Function

• Generally, shareholders are the owners of the corporation but they do not have the power to manage the corporation. Rather, shareholders elect a board of directors to manage the corporation. The board of directors is responsible for bringing lawsuits and defending the corporation from them. When the management fails to pursue a certain action that effects the corporation, the shareholders may sue in a representative capacity to protect the corporation's interests.
  
  

Process

• A shareholder must first make a demand on the directors that they proceed with the action unless making such a request would be futile for one of the following reasons: because a majority of the board is interested or under control of interested directors, the board did not inform itself of the transaction to the extent reasonably appropriate under the circumstances, or the transaction is so egregious on its face that it could not be a result of sound business judgment.
  
  If the shareholder's demand is refused by the board, the shareholder can bring a derivative suit if the majority of the board is interested or the procedure taken by the board in determining whether or not to bring the suit was incomplete or inadequate.
  
  However, the corporation may move to have the derivative suit dismissed upon a finding by independent directors that the suit is not in corporation's best interests.
  
  

Requirements

• In order to bring a derivative suit, the shareholder must be eligible to do so. To be eligible, a shareholder must have had stock ownership when the claim arose, and he must adequately represent the interests of corporation and the interests of other shareholders. The shareholder may also be required to post security for costs.
  
  

Effects

• When a shareholder successfully brings a derivative suit, any awarded damages go to the corporation unless doing so would be against the interests of justice. The successful shareholder is not entitled to the damages but is entitled to collect costs and attorney's fees from the corporation.
  
  However, if the shareholder's derivative suit is unsuccessful, the shareholder cannot recover costs and expenses from the corporation and the shareholder may also be personally liable to the defendant for costs.
  
  

Expert insight

• Typically, in derivative suits, the actions of the corporation's executives are at issue and the shareholder is bringing an action against the directors, management, or other shareholders of the corporation for failing to manage the corporation. In other words, the shareholder is usually acting on behalf of the corporation because the directors and management have failed to exercise their authority for the benefit of the corporation and all of its shareholders.
  
  Derivative suits often arise out of instances of fraud, mismanagement, self-dealing or dishonesty when the corporation's officers or directors have ignored or not dealt with those instances.