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How derivative actions help shareholders protect their investments

On Behalf of | May 12, 2024 | Uncategorized

Shareholders play a crucial role at many organizations. They purchase a partial interest in the company, which can provide financial support to the company during times of growth or operational transition. Shareholders can voice their opinions at shareholder meetings, potentially influencing the future operations of the company.

Shareholders can help select leadership at an organization in some scenarios and can also help hold the company accountable for misconduct. They can also receive income in the form of dividends when the company generates profit. Shareholders have an interest in keeping the company operational and profitable both to ensure the value of their initial investment and to continue receiving dividends. Occasionally, shareholders who have invested in a company decide to pursue derivative actions as a means of protecting the investment they have previously made.

What a derivative action requires

A derivative action is technically a lawsuit against a company brought by shareholders. Their goal is to address serious issues, such as illegal activity within the organization. Typically, it is misconduct or incompetence on the part of officers or directors that leads to derivative actions. LLC members can also initiate derivative actions when they question the conduct of others involved in running the business.

Shareholders technically sue not on their own behalf but instead initiate legal action on behalf of the company itself. They generally need to be able to prove that officers or directors violated their duty to the organization through inappropriate conduct or incompetence. Fraud, poor management, embezzlement and other breaches of fiduciary duty can lead to derivative actions.

When successful, derivative actions can lead to changes in company operations or the removal of someone in a position of authority who harmed the company. A derivative action can reduce the risk of shareholders losing what they have invested due to company downturns.

Recognizing when legal action is necessary to protect an investment can benefit those who have decided to become shareholders. The decision to pursue a derivative action is never an easy one, but it may be the safest and most effective means of protecting the investment previously made in an organization from the impacts of misconduct.