A derivative action is a type of lawsuit in which the corporation asserts a wrong against the corporation and seeks damages.
Derivative actions represent two lawsuits in one: (1) the failure of the board of directors to sue on an existing corporate claim and (2) the existing claim.
Because the corporation is an inanimate corporate entity, claims regarding a breach of directors’ fiduciary duties are, by necessity, brought by the corporation’s shareholders as derivative suits. Still, derivative action involves a wrong against the corporation and not individual shareholders; therefore, damages do not go to the shareholders personally but to the corporation itself.
However, shareholders often bring derivative suits because they stand to indirectly gain from winning a derivative suit. If a shareholder wins a derivative suit, the corporation can undergo higher share prices. This often results in higher dividends to shareholders.
Derivative suits are necessary because the board of directors are the primary operators of the corporation. The directors make decisions about when a corporation can sue someone else for a breach of contract, breach of duty of care, etc. As such, in the case of a breach of fiduciary duties of directors, the directors are making decisions on behalf of the corporation regarding whether or not to sue those very same directors.
See also: Shareholder Derivative Suit
[Last updated in January of 2022 by the Wex Definitions Team]
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