What is the difference between direct and derivative shareholder lawsuits?

Shareholders are legal entities or individuals who have registered shares in either private or public corporations. Despite having a financial interest in a company, most shareholders generally have little to do with the day-to-day business operations.

If the company remains profitable and directors do not take unnecessary risks, then disputes are less likely to arise. However, if a director has breached their duty, resulting in share prices plummeting, shareholders may have valid cause to file a legal claim. Two options that shareholders have when they have suffered harm due to a director breach are direct suits and derivative suits.

A key distinction: Who has suffered harm?

The key distinction between direct and derivative suits is who has suffered actual harm. A direct suit is applicable if the breach from a director has resulted in direct harm to a specific shareholder. One example may be if the shareholder wishes to convert their preferred shares into common shares and is denied, suffering financial harm as a result. This type of claim is very uncommon as it can be difficult to prove that the shareholder has suffered harm as a direct result of the director’s actions. It’s important to note that if the shareholder is successful in this type of claim, then they will personally be awarded any damages.

A far more common type of breach occurs when the actions of a director negatively affect their duty toward the corporation as a whole. For instance, a director might make misleading claims about the company that cause significant reputational damage and a drop in share prices. Before a derivative suit can be launched, the concerned parties must write a written demand letter outlining the alleged breaches, harm suffered and give an opportunity for the director to rectify the situation. Typically, they have 90 days to respond. If no response is received, or the ongoing damage to the corporation would be insurmountable without immediate action, the derivative suit can likely go ahead right away. If the case is successful, damages will be distributed equally among the shareholders.

Business disputes can be complex, which is why it’s so important to seek legal guidance in this type of situation. We help shareholders in the midst of disputes, contact us for a consultation.