What is a shareholder derivative action?

A shareholder derivative action is a lawsuit brought by a shareholder on behalf of the corporation to redress a wrong done to the corporation, rather than to the shareholder directly. For example, if a director or officer breaches a fiduciary duty owed to the corporation and the breach causes the corporation as a whole to lose money, then the action is one belonging to the corporation, even though the shareholder’s stock may be devalued, and the shareholder must proceed derivatively. Because the action is brought in the right of the corporation, which has failed to proceed on its own behalf, there are certain procedural safeguards put in place to ensure that the shareholder is acting in the best interests of the corporation. For example, before bringing a derivative action, the shareholder must generally have made a demand on the corporation itself to bring the action and had that demand refused. In many jurisdictions, the demand requirement may be excused if the shareholder can show that demand would be futile, as, for example, if the shareholder alleges wrongdoing by those in charge of the corporation. In federal court, the shareholder must specifically allege in her complaint (1) the effort she made to “obtain the desired action from the directors,” and (2) “the reasons for not obtaining the action or not making the effort.” Fed. R. Civ. P. 23.1(b)(3). In addition, the derivative action may not go forward “if it appears that the plaintiff does not fairly and adequately represent the interests of shareholders or members who are similarly situated in enforcing the right of the corporation.” Fed. R. Civ. P. 23.1(a). In other words, the shareholder must be able to show that she is acting for the benefit of all the shareholders, and not just herself.