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What Is Derivative Action?

What Is Derivative Action?

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What Is Derivative Action?

If you own at least one share in a company, that makes you a shareholder. And while purchasing shares in a company can often be a smart investment, it’s not a decision that should be made lightly. 

Being a shareholder comes with a number of advantages, like:

  • The ability to see your capital appreciate
  • The ability to receive dividends
  • Access to limited liability
  • Voting rights for certain important matters

However, despite these advantages, there are a few drawbacks as well. As a shareholder, you are putting your capital at risk, and it’s possible that you could face serious losses. You could end up seeing nothing for your investment if the company is forced into bankruptcy.

If you are considering becoming a shareholder for the first time, you may want to speak with an attorney about the role. There may yet be a lot you don’t know or understand. For example, you could find yourself asking, “What is derivative action?” 

If you need answers to this question and others, keep reading. This helpful article will inform you of your basic rights and responsibilities as a shareholder. And if you would still like to speak with a member of the Morgan & Morgan team, make sure to schedule your free case evaluation using our convenient online form.

Who Can Bring a Derivative Action Lawsuit? 

First, let’s answer the question, “What is derivative action?” Essentially, this term refers to a type of lawsuit that can be filed by a shareholder on behalf of the company. The lawsuit is typically aimed at a group or individual that is close to the company, like a managing director or a CEO.

It’s important to understand that any proceeds of the lawsuit will be awarded to the company as a whole, not to the individual or shareholder who filed the complaint. Only shareholders of the company in question can file a derivative action lawsuit. And they can only file if they believe that the defendant has caused harm to the company. 

Derivative action lawsuits can quickly become complicated. If you believe you may have cause to consider derivative action, it’s best to call an attorney to discuss the facts and whether you have a viable case.

What Does It Mean to Be a Shareholder?

Now you know the answer to, “What is derivative action?” And you know that only a shareholder can file this type of lawsuit. But who or what qualifies as a shareholder for the purposes of these cases?

We often think of shareholders as individuals, but any legal entity with enough capital can purchase shares and thus become a shareholder. That means a shareholder might be a corporation, an institution, or some other entity. 

As a potential shareholder, you have the option to purchase one of two types of shares: common or preferred. Common shares are, obviously, the most common and numerous. They usually come with voting rights and eligibility to receive dividends. 

Preferred shares are less common. They often don’t come with voting rights but they do allow you the opportunity to receive higher dividends on a fixed and regular schedule.

Regardless of what type of shares you invest in, by doing so you will become a shareholder. Thus, you will be able to file a derivative action lawsuit should the need arise.

The Rights of a Shareholder

Once you become a shareholder, you are entitled to certain rights. And if those rights are ever violated, you should call an attorney. In addition to your right to file for a derivative action, you also have these guaranteed rights:

The Right to Participate in Profitability

As a shareholder, you have a right to share in the company’s profitability. The amount of profit you are entitled to will depend upon the type and amount of shares you own. With the right investment, this profitability can become quite substantial over time. 

The Right to Influence Management

As a shareholder, you also have certain perks that allow you to influence the management of the company. Most importantly, you have voting rights that allow you to have a say regarding the board of directors. 

The Right to Purchase New Shares

As a current shareholder, you have earlier access to new shares that are released to the public. Essentially, you have first dibs if you want to increase your investment later on. 

The Right to Vote

In addition to electing board members, you have other voting rights as a common shareholder. At the company’s annual meetings, you’ll have the opportunity to vote on potential changes before they take place. 

On top of all these rights, you have the right to sue if your rights as a shareholder are violated. If you believe yours have been neglected or ignored, call an attorney to discuss your options. 

When Can a Shareholder Be Removed?

Now that you understand your basic rights as a shareholder, you may still have some questions. For example, you may wonder, “What is derivative action?” and “Can you ever be removed from the company after becoming a shareholder?” 

It is possible to be removed as a shareholder, but the company must follow certain steps to do so. If you are a shareholder and an employee, you can be fired from both positions so long as you do not have control of the company. If you are on the board of directors, a vote may be required before your firing. 

Once you or another shareholder are fired, the controlling shareholders have the option to buy back your shares or offer them to the remaining shareholders. The most important part of this entire process is that any and all employment agreements are followed to the letter. 

Firing an employee is complicated enough, when that employee is also a shareholder, it’s important for a company to cross its T’s and dot its I’s. 

Common Causes of Derivative Action Lawsuits

Remember that a derivative action lawsuit is based on wrongs that are committed to the company, not the individual shareholder. Sometimes this difference is difficult to distinguish, so if you have a problem arise it’s best to call an attorney. Sometimes both the company and the individual are negatively affected; an attorney can help you sort out the best course of action.

The most common causes of derivative action lawsuits include:

  • Unjust enrichment
  • Negligence
  • Insider trading
  • Breach of fiduciary duty

If you believe that any of these scenarios have caused serious harm to the company of which you are a shareholder, call an attorney. It may be time to answer, “What is derivative action?” in a more specific way.

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  • Can Multiple Law Firms Become Involved in a Derivative Action Suit?

    When misconduct from an officer or director of a company affects that company, it’s not uncommon for more than one shareholder to file a lawsuit. When that happens, multiple law firms may become involved as complaints are filed. 

    Over time, these lawsuits will likely be consolidated so that they can be litigated together, in which case a single law firm will be appointed as “lead counsel” for the shareholders.

  • How Does Derivative Action Benefit Me as a Shareholder?

    Remember that any relief awarded as the result of derivative action will go to the company, not the shareholders. So a derivative action lawsuit may not benefit you, the shareholder, directly. 

    But a successful lawsuit does have the potential to benefit the company you are invested in. As a result of the lawsuit, transparency and proper governance will ideally increase, which will maximize shareholder value. 

  • What Will It Cost Me to File a Derivative Action Lawsuit?

    With Morgan & Morgan, you do not have to worry about the cost of a derivative action lawsuit. Instead, we will work on a contingency fee basis so that no money is owed unless the lawsuit is won and a settlement is reached. At that time, our fee will be awarded by the Court and paid for by either the company or its insurance provider.

  • How to Decide if Derivative Action Is Necessary

    If you are still in the early phases of understanding whether a problem exists, you may wonder at what point a derivative action lawsuit becomes necessary. 

    We recommend you start by bringing the perceived issue to the board and demanding that it be righted. If that tactic does not work to resolve the perceived wrong, contact an attorney who has experience with derivative action. 

    Whether it is a case of malpractice, conspiracy, mismanagement, or something even more harmful, an attorney can help you decide whether to move forward with the case.

    Sometimes, it may make more sense to file a direct lawsuit, instead of one involving derivative action. If you appear to be the only party injured by the wrongs of a board member, we may recommend you take this course. Again, the only way to decide definitively what your next best step will be is with the help of a legal professional.

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    Remember, company officers and corporate boards owe a duty to act in the best interest of the company. If behaviors or actions taken to indicate that this has not been the case, it may be time to consider a lawsuit. 

    However, you should know those derivative action lawsuits are often long and complicated. The court is often reluctant to second-guess the decisions of officers and board members unless it is clear that misconduct has occurred.

    For that reason, the best step you can take for yourself and your company is to hire a qualified attorney. At Morgan & Morgan, we understand and have a wealth of experience in this area of law. We can discuss the facts of your situation with you to determine the best way to proceed. Ready to talk further? Schedule a free case evaluation using our simple online form.

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Last updated on Dec 05, 2022

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