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Should You File a Derivative or Direct Shareholder Lawsuit?

Clark Law Firm PC Feb. 22, 2023

Falling stock market on tablet screenCorporations operate in every state, but they may be registered in corporate-friendly states like Delaware, Wyoming, or Nevada. Nonetheless, corporations are owned by their shareholders, that is, those who own shares in the entity.  

Shareholders elect a board of directors to run the corporation, and the directors in turn hire corporate officers and executives to manage the day-to-day operations. Both the directors and corporate executives are responsible to the shareholders.  

What happens if the directors or officers do or fail to do something that results in harm or loss to the corporation – and, indirectly, to the shareholders? Such as accounting fraud which, when discovered, causes the share value to plummet. Or, perhaps the directors have a vendetta against a single shareholder or class of shareholders and disregard their voting rights to preserve their own power. 

In these cases, the shareholders have a right to file a lawsuit. If the shareholders as a whole are harmed – perhaps by the accounting fraud and share price plunge – then a single shareholder can file what is called a derivative lawsuit against the corporation on behalf of all shareholders. If a single shareholder, or perhaps a minority group, is harmed, they can file direct lawsuits. 

If you as a shareholder sense that shareholders as a group or you as an individual or member of a minority ownership group have been harmed by the actions of the officers or directors of a corporation in or around Birmingham, Alabama, contact the business litigation attorney at Clark Law Firm PC.  

John will assess the situation and advise you of your legal options, including whether a derivative or direct lawsuit is warranted. His firm serves clients throughout Alabama and the Florida Panhandle. 

Derivative Lawsuits: What They Are 

Derivative lawsuits often make headlines. A significant one involved Alphabet, formerly known as Google. In 2020, the corporation agreed to establish a 10-year, $310 million fund over allegations that senior executives’ harassment incidents were mishandled. 

In another case involving Elon Musk, a shareholder lawsuit against Tesla over the company’s acquisition of SolarCity ended in a $60 million settlement over allegations that the acquisition inappropriately benefited Musk, his cousins, and directors who owned stakes in SolarCity. 

Derivative lawsuits often revolve around mergers and acquisitions when shareholders feel the pending transaction is going to rob them of share value, that is, diminish their ownership stake in terms of cash value. Other derivative lawsuits concern malfeasance or other mistaken decisions or inappropriate behavior by officers or directors. 

In a derivative lawsuit, one shareholder assumes the mantle of the plaintiff on behalf of all shareholders, but before filing the action, the plaintiff must press the board of directors to fix the problem. If the board fails to respond, then the lawsuit can proceed. The other option is to claim that asking the board to act would be futile, which might pose a high bar to proving some pattern of behavior by the board. 

If a derivative lawsuit is successful, the award or corrective order by the court goes to the corporation itself, not to the shareholders. The shareholders will benefit from any rise in share value. 

Direct Lawsuits: When the Harm Is More Limited 

A direct shareholder lawsuit, in contrast, is possible if a single shareholder or a group of shareholders is personally harmed by the actions of the corporation. For instance, the defendant or defendants can sue because their votes weren’t counted or they weren’t paid dividends owed to them, although other shareholders were unaffected. In other words, the harm was done to an individual or individuals and not the corporation itself, which would warrant a derivative shareholder lawsuit. 

Which Way to Go? 

It may be fairly clear which path to take – direct or derivative – but if you need a legal assessment and guidance on which route is best, consult with a business litigation attorney who is experienced in corporate matters. Remember, a derivative lawsuit is for actions that harm the corporation in the person of all its shareholders, while a direct lawsuit concerns actions that harm one shareholder or just a group of shareholders and not the whole class of shareholders. 

Rely on Experienced Business Litigation Expertise 

If you’re a shareholder of a corporation in Alabama or the Florida Panhandle, and you suspect the company is doing something to harm share value, whether for you as an individual or for the corporation as a whole, contact Clark Law Firm PC immediately.  

Our business litigation attorney will listen to your story, assess the circumstances, and advise you of the best options going forward to remedy matters. Reach out with all your shareholder questions and concerns. o