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Corporations • Rights of Shareholders
CORP#040
Legal Definition
A shareholder may sue derivatively for a breach of duty on behalf of the corporation. A suit is derivative where a corporation could have brought suit itself initially but, for some reason, did not.
Plain English Explanation
There are two types of shareholder lawsuits that are covered in separate cards, but it is helpful to discuss them together so you can compare them. They are: (1) direct actions, and (2) derivative actions.
A direct action is a lawsuit where the shareholder is directly and personally suing either the corporation, one of its directors or officers, or another shareholder that owns so many shares of stock in the company that they have control over it. What is the shareholder suing for in a direct action? They are suing because they feel as if they have been personally hurt due to a duty owed to them being breached by either the corporation, one of its directors or officers, or a controlling shareholder.
In contrast, a derivative action is a lawsuit where the shareholder believes the corporation has been harmed due to the people who run it breaching their duties owed to the corporation. In a perfect world, the corporation would bring the lawsuit itself to recover from the harm caused by its incompetent management but, as you can imagine, sometimes the people running a corporation aren't motivated to sue themselves. Thus, a derivative lawsuit allows a shareholder to come to the rescue of the corporation and sue on behalf of it.
So, to summarize, if a shareholder is suing because they have been harmed, then it is a direct action. In contrast, if a shareholder is suing because the corporation has been harmed, then it is a derivative action.
A direct action is a lawsuit where the shareholder is directly and personally suing either the corporation, one of its directors or officers, or another shareholder that owns so many shares of stock in the company that they have control over it. What is the shareholder suing for in a direct action? They are suing because they feel as if they have been personally hurt due to a duty owed to them being breached by either the corporation, one of its directors or officers, or a controlling shareholder.
In contrast, a derivative action is a lawsuit where the shareholder believes the corporation has been harmed due to the people who run it breaching their duties owed to the corporation. In a perfect world, the corporation would bring the lawsuit itself to recover from the harm caused by its incompetent management but, as you can imagine, sometimes the people running a corporation aren't motivated to sue themselves. Thus, a derivative lawsuit allows a shareholder to come to the rescue of the corporation and sue on behalf of it.
So, to summarize, if a shareholder is suing because they have been harmed, then it is a direct action. In contrast, if a shareholder is suing because the corporation has been harmed, then it is a derivative action.
Hypothetical
Hypo 1: Bob was the largest shareholder of HypoCorp. Sam was the Chairman of the board for BuyCorp. A year ago, HypoCorp was acquired by BuyCorp. As part of the acquisition, Bob received 100,000 shares in BuyCorp and a seat on its board. Recently, it was discovered that Sam was having an affair with Bob's wife. Bob flipped out. Due to the toxic nature of the situation, the board felt it best to remove Bob and approved a purchase of all of Bob's shares for $100 per share. The same day they purchased Bob's shares for $100, HypoCorp shares were trading for $90 per share on the public stock exchange. Moreover, HypoCorp is financially struggling, and its purchase of Bob's shares could cause substantial harm. Amy, a shareholder of HypoCorp, finds out about all of this and is super upset. Amy wants to sue. Result: Amy can file a derivative lawsuit and sue on behalf of HypoCorp. Amy can claim that Sam and the other directors breached their fiduciary duties to HypoCorp by allowing the emotions and drama of Sam's affair result in financially harming HypoCorp by attempting to pay off Bob with an overpriced stock purchase. Amy would seek to have the purchase agreement rescinded.
Related Concepts
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