A shareholder derivative suit is a lawsuit brought by a shareholder on behalf of the corporation against a third party, typically an insider such as a member of management or a director. Derivative suits are a unique component of traditional state corporate law, under which management is responsible for bringing and defending a company against lawsuits. Derivative lawsuits allow shareholders to initiate a suit when they believe management has failed to take appropriate action.
Current law is designed to ensure only the most legitimate shareholder suits continue through the legal process. Under federal and state procedural laws, plaintiff shareholders must make a demand on the board of directors before filing a derivative suit. A “pre-suit demand” is a statement outlining the harms the corporation is currently suffering from as a result of action or inaction by the board and executives. In the demand, the plaintiff must be able to state particular facts raising a reasonable doubt that the board or management used appropriate business judgment in deciding to act or not to act on the matter in question. The standards are typically difficult to meet.
Because derivative suits are at its core a legal action in which a corporation sues itself, there are no monetary damages or rewards issued to victorious shareholders. However, these suits are typically enormously complex and require extensive attorney involvement resulting in very high attorney’s fees.