Shareholder derivative action

What it means

A shareholder derivative action is a lawsuit in which a shareholder pursues, on the company's behalf, the company's claim against a director or another shareholder when the company itself fails to act. It usually concerns damages, payment of a contribution or the return of payments made in breach of the law.

Its purpose is to protect minority shareholders from management inaction. If the majority shareholder also controls the director, there would otherwise be nobody to bring the claim, and the loss would ultimately be borne by all shareholders in proportion to their stakes.

The Commercial Code provides this option for both the limited liability company and the joint-stock company, under different conditions. The shareholder does not sue for their own benefit but for the company's, so anything recovered belongs to the company rather than to the claimant.

How it works in practice

Most often the action concerns the liability of a managing director for damage caused by breaching the duty of due care, for instance through unfavourable deals with related parties or paying remuneration without a shareholders' resolution.

Before filing, the shareholder usually gathers evidence. The shareholder's right to information and inspection of company documents help here. If the company has a supervisory board, it may be sensible first to ask it or the general meeting to pursue the claim themselves.

Proceedings are costly and slow for the claimant, who bears the risk of legal costs and the court fee. In practice a derivative action therefore often also serves as leverage in negotiations, for example over buying out the minority shareholder's stake at a fair price.

What to watch out for

Claims against directors are subject to limitation, so one cannot wait long. The period runs from when the company learned or could have learned of the damage and of who is responsible, and a late filing may fail regardless of the merits.

A director is not released from liability by having followed an instruction of the general meeting if that instruction breached the law or the articles. On the other hand, a court does not judge whether a business decision worked out, but whether the director acted on an informed basis and in good faith.