholder must have standing to initiate a shareholder derivatives lawsuit. This means that the representative shareholders must have been shareholders at the time of the alleged act or omission and must be majority shareholders. The corporate procedure varies from state to state but, whatever the procedure, the shareholder must follow it. The corporate procedure generally provides that the shareholders request in advance, in writing, that the board of directors itself pursue the action. If the board refuses, a derivative action lawsuit can be filed within a prescribed period of time.
In most states, the cost of such a lawsuit correlates with the end result. If a lawsuit brought by a shareholder results in a material benefit to the company, the company must pay the shareholder’s attorney fees. Conversely, if a stockholder’s derivative action was brought without reasonable cause or for an improper purpose, the company/plaintiff may be ordered to pay attorneys’ fees.
Many states have a statutory provision called the “business judgment rule”. The economic judgment rule derives from the common law and dictates that a shareholder derivative action suit requires clear evidence of abuse of discretion. It also specifies that a court will not be involved in the business decisions of a board of directors if the board acted in good faith. If no abuse of discretion or bad faith can be proven, the board of directors will be protected in a closed case.
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