What is a Derivative Action?

A derivative action is a lawsuit brought by shareholders of a corporation on behalf of the corporation itself because company is not taking action to protect its legal rights and interests. Such suits are also known as derivative suits or shareholders' derivative suits. They are somewhat unusual in the legal sense because corporations are expected to be able to defend themselves and to take appropriate action when an activity reneges upon their interests.

Usually, a derivative action is brought against the officers or directors of a corporation. These suits occur when shareholders believe that fraud, mismanagement, or other activities which could hurt the corporation are occurring. In these cases, the company may not take action on its own because it is unable to; if the directors are the ones defrauding the company, for example, they aren't going to bring suit against themselves. Shareholders may also file such suits if they feel that a company is not taking appropriate action in response to management problems.

The shareholders usually retain a legal team to assist with filing and pursuing the derivative action in court. Corporations may bring their own lawyers to bear on the case and the costs can quickly become quite high, between court costs associated with legal procedures and billable hours for the lawyers involved. Because of the costs, such suits can be difficult to sustain to the end, especially if not all of the shareholders are interested in cooperating.

Dishonesty, mismanagement, corporate fraud, self-dealing, and questionable ethical activities can all be addressed with derivative actions. A corporation shareholder has the right to file such a suit because the corporation has a responsibility to behave in a way which will benefit shareholders; by insisting that the corporation protect its interests, the shareholder is also protecting her or his personal interest in the company.

When shareholders bring a derivative action, the corporation may initially be a defendant but it can transition to the role of plaintiff, alongside the shareholders, depending on the structure of the suit and the situation. Such cases sometimes attract public interest and attention, especially if a company has already developed a high profile as a result of questionable activities. Publications which cover the financial industry may discuss such suits in detail even when the mainstream media does not cover them, and such publications may also discuss the legal aspects of the derivative action in detail, for those who are interested.