Derivative and Direct Shareholder Actions: What’s the Difference?

A company with shareholders owes duties towards its shareholders. There is no one comprehensive list of those duties, but generally, a company and its owners or officers must act diligently, intelligently, with due care, and should avoid things like self dealing or conflicts of interest that put them, individually, ahead of the good of the company and thus the shareholder.

Shareholder Derivative Lawsuits

When a company and its officers don’t do this, and they breach those duties, they can be sued by shareholders in what is known as a shareholders derivative lawsuit. This is where a shareholder, on behalf of other shareholders, alleges that the company is doing or not doing things that are lowering the value of the shareholder’s shares—that is, that they are harming the company through their official duties.

But not everybody can file a shareholder derivative action. Aside from, of course, actually being a shareholder, someone who sues must demonstrate that the harm they are experiencing is harming all shareholders. In this way, think of a derivative lawsuit as a “mini class action,” where all the shareholders have similar injuries—the injury being the loss of value of the shares or stock.

Direct Actions

Often, a shareholder will bring a derivative action alleging harm or damages, but that harm is only harming that individual shareholder—not all the shareholders equally. That is called a direct shareholder lawsuit. If a shareholder files a shareholder derivative lawsuit when it should be filed as a direct lawsuit, the case could be dismissed.

An example of a direct shareholder lawsuit would be an alleged violation of a shareholders agreement. For example, the shareholder believes he or she isn’t getting the voting rights she should get, or the shareholder alleges that her dividends weren’t paid the way that they should be paid. Or imagine that a shareholder feels he or she has been forced out of the company, or forced to give up her shares.

Other shareholders, in this situation, aren’t experiencing the same losses or wrongs as the aggrieved shareholder. So, it would properly be a direct shareholder action.

In a direct action, only the aggrieved, suing shareholder, will get any damages, if they are awarded. Compare that to a derivative lawsuit, where all shareholders will receive some form of compensation, if the lawsuit is successful.

Derivative Requirements

Many cases are derivative in nature, because often, when someone alleges mismanagement, or theft, or failure to take action on behalf of the company, it affects the value of every shareholder’s shares.

Unlike a direct lawsuit, in a derivative lawsuit, the shareholder representing the other shareholders, must send a demand letter to the company before suing, giving the company the chance to rectify the situation.

We can help with your shareholder lawsuit. Call the West Palm Beach commercial litigation lawyers at Pike & Lustig today if you are a shareholder that feels that the value of your shares have been negatively affected by something the company is doing or not doing.

Sources:

corpgov.law.harvard.edu/2024/05/14/the-distinction-between-direct-and-derivative-shareholder-claims/

law.cornell.edu/wex/shareholder_derivative_suit